**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20006**

 

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**FORM 10-K**

 

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

 

**For thefiscal year ended December 31, 2003**

 

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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 |

 

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

 

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

 

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Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes    ý        No    o

 

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

 

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

 

Asof June 30, 2003, the aggregate market value of the voting stock held bynon-affiliates of the Registrant was approximately $39.7 million, based on thesales price reported to the Registrant on that date of $18.68 per share.

 

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

 

Thenumber of shares of Common Stock of the registrant outstanding as ofMarch 22, 2004 was 3,638,912.

 

DocumentsIncorporated by Reference:   Portions of the definitiveproxy statement for the 2004 Annual Meeting of Shareholders to be filed withthe Federal Deposit Insurance Corporation pursuant to SEC Regulation 14A areincorporated by reference in Part III, Items 10-14.

 

 

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**TABLEOF 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             |   |
|       |                                                                                                       |   |
|       | Item  9a.  Controls and Procedures                                                                    |   |
|       |                                                                                                       |   |
| PART  III  |                                                                                                       |
|       |                                                                                                       |   |
|       | Item  10.  Directors and Executive Officers  of the Registrant                                        |   |
|       |                                                                                                       |   |
|       | Item  11.  Executive Compensation                                                                     |   |
|       |                                                                                                       |   |
|       | Item 12.  Security Ownership of Certain Beneficial  Owners and Management                             |   |
|       |                                                                                                       |   |
|       | Item  13.  Certain Relationships and Related  Transactions                                            |   |
|       |                                                                                                       |   |
|       | Item 14.  Principal Accounting Fees and Services                                                      |   |
|       |                                                                                                       |   |
| PART IV    |                                                                                                       |
|       |                                                                                                       |   |
|       | Item  15.  Exhibits, Financial Statement  Schedules, and Reports on Form 8-K                          |   |
|       |                                                                                                       |   |
| SIGNATURES |                                                                                                       |

 

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**PART I**

 

**Item 1****.****           Business**

 

**General**

 

**The Company**

 

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, 2003, the Company had consolidated assets of$386.7million, deposits of $342.5 million and shareholders’ equity of $29.9million.  The Company’s liabilitiesinclude $8.2 million in subordinated debentures issued to Community ValleyTrust 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 Companyfiles annual, quarterly and other reports under the Securities Exchange Act of1934 with the Securities and Exchange Commission. These reports are posted andare available at no cost on the Company’s website,www.communityvalleybancorp.com through the reports link, as soon as reasonablypracticable after the Company files such documents with the SEC.  The Company’s filings are also availablethrough the SEC’s website at www.sec.gov. 

 

**The Bank**

 

Butte Community Bank was incorporated under the laws of the State ofCalifornia on May 11, 1990 and commenced operations as a Californiastate-chartered commercial bank on December 14, 1990.  The Bank’s Administrative Office is locatedat 2041 Forest Avenue, Chico, California. The Bank is an insured bank under the Federal Deposit Insurance Act upto the maximum limits thereof.  The Bankis not a member of the Federal Reserve System. At December 31, 2003, the Bank had approximately $385.1 million inassets, $270.2 million in loans and $346 million in deposits.

 

We operate seven full-service branch offices in four Butte Countycommunities, one full-service branch office in Sutter County, one LoanProduction office in Sacramento County, and one Loan Production office inShasta County.  We offer a full range ofbanking services to individuals and various-sized businesses in the communitieswe serve.  The locations of thoseoffices are: 

 

 
| Chico:         |   | Main Office  2041 Forest Avenue                      |   | Paradise  |   | South Paradise Branch  672 Pearson Road |   |
|----------------|--------|------------------------------------------------------|--------|-----------|--------|-----------------------------------------|--------|
|           |   |                                                 |   |      |   |                                    |   |
|           |   | Administrative Headquarters  2041 Forest Avenue      |   |      |   | North Paradise Branch  6653 Clark Road  |   |
|           |   |                                                 |   |      |   |                                    |   |
|           |   | North Chico Branch  237 West East Avenue             |   | Oroville  |   | Oroville Branch  2227 Myers Street      |   |
|           |   |                                                 |   |      |   |                                    |   |
|           |   | Central Chico Branch  900 Mangrove Avenue            |   | Magalia   |   | Magalia Branch  14001 Lakeridge Circle  |   |
|           |   |                                                 |   |      |   |                                    |   |
| Citrus Heights |   | Citrus Heights Loan Office  5959 Greenback Lane #450 |   | Yuba City |   | Yuba City Branch  1600 Butte House Road |   |
|           |   |                                                 |   |      |   |                                    |   |
| Redding        |   | Redding Loan Office  100 East Cypress Ave Suite 150  |   |      |   |                                    |   |

 

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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 Ridgewood Drive,Chico.  We also have specialized creditcenters for agricultural lending and construction and real estate lendingwithin a number of these branch offices. These facilities are located in the cities of Chico, Paradise, andOroville in Butte County, the city of Yuba City in Sutter County, the city ofCitrus Heights in Sacramento County, and the city of Redding in Shasta County.

 

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

 

With a predominant focus on personal service, Butte Community Bank haspositioned itself as a multi-community independent bank serving the financialneeds of individuals and businesses, including agricultural and real estatecustomers in Butte and other surrounding counties.    Our principal retail 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 $155 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 $7 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 two USDA Business and Industry Lender in California and seventh inthe nation during 2003.  The Bankoriginated $17 million in loans through this program during 2003.

 

As of December 31, 2003, the principal areas in which we directedour lending activities, and the percentage of our total loan portfolio forwhich each of these areas was responsible, were as follows: (i) agriculturalloans (8%); (ii) commercial and industrial (including SBA) loans (21%); (iii)real estate 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, 2003, we had 24,409 deposit accounts with balances totalingapproximately $343 million, compared to 22,623 deposit accounts with balancestotaling approximately $298 million at December 31, 2002.  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, directdeposit, 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 few years wehave substantially enhanced our ATM locations to include off-site areas notpreviously served by cash or deposit facilities.  We now have a total of seven such remote ATM’s at seven differentlocations, including a hospital, two convenience stores, an entertainmentcenter, and three gas stations.  Theselocations facilitate cash advances which would not otherwise be available toconsumers at non-branch locations, thereby increasing consumerconvenience.    In addition to suchspecifically oriented customer applications, we provide safe deposit, wiretransfer capabilities and a convenient customer service group in our CallCenter to answer questions and assure a high level of customer satisfactionwith the level of services and products we provide.

 

Most of the Bank’s deposits are attracted from individuals,business-related sources and smaller municipal entities.  This results in a relatively modest averagedeposit balance of approximately $11,000 at December 31, 2003, but makesthe Bank less subject to adverse effects from the loss of a substantial depositorwho may be seeking higher yields in other markets or who may have need of moneyotherwise on deposit with the Bank, especially during periods of inflation orconservative monetary policies.  TheBank has had a relationship with a local title company for many years.  They have kept substantial deposit balanceswhich increased dramatically during the height of the refinance activity in thesummer of 2003.  Management believesthis relationship to be very secure and does not anticipate this businessleaving the Bank.  

 

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 which are not FDIC insured.  They conduct business from offices locatedin 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.  All ofthese developments are meant to increase public convenience and enhance publicaccess to the electronic payments system. The cost to the Bank for these development, implementation, andmarketing activities cannot expressly be calculated with any degree of certainty.

 

The Bank holds no patents or licenses (other than licenses required byappropriate bank regulatory agencies), franchises, or concessions.    The Bank is not dependent on a singlecustomer or group of related customers for a material portion of its deposits,nor is a material portion of the Bank’s loans concentrated within a singleindustry or group of related industries. There has been no material effect upon the Bank’s capital expenditures,earnings, or competitive position as a result of Federal, state, or localenvironmental regulation.

 

**Recent Developments**

 

On July 16, 2001, Community Valley Bancorp was incorporated as abank holding company, for the purpose of acquiring Butte Community Bank (the“Bank”) in a one bank holding company reorganization. Shortly after theincorporation, Community Valley Bancorp filed a registration statement on FormS-4 with the Securities and Exchange Commission in order to register its commonstock which was issued pursuant to the terms of a Plan of Reorganization and Agreementof Merger dated April 22, 2002. 

 

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The Plan of Reorganization and Agreement of Merger provided for theexchange of shares of the Bank for shares of Community Valley Bancorp on ashare-for-share basis (the “Reorganization”). The registration statement was declared effective on April 16,2002.  The Reorganization was approvedby the Company’s shareholders on May 23, 2002, and all required regulatoryapprovals or non-disapprovals with respect to the Reorganization wereobtained.  The Reorganization wasconsummated on June 17, 2002, subsequent to which the Bank continued itsoperations as previously conducted but as a wholly-owned subsidiary ofCommunity Valley Bancorp.  The newcorporate structure is intended to give Community Valley Bancorp and the Bankgreater flexibility in terms of operation, expansion and diversification.

 

On December 19, 2002, Community Valley Bancorp Trust I, a newlyformed Delaware statutory business trust and a wholly-owned, unconsolidatedsubsidiary of the Company (the “Trust”), issued an aggregate of $8,000,000 ofprincipal amount of Floating Rate Trust Preferred Securities (Capital TrustPass-through Securities of the Trust) (the “Trust Preferred Securities”).  Bear Stearns, Inc. acted as placement agentin connection with the offering of the trust securities. The securities issuedby the Trust are fully guaranteed by the Company with respect to distributionsand amounts payable upon liquidation, redemption or repayment.  The entire proceeds to the Trust from thesale of the Trust Preferred Securities, along with initial capitalization of$248,000 were used by the Trust in order to purchase $8,248,000 in principalamount of Fixed Rate Junior Subordinated Deferrable Interest Debentures due2032 issued by the Company (the “Subordinated Debt Securities”).  A portion of the Trust Preferred Securitiesis included as Tier 1 capital for purposes of calculating the Company’sregulatory capital ratios.    A portionof the proceeds was used to retire debt incurred during 2002 to pay for theformation of the holding company, and the remainder was placed in a demanddeposit account at the Bank.  OnMarch 31, 2003, the Company down streamed $4,760,000 to improve the bank’scapital position and support planned growth.

 

**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 are ableto compete across geographic boundaries and provide customers increasing accessto 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 personal financesoftware.  Strong competition fordeposit and loan products affects the rates of those products as well as theterms on which they are offered to customers. Mergers between financial institutions have placed additional pressureon banks within the industry to streamline their operations, reduce expenses,and increase revenues to remain competitive. Competition has also intensifieddue to recently enacted federal and state interstate banking laws, which permitbanking organizations to expand geographically, and the California market hasbeen particularly attractive to out-of-state institutions.  The Financial Modernization Act, which,effective March 11, 2000, has made it possible for full affiliations tooccur between banks and securities firms, insurance companies, and otherfinancial companies, is also expected to intensify competitive conditions.

 

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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-service branches, and/or in-store branches. In addition to other banks,the sources of competition for such products include savings associations,credit unions, brokerage firms, money market and other mutual funds, assetmanagement groups, finance and insurance companies, internet-only financialintermediaries, and mortgage banking firms.

 

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 theirparticular preference.  Moreover, forcustomers whose loan demands exceed our legal lending limit, we attempt toarrange for such 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, 2003 the Company had 117 full-time and 81part-time employees.  On a full timeequivalent basis, the Company’s staff level was 177 at December 31, 2003,as compared to 152 at December 31, 2002. None of our employees is concurrently represented by a union or coveredby a collective bargaining agreement. Management of the Company believes its employee relations aresatisfactory.

 

**Regulation andSupervision**

 

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.

 

**Forward Looking Statements and RiskFactors That May Affect Results**

 

This report includesforward-looking statements within the meaning of the Securities Exchange Act of1934 (the “Exchange Act”). These statements are based on management’s beliefsand assumptions, and on information available to management as of the date ofthis document. Forward-looking statements include the information concerningpossible or assumed future results of operations of the Company set forth underthe heading “Management’s Discussion and Analysis of Financial Condition andResults of Operations.” Forward-looking statements also include statements inwhich words such as “expect,” “anticipate,” “intend,” “plan,” “believe,”“estimate,” “consider” or similar expressions are used. Forward-lookingstatements are not guarantees of future performance. They involve risks,uncertainties and assumptions, including the risks discussed under the heading“Risk Factors That May Affect Results” and elsewhere in this report. TheCompany’s actual future results and shareholder values may differ materiallyfrom those anticipated and expressed in these forward-looking statements. Manyof the factors that will determine these results and values, including thosediscussed under the heading “Risk Factors That May Affect Results,” are beyondthe Company’s ability to control or predict. Investors are cautioned not to putundue reliance on any forward-looking statements. In addition, the Company doesnot have any intention or and assumes no obligation to update forward-lookingstatements after the date of the filing of this report, even if newinformation, future events or other circumstances have made such statementsincorrect or misleading. Except as specifically noted herein all referenced tothe “Company” refer to Community Valley Bancorp, a California corporation, andits consolidated subsidiaries.

 

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**The Company**

 

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 the FederalReserve Board and is required to obtain Federal Reserve Board approval beforeacquiring, directly or indirectly, ownership or control of any voting shares ofany bank if, after such acquisition, it would directly or indirectly own orcontrol more than 5% of the voting stock of that bank, unless it already owns amajority of the voting stock of that bank.

 

The Federal Reserve Board has by regulation determined certainactivities in which a 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.

 

**Capital AdequacyRequirements**

 

The Company and the Bank are subject to the regulations of the FederalReserve Board and the FDIC, respectively, governing capital adequacy.  Those regulations incorporate bothrisk-based and leverage capital requirements. Each of the federal regulators has established risk-based and leveragecapital guidelines for the banks or bank holding companies it regulates, whichset total capital requirements and define capital in terms of “core capitalelements,” or Tier 1 capital; and “supplemental capital elements,” or Tier 2capital.  Tier 1 capital is generallydefined as the sum of the core capital elements less goodwill and certain otherdeductions, notably the unrealized net gains or losses (after tax adjustments)on available for sale investment securities carried at fair market value.  The following items are defined as corecapital 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.

 

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The minimum required ratio of qualifying total capital to totalrisk-weighted assets is 8.0% (“Total Risk-Based Capital Ratio”), at least one halfof which must be in the form of Tier 1 capital, and the minimum required ratioof Tier 1 capital to total risk-weighted assets is 4.0% (“Tier 1 Risk-BasedCapital Ratio”).  Risk-based capitalratios are calculated to provide a measure of capital that reflects the degreeof risk associated with a banking organization’s operations for bothtransactions reported on the balance sheet as assets, and transactions, such asletters of credit and recourse arrangements, which are recorded as off-balancesheet items.  Under the risk-basedcapital guidelines, the nominal dollar amounts of assets and credit-equivalentamounts of off-balance sheet items are multiplied by one of several riskadjustment percentages, which range from 0% for assets with low credit risk, suchas certain U. S. Treasury securities, to 100% for assets with relatively highcredit risk, such as business loans.  Asof December 31, 2003 and 2002, the Bank’s Total Risk-Based Capital Ratioswere 12.1% and 10.9%, respectively and its Tier 1 Risk-Based CapitalRatios were 10.9% and 9.7%, respectively. As of December 31, 2003 and 2002, the Company’s Total Risk-BasedCapital was 13.3% and 14% respectively, and its Tier 1 Risk-Based Capital Ratiowas 12.2%and 12.8% respectively.  Therisk-based capital requirements also take into account concentrations of credit(i.e., relatively large proportions of loans involving one borrower, industry,location, collateral or loan type) and the risks of “non-traditional”activities (those that have not customarily been part of the banking business).The regulations require institutions with high or inordinate levels of risk tooperate with higher minimum capital standards, and authorize the regulators toreview an institution’s management of such risks in assessing an institution’scapital adequacy.

 

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

 

The FDIC and the Federal Reserve Board also require the maintenance ofa leverage capital ratio designed to supplement the risk-based capitalguidelines.  Banks and bank 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 the volumeand severity of problem loans, and federal regulators may, however, set highercapital requirements when a bank’s particular circumstances warrant.  As of December 31, 2003 and 2002, theBank’s Leverage Capital Ratios were 8.8% and 7.9%, respectively.  As of December 31, 2003 and 2002, theCompany’s leverage capital ratios were 9.9% and 10.4%, respectively, exceedingregulatory minimums.  See Part II, Item7, Management’s Discussion and Analysis of Financial Condition and Results ofOperation — Liquidity and Market Risk Management.

 

**Prompt CorrectiveAction 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 1 Risk-BasedCapital Ratio of 6%; and Leverage Ratio of 5%); “adequately capitalized” (TotalRisk-Based Capital Ratio of 8%; Tier 1 Risk-Based Capital Ratio of 4%; andLeverage Ratio of 4%) (or 3% if the institution receives the highest ratingfrom its primary regulator); “undercapitalized” (Total Risk-Based Capital Ratioof less than 8%; Tier 1 Risk-Based Capital Ratio of less than 4%; or LeverageRatio of less than 4%) (or 3% if the institution receives the highest ratingfrom its primary regulator); “significantly undercapitalized” (Total Risk-BasedCapital Ratio of less than 6%; Tier 1 Risk-Based Capital Ratio of less than 3%;or Leverage Ratio less than 3%); and “critically undercapitalized” (tangibleequity to total assets less than 2%).  Abank may be treated as though it were in the next lower capital category ifafter notice and the opportunity for a hearing, the appropriate federal agencyfinds an unsafe or unsound condition or practice so warrants, but no bank maybe treated as “critically undercapitalized” unless its actual capital ratio warrantssuch 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.

 

9

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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.

 

**Safety and SoundnessStandards**

 

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.

 

**Premiums for DepositInsurance**

 

The FDIC regulations also implement a risk-based premium system,whereby insured depository institutions are required to pay insurance premiumsdepending on their risk classification. Under this system, institutions such as the Bank which are insured bythe Bank Insurance Fund (“BIF”) are categorized into one of three capital categories(well capitalized, adequately capitalized, and undercapitalized) and one ofthree supervisory categories based on federal regulatory evaluations.  The three supervisory categories are:financially sound with only a few minor weaknesses (Group A), demonstratesweaknesses that could result in significant deterioration (Group B), and posesa substantial probability of loss (Group C). The capital ratios used by the FDIC to define well capitalized,adequately capitalized and undercapitalized are the same in the FDIC’s promptcorrective action regulations.  Thecurrent BIF base assessment rates (expressed as cents per $100 of deposits) aresummarized as follows:  

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

 

In addition, BIF member banks (such as the Bank) must pay an amountwhich fluctuates but is currently 1.84 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.

 

10

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**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 Protection Laws and Regulations**

 

The bank regulatory agencies are increasingly focusing attention oncompliance with consumer protection laws and regulations.  Examination and enforcement has becomeintense, and banks have been advised to carefully monitor compliance withvarious consumer protection laws and their implementing regulations. Thefederal Interagency Task Force on Fair Lending issued a policy statement ondiscrimination in home mortgage lending describing three methods that federalagencies will use to prove discrimination: overt evidence of discrimination,evidence of disparate treatment, and evidence of disparate impact.  In 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.

 

**Interstate Bankingand Branching**

 

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994(the “Interstate Banking Act”) regulates the interstate activities of banks andbank holding companies and establishes a framework for nationwide interstatebanking and branching.  SinceJune 1, 1997, a bank in one state has generally been permitted to mergewith a bank in another state without the need for explicit state lawauthorization.  However, states weregiven the ability to prohibit interstate mergers with banks in their own stateby “opting-out” (enacting state legislation applying equality to allout-of-state banks prohibiting such mergers) prior to June 1, 1997.

 

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

 

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

 

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

 

The changes effected by Interstate Banking Act and California laws haveincreased competition in the environment in which the Bank operates to theextent that out-of-state financial institutions directly or indirectly enterthe Bank’s market areas.  It appearsthat the Interstate Banking Act has contributed to the acceleratedconsolidation of the banking industry. While many large out-of-state banks havealready entered the California market as a result of this legislation, it isnot possible to predict the precise impact of this legislation on the Bank andthe Company and the competitive environment in which they operate.

 

11

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**FinancialModernization Act**

 

Effective March 11, 2000 the Gramm-Leach-Bliley Act eliminatedmost barriers to affiliations among banks and securities firms, insurancecompanies, and other financial service providers, and enabled full affiliationsto occur between such entities.  Thislegislation permits bank holding companies to become “financial holdingcompanies” and thereby acquire securities firms and insurance companies andengage in other activities that are financial in nature.  A bank holding company may become afinancial holding company if each of its subsidiary banks is well capitalizedunder the FDICIA prompt corrective action provisions, is well managed, and hasat least a satisfactory rating under the CRA by filing a declaration that thebank holding company wishes to become a financial holding company.   No regulatory approval will be required fora financial holding company to acquire a company, other than a bank or savingsassociation, engaged in activities that are financial in nature or incidentalto activities that are financial in nature, as determined by the FederalReserve Board.  The Company has nocurrent intention of becoming a financial holding company, but may do at somepoint in the future if deemed appropriate in view of opportunities orcircumstances 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 thesubsidiary banks of the financial holding company or the bank has a CRA ratingof satisfactory or better.

 

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

 

12

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**Other Pending andProposed 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.

 

**RISKFACTORS**

 

This discussion and analysis provides insight into Management’sassessment of the operating trends over the last several years and itsexpectations for 2003.  Such expressionsof expectations are not historical in nature and are “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995.  Forward-looking statements aresubject to risks and uncertainties that may cause actual future results todiffer materially from those expressed in any forward-looking statement.  Such risks and uncertainties with respect tothe 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 faces competition from other financial institutions andfrom businesses in other industries that have developed financialproducts.  Banks once had an almostexclusive franchise for deposit products and provided the majority of businessfinancing.  With deregulation in the1980’s, other kinds of financial institutions began to offer competingproducts.  Also, increased competitionin consumer financial products has come from companies not typically associatedwith the banking and financial services industry, such as AT &T, GeneralMotors and various software developers. Similar competition is faced for commercial financial products frominsurance companies and investment bankers. Community banks, including the Company, attempt to offset this trend bydeveloping new products that capitalize on the service quality that a localinstitution can offer.  Among these arenew loan, deposit, and investment products. The Company’s primary competitors are different for each specificproduct and market area.  While thisoffers special challenges for the marketing of our products, it offersprotection from one competitor 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 national perspective, the most significant economic factorsimpacting the Company in the last three years have been the steady slowing ofgrowth in the economy and the actions of the Federal Reserve Board (“the Fed”)to manage the decline.  Early in 2001,the Fed began to lower rates and continued throughout the year until it hadlowered its target short-term rate by 4.75% to its lowest rate in 40years.  These changes, especially giventhe extreme rate of decline in 2001, impact the Company as market rates forloans, investments and deposits respond to the Fed’s actions.  We are also affected by certainindustry-specific economic factors. For example, a significant portion of ourtotal loan portfolio is related to real estate obligations, particularlyresidential real estate loans.  Adownturn in the residential real estate industry in California could have anadverse effect on our operations. Similarly, a sizable portion of our total loan portfolio is to borrowerseither directly or indirectly involved in the agricultural industry.

 

**Risk Management**

 

The Company sees the process of addressing the potential impacts of theexternal factors listed above as part of its management of risk.  In addition to common business risks such asdisasters, theft, and loss of market share, the Company is subject to specialtypes of risk due to the nature of its business.  New and sophisticated financial products are continuallyappearing with different types of risk which need to be defined and managed ifthe Company chooses to offer them to its customers.  Also, the risks associated with existing products must bereassessed periodically.  The Companycannot operate risk-free and make a profit. Instead, the process of risk definition and assessment allows theCompany to select the appropriate level of risk for the anticipated level ofreward and then decide on the steps necessary to manage this risk.  The Company’s Risk Officer and the othermembers of its Senior Management Team under the direction and oversight of theBoard of Directors lead the risk management process.

 

Some of the risks faced by the Company are those faced by mostenterprises — reputational risk, operational risk, and legal risk.  The special risks related to financialproducts are **credit risk** and **interest rate risk.**  Credit risk relates to the possibility thata debtor will not repay according to the terms of the debt contract.  Credit risk is discussed in the sectionsrelated to loans.  Interest rate risk relatesto the adverse impacts of changes in interest rates.  The effective management of these and other risks mentioned aboveis the backbone of the Company’s business strategy.

 

**Managing Our Growth**

 

Our Company’s (1) total assets increased from $337 million atDecember 31, 2002 to $387 million at December 31, 2003, with most ofthe growth occurring in the second half of the year.  Management’s intention is to leverage the Company’s currentinfrastructure to sustain the momentum achieved in the latter part of 2003,although no assurance can be provided that this strategy will result insignificant growth.  Our ability tomanage growth will depend primarily on our ability to:

 

•                  monitoroperations;

•                  controlfunding costs and operating expenses;

•                  maintainpositive customer relations; and

•                  attract,assimilate and retain qualified personnel.

 

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

 

14

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**The Impact of Changesin Assets and Liabilities to Net Interest Income and Net Interest Margin**

 

The Company earns income from two sources.  The primary source is from the management of its financial assetsand liabilities and the second is from charging fees for servicesprovided.  The first source involvesfunctioning as a **financial intermediary**, that is, the Company accepts fundsfrom depositors or obtains funds from other creditors and then either lends thefunds to borrowers or invests those funds in securities or other financialinstruments.  Income is earned as aspread between the interest earned from the loans or investments and theinterest paid on the deposits and other borrowings.  The second source, fee income, is discussed in other sections ofthis analysis, specifically in “Noninterest Revenue.”

 

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

 

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

 

**Net interest margin**isnet interest income expressed as a percentage of average earning assets.  It is used to measure the difference betweenthe average rate of interest earned on assets and the average rate of interestthat must be paid on liabilities used to fund those assets.   To maintain its net interest margin, theCompany must manage the relationship between interest earned and paid.  A shift in the relative size of the majorbalance sheet categories has an impact on net interest income and net interestmargin.  To the extent that fundsinvested in securities can be repositioned into loans, earnings increasebecause of the higher rates paid on loans. However, additional credit risk is incurred with loans compared to thevery low risk of loss on securities, and the Company must carefully monitor theunderwriting process to ensure that the benefit of the additional interestearned is not offset by additional credit losses.   In general, depositors are willing to accept a lower rate ontheir funds than are other providers of funds because of the Federal DepositInsurance Corporation (“FDIC”) insurance coverage.  To the extent that the Company can fund asset growth by deposits,especially the lower cost transaction accounts, rather than borrowing fundsfrom other financial institutions, the average rates paid on funds will beless, and net interest income more.

 

15

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**The Allowance forLoan Losses May Not Cover Actual Loan Losses.**  We attempt to limit the risk that borrowerswill fail to repay loans by carefully underwriting the loans, neverthelesslosses can and do occur.  We create anallowance for loan losses in our accounting records, based on estimates of thefollowing:

 

•                  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;

•                  loanimpairment.

 

We maintain an allowance for loan losses at a level which we believe isadequate to absorb any specifically identified losses as well as any otherlosses inherent in our loan portfolio. However, changes in economic, operating and other conditions, includingchanges in interest rates, which are beyond our control, may cause our actualloan losses to exceed our current allowance estimates.  If the actual loan losses exceed the amountreserved, it will hurt our business.  Inaddition, the FDIC and the Department of Financial Institutions, as part oftheir supervisory functions, periodically review our allowance for loanlosses.  Such agencies may require us toincrease our provision for loan losses or to recognize further loan losses,based on their judgments, which may be different from those of ourmanagement.  Any increase in theallowance required by the FDIC or the Department of Financial Institutionscould also impact our business.

 

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

 

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

 

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)                 |   |                   |   |                              |   |                        |      |
|                                                            |   |                   |   |                              |   |                        |      |
| 237 West East Ave                                               |   | Branch Office          |   | 4,771                             |   | $                           | 845,493   |   |
| Chico, California                                               |   |                   |   |                              |   |                        |      |
| (Opened June, 1999, moved to this location  November 2003) |   |                   |   |                              |   |                        |      |
| Building is owned, land is leased                               |   |                   |   |                              |   |                        |      |

 

The following facilities are leased by the Company:

 
| **Location**               |   | **Use of  Facilities** |   | **Square  Feet of  Office Space** |   | **Monthly  Rent  as of 12/31/03** |   | **Term of  Lease** |       |
|----------------------------|--------|------------------------|--------|-----------------------------------|--------|-----------------------------------|--------|--------------------|------------|
|                       |   |                   |   |                              |   |                              |   |               |       |
| 14001 Lakeridge Circle     |   | Branch Office          |   | 600                               |   | $                                 | 570    |               | 4/1/2008   | (1) |
| Magalia, California        |   |                   |   |                              |   |                              |   |               |       |
| Opened June 1993      |   |                   |   |                              |   |                              |   |               |       |
| (moved June 2003)     |   |                   |   |                              |   |                              |   |               |       |
|                       |   |                   |   |                              |   |                              |   |               |       |
| 237 West East Ave.         |   | Branch Office          |   |                              |   | $                                 | 3,958  |               | 10/31/2008 | (2) |
| Chico, California          |   |                   |   |                              |   |                              |   |               |       |
| land lease only            |   |                   |   |                              |   |                              |   |               |       |
|                       |   |                   |   |                              |   |                              |   |               |       |
| 900 Mangrove Ave.          |   | Branch Office          |   | 6,000                             |   | $                                 | 6,300  |               | 10/1/2004  | (3) |
| Chico, California          |   |                   |   |                              |   |                              |   |               |       |
|                       |   |                   |   |                              |   |                              |   |               |       |
| 6653 Clark Road            |   | Branch Office          |   | 4,640                             |   | $                                 | 4,700  |               | 4/1/2005   | (4) |
| Paradise, California       |   |                   |   |                              |   |                              |   |               |       |
| Opened June 2003      |   |                   |   |                              |   |                              |   |               |       |
|                       |   |                   |   |                              |   |                              |   |               |       |
| 100 East Cypress #150      |   | Loan Office            |   | 1,850                             |   | $                                 | 2,201  |               | 5/1/2004   | (5) |
| Redding, California        |   |                   |   |                              |   |                              |   |               |       |
|                       |   |                   |   |                              |   |                              |   |               |       |
| 5959 Greenback #450        |   | Loan Office            |   | 1,315                             |   | $                                 | 1,907  |               | 8/1/2004   | (6) |
| Citrus Heights, California |   |                   |   |                              |   |                              |   |               |       |
| moved from Roseville 8/03  |   |                   |   |                              |   |                              |   |               |       |
|                       |   |                   |   |                              |   |                              |   |               |       |
| 936 Mangrove Ave.          |   | General Offices        |   | 6,000                             |   | $                                 | 3,690  |               | 3/1/2004   | (7) |
| Chico, California          |   |                   |   |                              |   |                              |   |               |       |

 

17

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

 

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(1)****This is the termination dateof the current 5-year lease.  TheCompany also has two renewal options for five years each.

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

(3) This is the termination date of the current 10-year lease.  The Company also has four renewal optionsfor five years each.

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

(5)This is the termination date of the current 3-year lease.  The Company does not have renewal options onthis property. 

(6)This is the termination date of the current 3-year lease.  The Company does not have renewal options onthis property. 

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

 

18

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

 

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

 

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****.****           Submission of Matters to a Vote of SecurityHolders**

 

Not applicable.

 

19

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**PART II**

 

**Item 5****.****           Market for Common Equity and RelatedShareholder 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 Union Securities, GrassValley, 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** |       |
|-----------------------------|----------|------------------------------------------------------|---------|---------------------------------|------------|
|                        | **High** |                                                 | **Low** |                            | **Shares** |   |
| March 31, 2002         |     | 13.50                                                |    | 13.50                           |       | 53,500 |   |
| June 30, 2002          |     | 16.40                                                |    | 13.64                           |       | 67,000 |   |
| September 30, 2002     |     | 15.33                                                |    | 14.09                           |       | 27,600 |   |
| December 31, 2002      |     | 15.30                                                |    | 14.06                           |       | 64,500 |   |
| March 31, 2003         |     | 16.50                                                |    | 14.93                           |       | 139,900 |   |
| June 30, 2003          |     | 20.25                                                |    | 16.13                           |       | 78,000 |   |
| September 30, 2003     |     | 20.14                                                |    | 18.38                           |       | 112,300 |   |
| December 31, 2003      |     | 22.50                                                |    | 18.08                           |       | 118,500 |   |

 

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

 

On March 22, 2004 there were approximately 476 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 cash dividends quarterly totaling $1.08 million or$0.30 per share in 2003 and $1.08 million or $0.25 per share in 2002,representing 24% and 23%, respectively of the prior year’s earnings.  (As the holding company reorganization becameeffective 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 consistentwith the general dividend policy which declares that dividends must meetapplicable legal requirements while maintaining the minimum capital ratiosestablished by the Company.

 

20

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The policy is to declare and pay dividends of no more than 40% of itsprevious years net income to shareholders. However, no assurance can be given that the Bank’s and the Company’sfuture earnings and/or growth expectations in any given year will justify the paymentof 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 fiscalyear.  The payment of any cash dividendsby the Bank will depend not only upon the Bank’s earnings during a specifiedperiod, 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)****         ****Equity Compensation Plan Information**

 

The following chart sets forth information for the fiscal year endedDecember 31, 2003, regarding equity based compensation plans of theCompany. 

 
| **Plan category**                                           |   | **Number of securities to be****issued  upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted average exercise****price of  outstanding  options, warrants and  rights** | ** ** | **Number of securities  remaining available for  future issuance under****equity  compensation plans  (excluding securities  reflected in column (a)).** |       |
|-------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |   | **(a)**                                                                                               | ** ** | **(b)**                                                                               | ** ** | **(c)**                                                                                                                                                  | ** ** |
| Equity compensation plans approved by  security holders     |   | 463,407                                                                                               |       | $                                                                                     | 8.49       |                                                                                                                                                     | 74,271     |   |
|                                                        |   |                                                                                                  |       |                                                                                  |       |                                                                                                                                                     |       |
| Equity compensation plans not approved by  security holders |   | None                                                                                                  |       | None                                                                                  |       | None                                                                                                                                                     |       |
|                                                        |   |                                                                                                  |       |                                                                                  |       |                                                                                                                                                     |       |
| Total                                                       |   | 463,407                                                                                               |       | $                                                                                     | 8.49       |                                                                                                                                                     | 74,271     |   |

 

During 2003, the Company did not conduct any unregistered offerings orsales of its securities, nor did it repurchase any of its outstanding securities.

 

21

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**(e) Recent Sales ofUnregistered Securities**

 

On December 19, 2002, the Company issued an aggregate of$8,248,000 in principal amount of its Floating Rate Junior SubordinatedDeferrable 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 but unconsolidated 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.  TheSubordinated Debt Securities were issued to the Trust in consideration for thereceipt of the net proceeds (approximately $7.75 million) raised by the Trustfrom the sale of $8,000,000 in principal amount of the Trust’s Floating RateCapital Trust 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 (as defined in Rule 144A under the SecuritiesAct), (ii) to “accredited investors” (as defined in Rule 501(a)(1), (2), (3) or(7) or Regulation D promulgated under the Securities Act) or (iii) in offshoretransactions in compliance with Rule 903 of Regulation S under the SecuritiesAct.  The Trust Preferred Securitieswere not registered under the Securities Act in reliance on exemptions setforth in Rule 144A, Regulation D and Regulation S, as applicable.

 

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

 

The “selected financial data” for 2003 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 Management’sDiscussion and Analysis of Financial Condition and Results of Operations inItem 7 below.  Statistical informationbelow is generally based on average daily amounts.

 

**Selected FinancialData**

 
|                                                       |   | **As  of December 31,**                      |    |
|------------------------------------------------------------|--------|---------------------------------------------------|---------|
|                                                       |   | **(Dollars in thousands, except per share data)** |    |
|                                                       |   | **2003**                                          |    | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| **Income Statement  Summary**                              |   |                                              |    |   |   |   |   |   |   |   |   |
| Interest income                                            |   | $                                                 | 21,517  |   | $ | 18,977 |   | $ | 19,756 |   | $ | 16,532 |   | $ | 12,188 |   |
| Interest expense                                           |   | $                                                 | 4,396   |   | $ | 4,774 |   | $ | 7,344 |   | $ | 5,518 |   | $ | 3,705 |   |
| Net interest income before provision for  loan losses      |   | $                                                 | 17,121  |   | $ | 14,203 |   | $ | 12,411 |   | $ | 11,014 |   | $ | 8,483 |   |
| Provision for loan losses                                  |   | $                                                 | 655     |   | $ | 603 |   | $ | 500 |   | $ | 805 |   | $ | 305 |   |
| Non-interest income                                        |   | $                                                 | 5,950   |   | $ | 6,164 |   | $ | 3,659 |   | $ | 3,168 |   | $ | 2,796 |   |
| Non-interest expense                                       |   | $                                                 | 13,818  |   | $ | 12,539 |   | $ | 9,335 |   | $ | 8,398 |   | $ | 7,336 |   |
| Income before provision for income taxes                   |   | $                                                 | 8,598   |   | $ | 7,225 |   | $ | 6,235 |   | $ | 4,979 |   | $ | 3,638 |   |
| Provision for income taxes                                 |   | $                                                 | 3,329   |   | $ | 2,375 |   | $ | 2,424 |   | $ | 1,932 |   | $ | 1,415 |   |
| Net Income                                                 |   | $                                                 | 5,269   |   | $ | 4,850 |   | $ | 3,811 |   | $ | 3,047 |   | $ | 2,223 |   |
|                                                       |   |                                              |    |   |   |   |   |   |   |   |   |
| **Balance Sheet  Summary**                                 |   |                                              |    |   |   |   |   |   |   |   |   |
| Total loans, net                                           |   | $                                                 | 270,231 |   | $ | 229,699 |   | $ | 197,875 |   | $ | 167,092 |   | $ | 116,864 |   |
| Allowance for loan losses                                  |   | $                                                 | (3,587  | ) | $ | (3,007 | ) | $ | (2,397 | ) | $ | (2,000 | ) | $ | (1,390 | ) |
| Securities held to maturity                                |   | $                                                 | 3,823   |   | $ | 2,873 |   | $ | 2,507 |   | $ | 4,105 |   | $ | 5,062 |   |
| Securities available for sale                              |   | $                                                 | 502     |   | $ | 514 |   | $ | 500 |   | $ | 463 |   | $ | 263 |   |
| Interest bearing deposits in banks                         |   | $                                                 | 7,925   |   | $ | 4,061 |   | $ | 694 |   | $ | 1,584 |   | $ | 3,664 |   |
| Cash and due from banks                                    |   | $                                                 | 26,205  |   | $ | 15,621 |   | $ | 12,402 |   | $ | 12,100 |   | $ | 11,997 |   |
| Federal funds sold                                         |   | $                                                 | 50,605  |   | $ | 57,410 |   | $ | 37,270 |   | $ | 11,630 |   | $ | 8,500 |   |
| Other real estate                                          |   | $                                                 | —  |   | $ | — |   | $ | 12 |   | $ | 52 |   | $ | 431 |   |
| Premises and equipment, net                                |   | $                                                 | 8,554   |   | $ | 6,653 |   | $ | 5,642 |   | $ | 5,217 |   | $ | 5,595 |   |
| Total Interest-Earning Assets                              |   | $                                                 | 333,086 |   | $ | 294,557 |   | $ | 238,846 |   | $ | 184,874 |   | $ | 134,353 |   |
| Total Assets                                               |   | $                                                 | 386,723 |   | $ | 337,483 |   | $ | 272,464 |   | $ | 214,906 |   | $ | 159,332 |   |
| Total Interest-Bearing Liabilities                         |   | $                                                 | 274,048 |   | $ | 243,092 |   | $ | 201,434 |   | $ | 162,210 |   | $ | 123,291 |   |
| Total Deposits                                             |   | $                                                 | 342,511 |   | $ | 297,981 |   | $ | 246,420 |   | $ | 194,125 |   | $ | 142,873 |   |
| Total Liabilities                                          |   | $                                                 | 356,774 |   | $ | 312,103 |   | $ | 251,644 |   | $ | 198,062 |   | $ | 145,494 |   |
| Total Shareholders’ Equity                            |   | $                                                 | 29,949  |   | $ | 25,380 |   | $ | 20,820 |   | $ | 16,844 |   | $ | 13,838 |   |
| **Per Share Data(1)**                                      |   |                                              |    |   |   |   |   |   |   |   |   |
| Net Income, basic                                          |   | $                                                 | 1.50    |   | $ | 1.40 |   | $ | 1.15 |   | $ | 0.97 |   | $ | 0.72 |   |
| Book Value                                                 |   | $                                                 | 8.53    |   | $ | 7.33 |   | $ | 6.26 |   | $ | 5.34 |   | $ | 4.48 |   |
| Cash Dividends                                             |   | $                                                 | 0.30    |   | $ | 0.25 |   | $ | 0.17 |   | $ | — |   | $ | — |   |
| Weighted Average Common Shares Outstanding,  Basic         |   | 3,512,645                                         |    | 3,461,115 |   | 3,323,429 |   | 3,154,580 |   | 3,091,365 |   |
| Weighted Average Common Shares Outstanding,  Diluted       |   | 3,715,259                                         |    | 3,639,929 |   | 3,573,740 |   | 3,505,940 |   | 3,453,739 |   |
|                                                       |   |                                              |    |   |   |   |   |   |   |   |   |
| **Key Operating  Ratios:**                                 |   |                                              |    |   |   |   |   |   |   |   |   |
| **Performance Ratios:**                                    |   |                                              |    |   |   |   |   |   |   |   |   |
| Return on Average Equity(2)                                |   | 19.07                                             | %       | 20.82 | % | 19.73 | % | 20.08 | % | 17.61 | % |
| Return on Average Assets (3)                               |   | 1.44                                              | %       | 1.69 | % | 1.54 | % | 1.64 | % | 1.45 | % |
| Net Interest Margin (4)                                    |   | 5.32                                              | %       | 5.52 | % | 5.65 | % | 6.73 | % | 6.34 | % |
| Dividend Payout Ratio (5)                                  |   | 20.67                                             | %       | 17.84 | % | 14.83 | % |   |   |   |   |
| Equity to Assets Ratio (6)                                 |   | 7.54                                              | %       | 8.12 | % | 7.85 | % | 8.09 | % | 8.23 | % |
| Net Loans to Total Deposits at Period End                  |   | 78.90                                             | %       | 77.09 | % | 80.30 | % | 86.07 | % | 81.80 | % |
| **Asset Quality  Ratios:**                                 |   |                                              |    |   |   |   |   |   |   |   |   |
| Non Performing Loans to Total Loans                        |   | 0.02                                              | %       | 0.25 | % | 0.88 | % | 0.31 | % | 0.30 | % |
| Nonperforming Assets to Total Loans and  Other Real Estate |   | 0.02                                              | %       | 0.25 | % | 0.88 | % | 0.34 | % | 0.67 | % |
| Net Charge-offs to Average Loans                           |   | 0.03                                              | %       | 0.00 | % | 0.05 | % | 0.13 | % | 0.21 | % |
| Allowance for Loan Losses to Net Loans at  Period End      |   | 1.33                                              | %       | 1.31 | % | 1.21 | % | 1.06 | % | 1.62 | % |
| Allowance for Loan Losses to Non-Performing  Loans         |   | 6,642.59                                          | %       | 506.23 | % | 134.81 | % | 340.72 | % | 175.95 | % |
| **Capital Ratios:**                                        |   |                                              |    |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Adjusted Total Assets                    |   | 7.7                                               | %       | 10.4 | % | 7.7 | % | 7.8 | % | 8.7 | % |
| Tier 1 Capital to Total Risk-Weighted  Assets              |   | 12.2                                              | %       | 12.8 | % | 10.4 | % | 9.5 | % | 10.8 | % |
| Total Capital to Total Risk-Weighted Assets                |   | 13.4                                              | %       | 14.0 | % | 11.6 | % | 10.6 | % | 11.8 | % |

 

22

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----

(1)All per share data and the average number of shares outstanding have beenretroactively restated on a split-adjusted basis.

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

(3)Net income divided by average total assets.

(4)Net interest income divided by average earning assets.

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

(6)Average equity divided by average total assets.

 

23

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

 

This discussion presents Management’s analysis of the financialcondition as of December 31, 2003 and 2002 and results of operations ofthe Company for each of the years in the three-year period endedDecember 31, 2003. (1)  Thediscussion should be read in conjunction with the Consolidated Financial Statementsof the Company and the Notes related thereto presented elsewhere in this Form10-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 theSecurities Exchange Act of 1934 as amended, including the Company’sexpectations, 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.

 

**Critical Accounting Policies**

 

*General*

 

The Company’s significant accounting principles are described in Note 2of the consolidated financial statements and are essential to understandingManagement’s Discussion and Analysis of Results of Operations and FinancialCondition. Community Valley Bancorp’s consolidated financial statements areprepared in accordance with accounting principles generally accepted in theUnited States of America (GAAP). The financial information contained within ourstatements is, to a significant extent, financial information that is based onmeasures of the financial effects of transactions and events that have alreadyoccurred. Some of the Company’s accounting principles require significantjudgement to estimate values of assets or liabilities. In addition, certainaccounting principles require significant judgment in applying the complexaccounting principles to transactions to determine the most appropriatetreatment. The following is a summary of the more judgmental and complexaccounting estimates and principles. 

 

*Allowance for Loan Losses (ALL)*

 

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

 

Additional factors include concentrations of borrowers, industries,geographical sectors, loan product, loan classes and collateral types, volumeand trends of loan delinquencies and non-accrual, criticized and classifiedassets and trends in the aggregate in significant credits identified as watchlist items. There are several components to the determination of the adequacyof the ALL. Each of these components is determined based upon estimates thatcan and do change when the actual events occur. The Company estimates the SFASNo. 5 portion of the ALL based on the segmentation of its portfolio. Forthose segments that require an ALL, the Company estimates loan losses on amonthly basis based upon its ongoing loan review process and analysis of loanperformance. The Company follows a systematic and consistently applied approachto select the most appropriate loss measurement methods and support itsconclusions and rationale with written documentation. One method of estimatingloan losses for groups of loans is through the application of loss rates to thegroups’ aggregate loan balances. Such rates typically reflect historical lossexperience for each group of loans, adjusted for relevant economic factors overa defined period of time. The Company evaluates and modifies its lossestimation model as needed to ensure that the resulting loss estimate is consistentwith GAAP. 

 

----

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

 

24

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

 

*Loan Sales and Servicing*

 

The Company originates government guaranteed loansand mortgage loans that may be sold in the secondary market.  The amounts of gains recorded on sales ofloans and the initial recording of servicing assets and interest only (I/O)strips is based on the estimated fair values of the respective components.  In recording the initial value of theservicing assets and the fiar value of the I/O strips receivable, the Companyuses estimates which are made based on management’s expectations of futureprepayment and discount rates. Servicing assets are amortized over the estimated life of the relatedloan.  I/O strips are not significant atDecember 31, 2003.  Theseprepayment and discount rates were based on current market conditions andhistorical performance of the various pools of serviced loans.  If actual prepayments with respect to soldloans occur more quickly than projected the carrying value of the servicingassets may have to be adjusted through a charge to earnings.  

 

*Stock-Based Compensation*

 

TheCompany uses the intrinsic value based method for measuring compensation costrelated to stock options. Under the intrinsic value based method, compensationcost is the excess, if any, of the quoted market price of the stock at grantdate over the amount an employee must pay to acquire the stock. This cost isamortized on a straight-line basis over the vesting period of the optionsgranted. The Company applies Accounting Principles Board Opinion (“APB”)No. 25 *Accounting for Stock Issued toEmployees*and related interpretations in accounting for stockoptions.  No compensation cost has beenrecorded in the accompanying financial statements because all options have beengranted at an exercise price of no less than the fair market value at date ofgrant.

 

*Revenue recognition*

 

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

 

*Income Taxes*

 

TheCompany accounts for income taxes under the asset and liability method. Underthe asset and liability method, deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases. Deferred tax assets and liabilities are measuredusing currently enacted tax rates applied to such taxable income in the yearsin which those temporary differences are expected to be recovered or settled.The effect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. If futureincome should prove non-existent or less than the amount of deferred tax assetswithin the tax years to which they may be applied, the asset may not berealized and our net income will be reduced. 

 

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

 

For 2003, net income was $5.27 million, compared to the $4.85 millionearned in 2002 and net income of $3.81 million in 2001.  Net income per diluted share was $1.42 for2003, as compared to $1.33 during 2002 and $1.07 in 2001.  The Company’s Return on Average Assets(“ROA”) was 1.44% and Return on Average Equity (“ROE”) was 19.07% in 2003, ascompared to 1.69% and 20.82%, respectively, in 2002 and 1.54% and 19.73%,respectively, for 2001.

 

The Federal Reserve Board’s record reduction in the target overnightfed funds rate and discount rate during 2001 continued to impact the Companyduring 2003.  These rate reductionsinjected liquidity into the banking system, which forced other market interestrates to decline in response.  As istypical in many other community banks, the Company’s net interest margin wasnegatively impacted as market rates fell. The rate-related decline in netinterest income, however, was more than offset by the increased incomegenerated by a higher level of average earning assets and favorable changes inthe Company’s deposit mix, and net interest income increased by $2.9 millionfrom 2002 to 2003.  Moreover, thedecline in market rates boosted the Company’s volume of mortgage loans, whichwe were able to sell at substantial gains. The Company was also able to sell several USDA Business and Industryguaranteed loans and SBA loans for substantial gains.

 

25

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On December 19, 2002, Community Valley Bancorp Trust I (the“Trust”), a newly formed Delaware statutory business trust and a wholly-ownedunconsolidated subsidiary of the Company, issued an aggregate of $8,000,000 ofprincipal amount of Floating Rate Trust Preferred Securities (Capital TrustPass-through Securities of the Trust), which in turn were used to purchase$8,248,000 of Subordinated Debt Securities issued by the Company.  These Trust Preferred Securities currentlyqualify as Tier 1 capital when calculating regulatory risk-based capitalratios.  The issuance of the TrustPreferred Securities in the fourth quarter of 2002 resulted in substantialimprovement in the Company’s capital ratios which also carried over for 2003.  In addition, the Bank is considered to be“well capitalized” pursuant to the FDIC’s prompt corrective actionguidelines.  

 

26

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We anticipate that this increase in capital will provide a springboardfor future asset growth, while allowing the Company to maintain its wellcapitalized position.  There can be noabsolute assurance given that this in fact will occur, however, as numerouslocal market, general economic and regulatory changes could impact capitalratios 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 $17.1 million in 2003 compared to $14.2million and $12.4 million in 2002 and 2001, respectively.  This represents an increase of 20.6% in 2003over 2002 and an increase of 14.4% in 2002 over 2001.  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.  Change 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.

 

27

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|                               |   | **Years  Ended December 31,** |   |
|------------------------------------|--------|------------------------------------|--------|
|                               |   | **2003 over  2002**                |   | **2002 over  2001** |   |
| **Volume & Rate Variances**    |   | **Increase(decrease)  due to**     |   | **Increase(decrease)  due to** |   |
| **(dollars in thousands)**         |   | **Volume**                         |   | **Rate** |   | **Net** |   | **Volume** |   | **Rate** |   | **Net** |   |
|                               |   |                               |   |   |   |   |   |   |   |   |   |   |   |
| **Earning Assets:**                |   |                               |   |   |   |   |   |   |   |   |   |   |   |
| Loans                              |   | $                                  | 3,271  |   | $ | (900 | ) | $ | 2,371 |   | $ | 2,203 |   | $ | (2,870 | ) | $ | (667 | ) |
| Federal funds sold                 |   | $                                  | 356    |   | $ | (295 | ) | $ | 61 |   | $ | 506 |   | $ | (592 | ) | $ | (86 | ) |
| Investment Securities:             |   |                               |   |   |   | $ | — |   |   |   |   |   |   |   |
| Taxable                            |   | $                                  | 65     |   | $ | (51 | ) | $ | 14 |   | $ | (8 | ) | $ | 6 |   | $ | (2 | ) |
| Non-taxable(1)                     |   | $                                  | (38    | ) | $ | 11 |   | $ | (27 | ) | $ | (32 | ) | $ | (12 | ) | $ | (44 | ) |
| Deposits in banks                  |   | $                                  | 219    |   | $ | (99 | ) | $ | 120 |   | $ | 50 |   | $ | (30 | ) | $ | 20 |   |
| Total earning assets               |   | $                                  | 3,873  |   | $ | (1,334 | ) | $ | 2,539 |   | $ | 2,719 |   | $ | (3,498 | ) | $ | (779 | ) |
|                               |   |                               |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-Bearing  Liabilities**  |   |                               |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits:         |   |                               |   |   |   |   |   |   |   |   |   |   |   |
|                               |   |                               |   |   |   |   |   |   |   |   |   |   |   |
| Demand - interest bearing          |   | $                                  | 641    |   | $ | (619 | ) | $ | 22 |   | $ | 488 |   | $ | (329 | ) | $ | 159 |   |
| Savings Accounts                   |   | $                                  | 32     |   | $ | (84 | ) | $ | (52 | ) | $ | 76 |   | $ | (147 | ) | $ | (71 | ) |
| Certificates of Deposit            |   | $                                  | (60    | ) | $ | (721 | ) | $ | (781 | ) | $ | (989 | ) | $ | (1,653 | ) | $ | (2,642 | ) |
| Total interest bearing deposits    |   | $                                  | 613    |   | $ | (1,424 | ) | $ | (811 | ) | $ | (425 | ) | $ | (2,129 | ) | $ | (2,554 | ) |
| Borrowed funds:                    |   |                               |   |   |   | $ | — |   |   |   |   |   |   |   |
| Other Borrowings                   |   | $                                  | 431    |   | $ | 1 |   | $ | 432 |   | $ | 11 |   | $ | (26 | ) | $ | (15 | ) |
|                               |   |                               |   |   |   |   |   |   |   |   |   |   |   |
| Total Interest Bearing Liabilities |   | $                                  | 1,044  |   | $ | (1,423 | ) | $ | (379 | ) | $ | (414 | ) | $ | (2,155 | ) | $ | (2,569 | ) |
| **Net Interest  Margin/Income**    |   | $                                  | 2,829  |   | $ | 89 |   | $ | 2,918 |   | $ | 3,133 |   | $ | (1,343 | ) | $ | 1,790 |   |

 

----

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

 

The Company’s net interest margin is its net interest income expressedas a percentage of average earning assets. The Company’s net interest margin for 2003 was 5.32%, a decrease of 4basis points from the 5.36% reported for 2002. For the year 2001, this margin was 5.49%.  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 the Company’sinterest bearing liabilities. That same table also shows the Company’s averagedaily balances for each principal category of assets, liabilities andshareholders’ equity, the amount of interest income or interest expense, andthe average yield or rate for each category of interest-earning asset andinterest-bearing liability along with the net interest margin for each of thereported periods.

 

28

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|                                                       |   | **Year Ended  December 31,** |    |
|------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                       |   | **2003(a)**                       |    | **2002(a)** |   | **2001(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                                         |   | $                                 | 57,811  |   | $ | 634 |   | 1.10 | % | $ | 35,641 |   | $ | 573 |   | 1.61 | % | $ | 20,153 |   | $ | 659 |   | 3.27 | % |
| Taxable                                                    |   | $                                 | 2,308   |   | $ | 104 |   | 4.51 | % | $ | 1,341 |   | $ | 90 |   | 6.71 | % | $ | 1,475 |   | $ | 92 |   | 6.24 | % |
| Non-taxable(1)                                             |   | $                                 | 902     |   | $ | 49 |   | 5.43 | % | $ | 1,813 |   | $ | 76 |   | 4.19 | % | $ | 2,463 |   | $ | 120 |   | 4.87 | % |
| Deposits in Banks                                          |   | $                                 | 6,371   |   | $ | 201 |   | 3.15 | % | $ | 1,718 |   | $ | 81 |   | 4.71 | % | $ | 947 |   | $ | 61 |   | 6.44 | % |
| Total Investments                                          |   | $                                 | 67,392  |   | $ | 988 |   | 1.47 | % | $ | 40,513 |   | $ | 820 |   | 2.02 | % | $ | 25,038 |   | $ | 932 |   | 3.72 | % |
|                                                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans:                                                     |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Agricultural                                               |   | $                                 | 22,573  |   | $ | 1,671 |   | 7.40 | % | $ | 21,345 |   | $ | 1,511 |   | 7.08 | % | $ | 21,835 |   | $ | 1,889 |   | 8.65 | % |
| Commercial                                                 |   | $                                 | 55,694  |   | $ | 4,605 |   | 8.27 | % | $ | 50,412 |   | $ | 3,927 |   | 7.79 | % | $ | 43,226 |   | $ | 3,776 |   | 8.74 | % |
| Real Estate                                                |   | $                                 | 156,452 |   | $ | 12,866 |   | 8.22 | % | $ | 126,486 |   | $ | 11,305 |   | 8.94 | % | $ | 112,100 |   | $ | 11,618 |   | 10.36 | % |
| Consumer                                                   |   | $                                 | 19,963  |   | $ | 1,386 |   | 6.94 | % | $ | 18,710 |   | $ | 1,414 |   | 7.56 | % | $ | 17,287 |   | $ | 1,541 |   | 8.91 | % |
| Total Loans                                                |   | $                                 | 254,682 |   | $ | 20,528 |   | 8.06 | % | $ | 216,953 |   | $ | 18,157 |   | 8.18 | % | $ | 194,448 |   | $ | 18,824 |   | 9.68 | % |
| Total Earning Assets(2)                                    |   | $                                 | 322,074 |   | $ | 21,516 |   | 6.68 | % | $ | 257,466 |   | $ | 18,977 |   | 7.37 | % | $ | 219,486 |   | $ | 19,756 |   | 9.00 | % |
| Non-Earning Assets                                         |   | $                                 | 44,259  |   |   |   |   |   | $ | 29,401 |   |   |   |   |   | $ | 26,614 |   |   |   |   |   |
| **Total Assets**                                           |   | $                                 | 366,333 |   |   |   |   |   | $ | 286,867 |   |   |   |   |   | $ | 246,100 |   |   |   |   |   |
|                                                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and  Shareholders’ Equity**             |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing Deposits:                                 |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW                                                        |   | $                                 | 121,289 |   | $ | 1,050 |   | 0.87 | % | $ | 86,292 |   | $ | 1,043 |   | 1.21 | % | $ | 56,144 |   | $ | 680 |   | 1.21 | % |
| Savings                                                    |   | $                                 | 22,409  |   | $ | 121 |   | 0.54 | % | $ | 18,936 |   | $ | 173 |   | 0.91 | % | $ | 14,449 |   | $ | 244 |   | 1.69 | % |
| Money Market                                               |   | $                                 | 29,494  |   | $ | 356 |   | 1.21 | % | $ | 17,989 |   | $ | 341 |   | 1.90 | % | $ | 14,678 |   | $ | 545 |   | 3.71 | % |
| TDOA’s, and IRA’s                                |   | $                                 | 7,117   |   | $ | 201 |   | 2.82 | % | $ | 6,166 |   | $ | 228 |   | 3.70 | % | $ | 5,314 |   | $ | 292 |   | 5.49 | % |
| Certificates of Deposit < $100,000                      |   | $                                 | 50,744  |   | $ | 1,343 |   | 2.64 | % | $ | 59,010 |   | $ | 2,143 |   | 3.63 | % | $ | 71,623 |   | $ | 3,876 |   | 5.41 | % |
| Certificates of Deposit > $100,000                      |   | $                                 | 28,300  |   | $ | 853 |   | 3.01 | % | $ | 22,571 |   | $ | 807 |   | 3.58 | % | $ | 28,704 |   | $ | 1,652 |   | 5.76 | % |
| Total Interest-Bearing Deposits                            |   | $                                 | 259,353 |   | $ | 3,923 |   | 1.51 | % | $ | 210,964 |   | $ | 4,735 |   | 2.24 | % | $ | 190,912 |   | $ | 7,289 |   | 3.82 | % |
|                                                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Borrowed Funds:                                            |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                                           |   | $                                 | 9,038   |   | $ | 472 |   | 5.22 | % | $ | 767 |   | $ | 40 |   | 5.22 | % | $ | 641 |   | $ | 55 |   | 8.58 | % |
|                                                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Interest Bearing Liabilities                         |   | $                                 | 268,391 |   | 4,396 |   | 1.64 | % | $ | 211,731 |   | $ | 4,775 |   | 2.26 | % | $ | 191,553 |   | $ | 7,344 |   | 3.83 | % |
| Demand Deposits                                            |   | $                                 | 66,347  |   |   |   |   |   | $ | 48,774 |   |   |   |   |   | $ | 33,756 |   |   |   |   |   |
| Other Liabilities                                          |   | $                                 | 3, 961  |   |   |   |   |   | $ | 3,073 |   |   |   |   |   | $ | 1,478 |   |   |   |   |   |
| Shareholders’ Equity                                  |   | $                                 | 27,634  |   |   |   |   |   | $ | 23,289 |   |   |   |   |   | $ | 19,313 |   |   |   |   |   |
| **Total Liabilities  and Shareholders’ Equity**       |   | $                                 | 366,333 |   |   |   |   |   | $ | 286,867 |   |   |   |   |   | $ | 246,100 |   |   |   |   |   |
|                                                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income/Earning Assets                             |   |                              |    |   |   | 6.68 | % |   |   |   |   | 7.37 | % |   |   |   |   | 9.00 | % |
| Interest Expense/Earning Assets                            |   |                              |    |   |   | 1.36 | % |   |   |   |   | 1.85 | % |   |   |   |   | 3.35 | % |
| **Net Interest  Margin(3)**                                |   |                              |    | $ | 17,120 |   | 5.32 | % |   |   | $ | 14,202 |   | 5.52 | % |   |   | $ | 12,412 |   | 5.65 | % |

 

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

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

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

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

 

During 2003, the Company’s net interest margin was slightly impacted bythe overall decline in interest rates as maturing loans were replaced by new loansat lower rates.  However, the increasein volume caused interest income to increase by $2.5 million.  A large portion of the Bank’s loans carryvariable rates and re-price immediately, versus a large base of core depositswhich are generally slower to re-price. However, due to a favorable shift inthe mix of the deposits from higher cost certificates of deposit to lower costdemand accounts, the Company was able to decrease its interest expense by$379,000 and show an increase of $2.9 million in net interest income.  The Company funded much of its loan growthin 2003 with funds that had poured out of the equity markets during 2002 intoliquid deposit accounts such as NOW and money market checking accounts.  As floors on loan rates became effective anddeposit rates were lowered to match similar decreases in competitor rates netinterest income increased.  As ratescontinued to adjust downward during 2003, some existing customers wereunwilling to accept the lower rates being offered for non-liquid deposits andchose to roll their maturing time deposit money into money market and NOWaccounts.  

 

29

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Average time deposit balances fell by $2.5 million from 2002 to 2003,while money market and NOW account balances increased by $46 million.  Even more significantly, though, averagedemand deposit balances increased by nearly $18 million, or 36%, from 2002 to2003, which had a substantial positive impact on the Company’s net interestmargin.

 

From 2002 to 2003, the Company’s average loan portfolio grew byapproximately $38 million, or 17.4%, 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 2003, the loan portfolio averaged69.5% of total assets, while for 2001 and 2000 such balances represented 75.6%and 79.0%, 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 2004. TheCompany’s net interest margin is anticipated to stay approximately the same asin 2003, 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 2003, non-interest income decreased by $214,000 or (4%) to$5,950,000 as compared to $6,164,000 for 2002. The vast majority of this decrease represents the tax-free net proceedsfrom key man insurance policies the Bank received in March of 2002 as aresult of the death of the Company’s Chief Operating Officer.  The primary traditional sources ofnon-interest income for the Company are service charges on deposit accounts,gains on the sale of loans, loan servicing income, and merchant credit cardfees.    Service charges on depositaccounts and loan sales income in 2003 accounted for 23.5% and 46.8%,respectively, of total non-interest income, as compared to 16.7% and 37.8%,respectively, for 2002.  Loan servicingincome and merchant credit card fees for 2003 were 6.4% and 5.8% respectively,as compared to 5.8% and 5.7%, respectively, of total non-interest income during2002.

 

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 2003.  Mortgage loanactivity increased presumably as a result of the relatively low rates availableon such loans.  It is not expected thatthis level of loan sales income will be sustained throughout 2004 as consumerswho had contemplated refinancing their homes have probably done so.   We anticipate sales of existing homescontinuing throughout 2004 as mortgage rates stay at 40 year lows and theconstruction of new homes continues. The loan portfolio also includes loans which are 75% to 90% guaranteedby 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 besold to a third party, with the Company retaining the unguaranteedportion.   The Company generally receivesa premium in excess of the adjusted carrying value of the loan at the time ofsale.

 

Loan servicing income increased as well, as the portfolio of realestate loans being serviced by the Company grew by 63% from 2002 to 2003.   The portfolio of SBA, RBS and FSAgovernment guaranteed loans being serviced by the Company grew by 5% from 2002to 2003.

 

Merchant credit card fees decreased slightly from 2002 to 2003, butwere approximately the same percentage of average earning assets. Through moreaggressive marketing efforts of this product, management expects income fromthis area to increase somewhat in 2004.

 

The Company is increasingly focused on enhancing its fee income.  Based on the Company’s efficiency ratio of62% for 2003, 63% for 2002, and 60% for 2001 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 $13.8 million in2003, as compared to $12.5 million in 2002 and $9.3 million in 2001.

 

30

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The largest dollar increase in non-interest expense was in salaries andemployee benefits, which increased by $1,592,000, or 24.3% from 2002 to2003.  This increase resulted fromnormal cost of living raises, salaries paid to new employees at the new NorthParadise office, the expanded North Chico office and the Redding LoanProduction office, commissions paid to Butte Community Bank’s Real Estate Loanagents and staffing additions made during the year as the Company continued togrow and implement the new technology acquired throughout the year.  Full time equivalent employees increased to177 at December 31, 2003 from 152 at December 31, 2002. Benefit costsand employer taxes increased commensurate with the salaries.  It is management’s opinion that the Companycan achieve significant growth in loans and deposits with only minimalincreases in staff unless more expansion takes place.  Thus, it is expected that salaries and employee benefits willdecline as a percentage of earning assets during 2004.

 

Occupancy expenses were higher by $480,000 or 30.8% when compared tothe 2002 total of $1,557,000.  Much ofthe increase in occupancy expense was related to furniture, fixtures andequipment for the new North Paradise, North Chico and Redding Loan Productionoffices.    The lease agreement andremodeling costs associated with the North Paradise office, as well as theconstruction costs and land lease associated with the new North Chico office,also added to the year over year increase.  Advertising and marketing expenses decreased slightly from 2002 to 2003as we already had name recognition within the areas we expanded to.  The decrease in professional services costsof $98,000 from 2002 to 2003 relates to fewer legal fees paid to resolveproblem loans and the fees paid in association with the formation of theholding company, Community Valley Bancorp. 

 

Expenses representing telephone and data communications, postage andmail, stationery and supplies, merchant credit card and ATM operations, andsundry losses totaled $1,241,000 for 2003 as compared to $1,021,000 in 2002 anincrease of 21.5%.  Management considersthis increase in expenses commensurate with the growth of the Company during2003.

 

Other expenses decreased by $840,000 from 2002 to 2003.  As discussed in the non-interest incomesection, most of this decrease was attributable to the accelerated accrual in2002 of salary continuation plan benefits associated with the death of theCompany’s Chief Operating Officer that will be subsequently paid to hisbeneficiary.

 

31

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| **Non Interest Income/Expense**               |   | **For the  year ended December 31,** |   |
|-----------------------------------------------|--------|-------------------------------------------|--------|
| **(dollars in thousands, unaudited)**         |   | **2003**                                  |   | **% of Total** |   | **2002** |   | **% of Total** |   | **2001** |   | **% of Total** |   |
|                                          |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| OTHER OPERATING INCOME:                       |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| Service charges on deposit accounts           |   | $                                         | 1,397  |   | 23.48 | % | $ | 1,028 |   | 16.68 | % | $ | 966 |   | 26.40 | % |
| Merchant credit card fees                     |   | $                                         | 343    |   | 5.76 | % | $ | 354 |   | 5.74 | % | $ | 260 |   | 7.11 | % |
| Other service charges, commissions & fees |   | $                                         | 613    |   | 10.30 | % | $ | 467 |   | 7.58 | % | $ | 397 |   | 10.85 | % |
| Gains on sales of loans                       |   | $                                         | 2,783  |   | 46.77 | % | $ | 2,327 |   | 37.75 | % | $ | 1,422 |   | 38.86 | % |
| Loan servicing income                         |   | $                                         | 379    |   | 6.37 | % | $ | 356 |   | 5.78 | % | $ | 329 |   | 8.99 | % |
| Other                                         |   | $                                         | 435    |   | 7.31 | % | $ | 1,632 |   | 26.48 | % | $ | 285 |   | 7.79 | % |
| Total non-interest income                     |   | $                                         | 5,950  |   | 100.00 | % | $ | 6,164 |   | 100.00 | % | $ | 3,659 |   | 100.00 | % |
| As a percentage of average earning assets     |   |                                      |   | 2.31 | % |   |   | 2.39 | % |   |   | 1.67 | % |
|                                          |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| OTHER OPERATING EXPENSES:                     |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                |   | $                                         | 8,151  |   | 65.01 | % | $ | 6,559 |   | 52.31 | % | $ | 5,298 |   | 56.75 | % |
| Occupancy costs                               |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| Furniture & Equipment                     |   | $                                         | 1,180  |   | 9.41 | % | $ | 937 |   | 7.47 | % | $ | 837 |   | 8.97 | % |
| Premises                                      |   | $                                         | 857    |   | 6.83 | % | $ | 620 |   | 4.94 | % | $ | 499 |   | 5.34 | % |
| Advertising and marketing costs               |   | $                                         | 187    |   | 1.49 | % | $ | 191 |   | 1.52 | % | $ | 131 |   | 1.40 | % |
| Professional services costs                   |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| Legal & Accounting                        |   | $                                         | 154    |   | 1.23 | % | $ | 225 |   | 1.79 | % | $ | 177 |   | 1.90 | % |
| Other professional services                   |   | $                                         | 299    |   | 2.38 | % | $ | 397 |   | 3.17 | % | $ | 374 |   | 4.01 | % |
| Other operating costs                         |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| Credit Card / ATM                             |   | $                                         | 29     |   | 0.23 | % | $ | 70 |   | 0.56 | % | $ | 78 |   | 0.84 | % |
| Telephone & data communications           |   | $                                         | 263    |   | 2.10 | % | $ | 226 |   | 1.80 | % | $ | 209 |   | 2.24 | % |
| Postage & mail                            |   | $                                         | 241    |   | 1.92 | % | $ | 209 |   | 1.67 | % | $ | 188 |   | 2.01 | % |
| Other                                         |   | $                                         | 1,749  |   | 13.95 | % | $ | 2,589 |   | 20.65 | % | $ | 1,160 |   | 12.43 | % |
| Stationery & supply costs                 |   | $                                         | 632    |   | 5.04 | % | $ | 458 |   | 3.65 | % | $ | 323 |   | 3.46 | % |
| Sundry & teller costs                     |   | $                                         | 76     |   | 0.61 | % | $ | 58 |   | 0.46 | % | $ | 62 |   | 0.66 | % |
| Total non-interest expense                    |   | $                                         | 13,818 |   | 100.00 | % | $ | 12,539 |   | 100.00 | % | $ | 9,336 |   | 100.00 | % |
| As a % of average earning assets              |   |                                      |   | 4.29 | % |   |   | 4.87 | % |   |   | 4.25 | % |

 

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

###### ** **

Credit risk is inherent in the business of making loans.  The Company sets aside an allowance for 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 2003, 2002, and 2001 were $655,000,$603,000, and $500,000 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.” 

 

32

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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 to taxableincome, 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 31,2003, the Company’s $2.8 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 2003through 1999 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 $49 million, or 14.6%, as compared to growth in 2002 of $65million, or 23.8%. Notable growth was also achieved during 2001 when totalassets grew by $58 million or 26.8%.

 

On the liability side, the deposit mix changed significantly in 2003and 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.  By the end of 2003 all of these brokereddeposits had been replaced with deposits from our local markets.

 

###### **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, 2003, gross loansrepresented 70.8% of total assets, as compared to 69.0% and 73.8% atDecember 31, 2002 and 2001, respectively. The quality and diversification of the Company’s loan portfolio areimportant considerations when reviewing the Company’s results of operations.

 

33

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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 1999and 2003.  The Loan Distribution tablewhich follows sets forth the amount of the Company’s total loans outstanding ineach category 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**

(dollars in thousands)

 
|                                |   | **As of  December 31,** |    |
|-------------------------------------|--------|------------------------------|---------|
|                                |   | **2003**                     |    | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| Agricultural                        |   | $                            | 20,820  |   | $ | 18,935 |   | $ | 19,407 |   | $ | 18,832 |   | $ | 17,504 |   |
| Commercial                          |   | $                            | 54,077  |   | $ | 48,661 |   | $ | 42,517 |   | $ | 39,673 |   | $ | 33,356 |   |
| Real estate - mortgage              |   | $                            | 114,911 |   | $ | 82,057 |   | $ | 52,315 |   | $ | 50,069 |   | $ | 33,816 |   |
| Real estate - construction          |   | $                            | 63,196  |   | $ | 64,565 |   | $ | 68,943 |   | $ | 45,855 |   | $ | 19,893 |   |
| Installment                         |   | $                            | 21,847  |   | $ | 19,325 |   | $ | 17,764 |   | $ | 16,885 |   | $ | 13,989 |   |
|                                |   | $                            | 274,851 |   | $ | 233,543 |   | $ | 200,946 |   | $ | 171,314 |   | $ | 118,558 |   |
|                                |   |                         |    |   |   |   |   |   |   |   |   |
| Deferred loan origination fees, net |   | $                            | (1,033  | ) | $ | (837 | ) | $ | (674 | ) | $ | (562 | ) | $ | (304 | ) |
| Allowance for loan losses           |   | $                            | (3,587  | ) | $ | (3,007 | ) | $ | (2,397 | ) | $ | (2,000 | ) | $ | (1,390 | ) |
|                                |   | $                            | 270,231 |   | $ | 229,699 |   | $ | 197,875 |   | $ | 168,752 |   | $ | 116,864 |   |
|                                |   |                         |    |   |   |   |   |   |   |   |   |
| **Percentage of Total  Loans**      |   |                         |    |   |   |   |   |   |   |   |   |
| Agricultural                        |   | 7.58                         | %       | 8.11 | % | 9.66 | % | 10.99 | % | 14.76 | % |
| Commercial                          |   | 21.01                        | %       | 20.84 | % | 21.16 | % | 23.16 | % | 28.13 | % |
| Real Estate - mortgage              |   | 40.48                        | %       | 35.13 | % | 26.03 | % | 29.23 | % | 28.52 | % |
| Real Estate - construction          |   | 23.05                        | %       | 27.65 | % | 34.31 | % | 26.77 | % | 16.78 | % |
| Installment                         |   | 7.89                         | %       | 8.27 | % | 8.84 | % | 9.86 | % | 11.80 | % |
|                                |   | 100.00                       | %       | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |

 

As reflected in the Loan Distribution table, aggregate loan balanceshave increased $153 million, or 131%, over the last four years.   The largest percentage growth during 2003came in real estate mortgages, which was also the largest dollar volumeincrease.

 

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 $31 million, or 37.9%, andcommercial loans grew by $5 million, or 16.2%, during 2003.  Loans secured by real estate and commercialloans comprised 64.8% and 19.7%, respectively, of the Bank’s total loanportfolio at the end of 2003.

 

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 two USDA Business and Industry lender inCalifornia for the fiscal year ending September 30, 2003 by originatingover $17 million in loans.  Thisperformance also placed the Company at number seven in the entire UnitedStates.  The Company is also designatedas an SBA Preferred Lender, which means it has the authority to underwrite andapprove SBA loans locally.  Thisrecognition lends credence to the Company’s success in meeting the needs ofsmaller business owners in the communities in which the Company conducts itsbanking activities.

 

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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 from28.5% of total loans at the end of 1999 to 40.5% of total loans at the end of2003.  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 7.9% of total loan balances by the end of 2003 from11.8% at the end of 1999, and agricultural loans dropped during the same periodto 7.6% of the Company’s total loan balances from 14.8%.  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 yet 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 2003, the Company originated and sold aggregate balances ofapproximately $125 million of such loans, an increase from the $105 millionoriginated and sold in 2002.  TheCompany services the mortgage loans sold to the Federal National MortgageAssociation (FNMA).  As ofDecember 31, 2003, aggregate balances of $156 million were being servicedas compared to $96 million at the end of 2002.

 

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 $133 million at December 31, 2003as compared to $104 million at December 31, 2002.  These commitments represented 49% ofoutstanding gross loans at December 31, 2003 and 44% at December 31,2002, respectively.  The Company’sstand-by letters of credit at December 31, 2003 and 2002 were $3.5 millionand $2.2 million, respectively, which represented approximately 1% of totalcommitments outstanding at the end of 2003 and 2002.  It is not anticipated that all of these stand-by letters ofcredit will fund.

 

Approximately one half of the loans held by the Company have floatingrates of interest tied to the Company’s base lending rate or to another marketrate indicator so that they may be re-priced as interest rates change.  The 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 rates rise. The Company’s loans that have fixed rates generally have relativelyshort maturities or amortize monthly, which effectively lessens the marketrisk.  The table in Note 16 to theconsolidated financial statements shows that at December 31, 2003, thedifference in the carrying amount of loans, i.e., their face value, is about$7.2 million or 2.7% less than their fair value.  At the end of 2002, the fair value of loans was about $3.2million or 1.4% more 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 orliability related to environmental regulations.

 

**Loan Maturities**

 

The following Loan Maturity table shows the amounts of total loansoutstanding as of December 31, 2003, 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.)

 

35

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**Loan Maturity**

(dollarsin thousands)

 
|                     |   | **One  year or  less** |    | **One  to five  years** |   | **Over  five  years** |   | **Total** |   | **Floating  rate:  due after  one year** |   | **Fixed  rate:  due after  one year** |   |
|--------------------------|--------|------------------------|---------|-------------------------|--------|-----------------------|--------|-----------|--------|------------------------------------------|--------|---------------------------------------|--------|
| Agricultural             |   | $                      | 14,797  |                    | $      | 5,248                 |   | $         | 775    |                                     | $      | 20,820                                |   | $ | — |   | $ | 6,023 |   |
| Commercial               |   | $                      | 31,109  |                    | $      | 13,837                |   | $         | 12,793 |                                     | $      | 57,739                                |   | $ | 1,393 |   | $ | 25,237 |   |
| Real Estate Mortgage     |   | $                      | 65,763  |                    | $      | 35,330                |   | $         | 10,156 |                                     | $      | 111,249                               |   | $ | — |   | $ | 45,486 |   |
| Real Estate Construction |   | $                      | 48,013  |                    | $      | 14,943                |   | $         | 389    |                                     | $      | 63,345                                |   |   |   |   | $ | 15,332 |   |
| Installment              |   | $                      | 8,153   |                    | $      | 12,122                |   | $         | 1,423  |                                     | $      | 21,698                                |   | $ | — |   | $ | 13,545 |   |
|                     |   |                   |    |                    |   |                  |   |      |   |                                     |   |                                  |   |
| TOTAL                    |   | $                      | 167,835 |                    | $      | 81,480                |   | $         | 25,536 |                                     | $      | 274,851                               |   | $ | 1,393 |   | $ | 105,623 |   |

 

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 and geographicconcentrations.  In addition, thesepolicies establish the Company’s underwriting standards and the methods ofmonitoring 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 Sacramento andShasta counties); the Company has mitigated its risk to any one segment ofthese Northern Sacramento Valley markets. The Company’s asset quality continues to be excellent with delinquencyratios at very low levels.  The Companyis optimistic that the local and regional economy will continue to perform, butno assurance 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 as potentialproblem loans, and a portion of the allowance is assigned and/or allocated, asdiscussed below, to cover the Company’s exposure to loss would the borrowersindeed 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 (“ORE”).  Loans are generally placed on non-accrual status when they become90 days past due as to principal or interest. Loans may be restructured by management when a borrower has experiencedsome change in financial status causing an inability to meet the originalrepayment terms and where the Company believes the borrower will eventuallyovercome those circumstances and repay the loan in full.  ORE consists of properties acquired byforeclosure or similar means that management intends to offer for sale.

 

Management’s classification of a loan as non-accrual is an indicationthat there is reasonable doubt as to the full collectibility of principal orinterest on the loan; at that point, the Company stops recognizing income fromthe interest on the loan and reverses any uncollected interest that had beenaccrued but unpaid.  These loans may 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**

(dollars in thousands)

 
|                                                                     |   | **As of  December 31,** |   |
|--------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                     |   | **2003**                     |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| **Nonaccrual Loans:**                                                    |   |                         |   |   |   |   |   |   |   |   |   |
| Agricultural                                                             |   | $                            | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial and Industrial                                                |   | $                            | 46     |   | $ | 134 |   | $ | 1,544 |   | $ | 83 |   | $ | 103 |   |
| Real Estate                                                              |   |                         |   |   |   |   |   |   |   |   |   |
| Secured by Commercial/Professional Office                                |   | $                            | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 25 |   |
| Properties Including Construction and  Development                       |   | $                            | — |   | $ | — |   | $ | 221 |   | $ | 453 |   | $ | 96 |   |
| Secured by Residential Properties                                        |   | $                            | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 124 |   |
| Secured by Farmland                                                      |   | $                            | — |   | $ | 460 |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer Loans                                                           |   | $                            | 8      |   | $ | — |   | $ | — |   | $ | — |   | $ | 11 |   |
| **SUBTOTAL**                                                             |   | $                            | 54     |   | $ | 594 |   | $ | 1,765 |   | $ | 536 |   | $ | 359 |   |
|                                                                     |   |                         |   |   |   |   |   |   |   |   |   |
| ORE                                                                      |   | $                            | — |   | $ | — |   | $ | 13 |   | $ | 51 |   | $ | 431 |   |
| Total non-performing Assets                                              |   | $                            | 54     |   | $ | 594 |   | $ | 1,778 |   | $ | 587 |   | $ | 790 |   |
| Restructured Loans                                                       |   | N/A                          |   | N/A |   | N/A |   | N/A |   | N/A |   |
| Non-performing loans as % of total gross  loans                          |   | 0.02                         | %      | 0.25 | % | 0.88 | % | 0.31 | % | 0.30 | % |
| Non-performing assets as a % of total gross  loans and other real estate |   | 0.02                         | %      | 0.25 | % | 0.88 | % | 0.34 | % | 0.67 | % |

 

Total non-performing balances stood at $54,000 at the end of 2003,$37,000 of which is a government guaranteed commercial loan.  The Company’s non-performing assetsdecreased by $540,000 during 2003. Management considers those loans to be well-reserved (see Allowance forPossible Loan Losses below), and expects to resolve them during 2004.  ORE of $13,000 outstanding atDecember 31, 2001 was sold during 2002. There was no ORE outstanding at December 31, 2003.

 

37

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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 uncollectible; 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**

(dollars in thousands)

 
|                                                       |   | **As of  December 31,** |    |
|------------------------------------------------------------|--------|------------------------------|---------|
|                                                       |   | **2003**                     |    | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| **Balances:**                                              |   |                         |    |   |   |   |   |   |   |   |   |
| Average gross loans outstanding during  period             |   | $                            | 254,682 |   | $ | 216,953 |   | $ | 194,448 |   | $ | 146,517 |   | $ | 114,168 |   |
| Gross loans outstanding at end of period                   |   | $                            | 274,851 |   | $ | 233,542 |   | $ | 200,946 |   | $ | 171,315 |   | $ | 118,559 |   |
|                                                       |   |                         |    |   |   |   |   |   |   |   |   |
| **Allowance for Loan  Losses:**                            |   |                         |    |   |   |   |   |   |   |   |   |
| Balance at beginning of period                             |   | $                            | 3,007   |   | $ | 2,397 |   | $ | 2,000 |   | $ | 1,390 |   | $ | 1,329 |   |
| Adjustments                                                |   |                         |    | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Provision Charged to Expense                               |   | $                            | 655     |   | $ | 603 |   | $ | 500 |   | $ | 805 |   | $ | 305 |   |
|                                                       |   |                         |    |   |   |   |   |   |   |   |   |
| Loan Charge-offs                                           |   |                         |    |   |   |   |   |   |   |   |   |
| Agricultural                                               |   | $                            | —  |   | $ | — |   | $ | — |   | $ | — |   | — |   |
| Commercial & Industrial Loans                          |   | $                            | 77      |   | $ | — |   | $ | 29 |   | $ | 112 |   | $ | 146 |   |
| Real Estate Loans                                          |   | $                            | —  |   | $ | 4 |   | $ | — |   | $ | 37 |   | $ | 30 |   |
| Consumer Loans                                             |   | $                            | 4       |   | $ | 3 |   | $ | 95 |   | $ | 4 |   | $ | 51 |   |
| Credit Card Loans                                          |   | $                            | —  |   | $ | — |   | $ | 9 |   | $ | 63 |   | $ | 31 |   |
| Total                                                      |   | $                            | 81      |   | $ | 7 |   | $ | 133 |   | $ | 216 |   | $ | 258 |   |
|                                                       |   |                         |    |   |   |   |   |   |   |   |   |
| Recoveries                                                 |   |                         |    |   |   |   |   |   |   |   |   |
| Agricultural                                               |   | $                            | —  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial & Industrial Loans                          |   | $                            | —  |   | $ | 14 |   | $ | 16 |   | $ | 20 |   | $ | — |   |
| Real Estate Loans                                          |   | $                            | —  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer Loans                                             |   | $                            | 6       |   | $ | — |   | $ | 10 |   | $ | 1 |   | $ | 14 |   |
| Credit Card Loans                                          |   | $                            | —  |   | $ | — |   | $ | 4 |   | $ | — |   | $ | — |   |
| Total                                                      |   | $                            | 6       |   | $ | 14 |   | $ | 30 |   | $ | 21 |   | $ | 14 |   |
| Net Loan Charge-offs (Recoveries)                          |   | $                            | 75      |   | $ | (7 | ) | $ | 103 |   | $ | 195 |   | $ | 244 |   |
| Balance at end of period                                   |   | $                            | 3,587   |   | $ | 3,007 |   | $ | 2,397 |   | $ | 2,000 |   | $ | 1,390 |   |
|                                                       |   |                         |    |   |   |   |   |   |   |   |   |
| **Ratios:**                                                |   |                         |    |   |   |   |   |   |   |   |   |
| Net Loan Charge-offs to Average Loans                      |   | 0.03                         | %       | 0.00 | % | 0.05 | % | 0.13 | % | 0.21 | % |
| Allowance for Loan Losses to Gross Loans at  End of Period |   | 1.31                         | %       | 1.29 | % | 1.19 | % | 1.17 | % | 1.17 | % |
| Allowance for Loan Losses to Non-Performing  Loans         |   | 6,642.59                     | %       | 506.23 | % | 134.81 | % | 340.72 | % | 175.95 | % |

 

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 classification of loans are, to some extent, based onmanagement’s judgment and experience.

 

39

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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, loan concentrations and the rate ofportfolio growth are other qualitative factors 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 FDIC and the California Department of Financial Institutionsreview the allowance for loan losses as an integral part of the examinationprocesses.  Management believes that ourcurrent methodology is appropriate given our size and level of complexity.  Further, management believes that theallowance for loan losses is adequate as of December 31, 2003 to coverknown and inherent risks in the loan portfolio.  However, fluctuations in credit quality, or changes in economicconditions or other factors could cause management to increase or decrease theallowance 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.

 

**Allocation of Loan Loss Allowance**

(dollarsin thousands)

 
|              |   | **As of  December 31,** |   |
|-------------------|--------|------------------------------|--------|
|              |   | **2003**                     |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|              |   | **Amount**                   |   | **% Total  (1)  Loans** |   | **Amount** |   | **%  Total(1)  Loans** |   | **Amount** |   | **%  Total(1)  Loans** |   | **Amount** |   | **%  Total(1)  Loans** |   | **Amount** |   | **%  Total(1)  Loans** |   |
| Agricultural      |   | $                            | 179    |   | 7.58 | % | $ | 146 |   | 8.11 | % | $ | 142 |   | 9.66 | % | $ | 183 |   | 10.99 | % | $ | 170 |   | 14.76 | % |
| Commercial        |   | $                            | 1,258  |   | 21.01 | % | $ | 735 |   | 20.84 | % | $ | 494 |   | 21.16 | % | $ | 407 |   | 23.16 | % | $ | 348 |   | 28.13 | % |
| Real Estate       |   | $                            | 1,815  |   | 63.52 | % | $ | 1,379 |   | 62.78 | % | $ | 1,201 |   | 60.34 | % | $ | 874 |   | 55.99 | % | $ | 424 |   | 45.31 | % |
| Installment Loans |   | $                            | 335    |   | 7.89 | % | $ | 747 |   | 8.27 | % | $ | 560 |   | 8.84 | % | $ | 536 |   | 9.86 | % | $ | 448 |   | 11.80 | % |
| **TOTAL**         |   | $                            | 3,587  |   | 100.00 | % | $ | 3,007 |   | 100.00 | % | $ | 2,397 |   | 100.00 | % | $ | 2,000 |   | 100.00 | % | $ | 1,390 |   | 100.00 | % |
|                   |        |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

At December 31, 2002, the Company’s allowance for loan losses was$3.6 million.  The loan loss provisionsin 2003, 2002, and 2001 totaled $655,000, $603,000, and $500,000,respectively.  Over the past five years,net charge-offs have averaged $78,000. Through the diligent efforts of our loan officers and collectionpersonnel, the Company was able to end 2003 with net charge-offs of $75,000.

 

40

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**Other Loan PortfolioInformation**

 

Loan Concentrations:   The concentration profile of the Company’s loans is discussed inNote 7 to the accompanying Consolidated Financial Statements.

 

Loan Sales and Mortgage Servicing Rights:  The Company sells or brokers some of thefixed-rate single family mortgage loans it originates as well as other selectedportfolio loans.  Some are sold“servicing released” and the purchaser takes over the collection of thepayments.  However, most are sold with“servicing retained” and the Company continues to receive the payments from theborrower and forwards the funds to the purchaser.  The Company earns a fee for this service.  The sales are made without recourse, thatis, the purchaser cannot look to the Company in the event the borrower does notperform according to the terms of the note. Generally accepted accounting principles (“GAAP”) require companiesengaged in mortgage banking activities to recognize the rights to servicemortgage loans for others as separate assets. For loans originated for sale, a portion of the investment in the loanis attributed to the right to receive this fee for servicing and this value isrecorded as a separate asset.  Mortgageservicing assets are carried at their amortized cost, which approximates fairvalue.  At December 31, 2003 and2002, the amortized cost of these assets was $1,279,000 and $761,300 respectively.

 

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

 

The investment securities portfolio had a carrying value of $4.3million at December 31, 2003.  Inaccordance with SFAS No. 115 “Accounting for Certain Investments in Debt andEquity Securities”, the Company classified its investments into twoportfolios:  “held-to-maturity”, and“available-for-sale”.  While SFAS 115also provides for a trading portfolio classification, the Company has no investmentswhich are so classified.  Theheld-to-maturity portfolio should consist only of investments that the Companyhas both the intention and ability to hold until maturity, to be sold only inthe event of concerns with an issuer’s creditworthiness, a change in tax lawthat eliminates their tax exempt status or other infrequent situations aspermitted by SFAS 115.  Given the smalland non complex nature of the portfolio, management does not rely heavily onthese investments as a source of funds for the loan portfolio and therefore hasnot classified many of them as available-for-sale.

 

Securities pledged as collateral on repurchase agreements, publicdeposits and for other purposes as required or permitted by law were $1,004,000and $480,200, for December 31, 2003 and 2002, respectively.

 

The investment portfolio was increased in size in 2003 to $4.3 millionat the end of the year from its starting balance of $3.4 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 2003, with a shift out ofmunicipal obligations and into U.S. Agency issues which are the largest portionof the total portfolio at 82.7%, up from 64.7% at the end of 2002.  Municipal issues comprised 17.3% of totalinvestments at the end of 2003, down from 35.3% at the end of 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.

 

**Investment Portfolio**

(dollarsin thousands)

 
|                                      |   | **As of  December 31,** |   |
|-------------------------------------------|--------|-----------------------------------|--------|
|                                      |   | **2003**                          |   | **2002** |   | **2001** |   |
|                                      |   | **Amortized  Cost**               |   | **Fair  Market  Value** |   | **Amortized  Cost** |   | **Fair Market  Value** |   | **Amortized  Cost** |   | **Fair  Market  Value** |   |
| **Held to maturity**                      |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| US Government Agencies & Corporations |   | 3,277                             |   | 3,270 |   | 1,882 |   | 1,910 |   | 619 |   | 625 |   |
| State & political subdivisions        |   | 545                               |   | 554 |   | 991 |   | 1,014 |   | 1,888 |   | 1,912 |   |
| **Total held to  maturity**               |   | $                                 | 3,822  |   | $ | 3,824 |   | $ | 2,873 |   | $ | 2,924 |   | $ | 2,507 |   | $ | 2,537 |   |
| **Available for sale**                    |   |                              |   |   |   |   |   |   |   |   |   |   |   |
| US Government Agencies & Corporations |   | 300                               |   | 302 |   | 300 |   | 314 |   | 300 |   | 300 |   |
| State & political subdivisions        |   | 200                               |   | 200 |   | 200 |   | 200 |   | 200 |   | 200 |   |
| **Total available for  sale**             |   | $                                 | 500    |   | $ | 502 |   | $ | 500 |   | $ | 514 |   | $ | 500 |   | $ | 500 |   |
| **Total Investment  Securities**          |   | $                                 | 4,322  |   | $ | 4,326 |   | $ | 3,373 |   | $ | 3,438 |   | $ | 3,007 |   | $ | 3,037 |   |

 

41

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The investment maturities table below summarizes the maturity of theCompany’s investment securities and their weighted average yields atDecember 31, 2003.  Expectedremaining maturities may differ from remaining contractual maturities because obligorsmay have the right to repay certain obligations with or without penalties.

 

**Investment Maturities**

(dollarsin thousands)

 
|                                      |   | **As of  December 31, 2003** |   |
|-------------------------------------------|--------|-----------------------------------|--------|
|                                      |   | **Within One  Year**              |   | **After One  But  Within Five Years** |   | **After Five  Years But  Within Ten Years** |   | **After Ten  Years** |   | **Total** |   |
|                                      |   | **Amount**                        |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   |
| **Held to maturity**                      |   |                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US Government agencies & corporations |   | $                                 |   |   | n/a |   | $ | 48 |   | 6.20 | % | $ | 2,765 |   | 5.03 | % | $ | 189 |   | 5.85 | % | $ | 3,002 |   | 5.10 | % |
| State & political subdivisions        |   | 308                               |   | 6.55 | % | 512 |   | 6.31 | % | — |   | n/a |   | — |   | n/a |   | 820 |   | 6.40 | % |
| **Total held to  maturity**               |   | $                                 | 308    |   | 6.55 | % | $ | 560 |   | 6.30 | % | 2,765 |   | 5.03 | % | $ | 189 |   | 5.85 | % | $ | 3,822 |   | 5.38 | % |
| **Available for sale**                    |   |                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US Government agencies & corporations |   | —                            |   | n/a |   | — |   | n/a |   | 302 |   | 6.25 | % | — |   | n/a |   | 302 |   | 6.25 | % |
| State & political subdivisions        |   | —                            |   | n/a |   | — |   | n/a |   | 200 |   | 7.00 | % | — |   | n/a |   | 200 |   | 7.00 | % |
| **Total available for  sale**             |   | $                                 | — |   | n/a |   | $ |   |   | n/a |   | $ | 502 |   | 6.55 | % | $ |   |   | n/a |   | $ | 502 |   | 6.55 | % |
| **Total investment  securities**          |   | $                                 | 308    |   | 6.55 | % | $ | 560 |   | 6.30 | % | $ | 3,267 |   | 5.26 | % | $ | 189 |   | 5.85 | % | $ | 4,324 |   | 5.52 | % |

 

###### **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, 2003 these areas comprised 6.8% of totalassets, as compared to 4.6% of total assets at December 31, 2002.  The Company strives to maintain vault cashat a level consistent with the withdrawal needs of the customers.  Included in the vault cash amount forDecember 31, 2003 is $10 million the Bank has committed to fund ATM’sthrough a program facilitated by one of the Bank’s correspondent bankaffiliations.    This is not a loan, orovernight fed funds sold, as there is no physical counterparty.  This program merely provides for theadvancement of cash into an ATM in the form of currency. The bank receives thefederal funds target rate for the day plus 50 basis points on the outstandingdaily balance.

 

The Company’s operating branches lie within the Federal Reserve Bank(FRB) of San Francisco’s responsibility area of check clearing activities,while the Company’s item processing activities are performed in Chico. As aresult, a greater volume of the Company’s balances with correspondent bankshave been uncollected funds, and therefore due from bank balances could begreater than similar size institutions in metropolitan areas closer to SanFrancisco where collection activity is more centralized.  However, if and when the Federal ReserveBank starts 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.  Depreciation expense was $933,000 for theyear ended December 31, 2003 as compared to $743,000 during 2002.  The following premises and equipment tablereflects the balances by major category of fixed assets:

 

42

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**Premises & Equipment**

(dollars in thousands)

 
|                     |   | **As of  December 31,** |   |
|--------------------------|--------|------------------------------|--------|
|                     |   | **2003**                     |   | **2002** |   | **2001** |   |
|                     |   | **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 |   | $ | 1,193 |   | $ | — |   | $ | 1,193 |   |
| Buildings                |   | $                            | 5,667  |   | $ | 946 |   | $ | 4,721 |   | $ | 4,633 |   | $ | 773 |   | $ | 3,860 |   | $ | 3,565 |   | $ | 674 |   | $ | 2,891 |   |
| Leasehold Improvements   |   | $                            | 690    |   | $ | 168 |   | $ | 522 |   | $ | 330 |   | $ | 144 |   | $ | 186 |   | $ | 127 |   | $ | 122 |   | $ | 5 |   |
| Construction in progress |   | $                            | 138    |   | $ | — |   | $ | 138 |   | $ | 103 |   | $ | — |   | $ | 103 |   | $ | 418 |   | $ | — |   | $ | 418 |   |
| Furniture and Equipment  |   | $                            | 5,106  |   | $ | 3,126 |   | $ | 1,980 |   | $ | 3,977 |   | $ | 2,665 |   | $ | 1,312 |   | $ | 3,333 |   | $ | 2,197 |   | $ | 1,136 |   |
| **Total**                |   | $                            | 12,794 |   | $ | 4,240 |   | $ | 8,554 |   | $ | 10,236 |   | $ | 3,582 |   | $ | 6,654 |   | $ | 8,636 |   | $ | 2,993 |   | $ | 5,643 |   |

 

The net book value of the Company’s premises and equipment increased by$1.9 million in 2003 primarily due to the opening of the new North Paradise andNorth Chico branches.   As a percentageof total assets, the Company’s premises and equipment was to 2.2%, at the endof 2003, 2.0% at the end of 2002 and 2.1% at the end of 2001.

 

###### **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 $343 million at the endof 2003, as compared to $298 million at the end of 2002.  Deposit growth of $45 million was achievedduring 2003, both as a result of the two new branches opening and the growth ofthe other six branches within the system. A significant change in the mix of the deposits took place during 2003with lower cost core deposit accounts (demand deposits, NOW accounts, moneymarket, and savings) increasing by 20% or $44 million while the higher costcertificates of deposit balances only increased by 1% or $1 million.

 

As deposit rates continued to decline throughout 2003 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.

 

43

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The scheduled maturity distribution of the Company’s time deposits asof December 31, 2003 was as follows:

 

**Deposit MaturityDistribution**

(dollars in thousands)

 
|                                        |   | **As of  December 31, 2002** |   |
|---------------------------------------------|--------|-----------------------------------|--------|
|                                        |   | **Three  months  or less**        |   | **Three  to twelve  months** |   | **One  to three  years** |   | **Over  three  Years** |   | **Total** |   |
|                                        |   |                              |   |   |   |   |   |   |   |   |   |
| Time Certificates of Deposits < $100,000 |   | $                                 | 14,478 |   | $ | 18,958 |   | $ | 17,396 |   | $ | 1,355 |   | $ | 52,187 |   |
|                                        |   |                              |   |   |   |   |   |   |   |   |   |
| Other Time Deposits > $100,000           |   | $                                 | 5,240  |   | $ | 6,130 |   | $ | 19,997 |   | $ | 1,453 |   | $ | 32,820 |   |
|                                        |   |                              |   |   |   |   |   |   |   |   |   |
| TOTAL                                       |   | $                                 | 19,718 |   | $ | 25,088 |   | $ | 37,393 |   | $ | 2,808 |   | $ | 85,007 |   |

 

**Other Borrowings**

 

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 ofMarch 8, 2008.  AtDecember 31, 2003, the interest rate was 4.25%.  Advances on the line of credit totaled $831,900, 733,100 and 851,500at December 31, 2003, 2002 and 2001, respectively.  A summary of the activity in this line ofcredit 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, 2003 and 2002.

 

ESOP Note Payable

(dollarsin thousands)

 
|                                        |   | **2003** |   | **2002** |   | **2001** |   |
|---------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                        |   |     |   |     |   |     |   |
| Balance at December 31                 |   | $        | 832    |     | $      | 733      |   | $ | 851 |   |
|                                        |   |     |   |     |   |     |   |
| Average amount outstanding                  |   | $        | 786    |     | $      | 788      |   | $ | 770 |   |
|                                        |   |     |   |     |   |     |   |
| Maximum amount outstanding at any month end |   | $        | 843    |     | $      | 843      |   | $ | 885 |   |
|                                        |   |     |   |     |   |     |   |
| Average interest rate for the year          |   | 4.15     | %      | 4.67     | %      | 7.04     | %      |

 

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

 

At December 31, 2003, the Company had total shareholders equity of$29.9 million, comprised of $6.2 million in common stock, and $23.7 million inretained earnings. Total shareholders equity at the end of 2002 was $25.4million.  Net income has provided $13.9million in capital over the last three years, of which $2.6 million orapproximately 19% was distributed in dividends.  The retention of earnings has been the Company’s main source ofcapital since 1990, however the Company issued $8.2 million in SubordinatedDebentures in 2002, the proceeds of which are considered Tier 1 capital forregulatory purposes but long-term debt in accordance with generally acceptedaccounting principles.

 

The Company paid quarterly cash dividends totaling $1,080,000 or $.308per share in 2003 and $882,200 or $.248 per share in 2002, representing 20% and18%, 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 19% 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.

 

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In June 2003, the Board of Directors approved a plan to repurchaseup to $3,000,000 of the outstanding common stock of the Company.  Stock repurchases may be made from time totime on the open market or through privately negotiated transactions.  The timing of purchases and the exact numberof shares to be purchased will depend on market conditions.  The share repurchase program does notinclude specific price targets or timetables and may be suspended at any time.  No shares were repurchased under thisprogram in 2003.

 

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 external guidelines.  The external guidelines, which are issued bythe FDIC, establish a risk-adjusted ratio relating capital to differentcategories of assets and off balance sheet exposures.  There are two categories of capital under the FDIC guidelines:Tier 1 and Tier 2 Capital.  Tier 1Capital includes common shareholders’ equity and the proceeds from the issuanceof trust-preferred securities (subject to the limitations previouslydiscussed), less goodwill and certain other deductions, notably the unrealizednet gains or losses (after tax adjustments) on securities available for sale,which are carried at fair market value. Tier 2 Capital includes preferred stock and certain types of debtequity, which the Company does not hold, as well as the allowance for loanlosses, subject to certain limitations. (For a more detailed definition, see“Item 1, Business-Supervision and Regulation — Capital Adequacy Requirements”herein.)

 

At December 31, 2003, the Company had a Tier 1 risk based capitalratio of 12.2%, a total capital to risk-weighted assets ratio of 13.4%, and aleverage ratio of 10.4%.  The Companyhad a Tier 1 risk-based capital ratio of 12.8%, a total risk-based capitalratio of 14%, and a leverage ratio of 10.4% at December 31, 2002.  Note 11 of the Notes to ConsolidatedFinancial Statements provides more detailed information concerning theCompany’s capital amounts and ratios as of December 31, 2003 and 2002.

 

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.

 

**Off-Balance Sheet Items and ContractualObligations**

 

The Company has certain ongoing commitments under operating leases. SeeNote 7 to the consolidated financial statements at Item 8 of this report forthe terms. These commitments do not significantly impact operating results. Asof December 31, 2003 commitments to extend credit were the Company’s onlyfinancial instruments with off-balance sheet risk.  Loan commitments increased to $138 million from $104 million atDecember 31, 2002. The commitments represent 49% of the total loansoutstanding at year-end 2003 versus 44% at December 31, 2002.

 

The following chart summarizes certain contractual obligations of theCompany as of December 31, 2003:

 
|                              |   | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   | **More than  5 years** |   | **Total** |   |
|-----------------------------------|--------|-----------------------|--------|---------------|--------|---------------|--------|------------------------|--------|-----------|--------|
|                              |   |                  |   |          |   |          |   |                   |   |      |   |
| Subordinated debentures           |   | —                |   | —        |   | —        |   | 8,248                  |   | 8,248     |   |
| Operating lease obligations       |   | 406                   |   | 822           |   | 774           |   | 2,682                  |   | 4,684     |   |
| Deferred compensation (1)         |   | —                |   | —        |   | —        |   | 1,569                  |   | 1,569     |   |
| Supplemental retirement plans (1) |   | 106                   |   | 221           |   | 235           |   | 1,925                  |   | 2,487     |   |
| ESOP note payable                 |   |                  |   |          |   |          |   | 832                    |   | 832       |   |
|                              |   |                  |   |          |   |          |   |                   |   |      |   |
| Total contractual obligations     |   | $                     | 512    |          | $      | 1,043         |   | $                      | 1,009  |      | $      | 15,256 |   | $ | 17,820 |   |
|                                   |        |                       |        |               |        |               |        |                        |        |           |        |  |  |  |  |  |

 

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(1)   These amounts represent knowncertain payments to participants under the Company’s deferred compensation andsupplemental   retirement plans. SeeNote 15 to the consolidated financial statements at Item 8 of this report foradditional information related to the Company’s deferred compensation andsupplemental retirement plan liabilities.

 

###### **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.

 

45

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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 coincide withanticipated outflows, or sufficient liquidity resources must be available tomeet varying demands.  The Companymanages its own liquidity in such a fashion as to be able to meet unexpectedsudden changes in levels of its assets or deposit liabilities, withoutmaintaining excessive amounts of on-balance sheet liquidity.  Excess 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

 

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 the Company’sinvestment, 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 usesseven standard interest rate scenarios in conducting the simulation, namelystable, an upward shock of 100, 200, and 300 basis points, and a downward shockof 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 ofDecember 31, 2003, the Company had the following estimated net interestmargin sensitivity profile:

 
|                   |   | **Immediate  Change in Rate** |     | **Immediate  Change in Rate** |   | **Immediate  Change in Rate** |   |
|------------------------|--------|-------------------------------|----------|-------------------------------|--------|-------------------------------|--------|
|                   |   | **+100 bp**                   |     | **-100 bp**                   |   | **+200 bp**                   |   | **-200 bp** |   | **+300 bp** |   | **-300 bp** |   |
| Net Int. Income Change |   | $                             | (561,000 | )                             | $      | 555,000                       |   | $ | 286,000 |   | $ | 714,000 |   | $ | 1,137,000 |   | $ | 739,000 |   |
|                        |        |                               |          |                               |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

The above profile illustrates that if there were an immediate increaseof 200 basis points in interest rates, the Company’s annual net interest incomewould likely increase by around $286,000, or approximately 1.77%.  Likewise, if there were an immediatedownward adjustment of 200 basis points in interest rates, the Company’s net interestincome would likely increase by approximately $714,000, or 4.43%, over the nextyear.  The relationship between thechange in net interest income under rising and declining rate scenarios istypically inversely proportionate.  However, given the current interest rate environment and the unlikelyprospect that interest rates will go any lower the company’s balance sheet ispositioned to benefit from rising rates with the exception of the 100 basispoints up scenario.  In this case, thecompany would actually see a decline in the net interest margin because offloors put in place on variable rate loans during the past two years as rateswere declining rapidly.  Many of theseloans would not adjust up because the floor rates assigned to them would be higherthan the adjusted rates.

 

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

 

46

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likelihood of prepayment or repayment, whether its rate is fixed orfloating, the maturity of the instrument and the particular circumstances ofthe customer.  The quantification of 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.

 

**SelectedQuarterly Financial Data**

 
| **Quarterly Financial Data**                         |   | **(Dollars  in thousands, except per share data)**  |       |
|------------------------------------------------------|--------|-----------------------------------------------------|------------|
| **2003 Quarter**                                     |   | **1st**                                             |       | **2nd** |   | **3rd** |   | **4th** |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Interest income                                      |   | $                                                   | 5,053      |   | $ | 5,164 |   | $ | 5,525 |   | $ | 5,775 |   |
| Net Interest income                                  |   | $                                                   | 3,902      |   | $ | 4,033 |   | $ | 4,449 |   | $ | 4,736 |   |
| Net interest income after provision for  loan losses |   | $                                                   | 3,752      |   | $ | 3,913 |   | $ | 4,239 |   | $ | 4,561 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Net Income                                           |   | $                                                   | 1,037      |   | $ | 1,116 |   | $ | 1,434 |   | $ | 1,682 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Net income per share, basic                          |   | $                                                   | .29        |   | $ | .31 |   | $ | .41 |   | $ | .49 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Net income per share, diluted                        |   | $                                                   | .28        |   | $ | .30 |   | $ | .38 |   | $ | .46 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Dividends Declared                                   |   | $                                                   | .075       |   | $ | .075 |   | $ | .075 |   | $ | .075 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| **Quarterly Financial Data**                         |   | **(Dollars  in thousands, except per share data )** | ** ** |
| **2002 Quarter**                                     |   | **1st**                                             | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Interest income                                      |   | $                                                   | 4,417      |   | $ | 4,379 |   | $ | 4,891 |   | $ | 5,290 |   |
| Net Interest income                                  |   | $                                                   | 3,077      |   | $ | 3,212 |   | $ | 3,773 |   | $ | 4,140 |   |
| Net interest income after provision for  loan losses |   | $                                                   | 2,974      |   | $ | 3,062 |   | $ | 3,623 |   | $ | 3,940 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Net Income                                           |   | $                                                   | 1,253      |   | $ | 972 |   | $ | 1,292 |   | $ | 1,332 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Net income per share, basic                          |   | $                                                   | 0.37       |   | $ | 0.29 |   | $ | 0.37 |   | $ | 0.37 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Net income per share, diluted                        |   | $                                                   | 0.35       |   | $ | 0.27 |   | $ | 0.35 |   | $ | 0.36 |   |
|                                                 |   |                                                |       |   |   |   |   |   |   |
| Dividends Declared                                   |   | $                                                   | 0.056      |   | $ | 0.056 |   | $ | 0.06 |   | $ | 0.075 |   |

 

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

 

The financial statements begin on page 65 of this report

 

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

 

There were no changes or disagreements with Accountants for the year2003.

 

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

 

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

 

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**PART III**

 

**Item 10****.   Directorsand Executive Officers of the Registrant**

 

The following table sets forth, as of March 1, 2004, the names of,and certain information regarding, the directors of Community Valley Bancorp.

 
| **Name and Title  Other than Director**  |   | **Age** |   | **Year First  Appointed  Director** |   | **Principal  Occupation  During the  Past Five Years**                                                                                        |   |
|------------------------------------------|--------|---------|--------|-------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| M. Robert Ching, M.D.                    |   | 58      |   | 2002                                |   | Orthopedic surgeon.                                                                                                                           |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Eugene B. Even                           |   | 76      |   | 2002                                |   | Retired.                                                                                                                                      |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| John D. Lanam                            |   | 69      |   | 2002                                |   | Retired.  Former attorney and  senior partner of McKernan, Lanam, Bakke, Benson & Bodney, a law firm.                                |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Donald W. Leforce  Chairman of the Board |   | 56      |   | 2002                                |   | President and former Secretary/Treasurer of Compass Equipment, Inc.,  a mining and heavy equipment manufacturing corporation.                 |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Charles J. Mathews                       |   | 66      |   | 2003                                |   | Owner of Mathews Farms and Partner in Mathews Rice Dryer.                                                                                     |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Ellis L. Matthews                        |   | 70      |   | 2002                                |   | Retired.  Former certified  public accountant and senior partner of Matthews & Hutton, an accountancy  firm.                         |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Robert L. Morgan, M.D.                   |   | 76      |   | 2002                                |   | Retired.                                                                                                                                      |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| James S. Rickards  Secretary             |   | 53      |   | 2002                                |   | Real estate broker associated with Century 21 Select since April,  2000.  Former broker associate with  Prudential California from 1998. |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Keith C. Robbins  President/CEO          |   | 62      |   | 2002                                |   | President and Chief Executive Officer of the Bank.                                                                                            |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Gary B. Strauss, M.D.  Vice Chairman     |   | 73      |   | 2002                                |   | Retired.                                                                                                                                      |   |
|                                     |   |    |   |                                |   |                                                                                                                                          |   |
| Hubert I. Townshend                      |   | 67      |   | 2002                                |   | Semi-retired.  Involved in  general engi-neering, contracting and equipment rental.  Past partner of S&T Logging Co. Inc.       |   |

 

None of the directors were selected pursuant to any arrangement orunderstanding other than with the directors and executive officers (1) ofCommunity Valley Bancorp acting within their capacities as such.  There are no family relationships betweenany of the directors of Community Valley Bancorp.  No director of Community Valley Bancorp serves as a director ofany company which has a class of securities registered under, or which issubject to the periodic reporting requirements of the Securities Exchange Actof 1934, or of any company registered as an investment company under theInvestment Company Act of 1940.

 

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(1)  As used in this statement,the term “executive officer” of Community Valley Bancorp includes thePresident/Chief Executive Officer and the Executive Vice President/ChiefFinancial Officer-Chief Operating Officer.

 

**Compensation of Directors**

 

During 2003, directors, other than Mr. Robbins, received a base fee of$800.00 per month for serving as directors (provided the director attends 75%of the meetings) and received additional fees for chairing meetings andattending meetings.  Mr. Robbinsalso received a base fee of $800.00 per month for serving as a director.  Community Valley Bancorp’s Chairman of theBoard also received an additional $300 per month for serving as theChairman.  Any director, other than Mr.Robbins, who chaired a Board of Directors or committee meeting which met duringthe month received an additional $50.00 per month for serving as the chairman.  In addition, directors, other thanMr. Robbins, but including the chairman, who attended any Board meetingalso received an additional $315.00 per Board of Directors meetingattended.  Directors, other than Mr.Robbins, but including the chairman of any committee, who attended any committeemeeting held at the same gathering as a Board of Director’s meeting (other thanone committee meeting held concurrently with the Board meeting) also receivedan additional $50.00 per committee meeting attended.  Directors, other than Mr. Robbins, but including the chairman ofany committee, who attended any other committee meeting received $300 percommittee meeting attended.  Inaddition, if any Board of Directors or committee meeting extended beyond threehours, directors, other than Mr. Robbins, received an additional $105.00 perhour for each hour the meeting extended over three hours, subject to a maximumadditional $210.00 per meeting. Directors, other than Mr. Robbins, who traveled to a Board of Directorsor committee meeting held outside the town of the director’s residence receivedan additional $15.00 travel fee per meeting and all other travel in connectionwith the Board of Director’s or Community Valley Bancorp’s activities wascompensated at $.31 per mile.  During2004, the compensation to directors will be the same as the compensation during2003.

 

In May, 1997, each director of Community Valley Bancorp received astock option under Community Valley Bancorp’s 1997 Stock Option Plan to acquire13,197 shares of common stock, post the four 4-for-3 stock splits.  The exercise price for these shares is $4.63per share, post the four 4-for-3 stock splits. The options are for a term of ten years expiring in May, 2007 and are100% vested.  In addition, in May, 2000,each director of Community Valley Bancorp, other than Mr. Robbins,received a stock option under Community Valley Bancorp’s 2000 Stock Option Planto acquire 13,333 shares of common stock, post the two 4-for-3 stocksplits.  The exercise price for theseshares is $9.42 per share, post the two 4-for-3 stock splits.  The options are for a term of ten yearsexpiring in May, 2010.  The vesting ofthe director options is 20% of the total option amount per year with the first20% amount having vested in May, 2001.

 

**Director Retirement Agreements**

 

In April, 1998, each director of Community Valley Bancorp, other thanMr. Robbins, entered into a Director Retirement Agreement which provides forthe payment of a monthly retirement benefit for a period of sixty months basedupon an individualized vesting schedule which takes into account the yearsof service as a director and each director’s individual retirement age.  The agreement also pays in the event of achange in control of Community Valley Bancorp or disability or death of thedirector.  The vestingschedule provides for a maximum payment of $500 per month.

 

**Director Deferred Fee Agreements**

 

Directors of Community Valley Bancorp have the option of participatingin Community Valley Bancorp’s Director Deferred Fee Program.  Pursuant to the Director Deferred FeeProgram, directors make an initial deferral election by filing with CommunityValley Bancorp a signed election form which sets forth the amount of thedirector’s fees to be deferred. Community Valley Bancorp then establishes a Deferral Account on itsbooks for the director and credits to the Deferral Account the fees deferred bythe director and interest on the account balance at a rate equal to CommunityValley Bancorp’s prime lending rate as of December 31 of the previous yearplus one-half percent compounded each December 31 and assuming alldeferrals have been made as of January 1 of such year.  The Deferral Account is not a trust fund ofany kind and the director is a general unsecured creditor of Community ValleyBancorp for the payment of the benefits. Benefits under the Director Deferred Fee Program are payable upon thedirector’s termination of service.  Theamount of benefit payable is the Deferral Account balance at the date oftermination of service.  This amountshall be paid to the director in 120 monthly installments commencing on thefirst day of the month following the director’s termination of service.  Dr. Ching and Mr. Leforce have each enteredinto Director Deferred Fee Agreements with Community Valley Bancorp.

 

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**Director Emeritus Plan**

 

During 2001, Community Valley Bancorp also established a DirectorsEmeritus Plan.  Those directors who haveserved ten or more consecutive years as an outside director and any outside directorswho have served five or more consecutive years as an outside director andimmediately prior thereto served five or more years as an inside director, areeligible to participate in the Directors Emeritus Plan.  Each Director Emeritus will be a five yearposition or until a Director Emeritus shall sell a majority of his or herownership in Community Valley Bancorp. Directors Emeritus will receive a monthly fee equal to a percent of thebase director fee they were receiving for serving as a director at the timethey became Director Emeritus.  For thefirst year, they shall receive 90%, for the second year, they shall receive80%, for the third year, they shall receive 60%, for the fourth year, theyshall receive 50%, and for the fifth year, they shall receive 40%.  In the event of any merger, consolidation ofacquisition where Community Valley Bancorp is not the surviving entity, theDirector Emeritus Plan shall remain in full force and effect; provided,however, the resulting corporation may elect to pay the Director Emeritus alump sum amount in cash equal to 50% of the remaining benefits due the DirectorEmeritus.

 

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**Executive Officers**

 

The following table sets forth information, as of March 1, 2004, concerningexecutive officers of Community Valley Bancorp:

 
| **Name**         |   | **Age** |   | **Position  and Principal Occupation  For the Past Five Years**                                                |
|------------------|--------|---------|--------|----------------------------------------------------------------------------------------------------------------|
| Keith C. Robbins |   | 62      |   | President and Chief Executive Officer of Community Valley Bancorp                                              |
|             |   |    |   |                                                                                                           |
| John F. Coger    |   | 54      |   | Executive Vice President and Chief Financial Officer and Chief  Operating Officer of Community Valley Bancorp. |

 

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**Item 11****.  ExecutiveCompensation**

 

The persons serving as the executive officers of Community Valley Bancorpreceived during 2003, and are expected to continue to receive in 2004, cashcompensation in their capacities as executive officers of Community ValleyBancorp

 

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

 

**SummaryCompensation Table**

 
| **Annual  Compensation**         |   | **Long Term  Compensation** |   |            |    |
|----------------------------------|--------|-----------------------------|--------|-----------------|---------|
| **Awards**                       |   | **Payouts**                 |
| **(a)**                          |   | **(b)**                     |   | **(c)**         |    | **(d)** |   | **(e)** |   | **(f)** |   | **(g)** |   | **(h)** |   | **(i)** |   |
| **Name and  Principal Position** |   | **Year**                    |   | **Salary  ($)** |    | **Bonus  ($)** |   | **Other  Annual  Compen-  sation  ($)** |   | **Restricted  Stock  Award(s)  ($)** |   | **Options/  SARS** |   | **LTIP  Payouts  ($)** |   | **All Other  Compen-  sation  ($)(3)(4)** |   |
| Keith C Robbins                  |   | 2003                        |   | $               | 234,108 | (2) | $ | 237,527 |   | 0 |   | 0 |   |   |   | 0 |   | $ | 19,129 |   |
| President and Chief              |   | 2002                        |   | $               | 216,121 | (1) | $ | 240,851 |   | 0 |   | 0 |   |   |   | 0 |   | $ | 17,242 |   |
| Executive Officer                |   | 2001                        |   | $               | 175,253 | (1) | $ | 230,159 |   | 0 |   | 0 |   |   |   | 0 |   | $ | 13,122 |   |
|                             |   |                        |   |            |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| John F Coger                     |   | 2003                        |   | $               | 145,140 |   | $ | 181,654 |   | 0 |   | 0 |   |   |   | 0 |   | $ | 10,948 |   |
| Executive Vice President         |   | 2002                        |   | $               | 135,644 |   | $ | 185,012 |   | 0 |   | 0 |   |   |   | 0 |   | $ | 10,255 |   |
| and Chief Financial Officer      |   | 2001                        |   | $               | 104,060 |   | $ | 189,441 |   | 0 |   | 0 |   |   |   | 0 |   | $ | 9,452 |   |

 

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(1) Includes $6,300 in directors fees

(2) Includes $9,600 in directors fees

(3) This amount represents Community ValleyBancorp’s contribution under Community Valley Bancorp’s Employee StockOwnership Plan, and the cost of premiums for excess medical, dental and lifeinsurance

(4) This amount does not include CommunityValley Bancorp’s contribution under Community Valley Bancorp’s Employee StockOwnership Plan as such amount has not yet been determined.

 

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**Option/SARExercises and Year-End Value Table****Aggregated Option/SAR Exercises in Last Fiscal Year andYear-End Option/SAR Value**

 
| **(a)**         |   | **(b)**                               |   | **(c)**                  |   | **(d)**                                                                                |   | **(e)**                                                                                              |   |
|-----------------|--------|---------------------------------------|--------|--------------------------|--------|----------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|
| **Name**        |   | **Shares  Acquired on  Exercise (#)** |   | **Value  Realized  ($)** |   | **Number of  Unexercised  Options/SARs at  Year-End (#)  Exercisable/  Unexercisable** |   | **Value of  Unexercised In-  the-Money  Options/SARs at  Year-End ($)  Exercisable/  Unexercisable** |   |
|            |   |                                  |   |                     |   | Options Only                                                                           |   | Options Only                                                                                         |   |
| Keith C Robbins |   | -0-                                   |   | -0-                      |   | 18,056/8,000                                                                           |   | $256,983/$86,640                                                                                     |   |
|            |   |                                  |   |                     |   |                                                                                   |   |                                                                                                 |   |
|            |   |                                  |   |                     |   | Options Only                                                                           |   | Options Only                                                                                         |   |
| John F Coger    |   | -0-                                   |   | -0-                      |   | 5,333/8,000                                                                            |   | $57,756/$86,640                                                                                      |   |

 

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Mr. Robbins has a three year employment contract with Community ValleyBancorp beginning April 27, 1995 and which currently expiresApril 27, 2004.  In addition,unless the employment contract is otherwise terminated, the term of theemployment contract shall automatically extend in annual increments of one yearso as to always remain a three year employment contract.  Mr. Robbins’ annual salary is currentlyfixed at $234,108 and may be renegotiated. Under the terms of the employment contract, Mr. Robbins is entitledto incentive compensation provided that Community Valley Bancorp attains aminimum 10% return on equity each year, as well as other criteria.  In the event Community Valley Bancorpattains the minimum 10% return on equity, as well as meeting otherrequirements, a bonus pool will be established in an amount equal to 21.5% ofthe amount in excess of the 10% return on equity.  Mr. Robbins will be entitled to incentive compensation in theamount of 38.45% of the bonus pool. Mr. Robbins’ employment contract provides that in the event hebecomes disabled, he shall be entitled to 100% of his salary for ninetydays.  In addition, if Community ValleyBancorp is merged, sold or acquired and the merging, purchasing or acquiringentity elects not to employ Mr. Robbins in a like position, he shall paidan amount equal to the remaining term of the employment contract.

 

Mr. Robbins has a salary continuation agreement with Community ValleyBancorp which provides that Community Valley Bancorp will pay him $150,000 plusa 3% cost of living adjustment per year for 20 years following his retirementfrom Community Valley Bancorp at age 65 (“Retirement Age”), or until the deathof the Employee whichever event last occurs In the event of disability while Mr. Robbins is actively employedprior to Retirement Age, he will have the option to take the $150,000 plus a 3%cost of living adjustment per year for 20 years beginning at the earlier of thetime when he reaches age 65 or the date on which he is no longer entitled todisability benefits under his principal disability insurance policy.  In the event Mr. Robbins dies while activelyemployed by Community Valley Bancorp prior to Retirement Age, his beneficiarywill receive from Community Valley Bancorp $150,000 plus a 3% cost of livingadjustment per year for 20 years beginning one month after his death.  In the event of termination without cause,early retirement, or voluntary termination, Mr. Robbins shall receive $150,000plus a 3% cost of living adjustment per year for 20 years beginning with themonth following the month in which Mr. Robbins terminates employment andattains age 65.  In the event Mr.Robbins is terminated for cause he will forfeit any benefits from the salarycontinuation agreement.

 

Mr. Robbins has an Executive Supplemental Retirement Plan Agreementthat provides him with the option of deferring a portion of his salary.  Mr. Robbins has elected to defer $20,000 peryear.  Community Valley Bancorp hasestablished a Deferral Account on its books for Mr. Robbins and credits tothe Deferral Account the fees deferred by Mr. Robbins and interest on theaccount balance at a rate equal to Community Valley Bancorp’s prime lendingrate as of December 31 of the previous year plus one-half percentcompounded each December 31 and assuming all deferrals have been made asof January 1 of such year.  Inaddition, Community Valley Bancorp has purchased an annuity for protection ofthe benefits.  All earnings receivedabove Community Valley Bancorp’s normal anticipated after tax return earningson the annuity and the cost of an insurance policy related to this benefit arealso credited to Mr. Robbins’ Deferral Account.  The Deferral Account is not a trust fund of any kind and Mr.Robbins is a general unsecured creditor of Community Valley Bancorp for thepayment of the benefits.  Benefits underthe Supplemental Retirement Plan Agreement are payable upon Mr. Robbins’termination of service.  Upon Mr.Robbins’ retirement at age 65, he will be entitled to the Deferral Accountbalance in one hundred eighty (180) monthly installments beginning on the firstday of the month following his retirement, unless Mr. Robbins elects oneyear prior to receiving any benefits to take benefits in a lump sum orotherwise.  If Mr. Robbins retires orterminates service prior to the age of 65, the amount of benefit payable isalso the Deferral Account balance at the date of termination of service in onehundred eighty (180) monthly installments beginning on the first day of monthfollowing his attaining age 65, unless Mr. Robbins elects one year priorto receiving any benefits to take benefits in a lump sum or otherwise.  If termination of service occurs due todisability, the amount of benefit payable is also the Deferral Account balanceat the date of termination of service in one hundred eighty (180) monthlyinstallments beginning on the first day of month following his disability,unless Mr. Robbins elects one year prior to receiving any benefits to takebenefits in a lump sum or otherwise.  Iftermination of service occurs due to a change in control of Community ValleyBancorp, Community Valley Bancorp shall credit Mr. Robbins’ Deferral Accountwith the entire amount that Mr. Robbins would have deferred for the entiredeferral period, and the amount of benefit shall be paid to Mr. Robbins within30 days of the change in control.  IfMr. Robbins suffers hardship, Community Valley Bancorp may distribute tohim all or a portion of the Deferral Account balance as necessary to relievethe financial hardship.  Finally, iftermination of service occurs due to Mr. Robbins’ death, Community ValleyBancorp shall credit Mr. Robbins’ Deferral Account with the entire amount thatMr. Robbins would have deferred for the entire deferral period utilizing theproceeds from the insurance policy which Community Valley Bancorp purchased inconnection with this agreement.  Theamount shall be paid in one hundred eighty (180) monthly installments beginningon the first day of the month following his death.  Interest accrues on all amounts deferred until final payment.

 

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Mr. Coger has a three year employment contract with Community ValleyBancorp beginning April 27, 1995 and which currently expiresApril 27, 2004.  In addition,unless the employment contract is otherwise terminated, the term of theemployment contract shall automatically extend in annual increments of one yearso as to always remain a three year employment contract.  Mr. Coger’s annual salary is currentlyfixed at $145,140 and may be renegotiated. Under the terms of the employment contract, Mr. Coger is entitledto incentive compensation provided that Community Valley Bancorp attains aminimum 10% return on equity each year, as well as other criteria.  In the event Community Valley Bancorpattains the minimum 10% return on equity, as well as meeting otherrequirements, a bonus pool will be established in an amount equal to 21.5% ofthe amount in excess of the 10% return on equity.  Mr. Coger will be entitled to incentive compensation in theamount of 29.33% of the bonus pool. Mr. Coger’s employment contract provides that in the event hebecomes disabled, he shall be entitled to 100% of his salary for ninety days.  In addition, if Community Valley Bancorp ismerged, sold or acquired and the merging, purchasing or acquiring entity electsnot to employ Mr. Coger in a like position, he shall paid an amount equalto the remaining term of the employment contract.

 

Mr. Coger has a salary continuation agreement with Community Valley Bancorpwhich provides that Community Valley Bancorp will pay him $125,000 plus a 3%cost of living adjustment per year for 20 years following his retirement fromCommunity Valley Bancorp at age 65 (“Retirement Age”), or until the death ofthe Employee whichever event last occurs. In the event of disability while Mr. Coger is actively employedprior to Retirement Age, he will have the option to take the $125,000 plus a 3%cost of living adjustment per year for 20 years beginning at the earlier of thetime when he reaches age 65 or the date on which he is no longer entitled todisability benefits under his principal disability insurance policy.  In the event Mr. Coger dies whileactively employed by Community Valley Bancorp prior to Retirement Age, hisbeneficiary will receive from Community Valley Bancorp $125,000 plus a 3% costof living adjustment per year for 20 years beginning one month after hisdeath.  In the event of terminationwithout cause, early retirement, or voluntary termination, Mr. Coger shallreceive $125,000 plus a 3% cost of living adjustment per year for 20 yearsbeginning with the month following the month in which Mr. Coger terminatesemployment and attains age 65.  In theevent Mr. Coger is terminated for cause he will forfeit any benefits from thesalary continuation agreement.

 

Mr. Coger has an Executive Supplemental Retirement Plan Agreement thatprovides him with the option of deferring a portion of his salary.  Mr. Coger has elected to defer $10,000 peryear.  Community Valley Bancorp hasestablished a Deferral Account on its books for Mr. Coger and credits tothe Deferral Account the fees deferred by Mr. Coger and interest on the accountbalance at a rate equal to Community Valley Bancorp’s prime lending rate as ofDecember 31 of the previous year plus one-half percent compounded eachDecember 31 and assuming all deferrals have been made as of January 1of such year.  In addition, CommunityValley Bancorp has purchased an annuity for protection of the benefits.  All earnings received above Community ValleyBancorp’s normal anticipated after tax return earnings on the annuity and thecost of an insurance policy related to this benefit are also credited to Mr.Coger’s Deferral Account.  The DeferralAccount is not a trust fund of any kind and Mr. Coger is a general unsecuredcreditor of Community Valley Bancorp for the payment of the benefits.  Benefits under the Supplemental RetirementPlan Agreement are payable upon Mr. Coger’s termination of service.  Upon Mr. Coger’s retirement at age 65, hewill be entitled to the Deferral Account balance in one hundred eighty (180)monthly installments beginning on the first day of the month following hisretirement, unless Mr. Coger elects one year prior to receiving anybenefits to take benefits in a lump sum or otherwise.  If Mr. Coger retires or terminates service prior to the ageof 65, the amount of benefit payable is also the Deferral Account balance atthe date of termination of service in two hundred forty (240) monthlyinstallments beginning on the first day of month following his attaining age65, unless Mr. Coger elects one year prior to receiving any benefits totake benefits in a lump sum or otherwise. If termination of service occurs due to disability, the amount ofbenefit payable is also the Deferral Account balance at the date of terminationof service in two hundred forty (240) monthly installments beginning on thefirst day of month following his disability, unless Mr. Coger elects oneyear prior to receiving any benefits to take benefits in a lump sum orotherwise.  If termination of serviceoccurs due to a change in control of Community Valley Bancorp, Community ValleyBancorp shall credit Mr. Coger’s Deferral Account with the entire amount thatMr. Coger would have deferred for the entire deferral period, and theamount of benefit shall be paid to Mr. Coger within 30 days of the change incontrol.  If Mr. Coger suffershardship, Community Valley Bancorp may distribute to him all or a portion ofthe Deferral Account balance as necessary to relieve the financialhardship.  Finally, if termination ofservice occurs due to Mr. Coger’s death, Community Valley Bancorp shallcredit Mr. Coger’s Deferral Account with the entire amount that Mr. Coger wouldhave deferred for the entire deferral period utilizing the proceeds from theinsurance policy which Community Valley Bancorp purchased in connection withthis agreement.  The amount shall bepaid in two hundred forty (240) monthly installments beginning on the first dayof the month following his death. Interest accrues on all amounts deferred until final payment.

 

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**Item 12****.  SecurityOwnership of Certain Beneficial Owners and Management**

 

Management of Community Valley Bancorp knows of no person who owns,beneficially or of record, either individually or together with associates, 5percent or more of the outstanding shares of common stock, except as set forthin the table below.  The following tablesets forth, as of March 1, 2004, the number and percentage of shares ofoutstanding common stock beneficially owned, directly or indirectly, by each ofCommunity Valley Bancorp’s directors and principal shareholders and by thedirectors and officers of Community Valley Bancorp as a group.  The shares “beneficially owned” aredetermined under Securities and Exchange Commission Rules, and do notnecessarily indicate ownership for any other purpose.  In general, beneficial ownership includes shares over which thedirector, principal shareholder or officer has sole or shared voting orinvestment power and shares which such person has the right to acquire within60 days of March 1, 2004.  Unlessotherwise indicated, the persons listed below have sole voting and investmentpowers of the shares beneficially owned. Management is not aware of any arrangements which may, at a subsequentdate, result in a change of control of Community Valley Bancorp.

 
| **Amount and Nature of  Beneficial Owner** |   | **Beneficial  Ownership** |   | **Percent of  Class(1)** |   |
|--------------------------------------------|--------|---------------------------|--------|--------------------------|--------|
|                                       |   |                      |   |                     |   |
| Directors and Named Officers:              |   |                      |   |                     |   |   |
| M. Robert Ching, M.D.                      |   | 101,720                   | (2)    |                     | 2.7    |   |
| John F. Coger                              |   | 89,837                    | (3)    |                     | 2.3    |   |
| Eugene B. Even                             |   | 73,325                    | (4)    |                     | 1.9    |   |
| John D. Lanam                              |   | 87,055                    | (5)    |                     | 2.3    |   |
| Donald W. Leforce                          |   | 104,203                   | (6)    |                     | 2.7    |   |
| Charles J. Mathews                         |   | 0                         |   |                     | 0      |   |
| Ellis L. Matthews                          |   | 56,853                    | (7)    |                     | 1.5    |   |
| Robert L. Morgan, M.D.                     |   | 140,158                   | (8)    |                     | 3.1    |   |
| James S. Rickards                          |   | 91,862                    | (9)    |                     | 2.4    |   |
| Keith C. Robbins                           |   | 94,722                    | (10)   |                     | 2.5    |   |
| Gary B. Strauss, M.D.                      |   | 160,853                   | (11)   |                     | 4.2    |   |
| Hubert I. Townshend                        |   | 117,785                   | (12)   |                     | 3.0    |   |
|                                       |   |                      |   |                     |   |   |
| Principal Shareholder                      |   |                      |   |                     |   |   |
| Butte Community Bank ESOP                  |   | 196,090                   | (13)   |                     | 5.4    |   |
| Schmelke Family Trust                      |   | 194,844                   | (14)   |                     | 5.4    |   |
|                                       |   |                      |   |                     |   |   |
| All Directors and Officers                 |   |                      |   |                     |   |   |
| as a Group (12 in all)                     |   | 1,097,176                 |   |                     | 30.2   |   |

 

----

(1)           Includes shares subjectto options held by each director and the directors and officers as a group thatare exercisable within 60 days of March 1, 2004.  These are treated as issued and outstanding for the purpose ofcomputing the percentage of each director and the directors and officers as agroup but not for the purpose of computing the percentage of class of any otherperson.  Total shares and ownership havebeen adjusted for four-for-three stock split with record date of March 2,2004.

 

(2)           Dr. Ching has sharedvoting and investment powers as to 25,333 these shares and has 18,530acquirable by exercise of stock options.

 

(3)           Mr. Coger has sharedvoting and investment powers as to 62,806 of these shares and has 5,333 sharesacquirable by exercise of stock options.

 

(4)           Mr. Even has 8,000shares acquirable by exercise of stock options.

 

(5)           Mr. Lanam has sharedvoting and investment powers as to 54,477 shares and has 17,612 sharesacquirable by exercise of stock options.

 

(6)           Mr. Leforce has sharedvoting and investment powers as to 80,565 shares and has 20,396 sharesacquirable by exercise of stock options.

 

(7)           Mr. E. Matthews has17,863 shares acquirable by exercise of stock options.

 

(8)           Dr. Morgan has 21,197shares acquirable by exercise of stock options.

 

57

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(9)           Mr. Rickards has sharedvoting and investment powers as to 56,514 shares and has 17,884 sharesacquirable by exercise of stock options.

 

(10)         Mr. Robbins has sharedvoting and investment powers as to 24,794 shares and has 18,056 sharesacquirable by exercise of stock options.

 

(11)         Dr. Strauss has sharedvoting and investment powers as to 109,696 shares and has 21,196 sharesacquirable by exercise of stock options.

 

(12)         Mr. Townshend has 16,056shares acquirable by exercise of stock options.

 

(13)         Community Valley BancorpESOP’s address is c/o Community Valley Bancorp, 2041 Forest Avenue, Chico,California 95928.

 

(14)         The Schmelke FamilyTrust’s address is c/o Community Valley Bancorp, 2041 Forest Avenue, Chico,California 95928.

 

**Item13****.  Certain Relationships and RelatedTransactions**

 

Some of the directors and officers of Community Valley Bancorp and thecompanies with which they are associated are customers of, or have had bankingtransactions with, Community Valley Bancorp in the ordinary course of CommunityValley Bancorp’s business, and Community Valley Bancorp expects to have bankingtransactions with such persons in the future. In the opinion of Community Valley Bancorp’s management, all loans andcommitments to lend in such transactions were made in compliance withapplicable laws and on substantially the same terms, including interest ratesand collateral, as those prevailing for comparable transactions with otherpersons of similar creditworthiness and did not involve more than a normal riskof collectibility or present other unfavorable features.

 

# **Item 14**.  Principal Accountant Fees and Services

# ** **

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

 

58

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**PART IV**

 

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

 

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

 

(1)           **Financial Statements**

 

The following financial statements and independent auditor’s reportsare included in this Annual Report on Form 10-K immediately following.

 
| I.   |   | Independent  Auditor’s Report                                                                                   |
|------|--------|----------------------------------------------------------------------------------------------------------------------|
| II.  |   | Consolidated Balance Sheet - December 31, 2003 and 2002                                                         |
| III. |   | Consolidated Statement of Income - Years  Ended  December 31, 2003, 2002 and 2001                               |
| IV.  |   | Consolidated Statement of Changes in Shareholders’ Equity - Years  Ended  December 31, 2003, 2002 and 2001 |
| V.   |   | Consolidated Statement of Cash Flows - Years Ended  December 31, 2003, 2002 and 2001                            |
| VI.  |   | Notes to the Consolidated Financial Statements                                                                       |

 

(2)           **Financial Statement Schedules**

 

Schedules to the financial statements are omitted because the requiredinformation is not applicable or because the required information is presentedin the Company’s Consolidated 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.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                        |
| (10.2)              |   | Salary Continuation Agreement dated  April 14, 1998, and Amendment to Salary Continuation Agreement dated  January 10, 2002, for Keith C. Robbins.   Incorporated by reference to  the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                 |
| (10.2)1.            |   | Amendment  to Salary Continuation Agreement of April 14, 1998 for Keith C Robbins  dated January 1, 2004. Incorporated in document on page 55.                                                                                                                                                                                                        |
| (10.3)              |   | Executive Supplemental Retirement Plan  dated August 1, 2000, and Amendment to Executive Supplement Retirement  Plan dated January 10, 2002,  for  Keith C. Robbins. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002. |
| (10.4)              |   | 1997 Stock Option Agreement for Keith C.  Robbins dated May 1, 1997.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                          |
| (10.5)              |   | 2000 Stock Option Agreement for Keith C.  Robbins dated March 14, 2000. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                                        |
| (10.6)              |   | Employment Agreement with John F. Coger  dated April 27, 1995.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                           |

 

59

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| (10.7)   |   | Salary Continuation Agreement dated  April 14, 1998, and Amendment to Salary Continuation Agreement dated  January 10, 2002, for John F Coger.   Incorporated by reference to  the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                 |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10.7)1. |   | Amendment  to Salary Continuation Agreement of April 14, 1998 for John F Coger  dated January 1, 2004. Incorporated in document on page 56.                                                                                                                                                                                                       |
| (10.8)   |   | Executive Supplemental Retirement Plan  dated August 1, 2000, and Amendment to Executive Supplement Retirement  Plan dated January 10, 2002, for John F. Coger.  Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002. |
| (10.9)   |   | 2000 Stock Option Agreement for John F.  Coger dated March 14, 2000  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                      |
| (10.10)  |   | 1997 Stock Option Agreement for M. Robert  Ching dated May 1, 1997 Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002..                                                                                                             |
| (10.11)  |   | 2000 Stock Option Agreement for M. Robert  Ching dated May 1, 2000.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                       |
| (10.12)  |   | 1997 Stock Option Agreement for Eugene B.  Even dated May 1, 1997 Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002..                                                                                                              |
| (10.13)  |   | 2000 Stock Option Agreement for Eugene B.  Even dated May 1, 2000.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                        |
| (10.14)  |   | 1997 Stock Option Agreement for John D.  Lanam dated May 1, 1997.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                         |
| (10.15)  |   | 2000 Stock Option Agreement for John D.  Lanam dated May 1, 2000. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                                                               |
| (10.16)  |   | 1997 Stock Option Agreement for Donald W.  Leforce dated May 1, 1997.  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002.                                                                                                          |
| (10.17)  |   | 2000 Stock Option Agreement for Donald W.  Leforce dated May 1, 2000  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                          |
| (10.18)  |   | 1997 Stock Option Agreement for Ellis L.  Matthews dated May 1, 1997  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                          |
| (10.19)  |   | 2000 Stock Option Agreement for Ellis L.  Matthews dated May 1, 2000  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                          |
| (10.20)  |   | 1997 Stock Option Agreement for Robert L.  Morgan dated May 1, 1997  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                           |
| (10.21)  |   | 2000 Stock Option Agreement for Robert L.  Morgan dated May 1, 2000  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                           |
| (10.22)  |   | 1997 Stock Option Agreement for James S.  Rickards dated May 1, 1997.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                     |
| (10.23)  |   | 2000 Stock Option Agreement for James S.  Rickards dated May 1, 2000  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                          |
| (10.24)  |   | 1997 Stock Option Agreement for Gary B.  Strauss dated May 1, 1997  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                            |
| (10.25)  |   | 2000 Stock Option Agreement for Gary B.  Strauss dated May 1, 2000.  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002.                                                                                                            |

 

60

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| (10.26) |   | 1997 Stock Option Agreement for Hubert I.  Townshend dated May 1, 1997  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                                      |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10.27) |   | 2000 Stock Option Agreement for Hubert I.  Townshend dated May 1, 2000  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                                      |
| (10.28) |   | Director Deferred Fee Agreement for M.  Robert Ching dated April 8, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                               |
| (10.29) |   | Director Retirement Agreement for M. Robert  Ching dated April 14, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                                |
| (10.30) |   | Director Retirement Agreement for Eugene B.  Even dated April 14, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                                 |
| (10.31) |   | Director Retirement Agreement for John D.  Lanam dated April 14, 1998.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                                                                             |
| (10.32) |   | Director Deferred Fee Agreement for Donald  W. Leforce dated April 14, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                            |
| (10.33) |   | Director Retirement Agreement for Donald W.  Leforce dated April 14, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                              |
| (10.34) |   | Director Retirement Agreement for Ellis L.  Matthews dated April 14, 1998.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                                                                         |
| (10.35) |   | Director Retirement Agreement for Robert L.  Morgan dated April 14, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                               |
| (10.36) |   | Director Retirement Agreement James S.  Rickards dated April 14, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002..                                                                                                                                                                  |
| (10.37) |   | Director Retirement Agreement for Gary B.  Strauss dated April 14, 1998.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                                                                                                           |
| (10.38) |   | Director Retirement Agreement for Hubert I.  Townshend dated April 14, 1998.  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on  August 14, 2002.                                                                                                                                                            |
| (10.39) |   | Lease agreement between Butte Community  Bank and Anna Laura Schilling Trust dated March 20, 2001, related to 900  Mangrove Ave., Chico, California.  Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed  with the Commission on August 14, 2002.                                                                               |
| (10.40) |   | 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.                                                                                                                                                                                                                                                                                                                                                                          |
| (31.1)  |   | Rule 13a-14(a)/15d-14(a) certification of  Chief Executive Officer                                                                                                                                                                                                                                                                                                                                                        |
| (31.2)  |   | Rule 13a-14(a)/15d-14(a) certification of  Chief Financial Officer                                                                                                                                                                                                                                                                                                                                                        |
| (32.1)  |   | Section 1350 certification of Chief  Executive Officer                                                                                                                                                                                                                                                                                                                                                               |
| (32.2)  |   | Section 1350 certification of Chief  Financial Officer                                                                                                                                                                                                                                                                                                                                                               |
| (99.1)  |   | 1991 Stock Option Plan is incorporated by  reference from the Company’s Registration Statement Form S-8, filed  August 14, 2002.                                                                                                                                                                                                                                                                                |
| (99.2)  |   | 1997 Stock Option Plan is incorporated by  reference from the Company’s Registration Statement Form S-8, filed  August 14, 2002.                                                                                                                                                                                                                                                                                |
| (99.3)  |   | 2000 Stock Option Plan is incorporated by  reference from the Company’s Registration Statement Form S-8, filed  August 14, 2002.                                                                                                                                                                                                                                                                                |
| (99.4)  |   | Director Emeritus Plan dated March 20,  2001.  Incorporated by reference to the Company’s Quarterly Report on Form  10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002.                                                                                                                                                                                      |

 

61

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(b)  Reports on Form 8-K

 

OnDecember 19, 2003, the Company filed a Report on Form 8-K announcing a tencent per share Cash Dividend.

 

62

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities and Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.
| Dated:  March 24, 2004 | **COMMUNITY VALLEY  BANCORP** |
|----------------------------------|-------------------------------|
|                             | a California corporation      |
|                             |                          |   |
|                             | By:                           | /s*/  Keith C. Robbins* |   |
|                             |                          |   | Keith C. Robbins |
|                             |                          |   | President and Chief Executive Officer |
|                             |                          |   |
|                             | By:                           | */s/ John F. Coger* |   |
|                             |                          |   | John F. Coger |
|                             |                          |   | Executive Vice President  and Chief Financial Officer |
|                                  |                               |  |  |  |

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.
| **Signature**            |   | **Title** |                        | **Date** |
|--------------------------|--------|-----------|-----------------------------|----------|
|                     |   |      |                        |     |   |
| */s/ M. Robert  Ching*   |   |      | Director                    |     | March 24, 2004 |
| M. Robert Ching          |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| */s/ Eugene B. Even*     |   |      | Director                    |     | March 24, 2004 |
| Eugene B. Even           |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| */s/ John D. Lanam*      |   |      | Director                    |     | March 24, 2004 |
| John D. Lanam            |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| */s/ Donald W.  Leforce* |   |      | Chairman of the Board       |     | March 24, 2004 |
| Donald W. Leforce        |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| */s/ Charles  Mathews*   |   |      | Director                    |     | March 24, 2004 |
| Charles Mathews          |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| */s/ Ellis L.  Matthews* |   |      | Director                    |     | March 24, 2004 |
| Ellis L. Matthews        |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| */s Robert L.  Morgan*   |   |      | Director                    |     | March 24, 2004 |
| Robert L. Morgan         |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| /s*/  Keith C. Robbins*  |   |      | President, Chief Executive  |     | March 24, 2004 |
| Keith C. Robbins         |   |      | Officer and Director        |     |   |
|                     |   |      |                        |     |   |
| */s/ James S.  Rickards* |   |      | Director and                |     | March 24, 2004 |
| James S. Rickards        |   |      | Corporate Secretary         |     |   |
|                     |   |      |                        |     |   |
| */s/ Gary B.  Strauss*   |   |      | Director                    |     | March 24, 2004 |
| Gary B. Strauss          |   |      | Vice Chairman               |     |   |
|                     |   |      |                        |     |   |
| */s/ Hubert  Townshend*  |   |      | Director                    |     | March 24, 2004 |
| Hubert Townshend         |   |      |                        |     |   |
|                     |   |      |                        |     |   |
| */s/ John F. Coger*      |   |      | Executive Vice President    |     | March 24, 2004 |
| John F. Coger            |   |      | and Chief Financial Officer |     |   |

 

63

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDFINANCIAL STATEMENTS**

 

**FORTHE YEARS ENDED**

 

**DECEMBER 31,2003, 2002 AND 2001**

 

**AND**

 

**INDEPENDENTAUDITOR’S REPORT**

 

----

 

# ***INDEPENDENT****AUDITOR’SREPORT*

 

 

The Board of Directorsand Shareholders

Community Valley Bancorpand Subsidiary

 

We have audited the accompanying consolidated balance sheet ofCommunity Valley Bancorp and subsidiary as of December 31, 2003 and 2002,and the related consolidated statements of income, changes in shareholders’equity and cash flows for each of the years in the three-year period endedDecember 31, 2003.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

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

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof Community Valley Bancorp and subsidiary as of December 31, 2003 and2002 and the consolidated results of their operations and their cash flows foreach of the years in the three-year period ended December 31, 2003, inconformity with accounting principles generally accepted in the United Statesof America.

 

 
|                   | /s/ Perry-Smith LLP |   |
|------------------------|---------------------|--------|
|                   |
|                   |
| Sacramento, California |
| February 20, 2004 |

 

F-1

----

 

**COMMUNITYVALLEY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATED BALANCESHEET**

 

**December 31,2003 and 2002**

 
|                                                                                                                                    |   | **2003**    |        | **2002**    |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|-------------|--------|
|                                                                                                                                    |   |        |        |        |   |
| **ASSETS**                                                                                                                              |   |        |        |        |   |
|                                                                                                                                    |   |        |        |        |   |
| Cash and due from banks                                                                                                                 |   | $           | 26,204,700  |        | $      | 15,621,400 |   |
| Federal funds sold                                                                                                                      |   | 50,605,000  |        | 57,410,000  |   |
| Interest-bearing deposits in banks                                                                                                      |   | 7,925,000   |        | 4,061,000   |   |
| Loans held for sale                                                                                                                     |   | 2,279,100   |        | 7,911,700   |   |
| Investment securities (Note 2):                                                                                                         |   |        |        |        |   |
| Available-for-sale, at market value                                                                                                     |   | 502,000     |        | 514,000     |   |
| Held-to-maturity, at cost, with market  values of $3,823,700 in 2003 and $2,924,000 in 2002                                             |   | 3,822,500   |        | 2,872,900   |   |
|                                                                                                                                    |   |        |        |        |   |
| Loans, less allowance for loan losses of  $3,587,200 in 2003 and $3,006,800 in 2002 (Notes 3, 7 and 14)                                 |   | 270,231,300 |        | 229,699,200 |   |
| Premises and equipment, net (Note 5)                                                                                                    |   | 8,553,900   |        | 6,653,100   |   |
| Accrued interest receivable and other  assets (Notes 4, 13 and 15)                                                                      |   | 16,599,200  |        | 12,740,000  |   |
|                                                                                                                                    |   |        |        |        |   |
|                                                                                                                                    |   | $           | 386,722,700 |        | $      | 337,483,300 |   |
|                                                                                                                                    |   |        |        |        |   |
| **LIABILITIES AND  SHAREHOLDERS’ EQUITY**                                                                                          |   |        |        |        |   |
|                                                                                                                                    |   |        |        |        |   |
| Deposits:                                                                                                                               |   |        |        |        |   |
| Non-interest bearing                                                                                                                    |   | $           | 68,463,100  |        | $      | 62,888,900 |   |
| Interest bearing (Note 6)                                                                                                               |   | 274,048,300 |        | 235,091,900 |   |
|                                                                                                                                    |   |        |        |        |   |
| Total deposits                                                                                                                          |   | 342,511,400 |        | 297,980,800 |   |
|                                                                                                                                    |   |        |        |        |   |
| Employee stock ownership plan (ESOP) note  payable (Notes 10 and 15)                                                                    |   | 831,900     |        | 732,100     |   |
| Junior subordinated debentures (Note 8)                                                                                                 |   | 8,248,000   |        | 8,248,000   |   |
| Accrued interest payable and other  liabilities (Note 15)                                                                               |   | 5,182,900   |        | 5,141,800   |   |
|                                                                                                                                    |   |        |        |        |   |
| Total liabilities                                                                                                                       |   | 356,774,200 |        | 312,102,700 |   |
|                                                                                                                                    |   |        |        |        |   |
| Commitments and contingencies (Note 7)                                                                                                  |   |        |        |        |   |
|                                                                                                                                    |   |        |        |        |   |
| Shareholders’ equity (Note 11):                                                                                                    |   |        |        |        |   |
| Common stock - no par value; authorized –  20,000,000 shares, issued – 3,621,824 shares in 2003 and 3,580,468 shares in  2002 |   | 7,271,400   |        | 6,660,000   |   |
| Unearned ESOP shares (90,909 shares in 2003  and 87,249 shares in 2002, at cost) (Note 15)                                              |   | (1,070,700  | )           | (851,900    | )      |
| Retained earnings                                                                                                                       |   | 23,745,700  |        | 19,558,400  |   |
| Accumulated other comprehensive income  (Note 2)                                                                                        |   | 2,100       |        | 14,100      |   |
|                                                                                                                                    |   |        |        |        |   |
| Total shareholders’ equity                                                                                                         |   | 29,948,500  |        | 25,380,600  |   |
|                                                                                                                                    |   |        |        |        |   |
|                                                                                                                                    |   | $           | 386,722,700 |        | $      | 337,483,300 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

F-2

----

 

**COMMUNITYVALLEY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENT OF INCOME**

 

**For the Years Ended December 31, 2003,2002 and 2001**

 
|                                                     |   | **2003**   |       | **2002**   |   | **2001**   |   |
|----------------------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
|                                                     |   |       |       |       |   |       |   |
| Interest income:                                         |   |       |       |       |   |       |   |
| Interest and fees on loans                               |   | $          | 20,528,000 |       | $      | 18,157,400 |   | $ | 18,823,700 |   |
| Interest on Federal funds sold                           |   | 633,900    |       | 572,700    |   | 659,400    |   |
| Interest on deposits in banks                            |   | 201,400    |       | 81,200     |   | 60,800     |   |
| Interest on investment securities:                       |   |       |       |       |   |       |   |
| Taxable                                                  |   | 104,700    |       | 76,200     |   | 91,700     |   |
| Exempt from Federal income taxes                         |   | 48,600     |       | 89,400     |   | 120,100    |   |
|                                                     |   |       |       |       |   |       |   |
| Total interest income                                    |   | 21,516,600 |       | 18,976,900 |   | 19,755,700 |   |
|                                                     |   |       |       |       |   |       |   |
| Interest expense:                                        |   |       |       |       |   |       |   |
| Interest expense on deposits (Note 6)                    |   | 3,924,300  |       | 4,735,000  |   | 7,289,300  |   |
| Interest expense on junior subordinated  debentures      |   | 438,800    |       |       |   |       |   |
| Interest expense on ESOP note payable  (Notes 10 and 15) |   | 33,100     |       | 39,500     |   | 55,000     |   |
|                                                     |   |       |       |       |   |       |   |
| Total interest expense                                   |   | 4,396,200  |       | 4,774,500  |   | 7,344,300  |   |
|                                                     |   |       |       |       |   |       |   |
| Net interest income                                      |   | 17,120,400 |       | 14,202,400 |   | 12,411,400 |   |
|                                                     |   |       |       |       |   |       |   |
| Provision for loan losses (Note 3)                       |   | 655,000    |       | 603,000    |   | 500,000    |   |
|                                                     |   |       |       |       |   |       |   |
| Net interest income after provision for loan  losses     |   | 16,465,400 |       | 13,599,400 |   | 11,911,400 |   |
|                                                     |   |       |       |       |   |       |   |
| Non-interest income:                                     |   |       |       |       |   |       |   |
| Service charges and fees                                 |   | 1,397,300  |       | 1,028,300  |   | 965,800    |   |
| Loan servicing income                                    |   | 379,500    |       | 356,200    |   | 329,000    |   |
| Gain on sale of loans                                    |   | 2,783,400  |       | 2,326,500  |   | 1,421,700  |   |
| Other (Note 12)                                          |   | 1,390,200  |       | 2,453,000  |   | 942,900    |   |
|                                                     |   |       |       |       |   |       |   |
| Total non-interest income                                |   | 5,950,400  |       | 6,164,000  |   | 3,659,400  |   |
|                                                     |   |       |       |       |   |       |   |
| Non-interest expense:                                    |   |       |       |       |   |       |   |
| Salaries and employee benefits (Notes 3 and  15)         |   | 8,150,800  |       | 6,558,700  |   | 5,297,800  |   |
| Occupancy and equipment (Notes 5 and 7)                  |   | 2,037,200  |       | 1,557,400  |   | 1,336,300  |   |
| Other (Note 12)                                          |   | 3,629,600  |       | 4,422,700  |   | 2,701,300  |   |
|                                                     |   |       |       |       |   |       |   |
| Total non-interest expense                               |   | 13,817,600 |       | 12,538,800 |   | 9,335,400  |   |
|                                                     |   |       |       |       |   |       |   |
| Income before income taxes                               |   | 8,598,200  |       | 7,224,600  |   | 6,235,400  |   |
|                                                     |   |       |       |       |   |       |   |
| Income taxes (Note 13)                                   |   | 3,329,000  |       | 2,375,000  |   | 2,424,000  |   |
|                                                     |   |       |       |       |   |       |   |
| Net income                                               |   | $          | 5,269,200  |       | $      | 4,849,600  |   | $ | 3,811,400 |   |
|                                                     |   |       |       |       |   |       |   |
| Basic earnings per share (Note 11)                       |   | $          | 1.50       |       | $      | 1.40       |   | $ | 1.15 |   |
|                                                     |   |       |       |       |   |       |   |
| Diluted earnings per share (Note 11)                     |   | $          | 1.42       |       | $      | 1.33       |   | $ | 1.07 |   |

 

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

 

F-3

----

 

**COMMUNITY VALLEY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENT OF CHA****NGES IN SHAREHOLDERS’ EQUITY**

 

**Forthe Years Ended December 31, 2003, 2002 and 2001**

 
|                                                                       |   | **Common  Stock** |   | **Unearned  ESOP** |      | **Retained** |   | **Compre-  hensive** |   | **Share-  holders’** |       | **Accum-  ulated  Other  Compre-  hensive** |   |
|----------------------------------------------------------------------------|--------|-------------------|--------|--------------------|-----------|--------------|--------|----------------------|--------|---------------------------|------------|---------------------------------------------|--------|
|                                                                       |   | **Shares**        |   | **Amount**         |      | **Shares**   |   | **Earnings**         |   | **Income**                |       | **Equity**                                  |   | **Income** |   |
|                                                                       |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Balance, January 1, 2001                                              |   | 3,251,281         |   | $                  | 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)               |   | 279,904           |   | 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 - $.169 per share (Note 11)                                 |   |              |   |               |      |         |   | (590,600             | )      |                      |       | (590,600                                    | )      |   |   |
|                                                                       |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Balance, December 31, 2001                                            |   | 3,531,185         |   | 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)               |   | 49,283            |   | 426,200            |      |         |   |                 |   |                      |       | 426,200                                     |   |   |   |
| Earned ESOP shares (Note 15)                                               |   |              |   | 107,800            |      | 50,200       |   |                 |   |                      |       | 158,000                                     |   |   |   |
| Cash dividends - $.248 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                                            |   | 3,580,468         |   | 6,660,000          |      | (851,900     | )      | 19,558,400           |   | 14,100                    |       | 25,380,600                                  |   |   |   |
|                                                                       |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Comprehensive income:                                                      |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Net income                                                                 |   |              |   |               |      |         |   | 5,269,200            |   |                      |       | 5,269,200                                   |   | $ | 5,269,200 |   |
| Other comprehensive income:                                                |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Unrealized losses on available-for- sale  investment securities (Note 2)   |   |              |   |               |      |         |   |                 |   | (12,000                   | )          | (12,000                                     | )      | (12,000 | ) |
|                                                                       |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Total comprehensive income                                                 |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   | $ | 5,257,200 |   |
|                                                                       |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Exercise of stock options and related tax  benefit (Note 11)               |   | 41,356            |   | 461,900            |      |         |   |                 |   |                      |       | 461,900                                     |   |   |   |
| Earned ESOP shares (Note 15)                                               |   |              |   | 149,500            |      | 102,200      |   |                 |   |                      |       | 251,700                                     |   |   |   |
| Shares acquired or redeemed by ESOP (Note  15)                             |   |              |   |               |      | (321,000     | )      |                 |   |                      |       | (321,000                                    | )      |   |   |
| Cash dividends - $.30 per share (Note 11)                                  |   |              |   |               |      |         |   | (1,081,900           | )      |                      |       | (1,081,900                                  | )      |   |   |
|                                                                       |   |              |   |               |      |         |   |                 |   |                      |       |                                        |   |   |   |
| Balance, December 31, 2003                                            |   | 3,621,824         |   | $                  | 7,271,400 |         | $      | (1,070,700           | )      | $                         | 23,745,700 |                                        | $      | 2,100 |   | $ | 29,948,500 |   |   |   |

 

The accompanying notes are an integralpart of these consolidated financial statements.

 

F-4

----

 

**COMMUNITY VALLEY BANCORP AND SUBSIDIARY**

 

**CONSOLIDATED STATEMENT OF CASH****FLOWS**

 

**Forthe Years Ended December 31, 2003, 2002 and 2001**

 
|                                                                               |   | **2003**    |      | **2002**    |   | **2001**    |   |
|------------------------------------------------------------------------------------|--------|-------------|-----------|-------------|--------|-------------|--------|
|                                                                               |   |        |      |        |   |        |   |
| Cash flows from operating activities:                                              |   |        |      |        |   |        |   |
| Net income                                                                         |   | $           | 5,269,200 |        | $      | 4,849,600   |   | $ | 3,811,400 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |        |      |        |   |        |   |
| Provision for loan losses                                                          |   | 655,000     |      | 603,000     |   | 500,000     |   |
| Increase in loan origination fees, net                                             |   | 196,000     |      | 162,800     |   | 111,200     |   |
| Depreciation, amortization and accretion,  net                                     |   | 973,300     |      | 764,400     |   | 693,500     |   |
| Increase in cash surrender value of life  insurance policies, net                  |   | (379,700    | )         | (176,600    | )      | (206,000    | )      |
| Non-cash compensation cost associated with  the ESOP                               |   | 251,700     |      | 158,000     |   | 138,900     |   |
| Loss (gain) on disposition of equipment                                            |   | 8,400       |      | (153,000    | )      | (29,200     | )      |
| Gain on life insurance death benefit                                               |   |        |      | (1,172,600  | )      |        |   |
| Writedown of other real estate to market  value                                    |   |        |      |        |   | 39,200      |   |
| Decrease (increase) in loans held for sale                                         |   | 5,632,600   |      | (1,933,200  | )      | (4,318,900  | )      |
| (Increase) decrease in accrued interest  receivable and other assets               |   | (1,019,700  | )         | (2,388,700  | )      | 1,114,300   |   |
| Increase in accrued interest payable and  other liabilities                        |   | 38,200      |      | 699,900     |   | 879,400     |   |
| Deferred taxes                                                                     |   | (639,000    | )         | (634,000    | )      | (286,000    | )      |
|                                                                               |   |        |      |        |   |        |   |
| Net cash provided by operating activities                                          |   | 10,986,000  |      | 779,600     |   | 2,447,800   |   |
|                                                                               |   |        |      |        |   |        |   |
| Cash flows from investing activities:                                              |   |        |      |        |   |        |   |
| Purchase of available-for-sale investment  securities                              |   |        |      |        |   | (299,800    | )      |
| Purchase of held-to-maturity investment  securities                                |   | (4,542,300  | )         | (1,617,000  | )      | (462,200    | )      |
| Proceeds from matured or called  held-to-maturity investment securities            |   | 3,440,000   |      | 1,135,000   |   | 2,057,000   |   |
| Proceeds from principal repayments of  held-to-maturity investment securities      |   | 112,900     |      | 94,600      |   |        |   |
| Net (increase) decrease in interest-bearing  deposits in banks                     |   | (3,864,000  | )         | (3,367,000  | )      | 890,000     |   |
| Net increase in loans                                                              |   | (41,383,100 | )         | (32,589,900 | )      | (29,734,500 | )      |
| Premiums paid for life insurance policies                                          |   | (1,626,200  | )         | (396,300    | )      | (143,700    | )      |
| Death benefit from life insurance policies                                         |   |        |      | 1,750,000   |   |        |   |
| Purchases of premises and equipment                                                |   | (2,869,600  | )         | (2,017,000  | )      | (1,142,700  | )      |
| Proceeds from sale of equipment                                                    |   | 26,900      |      | 416,000     |   | 56,800      |   |
| Proceeds from sale of other real estate                                            |   |        |      | 12,600      |   |        |   |
|                                                                               |   |        |      |        |   |        |   |
| Net cash used in investing activities                                              |   | (50,705,400 | )         | (36,579,000 | )      | (28,779,100 | )      |
|                                                                                    |        |             |           |             |        |             |        |  |  |  |

 

F-5

----

 
|                                                                       |   | **2003**   |       | **2002**    |   | **2001**   |   |
|----------------------------------------------------------------------------|--------|------------|------------|-------------|--------|------------|--------|
|                                                                       |   |       |       |        |   |       |   |
| Cash flows from financing activities:                                      |   |       |       |        |   |       |   |
| Net increase in demand, interest-bearing  and savings deposits             |   | $          | 43,926,500 |        | $      | 72,408,500 |   | $ | 32,081,700 |   |
| Net increase (decrease) in time deposits                                   |   | 604,100    |       | (20,847,600 | )      | 20,213,300 |   |
| Repayments of ESOP note payable                                            |   | (221,200   | )          | (119,400    | )      | (83,800    | )      |
| Proceeds from ESOP note payable                                            |   | 321,000    |       |        |   | 291,900    |   |
| Purchase of unearned ESOP shares                                           |   | (321,000   | )          |        |   | (291,900   | )      |
| Proceeds from exercise of stock options                                    |   | 267,300    |       | 287,200     |   | 454,000    |   |
| Cash paid for fractional shares                                            |   |       |       | (5,300      | )      |       |   |
| Payment of cash dividend                                                   |   | (1,079,000 | )          | (812,200    | )      | (391,900   | )      |
| Proceeds from junior subordinated  debentures                              |   |       |       | 8,248,000   |   |       |   |
|                                                                       |   |       |       |        |   |       |   |
| Net cash provided by financing activities                                  |   | 43,497,700 |       | 59,159,200  |   | 52,273,300 |   |
|                                                                       |   |       |       |        |   |       |   |
| Increase in cash and cash equivalents                                      |   | 3,778,300  |       | 23,359,800  |   | 25,942,000 |   |
|                                                                       |   |       |       |        |   |       |   |
| Cash and cash equivalents at beginning of  year                            |   | 73,031,400 |       | 49,671,600  |   | 23,729,600 |   |
|                                                                       |   |       |       |        |   |       |   |
| Cash and cash equivalents at end of year                                   |   | $          | 76,809,700 |        | $      | 73,031,400 |   | $ | 49,671,600 |   |
|                                                                       |   |       |       |        |   |       |   |
| Supplemental disclosure of cash flow  information:                         |   |       |       |        |   |       |   |
|                                                                       |   |       |       |        |   |       |   |
| Cash paid during the year for:                                             |   |       |       |        |   |       |   |
| Interest                                                                   |   | $          | 4,395,700  |        | $      | 5,523,700  |   | $ | 7,240,600 |   |
| Income taxes                                                               |   | $          | 4,350,000  |        | $      | 2,751,000  |   | $ | 2,279,000 |   |
|                                                                       |   |       |       |        |   |       |   |
| Non-cash investing activities:                                             |   |       |       |        |   |       |   |
| Net change in unrealized gain on  available-for-sale investment securities |   | $          | (12,000    | )           | $      | 14,100     |   |   |   |
|                                                                       |   |       |       |        |   |       |   |
| Non-cash financing activities:                                             |   |       |       |        |   |       |   |
| Release of unearned ESOP shares                                            |   | $          | 102,200    |        | $      | 50,200     |   | $ | 61,300 |   |
| Accrual of cash dividend declared                                          |   | $          | 271,400    |        | $      | 268,500    |   | $ | 198,700 |   |

 

The accompanying notes are an integralpart of these consolidated financial statements.

 

F-6

----

 

**COMMUNITY VALLEY BANCORP AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL****STATEMENTS**

 

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

 

###### **General**

 

In May 2002, Community Valley Bancorp (“Community Valley”) was incorporatedas a bank holding company for the purpose of acquiring Butte Community Bank(the “Bank”) in a one bank holding company reorganization.  The new corporate structure gives CommunityValley and the Bank greater flexibility in terms of operation, expansion anddiversification.  The reorganization wasapproved by the Bank’s shareholders on May 23, 2002, and all requiredregulatory approvals with respect to the reorganization were obtained.  The reorganization was consummated inJune 2002, subsequent to which the Bank continued its operations aspreviously conducted but as a wholly-owned subsidiary of Community Valley.

 

Founded in 1990, the Bank is astate-chartered financial institution with eight branches in five citiesincluding Chico, Magalia, Oroville, Paradise and Yuba City and loan productionoffices in Roseville and Redding.  TheBank provides traditional deposit and lending services including commercial andconstruction loans, government guaranteed loans such as those available fromthe USDA and SBA, merchant services and investment services.

 

On December 19, 2002, Community Valley formed a wholly-ownedsubsidiary, Community Valley Bancorp Trust I (the “Trust”), a Delawarestatutory business trust, for the purpose of issuing trust preferred securities(see Note 8).

 

The accounting and reporting policies of Community Valley Bancorp andits subsidiary (collectively, the “Company”) conform with accounting principlesgenerally accepted in the United States of America and prevailing practicewithin the banking industry.  The moresignificant of these policies applied in the preparation of the accompanyingconsolidated financial statements are discussed below.

 

###### **Principles of Consolidation**

 

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

 

For financial reporting purposes, the Company’s investment in the Trust(see Note 8) is accounted for under the equity method and is included inaccrued interest receivable and other assets on the consolidated balancesheet.  The junior subordinateddebentures issued and guaranteed by the Company and held by the Trust arereflected in the Company’s consolidated balance sheet in accordance with theprovisions of Financial Accounting Standards Board (FASB) Interpretation No.46, *Consolidation of Variable InterestEntities*.

 

###### **Reclassifications**

 

Certain reclassifications have been made to prior years’ balances toconform to classifications used in 2003.

 

F-7

----

 

**Use of Estimates**

 

The preparation of consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions.  These estimates and assumptions affect thereported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from these estimates.

 

###### **Cash and Cash Equivalents**

 

For purposes of the consolidated statement of cash flows, cash and cashequivalents include cash and due from banks and federal funds sold.  Federal funds are generally sold for one-dayperiods.

 

###### **ATM Cash Funding Program**

 

During 2003, the Company entered into an ATM cash funding agreementthrough a correspondent bank.  Theprogram provides fee income to the Company equal to the average amount providedat the federal funds rate plus fifty basis points.  Under rules and regulations of the Federal Reserve Bank, thesefunds, totaling $9,982,800 at December 31, 2003, are considered to bevault cash and, accordingly, are included in the Company’s consolidated balancesheet as cash and due from banks.

 

**Investment Securities**

 

Investment securities are classified into the following categories:

 

•              Available-for-salesecurities, reported at fair value, with unrealized gains and losses excludedfrom earnings and reported, net of taxes, as accumulated other 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 the appropriate classification of its investmentsat the time of purchase and may only change the classification in certainlimited circumstances.  All transfersbetween categories are accounted for at fair value.

 

Gains or losses on the sale of investment securities are computed usingthe specific identification method. Interest earned on investment securities is reported in interest income,net of applicable adjustments for accretion of discounts and amortization ofpremiums.  In addition, unrealizedlosses that are other than temporary are recognized in earnings for allinvestments.

 

F-8

----

 

**Loans**

 

Loans are stated at principal balances outstanding, except for loanstransferred from loans held for sale which are carried at the lower ofprincipal balance or market value at the date of transfer, adjusted foraccretion of discounts.  Interest isaccrued daily based upon outstanding loan balances.  However, when, in the opinion of management, loans are consideredto be impaired and the future collectibility of interest and principal is inserious doubt, loans are placed on nonaccrual status and the accrual ofinterest income is suspended.  Anyinterest accrued but unpaid is charged against income.  Payments received are applied to reduceprincipal to the extent necessary to ensure collection.  Subsequent payments on these loans, or paymentsreceived on nonaccrual loans for which the ultimate collectibility of principalis not in doubt, are applied first to earned but unpaid interest and then toprincipal.

 

A loan is considered impaired when, based on current information andevents, it is probable that the Company will be unable to collect all amountsdue (including both principal and interest) in accordance with the contractualterms of the loan agreement.  Animpaired loan is measured based on the present value of expected future cashflows discounted at the loan’s effective interest rate or, as a practical matter,at the loan’s observable market price or the fair value of collateral if theloan is collateral dependent.

 

Substantially all loan origination fees, commitment fees, direct loanorigination costs and purchase premiums and discounts on loans are deferred andrecognized as an adjustment of yield, to be amortized to interest income overthe contractual term of the loan.  Theunamortized balance of deferred fees and costs is reported as a component ofnet loans.

 

Loan Sales and Servicing

 

Servicing rights acquired through 1) a purchase or 2) the originationof loans which are sold or securitized with servicing rights retained arerecognized as separate assets or liabilities. Servicing assets or liabilities are recorded at the difference betweenthe contractual servicing fees and adequate compensation for performing theservicing, and are subsequently amortized in proportion to and over the periodof the related net servicing income or expense.  Servicing assets are periodically evaluated for impairment.  Fair values are estimated using discountedcash flows based on current market interest rates.  For purposes of measuring impairment, servicing assets arestratified based on note rate and term. The amount of impairment recognized is the amount by which the servicingassets for a stratum exceed their fair value.

 

In addition, assets (accounted for as interest-only (IO) strips) arerecorded at the fair value of the difference between note rates and rates paidto purchasers (the interest spread) and contractual servicing fees, ifapplicable.  IO strips are carried atfair value with gains or losses recorded as a component of shareholders’equity, similar to available-for-sale investment securities.

 

F-9

----

 

***Government Guaranteed Loans***

 

Included in the portfolio are loans which are 85% to 90% guaranteed bythe Small Business Administration (SBA), U.S. Department of Agriculture, RuralBusiness – Cooperative Service (RBS) and Farm Services Agency (FSA).  The guaranteed portion of these loans may besold to a third party, with the Company retaining the unguaranteedportion.  The Company generally receivesa premium in excess of the adjusted carrying value of the loan at the time ofsale.  The Company may be required torefund a portion of the sales premium if the borrower defaults or the loanprepays within ninety days of the settlement date.

 

The Company’s investment in the loan is allocated between the retainedportion of the loan, the servicing asset, the IO strip, and the sold portion ofthe loan based on their relative fair values on the date the loan is sold.  The gain on the sold portion of the loan isrecognized as income at the time of sale. The carrying value of the retained portion of the loan is discountedbased on the estimated value of a comparable non-guaranteed loan.  The servicing asset is amortized over theestimated life of the related loan. Significant future prepayments of these loans will result in therecognition of additional amortization of related servicing assets and anadjustment to the carrying value of related IO strips.

 

The Company serviced SBA, RBS and FSA government guaranteed loans forothers totaling $63,510,800 and $58,867,200 as of December 31, 2003 and2002, respectively.

** **

***Mortgage Loans***

 

The Company originates mortgage loans that are either held in theCompany’s loan portfolio or sold in the secondary market.  Loans held for sale are carried at the lowerof cost or market value.  Market valueis determined by the specific identification method as of the balance sheetdate or the date which the purchasers have committed to purchase theloans.  At the time the loan is sold,the related right to service the loan is either retained, with the Company earningfuture servicing income, or released in exchange for a one-timeservicing-released premium.  Loanssubsequently transferred to the loan portfolio are transferred at the lower ofcost or market value at the date of transfer. Any difference between the carrying amount of the loan and its outstandingprincipal balance is recognized as an adjustment to yield by the interestmethod.

 

The Company serviced loans for the Federal National MortgageAssociation (FNMA) totaling $155,994,200 and $95,746,600 as ofDecember 31, 2003 and 2002, respectively.

 

*Participation Loans*

 

The Company also serviced loans which it has participated with otherfinancial institutions totaling $3,200,100 and $7,069,400 as ofDecember 31, 2003 and 2002, respectively.

 

F-10

----

 

**Allowance for Loan Losses**

 

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

 

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

 

The Company’s Loan Committee reviews the adequacy of the allowance forloan losses at least quarterly, to include consideration of the relative risksin the portfolio and current economic conditions.  The allowance for loan losses is adjusted based on that reviewif, in the judgment of the Loan Committee and management, changes arewarranted.

 

The allowance for loan losses is established through a provision forloan losses which is charged to expense. Additions to the allowance for loan losses are expected to maintain theadequacy of the total allowance after loan losses and loan growth.  The allowance for loan losses atDecember 31, 2003 and 2002 reflects management’s estimate of possiblelosses in the portfolio.

 

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

 

Premises and equipment are carried at cost.  Depreciation is determined using the straight-line method overthe estimated useful lives of the related assets.  The useful lives of premises are estimated to be thirty tothirty-nine years.  Leaseholdimprovements are amortized over the life of the improvement or the life of therelated lease, whichever is shorter. The useful lives of furniture, fixtures and equipment are estimated tobe three to ten years.  When assets aresold or otherwise disposed of, the cost and related accumulated depreciationare removed from the accounts, and any resulting gain or loss is recognized inincome for the period.  The cost ofmaintenance and repairs is charged to expense as incurred.

 

F-11

----

 

###### **Other Real Estate**

 

Other real estate includes real estate acquired in full or partialsettlement of loan obligations.  Whenproperty is acquired, any excess of the Company’s recorded investment in theloan balance and accrued interest income over the estimated fair market valueof the property is charged against the allowance for loan losses.  A valuation allowance for losses on otherreal estate is maintained to provide for temporary declines in value.  The allowance is established through a provisionfor losses on other real estate which is included in other expenses.  Subsequent gains or losses on sales orwritedowns resulting from permanent impairments are recorded in other income orexpense as incurred.  On theconsolidated balance sheet, other real estate is included in accrued interestreceivable and other assets.

 

**Income Taxes**

 

The Company files its income taxes on a consolidated basis with itssubsidiary.  The allocation of incometax expense (benefit) represents each entity’s proportionate share of theconsolidated provision for income taxes.

 

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

 

###### **Earnings Per Share**

 

Basic earnings per share (EPS), which excludes dilution, is computed bydividing income available to common shareholders by the weighted-average numberof common shares outstanding for the period, excluding the effect of unearnedshares of the Employee Stock Ownership Plan. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock, such as stock options, resultin the issuance of common stock which shares in the earnings of theCompany.  The treasury stock method hasbeen applied to determine the dilutive effect of stock options in computingdiluted EPS.

 

###### **Comprehensive Income**

 

Comprehensive income is reported in addition to net income for allperiods presented.  Comprehensive incomerepresents net income and other comprehensive income or loss.  Unrealized gains or losses on the Company’savailable-for-sale investment securities are the principle source of othercomprehensive income or loss.  Becausethe Company holds its investment securities principally as held-to-maturitysecurities, the Company’s net income approximates its comprehensive income.  Comprehensive income is reported in theaccompanying statement of changes in shareholders’ equity.

 

F-12

----

 

###### **Stock-Based Compensation**

 

At December 31, 2003, the Company has three stock-basedcompensation plans, which are described more fully in Note 11.  The Company accounts for these plans underthe recognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related Interpretations.  Nostock-based compensation cost is reflected in net income, as all optionsgranted under these plans had an exercise price equal to the market value ofthe underlying common stock on the date of grant.

 

The following table illustrates the effect on net income and earningsper share if the Company had applied the fair value recognition provisions ofFASB Statement No. 123, *Accounting forStock-Based Compensation*, to stock-based compensation.  Pro forma adjustments to the Company’sconsolidated net earnings and earnings per share are disclosed during the yearsin which the options become vested.

 
|                                                                                                                                           |   | **2003** |      | **2002** |   | **2001**  |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                                                                                                                                           |   |     |      |     |   |      |   |
| Net earnings, as reported                                                                                                                      |   | $        | 5,269,200 |     | $      | 4,849,600 |   | $ | 3,811,400 |   |
| Deduct:   Total stock-based compensation expense determined under the fair value  based method for all awards, net of related tax effects |   | 264,700  |      | 273,900  |   | 150,800   |   |
|                                                                                                                                           |   |     |      |     |   |      |   |
| Pro forma net earnings                                                                                                                         |   | $        | 5,004,500 |     | $      | 4,575,700 |   | $ | 3,660,600 |   |
|                                                                                                                                           |   |     |      |     |   |      |   |
| Basic earnings per share -as reported                                                                                                          |   | $        | 1.50      |     | $      | 1.40      |   | $ | 1.15 |   |
| Basic earnings per share - pro forma                                                                                                           |   | $        | 1.42      |     | $      | 1.32      |   | $ | 1.10 |   |
|                                                                                                                                           |   |     |      |     |   |      |   |
| Diluted earnings per share - as reported                                                                                                       |   | $        | 1.42      |     | $      | 1.33      |   | $ | 1.07 |   |
|                                                                                                                                           |   |     |      |     |   |      |   |   |   |   |
| Diluted earnings per share - pro forma                                                                                                         |   | $        | 1.36      |     | $      | 1.28      |   | $ | 1.06 |   |

 

The fair value of each option is estimated on the date of grant usingan option pricing model with the following assumptions:

 
|                                                            |   | **2003** |   | **2001** |   |
|-----------------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                            |   |     |   |     |   |
| Expected volatility                                             |   | 30.09    | %      | 64.58    | %      |
| Risk-free interest rate                                         |   | 4.52     | %      | 4.58     | %      |
| Expected option life                                            |   | 10 years |   | 10 years |   |
| Weighted average fair value of options  granted during the year |   | $        | 7.31   |     | $      | 5.72 |   |
|                                                                 |        |          |        |          |        |  |  |

 

F-13

----

 

**Impact of New Financial Accounting Standards**

 

On April 30, 2003, the FASB issued SFAS No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities*.  ThisStatement amends and clarifies the accounting for derivative instruments byproviding guidance related to circumstances under which a contract with a netinvestment meets the characteristics of a derivative as discussed in SFAS No.133.  The Statement also clarifies whena derivative contains a financing component. The Statement is intended to result in more consistent reporting forderivative contracts and must be applied prospectively for contracts enteredinto or modified after June 30, 2003, except for hedging relationshipsdesignated after June 30, 2003.  Inmanagement’s opinion, the adoption of this Statement did not have a materialimpact on the Company’s consolidated financial position or results ofoperations.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*.  This Statement establishes standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument thatis within its scope as a liability (or an asset in some circumstances).  This Statement is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterJune 15, 2003.  In managementsopinion, adoption of this Statement did not have a material effect on theCompany’s consolidated financial position or results of operations.

 

In December 2003, the FASB revised FASBInterpretation Number (FIN) 46, *Consolidationof Variable Interest Entities*. The purpose of this interpretation is to provide guidance on how toidentify a variable interest entity (VIE) and to determine when the assets,liabilities, noncontrolling interests, and results of operations of a VIE needto be included in a company’s consolidated financial statements.  A company that holds variable interests inan entity will need to consolidate that entity if the company’s interest in theVIE is such that the company will absorb a majority of the VIE’s expectedlosses and/or receive a majority of the VIE’s expected residual returns, ifthey occur.  FIN 46 is effective for allVIE’s created after January 31, 2003 and became effective for VIE’s thatexisted before February 1, 2003 for the first period ended afterDecember 15, 2003.  As ofDecember 31, 2003, the Company does not believe it has any VIE’s for whichthis interpretation would require consolidation.  However, under FIN 46, the Company’s subsidiary, Community ValleyBancorp Trust I, which issued mandatorily redeemable trust preferredsecurities, is required to be deconsolidated. Deconsolidation of the Trust did not have a material impact on theCompany’s consolidated financial position or results of operations.

 

F-14

----

 

In July 2003, the Board of Governors of theFederal Reserve System issued a supervisory letter instructing bank holdingcompanies to continue to include trust preferred securities in their Tier 1capital for regulatory capital purposes until notice is given to thecontrary.  The Federal Reserve intendsto review the regulatory implications of this accounting change and, ifnecessary or warranted, provide further appropriate guidance.  There can be no assurance that the FederalReserve will continue to allow institutions to include trust preferredsecurities in Tier 1 capital for regulatory capital purposes.

 

In December 2003, the AccountingStandards Executive Committee of the American Institute of Certified PublicAccountants issued Statement of Position 03-03, *Accounting for Certain Loans or Debt Securities Acquired in a Transfer*(SOP 03-03).  This SOP addressesaccounting for differences between contractual cash flows and cash flows expectedto be collected from an investor’s initial investment in loans or debtsecurities (loans) acquired in a transfer if those differences areattributable, at least in part, to credit quality.  It includes such loans acquired in purchase business combinationsand applies to all nongovernmental entities, including not-for-profitorganizations.  This SOP does not applyto loans originated by the entity.  ThisSOP limits the yield that may be accreted (accretable yield) to the excess ofthe investor’s estimate of undiscounted expected principal, interest, and othercash flows (cash flows expected at acquisition to be collected) over theinvestor’s initial investment in the loan. This SOP requires that the excess of contractual cash flows over cashflows expected to be collected (nonaccretable difference) not be recognized asan adjustment of yield, loss accrual, or valuation allowance.  This SOP prohibits investors from displayingaccretable yield and nonaccretable difference in the balance sheet.  Subsequent increases in cash flows expectedto be collected generally should be recognized prospectively through adjustmentof the loan’s yield over its remaining life. Decreases in cash flows expected to be collected should be recognized asimpairment, thereby retaining the accretable yield on the loan as adjusted.

 

This SOP prohibits “carrying over” orcreation of valuation allowances in the initial accounting for all loansacquired in a transfer that are within the scope of this SOP.  The prohibition of the valuation allowancecarryover applies to the purchase of an individual loan, a pool of loans, agroup of loans, and loans acquired in a purchase business combination.

 

This SOP is effective for loans acquired infiscal years beginning after December 15, 2004.  Management has not completed its evaluation of the impact thispronouncement may have on the Company’s consolidated financial position orresults of operations.

 

F-15

----

 

**2.****             INVESTMENTSECURITIES**

 

The amortized cost and estimated market value of investment securitiesat December 31, 2003 and 2002 consisted of the following:

 

Available-for-Sale:

 
|                                              |   | **2003**            |    |
|---------------------------------------------------|--------|---------------------|---------|
|                                              |   | **Amortized  Cost** |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
|                                              |   |                |    |   |   |   |   |   |   |
| U.S. Government agencies                          |   | $                   | 299,900 |   | $ | 2,100 |   |   |   | $ | 302,000 |   |
| Obligations of states and political  subdivisions |   | 200,000             |    |   |   |   |   | 200,000 |   |
|                                              |   |                |    |   |   |   |   |   |   |
|                                              |   | $                   | 499,900 |   | $ | 2,100 |   | $ | — |   | $ | 502,000 |   |
|                                              |   |                |    |   |   |   |   |   |   |
|                                              |   | **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  subdivisions |   | 200,000             |    |   |   |   |   | 200,000 |   |
|                                              |   |                |    |   |   |   |   |   |   |
|                                              |   | $                   | 499,900 |   | $ | 14,100 |   | $ | — |   | $ | 514,000 |   |

 

Unrealized gains on available-for-sale investment securities totaling$2,100 were recorded as accumulated other comprehensive income withinshareholders’ equity at December 31, 2003.  Unrealized gains on available-for-sale investment securitiestotaling $14,100 were recorded as accumulated other comprehensive income withinshareholders’ equity at December 31, 2002.  Tax liabilities associated with such gains was not significant.  There were no sales or transfers ofavailable-for-sale investment securities for the years ended December 31,2003, 2002 and 2001.

 

Held-to-Maturity:

 
|                                              |   | **2003**            |      |
|---------------------------------------------------|--------|---------------------|-----------|
|                                              |   | **Amortized  Cost** |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
|                                              |   |                |      |   |   |   |   |   |   |
| U.S. Government agencies                          |   | $                   | 3,278,100 |   | $ | 18,100 |   | $ | (26,400 | ) | $ | 3,269,800 |   |
| Obligations of states and political  subdivisions |   | 544,400             |      | 9,500 |   |   |   | 553,900 |   |
|                                              |   |                |      |   |   |   |   |   |   |
|                                              |   | $                   | 3,822,500 |   | $ | 27,600 |   | $ | (26,400 | ) | $ | 3,823,700 |   |

 

F-16

----

 
|                                              |   | **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  subdivisions |   | 990,900             |      | 23,900 |   | (1,100 | ) | 1,013,700 |   |
|                                              |   |                |      |   |   |   |   |   |   |
|                                              |   | $                   | 2,872,900 |   | $ | 52,300 |   | $ | (1,200 | ) | $ | 2,924,000 |   |

 

There were no sales or transfers of held-to-maturity investmentsecurities for the years ended December 31, 2003, 2002 and 2001.

 

At December 31, 2003, held-to-maturity investments in U.S.Government agencies with an estimated market value of $1,422,300 had grossunrealized losses of $26,400.  None ofthese unrealized losses have been in a continuous loss position for more than ayear.  Management periodically evaluateseach investment security for other than temporary impairment relying primarilyon industry analyst reports, observation of market conditions and interest ratefluctuations.  Management believes itwill be able to collect all amounts due according to the contractual terms ofthe underlying investment securities and that the noted decline is due only tointerest rate fluctuations.

 

The amortized cost and estimated market value of investment securitiesat December 31, 2003, by contractual maturity, are shown below.  Expected maturities will differ fromcontractual maturities because the issuers of securities may have the right tocall 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                    |   |                   |    |                         |   | $ | 307,800 |   | $ | 312,500 |   |
| After one year through five years  |   |                   |    |                         |   | 560,500 |   | 578,200 |   |
| After five years through ten years |   | $                      | 499,900 |                         | $      | 502,000 |   | 2,765,000 |   | 2,743,600 |   |
| After ten years                    |   |                   |    |                         |   | 189,200 |   | 189,400 |   |
|                               |   |                   |    |                         |   |   |   |   |   |
|                               |   | $                      | 499,900 |                         | $      | 502,000 |   | $ | 3,822,500 |   | $ | 3,823,700 |   |

 

F-17

----

 

Investment securities with amortized costs totaling $994,400 and$465,000 and market values totaling $1,003,900 and $480,200 were pledged tosecure public deposits and treasury, tax and loan accounts at December 31,2003 and 2002, respectively.

 

**3.****             LOANS**

 

Outstanding loans are summarized as follows:

 
|                                |   | **December 31,** |        |
|-------------------------------------|--------|-----------------------|-------------|
|                                |   | **2003**              |        | **2002** | ** ** |
|                                |   |                  |        |   |   |
| Real estate - mortgage              |   | $                     | 114,911,700 |   | $ | 82,056,900 |   |
| Real estate - construction          |   | 63,195,500            |        | 64,565,200 |   |
| Commercial                          |   | 54,076,500            |        | 48,660,700 |   |
| Agricultural                        |   | 20,819,900            |        | 18,934,700 |   |
| Installment                         |   | 21,847,400            |        | 19,325,000 |   |
|                                |   |                  |        |   |   |
|                                |   | 274,851,000           |        | 233,542,500 |   |
|                                |   |                  |        |   |   |
| Deferred loan origination fees, net |   | (1,032,500            | )           | (836,500 | ) |
| Allowance for loan losses           |   | (3,587,200            | )           | (3,006,800 | ) |
|                                |   |                  |        |   |   |
|                                |   | $                     | 270,231,300 |   | $ | 229,699,200 |   |

 

Changes in the allowance for loan losses were as follows:

 
|                            |   | **Year Ended  December 31,** |      |
|---------------------------------|--------|-----------------------------------|-----------|
|                            |   | **2003**                          |      | **2002** |   | **2001** |   |
|                            |   |                              |      |   |   |   |   |
| Balance, beginning of year      |   | $                                 | 3,006,800 |   | $ | 2,396,700 |   | $ | 2,000,200 |   |
| Provision charged to operations |   | 655,000                           |      | 603,000 |   | 500,000 |   |
| Losses charged to allowance     |   | (81,200                           | )         | (7,400 | ) | (133,300 | ) |
| Recoveries                      |   | 6,600                             |      | 14,500 |   | 29,800 |   |
|                            |   |                              |      |   |   |   |   |
| Balance, end of year            |   | $                                 | 3,587,200 |   | $ | 3,006,800 |   | $ | 2,396,700 |   |

 

The Company had no significant loans which management considered to beimpaired during the years ended December 31, 2003, 2002 and 2001.

 

At December 31, 2003 and 2002, nonaccrual loans totaled $54,200and $594,300, respectively.  Interestforegone on nonaccrual loans totaled $1,200, $35,400 and $21,600 for the yearsended December 31, 2003, 2002 and 2001, respectively.

 

Salaries and employee benefits totaling $1,032,300, $980,100 and$820,600 have been deferred as loan origination costs for the years endedDecember 31, 2003, 2002 and 2001, respectively.

 

F-18

----

 

**4.****             ACCRUED INTERESTRECEIVABLE AND OTHER ASSETS**

 

Accrued interest receivable and other assets consisted of thefollowing:

 
|                                                       |   | **December 31,** |       |
|------------------------------------------------------------|--------|-----------------------|------------|
|                                                       |   | **2003**              |       | **2002** |   |
|                                                       |   |                  |       |   |   |
| Accrued interest receivable                                |   | $                     | 2,607,300  |   | $ | 2,330,300 |   |
| Deferred tax assets, net (Note 13)                         |   | 2,787,000             |       | 2,148,000 |   |
| Cash surrender value of life insurance  policies (Note 15) |   | 6,296,800             |       | 4,290,900 |   |
| Mortgage servicing assets                                  |   | 1,397,000             |       | 761,300 |   |
| Prepaid expenses                                           |   | 872,200               |       | 820,000 |   |
| Other                                                      |   | 2,638,900             |       | 2,389,500 |   |
|                                                       |   |                  |       |   |   |
|                                                       |   | $                     | 16,599,200 |   | $ | 12,740,000 |   |

 

Originated mortgage servicing assets totaling $1,111,400, $546,000 and$87,700 were recognized during the years ended December 31, 2003, 2002 and2001, respectively.  Amortization ofmortgage servicing assets totaled $475,700, $209,900 and $176,300 for the yearsended December 31, 2003, 2002 and 2001, respectively.

 

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

 

Premises and equipment consisted of the following:

 
|                                            |   | **December 31,** |      |
|-------------------------------------------------|--------|-----------------------|-----------|
|                                            |   | **2003**              |      | **2002** |   |
|                                            |   |                  |      |   |   |
| Land                                            |   | $                     | 1,192,800 |   | $ | 1,192,800 |   |
| Buildings and improvements                      |   | 5,667,200             |      | 4,632,600 |   |
| Furniture, fixtures and equipment               |   | 5,106,200             |      | 3,977,100 |   |
| **Leasehold  improvements**                     |   | **690,100**           |      | **329,800** |   |
| **Construction in  progress**                   |   | **137,600**           |      | **102,700** |   |
|                                            |   |                  |      |   |   |
|                                            |   | 12,793,900            |      | 10,235,000 |   |
| Less accumulated depreciation and  amortization |   | (4,240,000            | )         | (3,581,900 | ) |
|                                            |   |                  |      |   |   |
|                                            |   | $                     | 8,553,900 |   | $ | 6,653,100 |   |

 

Depreciation and amortization included in occupancy and equipmentexpense totaled $933,500, $742,800 and $690,200 for the years endedDecember 31, 2003, 2002 and 2001, respectively.

 

F-19

----

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

 

Interest-bearing deposits consisted of the following:

 
|                           |   | **December 31,** |        |
|--------------------------------|--------|-----------------------|-------------|
|                           |   | **2003**              |        | **2002** |   |
|                           |   |                  |        |   |   |
| Savings                        |   | $                     | 24,945,800  |   | $ | 19,558,100 |   |
| Money market                   |   | 33,819,500            |        | 22,851,800 |   |
| NOW accounts                   |   | 130,275,200           |        | 108,615,100 |   |
| Individual retirement accounts |   | 7,211,100             |        | 6,874,400 |   |
| Time, $100,000 or more         |   | 31,393,700            |        | 23,830,800 |   |
| Other time                     |   | 46,403,000            |        | 53,361,700 |   |
|                           |   |                  |        |   |   |
|                           |   | $                     | 274,048,300 |   | $ | 235,091,900 |   |

 

Aggregate annual maturities of time deposits at December 31, 2003are as follows:

 

| **Year EndingDecember 31,** |   |       |       |
|----------------------------------|--------|------------|------------|
|                             |   |       |       |
| 2004                             |   | $          | 40,749,700 |   |
| 2005                             |   | 33,824,000 |       |
| 2006                             |   | 920,600    |       |
| After 2008                       |   | 2,302,400  |       |
|                             |   |       |       |
|                             |   | $          | 77,796,700 |   |

 

Interest expense recognized oninterest-bearing deposits consisted of the following:

 
|                           |   | **Year Ended  December 31,** |      |
|--------------------------------|--------|-----------------------------------|-----------|
|                           |   | **2003**                          |      | **2002** |   | **2001** |   |
|                           |   |                              |      |   |   |   |   |
| Savings                        |   | $                                 | 121,500   |   | $ | 173,400 |   | $ | 244,100 |   |
| Money market                   |   | 356,500                           |      | 341,400 |   | 545,100 |   |
| NOW accounts                   |   | 1,049,700                         |      | 1,042,800 |   | 680,400 |   |
| Individual retirement accounts |   | 185,400                           |      | 218,400 |   | 276,900 |   |
| Time, $100,000 or more         |   | 853,200                           |      | 807,300 |   | 1,652,000 |   |
| Other time                     |   | 1,358,000                         |      | 2,151,700 |   | 3,890,800 |   |
|                           |   |                              |      |   |   |   |   |
|                           |   | $                                 | 3,924,300 |   | $ | 4,735,000 |   | $ | 7,289,300 |   |

 

F-20

----

 

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

 

**Leases**

 

The Company leases three branch offices andcertain equipment under noncancellable operating leases.  Future minimum lease payments and subleaserental income are as follows:

 
| **Year Ending  December 31,** |   | **Minimum  Lease  Payments** |      | **Minimum  Sublease  Rental  Income** |   |
|------------------------------------|--------|------------------------------|-----------|---------------------------------------|--------|
|                               |   |                         |      |                                  |   |
| 2004                               |   | $                            | 406,400   |                                  | $      | 123,600 |   |
| 2005                               |   | 415,000                      |      | 119,800                               |   |
| 2006                               |   | 407,400                      |      | 115,900                               |   |
| 2007                               |   | 377,000                      |      | 110,600                               |   |
| 2008                               |   | 396,400                      |      | 101,100                               |   |
| Thereafter                         |   | 2,682,100                    |      | 448,700                               |   |
|                               |   |                         |      |                                  |   |
|                               |   | $                            | 4,684,300 |                                  | $      | 1,019,700 |   |

 

Rental expense included in occupancy andequipment expense totaled $391,200, $190,200 and $149,000 for the years endedDecember 31, 2003, 2002 and 2001, respectively.  Sublease income included in occupancy expense totaled $90,800,$45,400 and $11,200 for the years ended December 31, 2003, 2002 and 2001,respectively.

 

The North Chico branch lease can be renewedfor three successive five-year terms after the lease expires August 31,2028 and the Central Chico branch lease can be renewed for four successivefive-year terms after the lease expires September 30, 2011.  The Magalia branch lease can be renewed fortwo successive five-year terms after the lease expires March 31,2005.  The Paradise branch lease can berenewed for two successive five-year terms after the lease expiresMarch 31, 2013.  The North ValleyPlaza branch lease in Chico can be renewed for two successive five-year termsafter the lease expires February 28, 2013.

 

**Financial Instruments With Off-Balance-SheetRisk**

 

The Company is a party to financial instruments with off-balance-sheetrisk in the normal course of business in order to meet the financing needs ofits customers.  These financialinstruments include commitments to extend credit and letters of credit.  These instruments involve, to varyingdegrees, elements of credit and interest rate risk in excess of the amountrecognized on the consolidated balance sheet.

 

The Company’s exposure to credit loss in theevent of nonperformance by the other party for commitments to extend credit andletters of credit is represented by the contractual amount of thoseinstruments.  The Company uses the samecredit policies in making commitments and letters of credit as it does forloans included on the consolidated balance sheet.

 

F-21

----

 

The following financial instruments representoff-balance-sheet credit risk:

 
|                         |   | **December 31,** |        |
|------------------------------|--------|-----------------------|-------------|
|                         |   | **2003**              |        | **2002** |   |
|                         |   |                  |        |   |   |
| Commitments to extend credit |   | $                     | 137,857,000 |   | $ | 103,605,300 |   |
| Letters of credit            |   | $                     | 3,450,700   |   | $ | 2,229,500 |   |

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require payment ofa fee.  Since some of the commitmentsare expected to expire without being drawn upon, the total commitment amountsdo not necessarily represent future cash requirements.  Each customer’s creditworthiness isevaluated on a case-by-case basis.  Theamount of collateral obtained, if deemed necessary upon extension of credit, isbased on management’s credit evaluation of the borrower.  Collateral held varies, but may includedeposit accounts, accounts receivable, inventory, equipment and deeds of truston residential real estate and income-producing commercial properties.

 

Letters of credit are conditional commitmentsissued to guarantee the performance of a customer to a third party.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in extending loans tocustomers.

 

Commercial loan commitments representapproximately 15% of total commitments and are generally unsecured or securedby collateral other than real estate and have variable interest rates.  Agricultural loan commitments represent approximately8% of total commitments and are generally secured by crop assignments, accountsreceivable and farm equipment and have variable interest rates.  Real estate loan commitments representapproximately 69% of total commitments and are generally secured by propertywith a loan-to-value ratio not to exceed 80%. The majority of real estate commitments also have variable interestrates.  Personal lines of credit andhome equity lines of credit represent the remaining 8% of total commitments andare generally unsecured or secured by residential real estate and have bothvariable and fixed interest rates.

 

Significant Concentrations of Credit Risk

 

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

 

Although the Company has a diversified loanportfolio, a substantial portion of its portfolio is secured by commercial andresidential real estate.  However,personal and business income represent the primary source of repayment for amajority of these loans.

 

F-22

----

 

In addition, the Company’s real estate andconstruction loans represent approximately 65% of outstanding loans atDecember 31, 2003, compared to approximately 63% at December 31,2002.  Collateral values associated withthis lending concentration can vary significantly based on the general level ofinterest rates and both local and regional economic conditions.  In management’s opinion, although thisconcentration has no more than the normal risk of collection, a substantialdecline in the performance of the economy in general or a decline in realestate values in the Company’s primary market areas, in particular, could havean adverse impact on the collectibility of these loans.

 

###### **Correspondent Banking Agreements**

 

The Company maintains funds on deposit withother federally insured financial institutions under correspondent bankingagreements.  Uninsured deposits totaled$1,531,600 at December 31, 2003.

 

###### **Federal Reserve Requirements**

 

Banks are required to maintain reserves withthe Federal Reserve Bank equal to a percentage of their reservable depositsless vault cash.  The Bank’s vault cashfulfilled its reserve requirement at December 31, 2003.

 

###### **Contingencies**

 

The Company is subject to legal proceedingsand claims which arise in the ordinary course of business.  In the opinion of management, the amount ofultimate liability with respect to such actions will not materially affect thefinancial position or results of operations of the Company.

 

**8.****                                      JUNIORSUBORDINATED DEBENTURES**

 

 

Community Valley Bancorp Trust I (CVB TrustI) is a Delaware statutory business trust formed by the Company for the solepurpose of issuing trust preferred securities fully and unconditionallyguaranteed by the Company.  Forfinancial reporting purposes, the Company’s equity interest in the trust,totaling $248,000, is accounted for under the equity method and is included inaccrued interest receivable and other assets on the accompanying consolidatedbalance sheet and the junior subordinated debentures (the “SubordinatedDebentures”) held by the trust and issued and guaranteed by the Company arereflected on the Company’s consolidated balance sheet in accordance with theprovisions of FIN 46.  Under applicableregulatory guidance, the amount of trust preferred securities that is eligibleas Tier 1 capital is limited to twenty-five percent of the Company’s Tier 1capital on a pro forma basis.  AtDecember 31, 2003, all of the trust preferred securities that have beenissued qualify as Tier 1 capital.

 

F-23

----

 

In December 2002, the Company issued toCVB Trust I Subordinated Debentures due December 31, 2032.  Simultaneously, CVB Trust I issued 8,000floating rate trust preferred securities, with liquidation values of $1,000 persecurity, for gross proceeds of $8,000,000. The Subordinated Debentures represent the sole assets of the Trust.  The Subordinated Debentures are redeemableby the Company, subject to receipt by the Company of prior approval from theFederal Reserve Bank (FRB), if then required under applicable capitalguidelines or policies of the FRB.  TheCompany may redeem the Subordinated Debentures held by CVB Trust I on anyDecember 31st on or after December 31, 2007.  The redemption price shall be par plusaccrued and unpaid interest, except in the case of redemption under a specialevent, which is defined in the debenture. The floating rate trust preferred securities are subject to mandatoryredemption to the extent of any early redemption of the Subordinated Debenturesand upon maturity of the Subordinated Debentures on December 31, 2032.

 

Holders of the trust preferred securities areentitled to cumulative cash distributions on the liquidation amount of $1,000per security.  Interest rates on thetrust preferred securities and Subordinated Debentures are the same and arecomputed on a 360-day basis.  The statedinterest rate is the three-month London Interbank Offered Rate (LIBOR) plus3.30% with a maximum rate of 12.5% annually, adjustable quarterly.  The average LIBOR rate for the year endedDecember 31, 2003 was 1.26%.

 

**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, 2003 and 2002.

 

**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 April 8, 2010.  At December 31, 2003, the interest rate was 4.0%.  Advances on the line of credit totaled$831,900 and $732,100 at December 31, 2003 and 2002, respectively.

 

F-24

----

 

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

 

**Dividends**

 

The shareholders of theCompany will be entitled to receive dividends when and as declared by its Boardof Directors, out of funds legally available for the payment of dividends, asprovided in the California General Corporation Law.  The California General Corporation Law providesthat a corporation may make a distribution to its shareholders if retainedearnings immediately prior to the dividend payout at least equal the amount ofthe proposed distribution. In the event that sufficient retained earnings are notavailable for the proposed distribution, a corporation may, nevertheless, makea distribution, if it meets both the “quantitative solvency” and the“liquidity” tests.  In general, thequantitative solvency test requires that the sum of the assets of the corporationequal at least 1-1/4 times its liabilities. The liquidity test generally requires that a corporation have currentassets at least equal to current liabilities, or, if the average of theearnings of the corporation before taxes on income and before interest expensesfor the two preceding fiscal years was less than the average of the interestexpense of the corporation for such fiscal years, then current assets mustequal at least 1-1/4 times current liabilities. In certain circumstances, the Companymay be required to obtain the prior approval of the Federal Reserve Board tomake capital distributions to shareholders of the Company.

 

The California Financial Code restricts thetotal dividend payment of any bank in any calendar year to the lesser of (1)the bank’s retained earnings or (2) the bank’s net income for its last threefiscal years, less distributions made to shareholders during the samethree-year period.  At December 31,2003, retained earnings of $10,926,000 were free of such restrictions.

 

**Stock Split**

 

On February 20, 2004, the Board ofDirectors declared a four-for-three stock split effective March 26, 2004for shareholders of record on March 2, 2004.  All share and per share data has been retroactively adjusted toreflect the stock split.

 

On August 20, 2002, the Board ofDirectors declared a four-for-three stock split effective September 30,2002 for shareholders of record on September 16, 2002.  All share and per share data has been retroactivelyadjusted to reflect the stock split.

 

###### **Stock Repurchase Plan**

 

In June 2003, the Board of Directorsapproved a plan to repurchase up to $3,000,000 of the outstanding common stockof the Company.  Stock repurchases maybe made from time to time on the open market or through privately negotiatedtransactions.  The timing of purchasesand the exact number of shares to be purchased will depend on marketconditions.  The share repurchaseprogram does not include specific price targets or timetables and may besuspended at any time.  No shares were repurchasedunder this program in 2003.

 

F-25

----

 

**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, 201,588shares 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, 373,153 shares of common stock are reserved forissuance to employees and directors, of which 111,334 shares are available forfuture grants.

 
|                                   |   | **2003**   |         | **2002**                             |         | **2001**   |         |
|----------------------------------------|--------|------------|--------------|--------------------------------------|--------------|------------|--------------|
|                                   |   | **Shares** |         | **Weighted  Average  ExercisePrice** |         | **Shares** |         | **Weighted  Average  ExercisePrice** |   | **Shares** |   | **Weighted  Average  ExercisePrice** |   |
|                                   |   |       | *** *** |                                 | *** *** |       | *** *** |   | *** *** |   | *** *** |   | *** *** |
| ***Incentive Options***                |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
|                                   |   |       | *** *** |                                 | *** *** |       | *** *** |   | *** *** |   | *** *** |   | *** *** |
| Options outstanding, beginning of year |   | 266,113    |         | $                                    | 8.84         |       | 216,865      |   | $ | 6.35 |   | 392,764 |   | $ | 4.28 |   |
|                                   |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
| Options granted                        |   | 6,667      |         | $                                    | 19.31        |       | 84,888       |   | $ | 14.16 |   |   |   |   |   |
| Options exercised                      |   | (28,689    | )            | $                                    | 5.95         |       | (35,640      | ) | $ | 6.31 |   | (175,899 | ) | $ | 1.75 |   |
| Options cancelled                      |   | (3,556     | )            | $                                    | 13.73        |       |         |   |   |   |   |   |   |   |
|                                   |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
| Options outstanding, end of year       |   | 240,535    |         | $                                    | 9.41         |       | 266,113      |   | $ | 8.84 |   | 216,865 |   | $ | 6.35 |   |
|                                   |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
| Options exercisable, end of year       |   | 160,531    |         | $                                    | 7.36         |       | 144,207      |   | $ | 5.61 |   | 130,752 |   | $ | 5.25 |   |
|                                   |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
| ***Non-Qualified  Options***           |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
|                                   |   |       | *** *** |                                 | *** *** |       | *** *** |   | *** *** |   | *** *** |   | *** *** |
| Options outstanding, beginning of year |   | 232,872    |         | $                                    | 7.35         |       | 246,515      |   | $ | 7.20 |   | 350,520 |   | $ | 5.48 |   |
|                                   |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
| Options granted                        |   | 2,667      |         | $                                    | 19.31        |       |         |   |   |   |   |   |   |   |
| Options exercised                      |   | (12,667    | )            | $                                    | 7.64         |       | (13,643      | ) | $ | 4.59 |   | (104,005 | ) | $ | 1.48 |   |
|                                   |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
| Options outstanding, end of year       |   | 222,872    |         | $                                    | 7.49         |       | 232,872      |   | $ | 7.35 |   | 246,515 |   | $ | 7.20 |   |
|                                   |   |       |         |                                 |         |       |         |   |   |   |   |   |   |
| Options exercisable, end of year       |   | 170,072    |         | $                                    | 6.73         |       | 152,872      |   | $ | 6.28 |   | 139,848 |   | $ | 5.51 |   |

 

F-26

----

 

A summary ofoptions outstanding at December 31, 2003 follows:

 
| **Range of Exercise Prices** |   | **Number of  Options  Outstanding  December 31,  2003** |   | **Weighted  Average  Remaining  Contractual  Life** |   | **Number of  Options  Exercisable  December 31,  2003** |   |
|------------------------------|--------|--------------------------------------------------------------|--------|-----------------------------------------------------|--------|--------------------------------------------------------------|--------|
|                         |   |                                                         |   |                                                |   |                                                         |   |
| **Incentive Options**        |   |                                                         |   |                                                |   |                                                         |   |
|                         |   |                                                         |   |                                                |   |                                                         |   |
| $                            |   | 2.05                                                         | -      | $                                                   |   | 5.27                                                         |   | 92,171 |   | 3.4 years |   | 92,171 |   |
| $                            |   | 7.59                                                         | -      | $                                                   |   | 10.55                                                        |   | 61,253 |   | 6.0 years |   | 41,605 |   |
| $                            |   | 13.73                                                        | -      | $                                                   |   | 15.01                                                        |   | 80,444 |   | 8.8 years |   | 26,755 |   |
| $                            |   | 19.31                                                        |   |                                                |   |                                                         |   | 6,667 |   | 9.6 years |   |   |   |
|                         |   |                                                         |   |                                                |   |                                                         |   |
|                         |   | 240,535                                                      |   |                                                |   | 160,531                                                      |   |
|                         |   |                                                         |   |                                                |   |                                                         |   |
| **Non-qualified  Options**   |   |                                                         |   |                                                |   |                                                         |   |
|                         |   |                                                         |   |                                                |   |                                                         |   |
| $                            |   | 10.88                                                        |   | 94,872                                              |   | 3.3 years                                                    |   | 94,872 |   |
| $                            |   | 12.56                                                        |   | 125,333                                             |   | 6.3 years                                                    |   | 75,200 |   |
| $                            |   | 19.31                                                        |   | 2,667                                               |   | 9.8 years                                                    |   |   |   |
|                         |   |                                                         |   |                                                |   |                                                         |   |
|                         |   | 222,872                                                      |   |                                                |   | 170,072                                                      |   |

 

###### **Earnings Per Share**

 

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

 

 
| **For the Year Ended**           |   | **Net  Income** |      | **Weighted  Average  Number of  Shares  Outstanding** |      | **Per Share  Amount** |   |
|----------------------------------|--------|-----------------|-----------|-------------------------------------------------------|-----------|-----------------------|--------|
|                             |   |            |      |                                                  |      |                  |   |
| **December 31,  2003**      |   |            |      |                                                  |      |                  |   |
|                             |   |            |      |                                                  |      |                  |   |
| Basic earnings per share         |   | $               | 5,269,200 |                                                  | 3,512,645 |                  | $      | 1.50 |   |
|                             |   |            |      |                                                  |      |                  |   |
| Effect of dilutive stock options |   |            |      | 202,613                                               |      |                  |   |
|                             |   |            |      |                                                  |      |                  |   |
| Diluted earnings per share       |   | $               | 5,269,200 |                                                  | 3,715,258 |                  | $      | 1.42 |   |

 

F-27

----

 
| **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 |                                                  | 3,461,115 |                  | $      | 1.40 |   |
|                             |   |            |      |                                                  |      |                  |   |
| Effect of dilutive stock options |   |            |      | 178,815                                               |      |                  |   |
|                             |   |            |      |                                                  |      |                  |   |
| Diluted earnings per share       |   | $               | 4,849,600 |                                                  | 3,639,930 |                  | $      | 1.33 |   |
|                             |   |            |      |                                                  |      |                  |   |
| **December 31,  2001**      |   |            |      |                                                  |      |                  |   |
|                             |   |            |      |                                                  |      |                  |   |
| Basic earnings per share         |   | $               | 3,811,400 |                                                  | 3,323,429 |                  | $      | 1.15 |   |
|                             |   |            |      |                                                  |      |                  |   |
| Effect of dilutive stock options |   |            |      | 250,311                                               |      |                  |   |
|                             |   |            |      |                                                  |      |                  |   |
| Diluted earnings per share       |   | $               | 3,811,400 |                                                  | 3,573,740 |                  | $      | 1.07 |   |

 

Shares of commonstock issuable under stock options for which the exercise prices were greaterthan the average market prices were not included in the computation of dilutedearnings per share due to their antidilutive effect.  Options to issue 206,815 and 204,444 shares of common stock atprices ranging from $9.08 to $10.55 were not included in the computation ofdiluted earnings per share for the first two quarters of the year endingDecember 31, 2001 because their effect would be antidilutive.

 

Regulatory Capital

 

The Company and the Bank are subject tocertain regulatory capital requirements administered by the Board of Governorsof the Federal Reserve System and the Federal Depository Insurance Corporation(FDIC).  Failure to meet these minimumcapital requirements can initiate certain mandatory, and possibly additionaldiscretionary, actions by regulators that, if undertaken, could have a directmaterial effect on the Company’s consolidated financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital 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.

 

F-28

----

 

Quantitative measures established byregulation to ensure capital adequacy require the Company and the Bank tomaintain minimum amounts and ratios of total and Tier 1 capital to risk-weightedassets and of Tier 1 capital to average assets as set forth in the followingtable.  Each of these components isdefined in the regulations.  Managementbelieves that the Company and the Bank meet all their capital adequacyrequirements as of December 31, 2003 and 2002.

 

In addition, the most recent notificationfrom the FDIC categorized the Bank as well capitalized under the regulatoryframework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimumtotal risk-based, Tier 1 risk-based and Tier 1 leverage ratios as setforth below.  There are no conditions orevents since that notification that management believes have changed the Bank’scategory.

 
|                                       |              |      |             | **For  Capital  Adequacy Purposes** |              | **To Be Well  Capitalized  Under Prompt Corrective  Action Provisions** |             |
|--------------------------------------------|-------------------|-----------|------------------|-------------------------------------|-------------------|-------------------------------------------------------------------------|------------------|
| **Actual**                                 | **MinimumAmount** |      | **MinimumRatio** |                                | **MinimumAmount** |                                                                    | **MinimumRatio** |   |
| **Amount**                                 |              | **Ratio** |
|                                       |              |      | ** **       |                                | ** **        |                                                                    | ** **       |   | ** ** |   | ** ** |   | ** ** |
| **December 31,  2003**                |              |      |             |                                |              |                                                                    |             |   |   |   |   |   |   |
|                                       |              |      | ** **       |                                | ** **        |                                                                    | ** **       |   | ** ** |   | ** ** |   | ** ** |
| Company:                                   |              |      |             |                                |              |                                                                    |             |   |   |   |   |   |   |
| Total  capital (to risk- weighted assets)  |              | $         | 41,380,600       |                                | 13.3              | %                                                                       | $                | 24,828,600 |   | 8.0 | % | N/A |   | N/A |   |
| Tier 1  capital (to risk- weighted assets) |              | $         | 37,793,400       |                                | 12.2              | %                                                                       | $                | 12,414,300 |   | 4.0 | % | N/A |   | N/A |   |
| Tier 1  capital (to average assets)        |              | $         | 37,793,400       |                                | 9.9               | %                                                                       | $                | 15,340,000 |   | 4.0 | % | N/A |   | N/A |   |
|                                       |              |      |             |                                |              |                                                                    |             |   |   |   |   |   |   |
| Bank:                                      |              |      |             |                                |              |                                                                    |             |   |   |   |   |   |   |
| Total  capital (to risk- weighted assets)  |              | $         | 37,406,300       |                                | 12.1              | %                                                                       | $                | 24,808,600 |   | 8.0 | % | $ | 31,010,700 |   | 10.0 | % |
| Tier 1  capital (to risk- weighted assets) |              | $         | 33,819,100       |                                | 10.9              | %                                                                       | $                | 12,404,300 |   | 4.0 | % | $ | 18,606,400 |   | 6.0 | % |
| Tier 1  capital (to average assets)        |              | $         | 33,819,100       |                                | 8.8               | %                                                                       | $                | 15,303,300 |   | 4.0 | % | $ | 19,129,200 |   | 5.0 | % |
|                                       |              |      | ** **       |                                | ** **        |                                                                    | ** **       |   | ** ** |   | ** ** |   | ** ** |
| **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 | % |

 

F-29

----

 

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

 

Other non-interest income consisted of thefollowing:

 
|                                                                                         |   | **Year Ended  December 31,** |      |
|----------------------------------------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                                                         |   | **2003**                          |      | **2002** |   | **2001** |   |
|                                                                                         |   |                              |      |   |   |   |   |
| Earnings and death benefit from cash  surrender value life insurance policies, net (Note 15) |   | $                                 | 403,900   |   | $ | 1,406,400 |   | $ | 243,700 |   |
| Merchant card processing fees                                                                |   | 342,700                           |      | 353,700 |   | 259,700 |   |
| Other                                                                                        |   | 643,600                           |      | 692,900 |   | 439,500 |   |
|                                                                                         |   |                              |      |   |   |   |   |
|                                                                                         |   | $                                 | 1,390,200 |   | $ | 2,453,000 |   | $ | 942,900 |   |

 

Other expense consisted of the following:

 
|                                                                  |   | **Year Ended December 31,** |      |
|-----------------------------------------------------------------------|--------|----------------------------------|-----------|
|                                                                  |   | **2003**                         |      | **2002** |   | **2001** |   |
|                                                                  |   |                             |      |   |   |   |   |
| Professional fees                                                     |   | $                                | 537,100   |   | $ | 622,300 |   | $ | 550,900 |   |
| Telephone and postage                                                 |   | 498,000                          |      | 436,200 |   | 397,000 |   |
| Stationery and supplies                                               |   | 548,700                          |      | 457,800 |   | 323,400 |   |
| Director fees and retirement accrual                                  |   | 357,400                          |      | 298,000 |   | 207,000 |   |
| Advertising and promotion                                             |   | 188,300                          |      | 190,900 |   | 131,100 |   |
| Beneficiary benefit accrual under salary  continuation plan (Note 15) |   |                             |      | 1,136,400 |   |   |   |
| Other                                                                 |   | 1,500,100                        |      | 1,281,100 |   | 1,091,900 |   |
|                                                                  |   |                             |      |   |   |   |   |
|                                                                  |   | $                                | 3,629,600 |   | $ | 4,422,700 |   | $ | 2,701,300 |   |

 

Professional feesinclude amounts paid to outside vendors to perform accounting services forcompanies that maintain large non-interest bearing deposits with the Bank.  Total costs incurred were dependent upon thevolume of deposits and totaled $232,000, $126,000 and $231,900 for the yearsended December 31, 2003, 2002 and 2001, respectively.  During these same periods, the companiesmaintained average available balances of approximately $19.5 million, $15.3million and $12.8 million, respectively.

 

F-30

----

 

**13.****                               INCOMETAXES**

 

The provision for income taxes for the yearsended December 31, 2003, 2002 and 2001 consisted of the following:

 
|               |   | **Federal** |      | **State** |   | **Total** |   |
|--------------------|--------|-------------|-----------|-----------|--------|-----------|--------|
|               |   |        |      |      |   |      |   |
| 2003               |   |        |      |      |   |      |   |
|               |   |        |      |      |   |      |   |
| Current            |   | $           | 2,944,000 |      | $      | 1,024,000 |   | $ | 3,968,000 |   |
| Deferred           |   | (487,000    | )         | (152,000  | )      | (639,000  | )      |
|               |   |        |      |      |   |      |   |
| Income tax expense |   | $           | 2,457,000 |      | $      | 872,000   |   | $ | 3,329,000 |   |
|               |   |        |      |      |   |      |   |
| 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 |   |

 

Deferred tax assets(liabilities) are comprised of the following at December 31, 2003 and2002:

 
|                                           |   | **2003**  |      | **2002**  |   |
|------------------------------------------------|--------|-----------|-----------|-----------|--------|
|                                           |   |      |      |      |   |
| Deferred tax assets:                           |   |      |      |      |   |
| Allowance for loan losses                      |   | $         | 1,457,000 |      | $      | 1,171,000 |   |
| Deferred compensation                          |   | 1,320,000 |      | 1,056,000 |   |
| Future benefit of state tax deduction          |   | 334,000   |      | 254,000   |   |
|                                           |   |      |      |      |   |
| Total deferred tax assets                      |   | 3,111,000 |      | 2,481,000 |   |
|                                           |   |      |      |      |   |
| Deferred tax liabilities:                      |   |      |      |      |   |
| Future liability of state deferred tax  assets |   | (215,000  | )         | (163,000  | )      |
| Bank premises and equipment                    |   | (109,000  | )         | (170,000  | )      |
|                                           |   |      |      |      |   |
| Total deferred tax liabilities                 |   | (324,000  | )         | (333,000  | )      |
|                                           |   |      |      |      |   |
| Net deferred tax assets                        |   | $         | 2,787,000 |      | $      | 2,148,000 |   |

 

F-31

----

 

The provision for income taxes differs fromamounts computed by applying the statutory Federal income tax rate to operatingincome before income taxes.  The itemscomprising these differences are as follows:

 
|                                            |   | **Year Ended  December 31,** |      |
|-------------------------------------------------|--------|-----------------------------------|-----------|
|                                            |   | **2003**                          |      | **2002** |   | **2001** |   |
|                                            |   | **Amount**                        |      | **Rate%** |   | **Amount** |   | **Rate%** |   | **Amount** |   | **Rate%** |   |
|                                            |   |                              |      |   |   |   |   |   |   |   |   |   |   |
| Federal income tax expense, at statutory  rate  |   | $                                 | 2,923,000 |   | 34.0 |   | $ | 2,456,000 |   | 34.0 |   | $ | 2,120,000 |   | 34.0 |   |
| State franchise tax, net of Federal tax  effect |   | 589,000                           |      | 6.9 |   | 422,000 |   | 5.9 |   | 410,000 |   | 6.6 |   |
| Tax-exempt income from life insurance  policies |   | (137,000                          | )         | (1.6 | ) | (478,000 | ) | (6.6 | ) | (83,000 | ) | (1.3 | ) |
| Other                                           |   | (46,000                           | )         | (.6 | ) | (25,000 | ) | (.4 | ) | (23,000 | ) | (.4 | ) |
|                                            |   |                              |      |   |   |   |   |   |   |   |   |   |   |
|                                            |   | $                                 | 3,329,000 |   | 38.7 |   | $ | 2,375,000 |   | 32.9 |   | $ | 2,424,000 |   | 38.9 |   |

 

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

 

During the normalcourse of 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 2003:

 
| Balance, January 1, 2003                                       |   | $          | 4,473,800 |   |
|---------------------------------------------------------------------|--------|------------|-----------|--------|
|                                                                |   |       |      |
| Disbursements                                                       |   | 4,316,000  |      |
| Amounts repaid                                                      |   | (4,366,300 | )         |
|                                                                |   |       |      |
| Balance, December 31, 2003                                     |   | $          | 4,423,500 |   |
|                                                                |   |       |      |
| Undisbursed commitments to related parties,  December 31, 2003 |   | $          | 3,255,400 |   |

 

F-32

----

 

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

 

**Salary Continuation and Retirement Plans**

 

Salarycontinuation plans are in place for ten key executives.  In addition, a retirement plan is in placefor members of the Board of Directors. Under these plans, the directors and executives, or designatedbeneficiaries, will receive monthly payments for five to fifteen years afterretirement or death.  These benefits aresubstantially equivalent to those available under insurance policies purchasedby the Company on the lives of the directors and executives.  In addition, the estimated present value ofthese future benefits is accrued over the period from the effective dates ofthe plans until their expected retirement dates.  The expense recognized under these plans for the years endedDecember 31, 2003, 2002 and 2001 totaled $573,600, $225,300 and $224,500,respectively.

 

In connection withthese plans, the Company purchased single premium life insurance policies withcash surrender values totaling $6,296,800 and $4,290,900 at December 31,2003 and 2002, respectively.  On theconsolidated balance sheet, the cash surrender values are included in accruedinterest receivable and other assets. Income earned on these policies, net of expenses, totaled $395,500,$233,800 and $243,700 for the years ended December 31, 2003, 2002 and2001, respectively.

 

In addition, upon the death of one of theexecutives during 2002, salary continuation plan benefit expense totaling$1,081,600 was accelerated to accrue for benefits to be paid to the beneficiaryunder the plan.  This expense was offsetby tax-free death benefits totaling $1,172,600 from insurance policies on thelife of the executive.

 

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

 

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

 

•                                          A matching contribution to be determined by the Boardof Directors each plan year under which the Bank will match a percentage ofeach participant’s contribution.

 

•                                          A basic contribution that would be allocated in thesame ratio as each participant’s contribution bears to total compensation.

 

There were no employer contributions for theyears ended December 31, 2003, 2002 or 2001.

 

F-33

----

 

**Employee Stock Ownership Plan**

 

Under the Butte Community Bank Employee StockOwnership Plan (“ESOP”), employees who have been credited with at least 1,000hours of service during a twelve month period and who have attained ageeighteen are eligible to participate. The ESOP has funded purchases of the Bank’s common stock through a loanfrom another financial institution (see Note 10).  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 isrecognized on the loan in the Company’s consolidated financial statements.  Shares are allocated on the basis ofeligible compensation, as defined in the ESOP plan document, in the year ofallocation.  Benefits generally become100% vested after seven years of credited service.  Employees with at least three, but fewer than seven, years ofcredited service receive a partial vesting according to a sliding schedule.  However, in the event of normal retirement,disability, or death, any unvested portion of benefits vest immediately.

 

As shares are purchased by the ESOP withproceeds from the loan, the Company records the cost of these unearned ESOPshares as a contra-equity account. These amounts are shown as a reduction of shareholders’ equity in theCompany’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 toeligible employees.  As shares are releasedfrom unearned ESOP shares, the Company reports compensation expense equal tothe current 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.

 

During 2003 and 2001, the ESOP purchased 10,733 and29,119 shares of the Company’s common stock at a cost of $186,000 and $291,900,respectively, using the proceeds from the line of credit to the ESOP.  Additionally, during 2003, the ESOP redeemed6,487 shares of the Company’s common stock previously allocated to participantsunder the put option described above. The cost of these shares totaled $135,000 and was funded by the proceedsfrom the same line of credit.  No stockwas purchased with proceeds from the line of credit during the year endedDecember 31, 2002.  Interestexpense of $33,100, $39,500 and $55,000 was recognized in connection with theline of credit during the years ended December 31, 2003, 2002 and 2001,respectively.

 

Compensation expense of $251,700, $158,000 and $138,900was recognized for the years ended December 31, 2003, 2002 and 2001.

 

F-34

----

 

Allocated and unearned ESOP shares atDecember 31, 2003, 2002 and 2001, adjusted for stock splits, were asfollows:

 
|                          |   | **2003** |      | **2002** |   | **2001**  |   |
|-------------------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                          |   |     |      |     |   |      |   |
| Allocated shares              |   | 105,187  |      | 97,567   |   | 86,591    |   |
| Unearned shares               |   | 90,909   |      | 87,249   |   | 98,225    |   |
|                          |   |     |      |     |   |      |   |
| Total ESOP shares             |   | 196,096  |      | 184,816  |   | 184,816   |   |
|                          |   |     |      |     |   |      |   |
| Fair value of unearned shares |   | $        | 1,840,914 |     | $      | 1,328,371 |   | $ | 1,337,100 |   |
|                               |        |          |           |          |        |           |        |  |  |  |

 

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

 

Estimated fair values are disclosed forfinancial instruments for which it is practicable to estimate fair value.  These estimates are made at a specific pointin time based on relevant market data and information about the financialinstruments.  These estimates do notreflect any premium or discount that could result from offering the Company’sentire holdings of a particular financial instrument for sale at one time, nordo they attempt to estimate the value of anticipated future business related tothe instruments.  In addition, the taxramifications related to the realization of unrealized gains and losses canhave a significant effect on fair value estimates and have not been consideredin any of these estimates.

 

Because no market exists for a significantportion of the Company’s financial instruments, fair value estimates are basedon judgments regarding current economic conditions, risk characteristics ofvarious financial instruments and other factors.  These estimates are subjective in nature and involveuncertainties and matters of significant judgment and therefore cannot bedetermined with precision.  Changes inassumptions could significantly affect the fair values presented.

 

The followingmethods and assumptions were used by the Company to estimate the fair value ofits financial instruments at December 31, 2003 and 2002:

 

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

 

Interest-bearing deposits in banks:  The fair values of interest-bearing depositsin banks are estimated by discounting their future cash flows using rates ateach reporting date for instruments with similar remaining maturities offeredby 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.

 

F-35

----

 

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-marketable equitysecurities.  The carrying value of theseinvestments approximates their fair value.

 

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

 

Mortgage servicing rights:  The fair value of mortgage servicing rightsis estimated using projected cash flows, adjusted for the effects ofanticipated prepayments, using a market discount rate.

 

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

 

Junior subordinated debentures:  The fair value of the junior subordinateddebentures was determined based on the current market for like-kind instrumentsof a similar maturity and structure.

 

Commitments to extend credit:  Commitments to extend credit are primarilyfor variable rate loans and letters of credit. For these commitments, there is no difference between the committedamounts and their fair values. Commitments to fund fixed rate loans are at rates which approximate fairvalue at each reporting date.

 

F-36

----

 

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

 
|                                             |   | **December 31,  2003** |        | **December 31,  2002** |   |
|--------------------------------------------------|--------|-----------------------------|-------------|-----------------------------|--------|
|                                             |   | **Carrying  Amount**        |        | **Fair  Value**             |   | **Carrying  Amount** |   | **Fair  Value** |   |
|                                             |   |                        |        |                        |   |   |   |   |   |
| Financial assets:                                |   |                        |        |                        |   |   |   |   |   |
| Cash and due from banks                          |   | $                           | 26,204,700  |                        | $      | 26,204,700 |   | $ | 15,621,400 |   | $ | 15,621,400 |   |
| Federal funds sold                               |   | 50,605,000                  |        | 50,605,000                  |   | 57,410,000 |   | 57,410,000 |   |
| Interest-bearing deposits in banks               |   | 7,925,000                   |        | 7,981,100                   |   | 4,061,000 |   | 4,125,300 |   |
| Loans held for sale                              |   | 2,279,100                   |        | 2,421,300                   |   | 7,911,700 |   | 8,000,260 |   |
| Investment securities                            |   | 4,324,500                   |        | 4,325,700                   |   | 3,386,900 |   | 3,438,000 |   |
| Loans                                            |   | 270,231,300                 |        | 270,994,000                 |   | 229,699,200 |   | 232,882,317 |   |
| Other investments                                |   | 233,200                     |        | 233,200                     |   | 263,200 |   | 263,200 |   |
| Accrued interest receivable                      |   | 2,607,300                   |        | 2,607,300                   |   | 2,330,300 |   | 2,330,300 |   |
| Cash surrender value of life insurance  policies |   | 6,296,800                   |        | 6,296,800                   |   | 4,290,900 |   | 4,290,900 |   |
| Mortgage servicing rights                        |   | 1,397,000                   |        | 1,397,000                   |   | 761,300 |   | 761,300 |   |
|                                             |   |                        |        |                        |   |   |   |   |   |
| Financial liabilities:                           |   |                        |        |                        |   |   |   |   |   |
| Deposits                                         |   | $                           | 342,511,400 |                        | $      | 343,424,300 |   | $ | 297,980,800 |   | $ | 299,513,600 |   |
| Note payable                                     |   | 831,900                     |        | 831,900                     |   | 732,100 |   | 732,100 |   |
| Junior subordinated debentures                   |   | 8,248,000                   |        | 8,248,000                   |   | 8,248,000 |   | 8,248,000 |   |
| Accrued interest payable                         |   | 451,400                     |        | 451,400                     |   | 450,900 |   | 450,900 |   |
|                                             |   |                        |        |                        |   |   |   |   |   |
| Off-balance-sheet financial instruments:         |   |                        |        |                        |   |   |   |   |   |
| Commitments to extend credit                     |   | $                           | 137,857,000 |                        | $      | 137,857,000 |   | $ | 103,605,300 |   | $ | 103,605,300 |   |
| Standby letters of credit                        |   | $                           | 3,450,700   |                        | $      | 3,450,700 |   | $ | 2,229,500 |   | $ | 2,229,500 |   |

 

F-37

----

 

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

 

Community Valley Bancorp commenced operations in June 2002.  The information below is presented as ofDecember 31, 2003 and 2002 and for the years then ended as if thereorganization had taken place on January 1, 2002.

 

**BALANCESHEET**

 

**December 31, 2003 and 2002**

 
|                                            |   | **2003**   |       | **2002**   |   |
|-------------------------------------------------|--------|------------|------------|------------|--------|
|                                            |   |       |       |       |   |
| **ASSETS**                                      |   |       |       |       |   |
|                                            |   |       |       |       |   |
| Cash and due from banks                         |   | $          | 3,594,900  |       | $      | 7,758,600 |   |
| Investment in bank subsidiary                   |   | 33,868,700 |       | 25,542,900 |   |
| Other assets                                    |   | 1,050,200  |       | 549,700    |   |
|                                            |   |       |       |       |   |
| Total assets                                    |   | $          | 38,513,800 |       | $      | 33,851,200 |   |
|                                            |   |       |       |       |   |
| **LIABILITIES AND  SHAREHOLDERS’ EQUITY**  |   |       |       |       |   |
|                                            |   |       |       |       |   |
| Liabilities:                                    |   |       |       |       |   |
| Junior subordinated debentures                  |   | $          | 8,248,000  |       | $      | 8,248,000 |   |
| Other liabilities                               |   | 317,300    |       | 222,600    |   |
|                                            |   |       |       |       |   |
| Total liabilities                               |   | 8,565,300  |       | 8,470,600  |   |
|                                            |   |       |       |       |   |
| Shareholders’ equity:                      |   |       |       |       |   |
| Common stock                                    |   | 7,271,400  |       | 6,660,000  |   |
| Unearned ESOP shares                            |   | (1,070,700 | )          | (851,900   | )      |
| Retained earnings                               |   | 23,745,700 |       | 19,558,400 |   |
| Accumulated other comprehensive income          |   | 2,100      |       | 14,100     |   |
|                                            |   |       |       |       |   |
| Total shareholders’ equity                 |   | 29,948,500 |       | 25,380,600 |   |
|                                            |   |       |       |       |   |
| Total liabilities and shareholders’ equity |   | $          | 38,513,800 |       | $      | 33,851,200 |   |

 

F-38

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

 

**STATEMENT OF INCOME**

 

**For the Years Ended December 31, 2003and 2002**

 

 
|                                                        |   | **2003**  |       | **2002**  |       |
|-------------------------------------------------------------|--------|-----------|------------|-----------|------------|
|                                                        |   |      | ** ** |      | ** ** |
| Income:                                                     |   |      |       |      |       |
| Dividends declared by bank subsidiary                       |   | $         | 2,064,100  |      | $          | 794,700 |   |
|                                                        |   |      |       |      |       |
| Expenses:                                                   |   |      |       |      |       |
| Professional fees                                           |   | 147,200   |       | 97,200    |       |
| Interest expense                                            |   | 438,800   |       |      |       |
| Other expenses                                              |   | 100,700   |       | 23,300    |       |
|                                                        |   |      |       |      |       |
| Total expenses                                              |   | 686,700   |       | 120,500   |       |
|                                                        |   |      |       |      |       |
| Income before equity in undistributed  income of subsidiary |   | 1,377,400 |       | 674,200   |       |
|                                                        |   |      |       |      |       |
| Equity in undistributed income of  subsidiary               |   | 3,577,800 |       | 4,127,400 |       |
|                                                        |   |      |       |      |       |
| Income before income tax benefit                            |   | 4,955,200 |       | 4,801,600 |       |
|                                                        |   |      |       |      |       |
| Income tax benefit                                          |   | 314,000   |       | 48,000    |       |
|                                                        |   |      |       |      |       |
| Net income                                                  |   | $         | 5,269,200  |      | $          | 4,849,600 |   |

 

F-39

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

 

**STATEMENT OF CASH FLOWS**

 

**For the Years Ended December 31, 2003and 2002**

 

 
|                                                                               |   | **2003**   |       | **2002**   |       |
|------------------------------------------------------------------------------------|--------|------------|------------|------------|------------|
|                                                                               |   |       | ** ** |       | ** ** |
| Cash flows from operating activities:                                              |   |       |       |       |       |
| Net income                                                                         |   | $          | 5,269,200  |       | $          | 4,849,600 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |       |       |       |       |
| Undistributed net income of subsidiary                                             |   | (3,577,800 | )          | (4,127,400 | )          |
| Increase in other assets                                                           |   | (375,200   | )          | (301,700   | )          |
| Increase (decrease) in other liabilities                                           |   | 91,800     |       | (45,900    | )          |
|                                                                               |   |       |       |       |       |
| Net cash provided by operating activities                                          |   | 1,408,000  |       | 374,600    |       |
|                                                                               |   |       |       |       |       |
| Cash flows from investing activities:                                              |   |       |       |       |       |
| Investment in Butte Community Bank                                                 |   | (4,760,000 | )          | (85,700    | )          |
| Investment in Community Valley Bancorp  Trust I                                    |   |       |       | (248,000   | )          |
|                                                                               |   |       |       |       |       |
| Net cash used in investing activities                                              |   | (4,760,000 | )          | (333,700   | )          |
|                                                                               |   |       |       |       |       |
| Cash flows from financing activities:                                              |   |       |       |       |       |
| Proceeds from the issuance of junior  subordinated debentures                      |   |       |       | 8,248,000  |       |
| Dividends paid                                                                     |   | (1,079,000 | )          | (812,200   | )          |
| Proceeds from exercise of stock options                                            |   | 267,300    |       | 287,200    |       |
| Cash paid for fractional shares                                                    |   |       |       | (5,300     | )          |
|                                                                               |   |       |       |       |       |
| Net cash (used in) provided by financing  activities                               |   | (811,700   | )          | 7,717,700  |       |
|                                                                               |   |       |       |       |       |
| (Decrease) increase in cash and cash  equivalents                                  |   | (4,163,700 | )          | 7,758,600  |       |
|                                                                               |   |       |       |       |       |
| Cash and cash equivalents at beginning of  year                                    |   | 7,758,600  |       |       |       |
|                                                                               |   |       |       |       |       |
| Cash and cash equivalents at end of year                                           |   | $          | 3,594,900  |       | $          | 7,758,600 |   |

 

F-40

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