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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2009

Commission File Number 0-51678

COMMUNITY VALLEY BANCORP

(Exact name of registrant as specified in its charter)

(530) 899-2344

Registrant’s telephone number, including area code

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

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

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

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

Shares of Common Stock held by each officer and director and each person owning more than five percent of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of the affiliate status is not necessarily a conclusive determination for other purposes.

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

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on June 3, 2010, are incorporated by reference into Part III of this Report.

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PART I

Item 1.  Business

Forward Looking Statements

Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified. These statements are based on management’s beliefs and assumptions, and on information available to management as of the date of this document. Forward-looking statements include the information concerning possible or assumed future results of operations of the Company set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements also include statements in which words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” “consider” or similar expressions are used. Forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions, including the risks discussed under the heading “Risk Factors” and elsewhere in this report. The Company’s actual future results and shareholder values may differ materially from those anticipated and expressed in these forward-looking statements. Many of the factors that will determine these results and values, including those discussed under the heading “Risk Factors,” are beyond the Company’s ability to control or predict. Investors are cautioned not to put undue reliance on any forward-looking statements. In addition, the Company does not have any intention or and assumes no obligation to update forward-looking statements after the date of the filing of this report, even if new information, future events or other circumstances have made such statements incorrect or misleading. Except as specifically noted herein all referenced to the “Company” refer to Community Valley Bancorp, a California corporation, and its consolidated subsidiaries.

Recent Developments

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

On September 18, 2009, the Company gave formal written notice to the NASDAQ Stock Market of its intention to voluntarily delist its common stock from the NASDAQ Capital Market. The decision to delist was part of the overall strategy to conserve resources and improve cost effectiveness as the benefits of maintaining a NASDAQ listing have not materialized. Considering the limited trading volume and low trading prices on NASDAQ, the Company concluded a listing on NASDAQ does not justify the expense and administrative burden associated with maintaining such listing.

As a result of the Company’s 2009 strategic cost reduction plan, in March of 2009 the Gridley Loan Production Office (LPO) was consolidated with the full service Yuba City Office. In December 2009, the Redding Offices were consolidated into one location on Hilltop Drive. These offices were less than two miles apart and streamlining banking operations is part of the Company’s strategic plan to decrease expenses and increase efficiencies. In February 2010, the Citrus Heights Loan Production Office was consolidated with the Yuba City Office. With the slowdown in the real estate market, the consolidation of both LPOs into the Yuba City Office will allow the Company to continue to service its customers and provide opportunities for its lenders to gain exposure to all areas of lending.

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

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

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As a result of a regularly scheduled and recently concluded joint Federal Deposit Insurance Corporation (FDIC) and California Department of Financial Institutions (DFI) examination, management expects to receive a formal order (“Order”) from the FDIC and the DFI. The Order is expected to include provisions to further strengthen and improve asset quality, enhance problem loan identification policies and procedures including identification of impaired loans and troubled debt restructured loans, reduce the level of classified assets, maintain certain capital ratios and request regulatory approval prior to paying any cash dividends. At this time, management does not know what impact the Order will have on the Company’s business strategies. Various strategic options are being evaluated and management continues to act upon both tactical and strategic alternatives to raise capital and restructure the Company’s balance sheet. The Company formed a Board appointed Capital Augmentation Committee (“Committee”) and has engaged a financial advisor to explore alternatives to assist the Company in resolving its capital deficiency issues.

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

General

The Company

Community Valley Bancorp (the “Company”) is a California corporation registered as a financial holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is headquartered in Chico, California. The Company was incorporated in July, 2001 and acquired all of the outstanding shares of Butte Community Bank (the “Bank”) in May, 2002. The Company’s principal subsidiary is the Bank. On July 10, 2007 the Company formed a wholly-owned subsidiary, Community Valley Bancorp Trust II (the “Trust”), which is a Delaware statutory business trust, for the purpose of issuing trust preferred securities. The proceeds from the Trust were used to redeem 100% of the trust preferred securities issued by the 2002 Community Valley Bancorp Trust I.  After redemption Community Valley Bancorp Trust I was dissolved (see Note 9 to the Consolidated Financial Statements in Part II - Item 8).  The Company also has an insurance subsidiary in the name of Butte Community Insurance Agency, LLC which was formed in December 2004 to provide a full service insurance agency offering all lines of coverage. The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries as it may acquire or establish.

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

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

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

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

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The Bank

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

We operate seven full-service branch offices in four Butte County communities, one full-service branch office in Sutter County, two full-service branches in Tehama County, one full-service branch in Yuba County, one full-service branch in Colusa County, and two full-service branches in Shasta County. During 2009, management evaluated its administrative and retail branch facilities in order to identify opportunities for greater efficiencies in its operational structure. As a result of our expense control initiative, due to the downturn in the economy, a few locations were consolidated. The Gridley LPO moved to the Yuba City full service branch and in Redding, the Churn Creek branch consolidated with the Hilltop branch. In 2010, the Citrus Heights LPO moved to the Yuba City branch. Management considers these moves as part if its strategic plan to decrease expenses and increase efficiencies to continue to meet the needs of its customers.   We offer a full range of banking services to individuals and various-sized businesses in the communities we serve. The locations of those offices are:

In addition, our Data Processing, Call Center and Bank Card Center are located at 1390 Ridgewood Drive, Chico. Our Real Estate Loan Center and Central Note Department are located at 1360 East Lassen Avenue, Chico.  We also have specialized credit centers for agricultural lending and construction and real estate lending within a number of these branch offices. These facilities are located in the cities of Chico, Paradise, and Oroville in Butte County, the city of Yuba City in Sutter County, the cities of Red Bluff and Corning in Tehama County, the city of Marysville in Yuba County, the city of Colusa in Colusa County, and the cities of Anderson and Redding in Shasta County. Throughout the history of Butte Community Bank, our growth has been exclusively by establishing de novo full-service branch offices and credit centers in various locations in California’s Northern Sacramento Valley and foothill region.  With a predominant focus on personal service, Butte Community Bank has positioned itself as a multi-community independent bank serving the financial needs of individuals and businesses, including agricultural and real estate customers in Butte County and other surrounding counties. Our principal retail lending services include home equity and consumer loans. In addition, we have three other significant dimensions which surround this core of retail community banking:  Agricultural lending, commercial lending, and real estate financing (both construction and long term).

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The Agricultural Credit Centers located in Yuba City, Chico, and Red Bluff provide a complete line of credit services in support of the agricultural activities which are key to the continued economic development of the communities we serve. “Ag lending” clients include a full range of individual farming customers and small business farming organizations.

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

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

In addition to the lending activities noted above, we offer a wide range of deposit products for the retail banking market including checking, interest bearing transaction, savings, time certificates of deposit, retirement accounts, and business sweep, as well as telephone banking, mobile banking, and internet banking with bill pay options. Butte Community Bank attracts deposits through its customer-oriented product mix, competitive pricing, convenient locations, extended hours drive-up and on-line banking, all provided with the highest level of customer service.

We also offer other products and services to our customers which complement the lending and deposit services previously reviewed. These include cashier’s checks, traveler’s checks, bank-by-mail, ATM, night depository, safe deposit boxes, direct deposit, automated payroll services, cash management, lockbox, remote deposit capture and other customary banking services. Shared ATM and Point of Sale (POS) networks allow customers access to the national and international funds transfer networks. We have two remote ATMs which are located in a hospital and the Company’s administrative building, and five script machines located in four different movie theaters and one restaurant. These locations facilitate cash advances which would not otherwise be available to consumers at non-branch locations, thereby increasing consumer convenience. In addition to such specifically oriented customer applications, we provide wire transfer capabilities and a convenient customer service group in our Call Center to answer questions and assure a high level of customer satisfaction with 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 average deposit balance of approximately $11,100 at December 31, 2009, but makes the Bank less subject to adverse effects from the loss of a substantial depositor who may be seeking higher yields in other markets or who may have need of money otherwise on deposit with the Bank, especially during periods of inflation or conservative monetary policies.

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

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

The officers and employees of the Bank are continually engaged in marketing activities, including the evaluation and development of new products and services, which enable the Bank to retain and improve its competitive position in its service areas. All of these developments are meant to increase public convenience and enhance public access to the electronic payments system. The cost to the Bank for these development, implementation, and marketing activities cannot expressly be calculated with any degree of certainty.

The Bank holds no patents or licenses (other than licenses required by appropriate bank regulatory agencies), franchises, or concessions. The Bank is not dependent on a single customer or group of related customers for a material portion of its deposits. There has been no material effect upon the Bank’s capital expenditures, earnings, or competitive position as a result of Federal, state, or local environmental regulation.

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Competition

The banking business in California generally, and specifically in our market areas, is highly competitive with respect to virtually all products and services and has become increasingly more so in recent years. The industry continues to consolidate and strong, unregulated competitors have entered banking markets with focused products targeted at highly profitable customer segments. Many largely unregulated competitors are able to compete across geographic boundaries and provide customers increasing access to meaningful alternatives to banking services in nearly all significant products. These competitive trends are likely to continue.

With respect to commercial bank competitors, the business is largely dominated by a relatively small number of major banks with many offices operating over a wide geographical area.  These banks have, among other advantages, the ability to finance wide-ranging and effective advertising campaigns and to allocate their investment resources to regions of highest yield and demand. Many of the major banks operating in the area offer certain services which we do not offer directly but may offer indirectly through correspondent institutions. By virtue of their greater total capitalization, such banks also have substantially higher lending limits than we 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 banking firms. In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal finance software. Strong competition for deposit and loan products affects the rates of those products as well as the terms on which they are offered to customers. Mergers between financial institutions have placed additional pressure on banks within the industry to streamline their operations, reduce expenses, and increase revenues to remain competitive. Competition has also intensified due to recently enacted federal and state interstate banking laws, which permit banking organizations to expand geographically, and the California market has been particularly attractive to out-of-state institutions. The Financial Modernization Act, which, effective March 11, 2000, made it possible for full affiliations to occur between banks and securities firms, insurance companies, and other financial companies and has intensified competitive conditions.

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

For many years, we have countered this increasing competition by providing 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 provide through our flexible policies. In addition, to meet the needs of customers with electronic access requirements, the Company has embraced the electronic age and installed telephone banking, internet banking with bill payment capabilities, and mobile banking. This high tech and high touch approach allows the individual to customize the Bank’s contact methodologies to their particular preference. Moreover, for customers whose loan demands exceed our legal lending limit, we attempt to arrange for such loans on a participation basis with correspondent banks. We also assist our customers in obtaining from our correspondent banks other services that the Bank may not offer.

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

Employees

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

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Supervision and Regulation

The Company

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

We and our subsidiary are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or provision of services. For example, with certain exceptions, the bank may not condition an extension of credit on a customer obtaining other services provided by us, the bank or any other subsidiary of ours, or on a promise by the customer not to obtain other services from a competitor. In addition, federal law imposes certain restrictions on transactions between the bank and its affiliates. As affiliates, the bank and we are subject, with certain exceptions, to the provisions of federal law imposing limitations on and requiring collateral for extensions of credit by the bank to any affiliate.

The Bank

As a California state-chartered bank whose accounts are insured by the FDIC up to applicable limits per depositor, the Bank is subject to regulation, supervision and regular examination by the DFI and the FDIC. In addition, while the Bank is not a member of the Federal Reserve System, it is subject to certain regulations of the Federal Reserve Board. The regulations of these agencies govern most aspects of the Bank’s business, including the making of periodic reports by the Bank, and the Bank’s activities relating to dividends, investments, loans, borrowings, capital requirements, certain check-clearing activities, branching, mergers and acquisitions, reserves against deposits and numerous other areas. Supervision, legal action and examination of the Bank by the FDIC are generally intended to protect depositors and are not intended for the protection of shareholders.

The earnings and growth of the Bank are largely dependent on its ability to maintain a favorable differential or “spread” between the yield on its interest-earning assets and the rate paid on its deposits and other interest-bearing liabilities. As a result, the Bank’s performance is influenced by general economic conditions, both domestic and foreign, the monetary and fiscal policies of the federal government, and the policies of the regulatory agencies. California law presently permits a bank to locate a branch office in any locality in the state.  Additionally, California law exempts banks from California usury laws. The nature and impact of any future changes in monetary policies cannot be predicted.

Capital Standards

The FRB has risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are reported as off-balance-sheet items.  Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off-balance-sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. government securities, to 100% for assets with relatively higher credit risk, such as business loans.

A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk-adjusted assets and off-balance-sheet items.  The regulators measure risk-adjusted assets and off-balance-sheet items against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital.  Tier 1 capital consists of common stock, retained earnings, noncumulative perpetual preferred stock and minority interests in certain subsidiaries, less most other intangible assets.  Tier 2 capital may consist of a limited amount of the allowance for loan and lease losses and certain other instruments with some characteristics of equity.  The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies.  Since December 31, 1992, the FRB and the FDIC have required a minimum ratio of qualifying total capital to risk-adjusted assets and off-balance-sheet items of 8%, and a minimum ratio of Tier 1 capital to risk-adjusted assets and off-balance-sheet items of 4%.

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

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

A bank that does not achieve and maintain the required capital levels may be issued a capital directive by the FDIC to ensure the maintenance of required capital levels.  As discussed above, the Company is required to maintain certain levels of capital, as is the Bank.  The Company and the Bank were both under-capitalized at December 31, 2009. In addition, subsequent to a regulatory examination in 2009, the Bank is required to maintain a Tier 1 leverage ratio of 10%. See page 54, Capital Resources and Note 12 to the Consolidated Financial Statements for more comprehensive discussions on the Company’s regulatory capital requirements. The regulatory capital guidelines as well as the actual capitalization for the Bank and Company as of December 31, 2009 follow:

Prompt Corrective Action

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

In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency.  Enforcement actions may include the imposition of a conservator or receiver, the issuance of a consent order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.  Additionally, a holding company’s inability to serve as a source of strength to its subsidiary banking organizations could serve as an additional basis for a regulatory action against the holding company.

Premiums for Deposit Insurance

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

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

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

Federal Reserve System.  The FRB requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts and non-personal time deposits.  At December 31, 2009, we were in compliance with these requirements.

Impact of Monetary Policies.  The earnings and growth of the Company are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.  The earnings of the Company are affected not only by general economic conditions but also by the monetary and fiscal policies of the United States and federal agencies, particularly the FRB.  The FRB can and does implement national monetary policy, such as seeking to curb inflation and combat recession, by its open market operations in United States Government securities and by its control of the discount rates applicable to borrowings by banks from the FRB.  The actions of the FRB in these areas influence the growth of bank loans and leases, investments and deposits and affect the interest rates charged on loans and leases and paid on deposits.  The FRB’s policies have had a significant effect on the operating results of commercial banks and are expected to continue to do so in the future.  The nature and timing of any future changes in monetary policies are not predictable.

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

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

·                  any company controlled by any such executive officer, director or shareholder, or

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

Loans and leases extended to any of the above persons must comply with loan-to-one-borrower limits, require prior full board approval when aggregate extensions of credit to the person exceed specified amounts, must be made on substantially the same terms (including interest rates and collateral) as, and follow credit-underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with non-insiders, and must not involve more than the normal risk of repayment or present other unfavorable features.  In addition, Regulation O provides that the aggregate limit on extensions of credit to all insiders of a bank as a group cannot exceed the bank’s unimpaired capital and unimpaired surplus.  Regulation O also prohibits a bank from paying an overdraft on an account of an executive officer or director, except pursuant to a written pre-authorized interest-bearing extension of credit plan that specifies a method of repayment or a written pre-authorized transfer of funds from another account of the officer or director at the bank.

Consumer Protection Laws and Regulations.  The banking regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations.  Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with such laws and regulations.  The Company is subject to many federal and state consumer protection and privacy statutes and regulations, some of which are discussed below.

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

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The Equal Credit Opportunity Act (the “ECOA”) generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.

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

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

The Home Mortgage Disclosure Act (the “HMDA”), in response to public concern over credit shortages in certain urban neighborhoods, requires public disclosure of information that shows whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located.  The HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.

The Right to Financial Privacy Act (the “RFPA”) imposes a new requirement for financial institutions to provide new privacy protections to consumers.  Financial institutions must provide disclosures to consumers of its privacy policy, and state the rights of consumers to direct their financial institution not to share their nonpublic personal information with third parties.

Finally, the Real Estate Settlement Procedures Act (the “RESPA”) requires lenders to provide noncommercial borrowers with disclosures regarding the nature and cost of real estate settlements.  Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts.

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

Recent Legislation and Other Changes.  Federal and state laws affecting banking are enacted from time to time, and similarly federal and state regulations affecting banking are also adopted from time to time.  The following include some of the recent laws and regulations affecting banking.

In May 2009 the Helping Families Save Their Homes Act of 2009 was enacted to help consumers avoid mortgage foreclosures on their homes through certain loss mitigation actions including special forbearance, loan modification, pre-foreclosure sale, deed in lieu of foreclosure, support for borrower housing counseling, subordinate lien resolution, and borrower relocation.  The new law permits the Secretary of Housing and Urban Development (HUD), for mortgages either in default or facing imminent default, to: (1) authorize the modification of such mortgages; and (2) establish a program for payment of a partial claim to a mortgagee who agrees to apply the claim amount to payment of a mortgage on a 1-4family residence.  In implementing the law, the Secretary of HUD is authorized to (1) provide compensation to the mortgagee for lost income on monthly mortgage payments due to interest rate reduction; (2) reimburse the mortgagee from a guaranty fund in connection with activities that the mortgagee is required to undertake concerning repayment by the mortgagor of the amount owed to HUD; (3) make payments to the mortgagee on behalf of the borrower, under terms defined by HUD; and (4) make mortgage modification with terms extended up to 40 years from the modification date.  The new law also authorizes the Secretary of HUD to: (1) reassign the mortgage to the mortgagee; (2) act as a Government National Mortgage Association (GNMA, or Ginnie Mae) issuer, or contract with an entity for such purpose, in order to pool the mortgage into a Ginnie Mae security; or (3) resell the mortgage in accordance with any program established for purchase by the federal government of insured mortgages.  The new law also amends the Foreclosure Prevention Act of 2008, with respect to emergency assistance for the redevelopment of abandoned and foreclosed homes (neighborhood stabilization), to authorize each state that has received certain minimum allocations and has fulfilled certain requirements, to distribute any remaining amounts to areas with homeowners at risk of foreclosure or in foreclosure without regard to the percentage of home foreclosures in such areas.

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

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

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

On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted to provide stimulus to the struggling US economy.  ARRA authorizes spending of $787 billion, including about $288 billion for tax relief, $144 billion for state and local relief aid, and $111 billion for infrastructure and science.  In addition, ARRA includes additional executive compensation restrictions for recipients of funds from the US Treasury under the Troubled Assets Relief Program of the Emergency Economic Stimulus Act of 2008 (“EESA”).  The provisions of EESA amended by the ARRA include (i) expanding the coverage of the executive compensation limits to as many as the 25 most highly compensated employees of a TARP funds recipient and its affiliates for certain aspects of executive compensation limits and (ii) specifically limiting incentive compensation of covered executives to one-third of their annual compensation which is required to be paid in restricted stock that does not vest until all of the TARP funds are no longer outstanding (note that if TARP warrants remain outstanding and no other TARP instruments are outstanding, then such warrants would not be considered outstanding for purposes of this incentive compensation restriction).  In addition, the board of directors of any TARP recipient is required under EESA, as amended to have a company-wide policy regarding excessive or luxury expenditures, as identified by the Treasury, which may include excessive expenditures on entertainment or events; office and facility renovations; aviation or other transportation services; or other activities or events that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient.

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

EESA was amended by ARRA to also provide additional corporate governance provisions with respect to executive compensation including the following:

·                  ESTABLISHMENT OF STANDARDS - During the period in which any TARP obligation remains outstanding, each TARP recipient shall be subject to the standards in the regulations issued by the Treasury with respect to executive compensation limitations for TARP recipients, and the provisions of section 162(m)(5) of the Internal Revenue Code of 1986, as applicable (nondeductibility of executive compensation in excess of $500,000).

·                  COMPLIANCE WITH STANDARDS - The Treasury is required to see that each TARP recipient meet the required standards for executive compensation and corporate governance.

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·                  SPECIFIC REQUIREMENTS FOR THE REQUIRED STANDARDS -

·                  Limits on compensation that exclude incentives for senior executive officers of the TARP recipient to take unnecessary and excessive risks that threaten the value of the financial institution during the period in which any TARP obligation remains outstanding.

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

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

·                  A prohibition on any compensation plan that would encourage manipulation of the reported earnings of such TARP recipient to enhance the compensation of any of its employees.

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

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

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

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

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

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

On February 10, 2009, the U. S. Treasury, the Federal Reserve Board, the FDIC, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision all announced a comprehensive set of measures to restore confidence in the strength of U.S. financial institutions and restart the critical flow of credit to households and businesses.  This program is intended to restore the flows of credit necessary to support recovery.

The core program elements include:

·                  A new Capital Assistance Program to help ensure that our banking institutions have sufficient capital to withstand the challenges ahead, paired with a supervisory process to produce a more consistent and forward-looking assessment of the risks on banks’ balance sheets and their potential capital needs.

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

·                  A new Treasury and Federal Reserve initiative to dramatically expand — up to $1 trillion — the existing Term Asset-Backed Securities Lending Facility (TALF) in order to reduce credit spreads and restart the securitized credit markets that in recent years supported a substantial portion of lending to households, students, small businesses, and others.

·                  An extension of the FDIC’s Temporary Liquidity Guarantee Program to October 31, 2009. A new framework of governance and oversight to help ensure that banks receiving funds are held responsible for appropriate use of those funds through stronger conditions on lending, dividends and executive compensation along with enhanced reporting to the public.

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

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

·                  to the extent that the U. S. Treasury purchases mortgage securities as part of TARP, the Treasury shall implement a plan to minimize foreclosures including using guarantees and credit enhancements to support reasonable loan modifications, and to the extent loans are owned by the government to consent to the reasonable modification of such loans;

·                  limits executive compensation for executives for TARP participating financial institutions including a maximum corporate tax deduction limit of $500,000 for each of the top five highest paid executives of such institution, requiring clawbacks of incentive compensation that were paid based on inaccurate or false information, limiting golden parachutes for involuntary and certain voluntary terminations to 2.99x their average annual salary and bonus for the last five years, and prohibiting the payment of incentive compensation that encourages management to take unnecessary and excessive risks with respect to the institution;

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

·                  qualified financial institutions may count losses on FNMA and FHLMC preferred stock against ordinary income, rather than capital gain income.

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

On October 22, 2009, the Federal Reserve Board issued a comprehensive proposal on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking.  The proposal, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. The proposal also contemplates a detailed review by the Federal Reserve Board of the incentive compensation policies and practices of a number of “large, complex banking organizations.” Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or perform other actions.  In addition, the proposal provides that enforcement actions may be taken against a banking organization if its incentive compensation arrangements or related risk-management control or governance processes pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.  Similarly, on January 12, 2010, the FDIC announced that it would seek public comment through advance notice of rule making on whether banks with compensation plans that encourage risky behavior should be charged at higher deposit assessment rates than such banks would otherwise be charged.  On September 3, 2009, the U.S. Treasury issued a policy statement entitled “Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms.”  The statement was developed in consultation with the U.S. bank regulatory agencies and sets forth eight “core principles” intended to shape a new international capital accord.  Six of the core principles relate directly to bank capital requirements. The statement contemplates changes to the existing regulatory capital regime that would involve substantial revisions to, if not replacement of, major parts of the Basel I and Basel II and affect all regulated banking organizations and other systemically important institutions.  The statement calls for higher and stronger capital requirements for bank and non-bank financial firms that are deemed to pose a risk to financial stability due to their combination of size, leverage, interconnectedness and liquidity risk.  The statement suggested that changes to the regulatory capital framework be phased in over a period of several years with a recommended schedule providing for a comprehensive international agreement by December 31, 2010, with the implementation of reforms by December 31, 2012, although it does remain possible that U.S. bank regulatory agencies could officially

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adopt, or informally implement, new capital standards at an earlier date.  Following the issuance of the statement, on December 17, 2009, the Basel committee issued a set of proposals (the “Capital Proposals”) that would significantly revise the definitions of Tier 1 capital and Tier 2 capital, with the most significant changes being to Tier 1 capital.  Most notably, the Capital Proposals would disqualify certain structured capital instruments, such as trust preferred securities, from Tier 1 capital status.  The Capital Proposals would also re-emphasize that common equity is the predominant component of Tier 1 capital by adding a minimum common equity to risk-weighted assets ratio and requiring that goodwill, general intangibles and certain other items that currently must be deducted from Tier 1 capital instead be deducted from common equity as a component of Tier 1 capital. The Capital Proposals also leave open the possibility that the Basel committee will recommend changes to the minimum Tier 1 capital and total capital ratios of 4.0% and 8.0%, respectively.  Concurrently with the release of the Capital Proposals, the Basel committee also released a set of proposals related to liquidity risk exposure (the “Liquidity Proposals”).  The Liquidity Proposals have three key elements, including the implementation of (i) a “liquidity coverage ratio” designed to ensure that a bank maintains an adequate level of unencumbered, high-quality assets sufficient to meet the bank’s liquidity needs over a 30-day time horizon under an acute liquidity stress scenario, (ii) a “net stable funding ratio” designed to promote more medium and long-term funding of the assets and activities of banks over a one-year time horizon, and (iii) a set of monitoring tools that the Basel committee indicates should be considered as the minimum types of information that banks should report to supervisors and that supervisors should use in monitoring the liquidity risk profiles of supervised entities.

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

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

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

In 2008, the Federal Reserve Board, the FDIC, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision amended their regulatory capital rules to permit banks, bank holding companies, and savings associations (as to any of these a “financial institution”) to reduce the amount of goodwill that a banking organization must deduct from tier 1 capital by the amount of any deferred tax liability associated with that goodwill.  However, a financial institution that reduces the amount of goodwill deducted

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from tier 1 capital by the amount of the deferred tax liability is not permitted to net this deferred tax liability against deferred tax assets when determining regulatory capital limitations on deferred tax assets.  For these financial institutions, the amount of goodwill deducted from tier 1 capital will reflect each institution’s maximum exposure to loss in the event that the entire amount of goodwill is impaired or derecognized, an event which triggers the concurrent derecognition of the related deferred tax liability for financial reporting purposes.

On October 7, 2008 the FDIC adopted a restoration plan that increased the rates banks pay for deposit insurance, and adjusted the system that determines what deposit insurance premium rate a bank pays the FDIC.  In 2008, banks paid anywhere from five basis points to 43 basis points for deposit insurance. Under the new rule, the assessment rate schedule was raised uniformly by 7 basis points (annualized) beginning on January 1, 2009. Beginning with the second quarter of 2009, changes were made to the deposit insurance assessment system to make the increase in assessments fairer by requiring riskier institutions to pay a larger share.  Together, the changes would improve the way the system differentiates risk among insured institutions and help ensure that the reserve ratio returns to at least 1.15 percent by the end of 2013. The changes to the assessment system include assessing higher rates to institutions with a significant reliance on secured liabilities, which generally raises the FDIC’s loss in the event of failure without providing additional assessment revenue. The new rule also would assess higher rates for institutions with a significant reliance on brokered deposits but, for well-managed and well-capitalized institutions, only when accompanied by rapid asset growth. Brokered deposits combined with rapid asset growth have played a role in a number of costly failures, including some recent ones. The rule also would provide incentives in the form of a reduction in assessment rates for institutions to hold long-term unsecured debt and, for smaller institutions, high levels of Tier 1 capital. The FDIC also voted to maintain the Designated Reserve Ratio at 1.25 percent as a signal of its long term target for the fund.

The Federal Reserve Board in October 2008 approved final amendments to Regulation C that revise the rules for reporting price information on higher-priced mortgage loans. The changes are intended to improve the accuracy and usefulness of data reported under the Home Mortgage Disclosure Act. Regulation C currently requires lenders to collect and report the spread between the annual percentage rate (APR) on a mortgage loan and the yield on a Treasury security of comparable maturity if the spread is greater than 3.0 percentage points for a first lien loan or greater than 5.0 percentage points for a subordinate lien loan. This difference is known as a rate spread.  Under the final rule, a lender will report the spread between the loan’s APR and a survey-based estimate of APRs currently offered on prime mortgages of a comparable type (“average prime offer rate”) if the spread is equal to or greater than 1.5 percentage points for a first lien loan or equal to or greater than 3.5 percentage points for a subordinate-lien loan. The Board will publish average prime offer rates based on the Primary Mortgage Market Survey® currently published by Freddie Mac.  In setting the rate spread reporting threshold, the Board sought to cover subprime mortgages and generally avoid covering prime mortgages. The changes to Regulation C conform the threshold for rate spread reporting to the definition of higher-priced mortgage loans adopted by the Board under Regulation Z (Truth in Lending) in July of 2008.

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

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

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

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

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

·                  Require creditors to establish escrow accounts for property taxes and homeowner’s insurance for all first-lien mortgage loans.

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

·                  Creditors and mortgage brokers are prohibited from coercing a real estate appraiser to misstate a home’s value.

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·                  Companies that service mortgage loans are prohibited from engaging in certain practices, such as pyramiding late fees.  In addition, servicers are required to credit consumers’ loan payments as of the date of receipt and provide a payoff statement within a reasonable time of request.

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

For all mortgages, the rule also sets additional advertising standards.  Advertising rules now require additional information about rates, monthly payments, and other loan features.  The final rule bans seven deceptive or misleading advertising practices, including representing that a rate or payment is “fixed” when it can change.  The rule’s definition of “higher-priced mortgage loans” will capture virtually all loans in the subprime market, but generally exclude loans in the prime market.  To provide an index, the Federal Reserve Board will publish the “average prime offer rate,” based on a survey currently published by Freddie Mac.  A loan is higher-priced if it is a first-lien mortgage and has an annual percentage rate that is 1.5 percentage points or more above this index, or 3.5 percentage points if it is a subordinate-lien mortgage.  The new rules take effect on October 1, 2009.  The single exception is the escrow requirement, which will be phased in during 2010 to allow lenders to establish new systems as needed.

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

The enactment of AB1160 in 2009, requires a supervised financial institution in California that negotiates primarily in any of a number of specified languages in the course of entering into a contract or agreement for a loan or extension of credit secured by residential real property, to deliver, prior to the execution of the contract or agreement, and no later than 3 business days after receiving the written application, a specified form in that language summarizing the terms of the contract or agreement; provides for administrative penalties for violations; and requires the California Department of Corporations and the Department of Financial Institutions to create a form for providing translations and make it available in Spanish, Chinese, Tagalog, Vietnamese and Korean.  The statute becomes operative on July 1, 2010, or 90 days after issuance of the form, whichever occurs later.

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

The enactment of SB306 makes specified changes to clarify existing law related to filing a notice of default on residential real property in California, including (among other things): clarifying that the provisions apply to mortgages and deeds of trust recorded from January 1, 2003 through December 31, 2007, secured by owner-occupied 3-4 residential real property containing no more than 4 dwelling units; revising the declaration to be filed with the notice of default; specifying how the loan servicers have to maximize net present value under their pooling and servicing agreements applies to certain investors; specifying how and when the notice to residents of property subject to foreclosure is to be mailed; and extending the time during which the notice of sale must be recorded from 14 to 20 days.  The bill also makes certain changes related to short-pay agreements and short-pay demand statements.

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

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

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California Assembly Bill 1301 was signed by the Governor on July 16, 2008 and became law on January 1, 2009.  Among other things, the bill eliminated unnecessary applications that consume time and resources of bank licensees and which in many cases are now perfunctory.  All of current Article 5 — “Locations of Head Office” of Chapter 3, and all of Chapter 4 — “Branch Offices, Other Places of Business and Automated Teller Machines” were repealed.  A new Chapter 4 — “Bank Offices” was added.  The new Chapter 4 requires notice to the California Department of Financial Institutions (“DFI”) the establishment of offices, rather than the current application process.  Many of the current branch applications are perfunctory in nature and/or provide for a waiver of application.  Banks, on an exception basis, may be subject to more stringent requirements as deemed necessary.  As an example, new banks, banks undergoing a change in ownership and banks in less than satisfactory condition may be required to obtain prior approval from the DFI before establishing offices if such activity is deemed to create an issue of safety and soundness.  The bill eliminated unnecessary provisions in the Banking Law that are either outdated or have become undue restrictions to bank licensees.  Chapter 6 — “Powers and Miscellaneous Provisions” was repealed.  A new Chapter 6 - “Restrictions and Prohibited Practices” was added.  This chapter brings together restrictions in bank activities as formerly found in Chapter 18 — “Prohibited Practices and Penalties.”  However, in bringing the restrictions into the new chapter, various provisions were updated to remove the need for prior approval by the DFI Commissioner.  The bill renumbered current Banking Law sections to align like sections.  Chapter 4.5 — “Authorizations for Banks” was added. The purpose of the chapter is to provide exceptions to certain activities that would otherwise be prohibited by other laws outside of the Financial Code.  The bill added Article 1.5 - “Loan and Investment Limitations” to Chapter 10 — “Commercial Banks.”  This article is new in concept and acknowledges that investment decisions are business decisions — so long as there is a diversification of the investments to spread any risk.  The risk is diversified in this article by placing a limitation on the loans and investments that can be made to any one entity.  This section is a trade-off for elimination of applications to the DFI for approval of investments in securities, which were repealed.

Other changes AB 1301 made to the Banking Law:

·                  Authorized a bank or trust acting in any capacity under a court or private trust to arrange for the deposit of securities in a securities depository or federal reserve bank, and provided how they may be held by the securities depository;

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

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

·                  Provided that the examinations may be conducted in alternate examination periods if the DFI concludes that an examination of the state bank by the appropriate federal regulator carries out the purpose of this section, but the DFI may not accept two consecutive examination reports made by federal regulators;

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

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

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

Recent Accounting Pronouncements

Adoption of New Financial Accounting Standards

FASB Accounting Standards Codification™ (ASC or Codification)

In June 2009, the Financial Accounting Standards Board (FASB) issued new accounting standard ASC 105-10 (previously SFAS No. 168), The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles.  With the issuance of ASC 105-10, the FASB Accounting Standards Codification (“the Codification” or “ASC”) becomes the single source of authoritative U.S. accounting and reporting standards applicable for all nongovernmental entities.  Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants.  This change is effective for financial statements issued for interim or annual periods ended after September 15, 2009.  Accordingly, all specific references to generally accepted accounting principles (GAAP) refer to the Codification.

Noncontrolling Interests in Consolidated Financial Statements

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

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FASB Clarifies Other-Than-Temporary Impairment

In April 2009, the FASB issued ASC No. 320-10-35 (previously FSP 115-2 and 124-2 and EITF 99-20-2), Recognition and Presentation of Other-Than-Temporary-Impairment.  This standard (i) changes previously existing guidance for determining whether an impairment to debt securities is other than temporary and (ii) replaces the previously existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis.  Under this standard, declines in fair value below cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses for both held-to-maturity and available-for-sale securities.  The amount of impairment related to other factors is recognized in other comprehensive income.  These changes were effective for interim and annual periods ended after June 15, 2009.  We adopted the provisions of this standard on April 1, 2009 and they did not have a material impact on our financial condition or results of operations.

FASB Clarifies Application of Fair Value Accounting

In April 2009, the FASB issued ASC 820-10 (previously FSP FAS 157-4), Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.  This standard affirms the objective of fair value when a market is not active, clarifies and includes additional factors for determining whether there has been a significant decrease in market activity, eliminates the presumption that all transactions are distressed unless proven otherwise, and requires an entity to disclose a change in valuation technique.  This standard was effective for interim and annual periods ended after June 15, 2009.  We adopted the provisions of this standard on April 1, 2009 and they did not have a material impact on our financial condition or results of operations.

Measuring Liabilities at Fair Value

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

Business Combinations

In December 2007, the FASB issued ASC Topic 805 (previously SFAS 141(R)), Business Combinations.  This standard broadens the guidance for business combinations and extends its applicability to all transactions and other events in which one entity obtains control over one or more other businesses.  It broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations.  The acquirer is no longer permitted to recognize a separate valuation allowance as of the acquisition date for loans and other assets acquired in a business combination.  It also requires acquisition-related costs and restructuring costs that the acquirer expected but was not obligated to incur to be expensed separately from the business combination.  It also expands on required disclosures to improve the ability of the users of the financial statements to evaluate the nature and financial effects of business combinations.  This standard was effective for the first annual reporting period beginning on or after December 15, 2008.

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Item 1a. Risk Factors

This discussion provides insight into Management’s assessment of risks relating to our business and its expectations for 2010. Such expressions of expectations are not historical in nature and are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual future results to differ materially from those expressed in any forward-looking statement. Such risks and uncertainties with respect to the Company include:

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

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

·                  continued deterioration in real estate markets and in general economic conditions, internationally, nationally and in the State of California;

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

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

·                  the availability of sources of liquidity at a reasonable cost;

·                  increased competitive pressure among financial services companies;

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

·                  technology implementation problems, computer system failures or security breaches; and

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

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

The Company’s agreement with the Federal Reserve Board of Governors (“FRB”).  We entered into an agreement (“FRB Agreement”) with the FRB where we agreed to certain covenants and conditions that require us, among other things:

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

·                  to not declare or pay dividends or distributions without the prior approval of the FRB;

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

·                  to not issue any trust preferred securities without the prior approval of the FRB; and

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

The Bank is subject to certain operating restrictions.  The Bank agreed to certain covenants and conditions in the informal joint Memorandum of Understanding effective April 21, 2009 between the Bank and its primary regulators, the Federal Deposit Insurance Corporation (FDIC) and California Department of Financial Institutions (DFI)  that restrict the operations of the Bank, including retaining qualified management, improving asset quality by reducing classified assets by collection or charge-off, maintaining an adequate loan loss allowance, reducing the aggregate amount of credit outstanding for borrowers of non-owner occupied commercial real estate and construction land development loans, improving the Bank’s overall risk profile, increasing the Bank’s Tier 1 capital ratio to equal or exceed 10% and not paying cash dividends without the prior written consent of the FDIC and DFI.  Management of the Bank expects to fully comply with such operating restrictions, to include the raising of additional capital discussed at Note 2 to the Consolidated Financial Statements.  However, there are no assurances that the actions by management of the Bank and the Company to comply with such restrictions will be fully compliant.

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As a result of a regularly scheduled and recently concluded joint FDIC and DFI examination, management expects to receive a formal order (“Order”) from the FDIC and the DFI which will replace the informal Memorandum of Understanding discussed above.   The Order is expected to include provisions to further strengthen and improve asset quality, enhance problem loan identification policies and procedures including identification of impaired loans and troubled debt restructured loans, reduce the level of classified assets, maintain certain capital ratios and request regulatory approval prior to paying any cash dividends. At this time, management does not know what impact the Order will have on the Company’s business strategies. Furthermore as the Bank is considered “undercapitalized” for bank regulatory purposes under the Prompt Corrective Action regulations, it will be required to file a capital restoration plan and is automatically subject to among other things, restrictions on dividends, restrictions on access to the Federal Reserve’s discount window, restrictions on asset growth, and being prohibited from opening new branches, making acquisitions or engaging in new lines of business without the approval of the FDIC.

Continued deterioration of real estate markets could result in further losses for the Company as nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.  As of December 31, 2009, approximately 58% of the loans of the Bank were secured by real estate.  The risk of nonpayment of loans is inherent in commercial banking.  Such nonpayment, if it occurs, would likely have a material adverse effect on the Bank’s earnings and the overall financial condition of the Company.  Furthermore, the ability of the Bank to originate loans secured by real estate may be impaired by adverse changes in local and regional economic conditions in the real estate market, increasing interest rates or by acts of nature, including earthquakes and flooding.  Due to our concentration of real estate collateral, these events could have a material adverse impact on the value of the collateral underlying loans resulting in losses.  Such resulting losses might materially adversely affect our financial condition.

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

Continued deterioration of economic conditions could hurt the financial condition of the Company and the Bank.  The banking business is affected by general economic and political conditions, both domestic and international.  The weakened general economic conditions have adversely affected the profitability of the Company and the Bank.

Most of the Bank’s assets and deposits are generated in California.  As a result, poor economic conditions in California have caused the Bank to incur losses associated with higher default rates and decreased collateral values in its loan portfolio.  Economic conditions in California are subject to various uncertainties at this time, including the impact of the decline in real estate values, higher unemployment, inflation in energy costs and consumer prices, and the fiscal crisis of the state of California.  If economic conditions in California continue to decline, the Bank expects that its level of problem assets could increase accordingly.

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

·                  loan delinquencies and defaults may increase;

·                  problem assets and foreclosures may increase;

·                  demand for our products and services may decline;

·                  low cost or noninterest bearing deposits may decrease;

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

·                  foreclosed assets may not be able to be sold;

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

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

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Tight credit markets and liquidity risk could adversely affect our business, financial condition and results of operations.  Continued tight credit markets and/or any inability to obtain adequate funds for continued loan growth at an acceptable cost could adversely affect our asset growth and liquidity position and, therefore, our earnings capability.  In addition to core deposit growth, maturity of investment securities and loan payments, we also rely on nonbrokered time certificates of deposits. Our ability to obtain additional sources is impaired by the deterioration in our financial condition as well as factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations for the financial services industry or serious dislocation in the general credit markets.  In the event such a disruption should occur, our ability to access these sources could be adversely affected both as to price and availability, which would limit or potentially raise the cost of the funds available to us.

Our focus on lending to small to mid-sized community-based businesses may increase our credit risk.  As of December 31, 2009, our commercial real estate loans amounted to $228.7 million, or 52.79% of our total loan portfolio, and our commercial business loans amounted to $80.8 million, or 18.64% of our total loan portfolio.  Commercial real estate and commercial business loans generally are considered riskier than single-family residential loans because they have larger balances to a single borrower or group of related borrowers.  Commercial real estate and commercial business loans involve risks because the borrowers’ ability to repay the loans typically depends primarily on the successful operation of the businesses or the properties securing the loans.  Most of the Bank’s commercial real estate and commercial business loans are made to small business or middle market customers who may have a heightened vulnerability to economic conditions.  Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle.  Furthermore, the deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could adversely affect our results of operations.

Changes in net interest income and net interest margin.  Net interest income is the difference or spread between the interest and fees earned on loans and investments (the Company’s earning assets) and the interest expense paid on deposits and other liabilities. Net interest margin is net interest income expressed as a percentage of average earning assets. It is used to measure the difference between the average rate of interest earned on assets and the average rate of interest that must be paid on liabilities used to fund those assets. To maintain its net interest margin, the Company must manage the relationship between interest earned and paid. A shift in the relative size of these major balance sheet categories has an impact on net interest income and net interest margin. To the extent that funds invested in securities can be repositioned into loans, earnings increase because of the higher rates paid on loans. However, additional credit risk is incurred with loans compared to the very low risk of loss on securities, and the Company must carefully monitor the underwriting process to ensure that the benefit of the additional interest earned is not offset by additional credit losses. In general, depositors are willing to accept a lower rate on their funds than are other providers of funds because of FDIC insurance coverage. To the extent that the Company can fund asset growth by deposits, especially the lower cost transaction accounts, rather than borrowing funds from other financial institutions, the average rates paid on funds will be less, and net interest income more.

Although the Company expects to continue to realize income from its net interest margin spread, an increase in interest rates may adversely affect the ability of borrowers with variable rate loans to pay the interest on, and principal of, their obligations. The Company cannot control these factors. The changes in levels of market interest rates could materially affect our net interest spread, asset quality, loan origination volume and overall profitability.

The Company faces intense competition from larger, more established institutions.  The banking business in California is highly competitive with respect to virtually all products and services and has become increasingly so in recent years. With respect to commercial bank competitors, major banks dominate the industry.  Most such banks offer certain services which the Bank is not equipped to offer directly (but some of which the Bank offers indirectly through correspondent institutions) and, by virtue of their greater total capitalization, such banks also have substantially higher lending limits than the Bank has.  In addition to commercial banks, the Bank competes with savings institutions, credit unions, and numerous nonbanking companies that offer money market and mutual funds, wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal finance software.  Mergers between financial institutions, federal and state interstate banking laws, and technological innovation have also resulted in increased competition in the financial services markets.  No assurance can be given that the Bank’s efforts to compete with these other financial institutions will be successful.

The Company is dependent on management.  The success of the Company is dependent on the services and prospective customer relationships of its key officers.  The loss of any key officer for any reason could have a material adverse effect on the Company.  There is also no guaranty that the Company would be able to replace such individuals with persons of comparable skills or with comparable customer relationships.  The Company also may not be able to attract and retain additional key personnel with the skills and expertise necessary to achieve and manage its operations.

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Governmental supervision of banking, monetary policies and intervention to stabilize the U.S. financial system may affect our business and are beyond our control.  Banks are subject to extensive governmental supervision, regulation and control by regulatory agencies and entities, which have materially affected the business of financial institutions.  In recent years the regulations applicable to banks have changed dramatically, have substantially affected the banking business and increased the cost of doing business.  The primary objective of these agencies and entities is to protect bank depositors and other customers and not shareholders, whose respective interests will often differ.  The regulatory agencies and entities have the legal authority to impose restrictions which they believe are needed to protect depositors and customers of banking institutions, even if the restrictions limit the ability of the banking institution to expand its business and introduce new financial products and services.  Such regulatory restrictions are likely to reduce the amount of investment risk and resulting potential financial gains that banks may assume.

Recent legislation including the Emergency Economic Stabilization Act of 2008 (the “EESA”), signed into law by President Bush on October 3, 2008, and the American Recovery and Reinvestment Act of 2009 (the “ARRA”), signed into law by President Obama on February 17, 2009, each include programs that are intended to help stabilize the U.S. financial system.  However, it is uncertain whether such legislation will sufficiently resolve the volatility of capital and credit markets or improve capital and liquidity problems confronting the financial system.  The failure of the EESA or ARRA to mitigate or eliminate such volatility and problems affecting the financial markets and a continuation or worsening of current financial market conditions could limit our access to capital or sources of liquidity in amounts and at times necessary to conduct operations in compliance with applicable regulatory requirements.

Recent regulations issued by the FDIC to limit the interest rate that may be paid on deposits and the type of deposits that may be taken by insured depository institutions that are less than “well capitalized”, including the Bank, may result in lower total deposits at the Bank that may require the Bank to sell assets to compensate for lower total deposits.  The sale of assets at less than cost by the Bank to compensate for lower deposits may result in losses for the Bank.  In addition, the inability to bring in deposits will restrict the future growth of the Bank.  The Company will be required to raise additional capital to provide the necessary capital to the Bank to allow it to be “well capitalized” and be exempt from such interest rate limitations.

Technology implementation problems or computer system failures could adversely affect us.  Our future growth prospects will be highly dependent on the ability of the Bank to implement changes in technology that affect the delivery of banking services such as the increased demand for computer access to bank accounts and the availability to perform banking transactions electronically. The Bank’s ability to compete will depend upon its ability to continue to adapt technology on a timely and cost-effective basis to meet such demands. In addition, the Company’s business and operations and those of the Bank could be susceptible to adverse effects from computer failures, communication and energy disruption, and activities such as fraud of unethical individuals with the technological ability to cause disruptions or failures of the Bank’s data processing system.

Information security breaches or other technological difficulties could adversely affect us.  We cannot be certain that the continued implementation of safeguards will eliminate the risk of vulnerability to technological difficulties or failures or ensure the absence of a breach of information security. The Bank will continue to rely on the services of various vendors who provide data processing and communication services to the banking industry. Nonetheless, if information security is compromised or other technology difficulties or failures occur at the Bank or with one of our vendors, information may be lost or misappropriated, services and operations may be interrupted and the Bank could be exposed to claims from its customers as a result.

Our controls over financial reporting and related governance procedures may fail or be circumvented.  Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures.  We maintain controls and procedures to mitigate risks such as processing system failures or errors and customer or employee fraud, and we maintain insurance coverage for certain of these risks.  Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and provides only reasonable, not absolute, assurances that the objectives of the system are met.  Events could occur which are not prevented or detected by our internal controls, are not insured against, or are in excess of our insurance limits. Any failure or circumvention of our controls and procedures, or failure to comply with regulations related to controls and procedures, could have an adverse effect on our business.

The effects of legislation in response to current credit conditions may adversely affect us.  Legislation that has or may be passed at the federal level and/or by the State of California in response to current conditions affecting credit markets could cause us to experience higher credit losses if such legislation reduces the amount that the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Such legislation could also result in the imposition of limitations upon the Bank’s ability to foreclose on property or other collateral or make foreclosure less economically feasible. Such events could result in increased loan and lease losses and require a material increase in the allowance for loan and lease losses.

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

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2009 the Bank paid a special FDIC insurance assessment of $267,513.  The FDIC also adopted a rule requiring all insured depository institutions including the Bank to prepay three years of FDIC assessments in the fourth quarter of 2009.  The amount of this prepaid assessment was $3,879,000 which is to be charged against income over a three year period.  While the prepaid assessments are not charged to income for 2009, but rather will be expensed based on the Bank’s quarterly assessments under the new risk-based assessment system, the amount paid in December will reduce the cash and liquidity of the Bank at year end 2009. Due to the significant losses at failed banks and expected losses for banks that will fail, it is likely that FDIC insurance fund assessments on the Bank will increase, and such assessments may materially adversely affect the profitability of the Bank.

We may raise additional capital, which could have a dilutive effect on the existing holders of our common stock and adversely affect the market price of our common stock.  We are not restricted from issuing additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, common stock.  We are evaluating opportunities to access the capital markets taking into account our regulatory capital ratios, financial condition and other relevant considerations.  Such actions could include, among other things, the issuance of additional shares of common stock in public or private transactions in order to further increase our capital levels above the requirements for a well-capitalized institution established by the Federal banking regulatory agencies as well as other regulatory targets.

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

We are unable to pay cash dividends in the foreseeable future due to dividend restrictions on common stock under the Regulatory Agreement and FRB Agreement.  Under the FRB Agreement, we may not pay any dividends on common stock without the prior permission of the FRB for the duration of such agreement.  It is expected that prior permission of the FRB will not be allowed until the financial condition of The Company and the Bank improves significantly.

Item 1b. Unresolved Staff Comments

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

Item 2.           Properties

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

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The following facilities are leased by the Company:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Item 3.    Legal Proceedings

From time to time, the Company is a party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel to the Company as to the current status of these claims or proceedings to which the Company is a party, management is of the opinion that the ultimate aggregate liability represented thereby, if any, will not have a material adverse affect on the financial condition of the Company.

Item 4.    Not Applicable

PART II

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

(a)           Market Information

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

In September 2009, the Company voluntarily delisted from the Nasdaq capital Market and is now traded on NASD OTCBB under the symbol CVLL.OB. CUSIP remains 20415P101. In December 2009 the Company issued two series of Preferred Stock, both of which are currently restricted. Community Valley Bancorp Preferred Stock Series A CUSIP is 20415P200. Preferred Stock Series B does not have a CUSIP.

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

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

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(b)           Holders

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

(c)           Dividends

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

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

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

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

(d)           Stock Repurchase Plan

There was no stock repurchase plan in place for 2009.

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

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

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

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(e)           Equity Compensation Plan Information

The following chart sets forth information for the fiscal year ended December 31, 2009, regarding equity based compensation plans of the Company.

(f)            Sales of Unregistered Securities

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

On December 30, 2009, the Company, pursuant to a loan participation and debt conversion agreement (“Agreement”) converted $3.3 million in outstanding debt into shareholder equity by issuing Company preferred stock in a private placement transaction under Section 4(2) of the Securities Act of 1933.  The $3.3 million outstanding debt of the Company was the net balance of the principal amount of a loan from Pacific Coast Bankers’ Bank (“PCBB”) to the Company that was collateralized by all of the outstanding common stock of the Bank.  As part of the transaction, $1.2 million of the $3.3 million loan from PCBB was participated by PCBB to certain accredited investors, including certain directors of the Company in a private placement transaction under Section 4(2) of the Securities Act of 1933.  The participated debt of $1.2 million was then converted into 240,000 shares of 6% Mandatory Convertible Cumulative Preferred Stock Series A (“Preferred Stock Series A”).  The remaining $2.1 million of $3.3 million debt was converted into 105,647 shares of 8% Cumulative Perpetual Preferred Stock Series B (“Preferred Stock Series B”) that was issued in a private placement transaction Section 4(2) of the Securities Act of 1933 to Pacific Coast Bankers’ Bank.

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

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Item 6.    Selected Financial Data

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

Selected Financial Data

(dollars in thousands, except per share data)