The following discussion explains the significant factors affecting our operations and financial position for the periods presented. The discussion should be read in conjunction with our financial statements and the notes related thereto which appear elsewhere in this report.

Forward-Looking Statements

Some matters discussed in this Form 10-Q may be "forward-looking statements" within the meaning of the Private Litigation Reform Act of 1995 and therefore may involve risks, uncertainties and other factors which may cause our actual results to be materially different from the results expressed or implied by our forward-looking statements. These statements generally appear with words such as "anticipate," "believe," "estimate," "may," "intend," and "expect." Although management believes that the assumptions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to: economic conditions (both generally and in the markets where the Bank operates); competition from other providers of financial services offered by the Bank; government regulation and legislation; changes in interest rates; material unforeseen changes in the financial stability and liquidity of the Bank's credit customers; and other risks as may be detailed from time to time in the Company's filings with the Securities and Exchange Commission, all of which are difficult to predict and which may be beyond the control of the Company or the Bank. The Company undertakes no obligation to revise forward-looking statements to reflect events or changes after the date of this discussion or to reflect the occurrence of unanticipated events.

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Allowance for Loan Losses

Accounting for allowance for loan losses involves significant judgment and assumptions by management and is based on historical data and management's view of the current economic environment. At least on a quarterly basis, our management reviews the methodology and adequacy of allowance for loan losses and reports its assessment to the Board of Directors for its review and approval.

We base our allowance for loan losses on an estimation of probable losses inherent in our loan portfolio. Our methodology for assessing loan loss allowances are intended to reduce the differences between estimated and actual losses and involves a detailed analysis of our loan portfolio in three phases:

† the specific review of individual loans,

† the segmenting and review of loan pools with similar characteristics in accordance with SFAS No. 5, "Accounting for Contingencies," and

† our judgmental estimate based on various subjective factors:

The first phase of our methodology involves the specific review of individual loans to identify and measure impairment. We evaluate each loan by use of a risk rating system, except for homogeneous loans, such as automobile loans and home mortgages. Specific risk rated loans are deemed impaired if all amounts, including principal and interest, will likely not be collected in accordance with the contractual terms of the related loan agreement. Impairment for commercial and real estate loans is measured either based on the present value of the loan's expected future cash flows or, if collection on the loan is collateral dependent, the estimated fair value of the collateral, less selling and holding costs.

The second phase involves the segmenting of the remainder of the risk rated loan portfolio into groups or pools of loans, together with loans with similar characteristics, for evaluation in accordance with SFAS No. 5. We determine the calculated loss ratio to each loan pool based on its historical net losses and benchmark it against the levels of other peer banks.

In the third phase, we consider relevant internal and external factors that may affect the collectibility of loan portfolio and each group of loan pool. The factors considered are, but are not limited to:

† concentration of credits,

† nature and volume of the loan portfolio,

† delinquency trends,

† non-accrual loan trend,

† problem loan trend,

† loss and recovery trend,

† quality of loan review,

† lending and management staff,

† lending policies and procedures,

† economic and business conditions, and

† other external factors.

Our management estimates the probable effect of such conditions based on our judgment, experience and known or anticipated trends. Such estimation may be reflected as an additional allowance to each group of loans, if necessary. Management reviews these conditions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specific, identifiable problem credit or portfolio segment as of the evaluation date, management's evaluation of the inherent loss related to such condition is reflected in the unallocated allowance

Central to our credit risk management and our assessment of appropriate loss allowance is our loan risk rating system. Under this system, the originating credit officer assigns borrowers an initial risk rating based on a thorough analysis of each borrower's financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit administration personnel. Credits are monitored by line and credit administration personnel for deterioration in a borrower's financial condition which may impact the ability of the borrower to perform under the contract. Although management has allocated a portion of the allowance to specific loans, specific loan pools, and off-balance sheet credit exposures (which are reported separately as part of other liabilities), the adequacy of the allowance is considered in its entirety.

Non-Accrual Loan Policy

Interest on loans is credited to income as earned and is accrued only if deemed collectible. Accrual of interest is discontinued when a loan is over 90 days delinquent or if management believes that collection is highly uncertain. Generally, payments received on nonaccrual loans are recorded as principal reductions. Interest income is recognized after all principal has been repaid or an improvement in the condition of the loan has occurred that would warrant resumption of interest accruals.

Stock-Based Compensation

The Company recognizes in the income statement the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees' requisite service period (generally the vesting period). The Bank uses the straight-line recognition of expenses for awards with graded vesting. The Bank utilizes a binomial pricing model for all grants. Expected volatility is based on the historical volatility of the price of the Bank's stock for the period equal to the contractual stock option term. The Bank uses historical data to estimate option exercise and stock option forfeiture rates within the valuation model. The expected term of options granted for the binomial model is derived from applying a historical suboptimal exercise factor to the contractual term of the grant. For binomial pricing, the risk-free rate for periods is equal to the U.S. Treasury yield at the time of grant and commensurate with the contractual term of the grant.

Other Real Estate Owned

Other real estate owned, which represents real estate acquired through foreclosure, or deed in lieu of foreclosure in satisfaction of commercial and real estate loans, is carried at the lower of cost or estimated fair value less the estimated selling costs of the real estate. The fair value of the property is based upon a current appraisal. The difference between the fair value of the real estate collateral and the

loan balance at the time of transfer is recorded as a loan charge off if fair value is lower. Subsequent to foreclosure, management periodically performs valuations and the OREO property is carried at the lower of carrying value or fair value, less costs to sell. The determination of a property's estimated fair value incorporates (1) revenues projected to be realized from disposal of the property, (2) construction and renovation costs, (3) marketing and transaction costs, and (4) holding costs (e.g., property taxes, insurance and homeowners' association dues). Any subsequent declines in the fair value of the OREO property after the date of transfer are recorded through a write-down of the asset. Any subsequent operating expenses or income, reduction in estimated fair values, and gains or losses on disposition of such properties are charged or credited to current operations.

Introduction

Effective July 3, 2008, Oak Valley Community Bank became a subsidiary of Oak Valley Bancorp, a newly established bank holding company. Oak Valley Bancorp operates Oak Valley Community Bank as a community bank in the general commercial banking business, with our primary market encompassing the California Central Valley around Oakdale and Modesto, and the Eastern Sierras. As such, unless otherwise noted, all references are about Oak Valley Bancorp.

Overview of Results of Operations and Financial Condition

† The Company recognized net income available to common shareholders of $219,899 for the three month period ended March 31, 2009 as compared with $775,797 for the same period in 2008. Net income before preferred stock dividends and accretion was $430,310 for the first quarter of 2009. The factors resulting in this decrease will be discussed below.

† The Company recognized expense of $210,411 in the first quarter of 2009 associated with the accrual for preferred stock dividends and accretion of the preferred stock discount. No expense was recognized in the first quarter of 2008, as the preferred stock was issued in December 2008.

† Net interest income increased $847,363 or 17.6% for the three month period ended March 31, 2009 compared to the same period in 2008. This increase was primarily due to the net interest margin increase of 28 basis points from 4.59% in the first quarter of 2008 to 4.87% in the first quarter of 2009. In addition, average earning assets increased by $57.8 million for the three month period ended March 31, 2009. The net interest margin increase is attributable primarily to liabilities repricing faster than assets in the current declining rate environment as described in further detail below.

† The provision for loan losses in the three month period ended March 31, 2009 increased by $1,755,000, compared to the same period in 2008, due to loan growth, an increase in the level of non-accrual loans and management's assessment of the appropriate level for the allowance for loan losses.

† For the three month period ended March 31, 2009, non-interest income decreased by $15,274 or 2.5%, from the same period in 2008, primarily due to decreased service charges on deposits of $20,542 as described below.

† Non-interest expense decreased by $118,263 or 2.9% for the three month period ended March 31, 2009, as compared to the same period in 2008, primarily due to a decrease in salaries and benefits as described below.

† Total assets increased $15.5 million or 3.1% from December 31, 2008. Total net loans increased by $1.3 million or 0.3% and investment securities increased by $11.0 million or 26.6% from December 31, 2008 to March 31, 2009, while deposits increased by $31.8 million or 8.4%.

Income Summary

For the three month period ended March 31, 2009, the Company recorded net income available to shareholders of $219,899, a decrease of $555,898, as compared to the $775,797 for the same period in 2008. Return on average assets (annualized) was 0.34% for the first quarter of 2009, as compared with 0.68% for the same period in 2008. Annualized return on average common equity was 1.97% for the first quarter of 2009, as compared with 7.16% for the same period of 2008.

Net income before provisions for income taxes and preferred stock dividends and accretion for the first quarter of 2009 was down $804,648 from the comparable 2008 period. The income statement components of these variances are as follows:

Pre-Tax Income Variance Summary

(In thousands)



                                                                   Effect on Pre-Tax
                                                                         Income
                                                                  Increase (Decrease)
                                                                      Three Months
Change from 2008 to 2009 in:
Net interest income                                               $                847
Provision for loan losses                                                       (1,755 )
Non-interest income                                                                (15 )
Non-interest expense                                                               118
Change in net income before income taxes and preferred stock
dividends and accretion                                           $               (805 )

These variances will be explained in the discussion below.

Net Interest Income

Net interest income is the largest source of the Bank's operating income. For the three month period ended March 31, 2009, net interest income was $5.66 million, an increase of $847,363 or 17.6% from the comparable period in 2008.

The net interest margin (net interest income as a percentage of average interest earning assets) was 4.87% for the three month period ended March 31, 2009, an increase of 28 basis points as compared to the same period in 2008. The increase in the net interest margin in 2009 was primarily attributable to the impact that the decline in market interest rates had on our liability sensitive balance sheet which caused interest-bearing liabilities to decrease faster than the yields on earning assets. The compression of the yield on interest earning assets was lessened due to a portion of our loan portfolio that was at the contractual rate floors. In addition, yield on investments increased by 118 basis points as a result of approximately $12.5 million municipal securities purchased in the fourth quarter of 2008 and first quarter 2009 and the related fully taxable equivalent benefit.

The following tables shows the relative impact of changes in average balances of interest earning assets and interest bearing liabilities, and interest rates earned and paid by the Company on those assets and liabilities for the three month period ended March 31, 2009 and 2008:

Net Interest Analysis

(Dollars in thousands)



                                   Three months ended                   Three months ended
                                     March 31, 2009                       March 31, 2008
                                         Interest       Avg                    Interest      Avg
                            Average      Income /      Rate/      Average      Income /     Rate/
                            Balance      Expense       Yield      Balance      Expense      Yield
Assets:
Earning assets:
Gross loans (1) (2)        $ 429,860    $    6,604       6.23 %  $ 388,096    $    6,941      7.17 %
Investment securities
(2)                           46,999           708       6.11 %     33,099           407      4.93 %
Federal funds sold             1,383             1       0.27 %        597             5      3.43 %
Interest-earning
deposits                       1,525             1       0.21 %        219             1      1.31 %
Total interest-earning
assets                       479,767         7,314       6.18 %    422,012         7,354      6.99 %
Total noninterest
earning assets                37,768                                32,202
Total Assets                 517,535                               454,214
Liabilities and
Shareholders' Equity:
Interest-bearing
liabilities:
Money market deposits        163,514           628       1.56 %    140,389           979      2.80 %
NOW deposits                  53,950            75       0.56 %     53,907            95      0.71 %
Savings deposits              13,595            34       1.02 %     15,735           107      2.72 %
Time certificates of
deposit $100,000 or
more                          41,964           287       2.77 %     47,600           525      4.43 %
Other time deposits           51,450           301       2.37 %     43,245           451      4.18 %
Other borrowings              70,075           229       1.32 %     43,055           368      3.43 %
Total interest-bearing
liabilities                  394,548         1,554       1.60 %    343,932         2,526      2.95 %
Noninterest-bearing
liabilities:
Noninterest-bearing
deposits                      61,285                                63,797
Other liabilities              2,928                                 3,123
Total
noninterest-bearing
liabilities                   64,213                                66,920
Shareholders' equity          58,774                                43,362
Total liabilities and
shareholders' equity       $ 517,535                             $ 454,214
Net interest income                     $    5,760                            $    4,828
Net interest spread (3)                                  4.59 %                               4.04 %
Net interest margin (4)                                  4.87 %                               4.59 %

(2) Yields on municipal securities and loans have been adjusted to their fully-taxable equivalents, based on a federal marginal tax rate of 34.0%.

(3) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

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

Shown in the following tables are the relative impacts on net interest income of changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by the Company on those assets and liabilities for the three month period ended March 31, 2009 and 2008. Changes in interest income and expense that are not attributable specifically to either rate or volume are allocated to the rate column below.

Rate / Volume Variance Analysis

(In thousands)



                                   For the Three Months Ended March 31,
                                               2009 vs 2008
                                            Increase (Decrease)
                                      in interest income and expense
                                            due to changes in:
                                 Volume           Rate             Total
Interest income:
Gross loans (1)                 $     747    $        (1,084 )  $      (337 )
Investment securities                 171                130            301
Federal funds sold                      7                (11 )           (4 )
Interest-earning deposits               1                 (1 )            0
Total interest income           $     926    $          (966 )  $       (40 )

Interest expense:
Money market deposits                 161               (512 )         (351 )
NOW deposits                            0                (20 )          (20 )
Savings deposits                      (15 )              (58 )          (73 )
Time CD $100K or more                 (62 )             (177 )         (239 )
Other time deposits                    86               (235 )         (149 )
Other borrowings                      231               (371 )         (140 )
Total interest expense          $     401    $        (1,373 )  $      (972 )

Change in net interest income   $     525    $           407    $       932

The table above reflects the market interest rate decline has impacted liabilities slightly more than assets as indicated by the increase of $407,000 in net interest income due to the rate change. The increased loan volume and the overall change in mix of deposit balances contributed an increase of $525,000 to net interest income.

Non-Interest Income

Non-interest income represents service charges on deposit accounts and other non-interest related charges and fees, including fees from the sale of loans. For the three month period ended March 31, 2009, non-interest income was $598,309, a decrease of $15,274 or 2.5% from the same period in 2008.

The following table shows the major components of non-interest income:

Non-Interest Income

(In thousands)



                                               For the Three Months Ended March 31,
                                        2009          2008        $ change        % change
Service charges on deposits          $      282    $      303    $       (21 )           (6.8 )%
Earnings on cash surrender value
of life insurance                           101            81             20             24.3 %
Mortgage commissions                         43            50             (7 )          (14.5 )%
Other                                       172           180             (8 )           (4.1 )%
                                     $      598    $      614    $       (16 )           (2.5 )%

Service charges on deposits decreased by $20,542 or 6.8% in the three month period ended March 31, 2009, as compared to the same periods in 2008, which is primarily due to decreased NSF fee income. The Bank continues to expand its offerings to the consumer and business depositor. Offsetting the decrease to service charges on deposits, was an increase of $19,781 in earnings on cash surrender of life insurance as a result of the $4.74 million invested in additional life insurance policies on certain officers and directors during the first quarter of 2008.

Non-Interest Expense

Non-interest expense represents salaries and benefits, occupancy expenses, professional expenses, outside services, and other miscellaneous expenses necessary to conduct business.

The following table shows the major components of non-interest expenses:

Non-Interest Expense

(In thousands)



                                       For the Three Months Ended March 31,
                                    2009          2008        $ change    % change
Salaries and employee benefits   $    2,050    $    2,446    $     (396 )    (16.2 )%
Occupancy expenses                      695           670            25        3.9 %
Data processing fees                    218           179            39       22.4 %
OREO expenses                           125             -           125
Other operating expenses                850           762            88       11.5 %
                                 $    3,938    $    4,057    $     (119 )     (2.9 )%

Non-interest expenses decreased by $118,263 or 2.9% for the three months ended March 31, 2009, as compared to the same period of 2008. Salaries and employee benefits decreased $396,543 for the three months ended March 31, 2009, as compared to the same periods of 2008 as a result of a reduction in full time equivalent employees in effort to improve operating efficiency and an increase in deferred loan costs. Data processing fees increased by $39,957 or 22.4% for the first quarter 2009 compared to the same period of 2008, as a result of an increased number of transaction accounts. A primary component of the $87,449 increase in other operating expense, was FDIC assessments which increased by $55,643 for the first quarter 2009 compared to first quarter 2008. OREO expenses were $125,029 in the first quarter of 2009 compared to no expenses in the comparable period of 2008. These expenses resulted from various overhead costs associated with the three properties classified as other real estate owned.

Management anticipates that noninterest expense will continue to increase as we continue to grow. However, management remains committed to cost-control and efficiency, and we expect to keep these increases to a minimum relative to growth.

Income Taxes

Provision for income taxes for the three months ended March 31, 2009, was a net tax benefit of $13,912, a decrease of $459,161 or 103.1% from the same period in 2008. The effective tax rate (income tax expense as a percentage of pre-tax income) for the first quarter of 2009 was (3.3%), compared with 36.5% for the same period in 2008. The disparity between the effective tax rates in 2009 as compared to 2008 is primarily due to tax credits from California Enterprise Zones and low income housing projects as well as tax free-income on loans within these enterprise zones and municipal securities and loans that comprise a larger proportion of pre-tax income in 2009 as compared to 2008.

Asset Quality

Nonperforming assets consist of loans on non-accrual status, loans 90 days or more past due and still accruing interest, loans restructured, where the terms of repayment have been renegotiated resulting in a reduction or deferral of interest or principal, and other real estate owned ("OREO").

Loans are generally placed on non-accrual status when they become 90 days past due, unless management believes the loan is adequately collateralized and in the process of collection. The past due loans may or may not be adequately . . .