Certain statements in this Form 10-Q (excluding statements of fact or historical financial information) involve forward-looking information within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the "safe harbor" created by those sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors:
competitive pressure in banking industry increases significantly; changes in the interest rate environment reduce margins; general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; changes in business conditions, particularly in the Northern California region; volatility of rate sensitive deposits; operational risks including data processing system failures or fraud; asset/liability matching risks and liquidity risks; the California power crises; the U.S. "war on terrorism" and military action by the U.S. in the Middle East, and changes in the securities markets.

Critical Accounting Policies

General

North Valley Bancorp's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan and lease portfolio. Actual losses could differ significantly from the historical factors that we use. Another estimate that we use is related to the expected useful lives of our depreciable assets. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses is maintained to provide for losses related to impaired loans and leases and other losses that can be reasonably expected to occur in the normal course of business. The allowance for loan and lease losses is established through a provision for loan and lease losses charged to operations. Loans and leases are charged against the allowance for loan and lease losses when management believes that the collectibility of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. Management attributes formula reserves to different types of loans using percentages which are based upon perceived risk associated with the portfolio and underlying collateral, historical loss experience, and vulnerability to existing economic conditions, which may affect the collectibility of the loans. Specific reserves are allocated for impaired loans and leases which have experienced a decline in internal grading and when management believes additional loss exposure exists. The unallocated allowance is based upon management's evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of inherent losses with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. Although the allowance for loan and lease losses is allocated to various portfolio segments, it is general in nature and is available for the loan and lease portfolio in its entirety. The allowance is an amount that management believes will be adequate to absorb losses inherent in existing loans and leases. Actual amounts could differ from those estimates.

The Company considers a loan or lease impaired if, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on the fair value of the collateral.

Share Based Compensation

At June 30, 2009, the Company had three shareholder approved stock-based compensation plans: the 1998 Employee Stock Incentive Plan, the 1999 Director Stock Option Plan and the 2008 Stock Incentive Plan. The North Valley Bancorp 2008 Stock Incentive Plan was adopted by the Company's Board of Directors on February 27, 2008, effective that date, and was approved by the Company's shareholders at the Annual Meeting, May 22, 2008. The terms of the 2008 Stock Incentive Plan are substantially the same as the North Valley Bancorp 1998 Employee Stock Incentive Plan. See Note C - STOCK-BASED COMPENSATION to the Unaudited Condensed Consolidated Financial Statements in Item 1 - Financial Statements.

Business combinations involving the Company's acquisition of the equity interests or net assets of another enterprise may give rise to goodwill. Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed in transactions accounted for under the purchase method of accounting. Goodwill of $15,187,000 was recorded in the Company's acquisition of Yolo Community Bank. The value of goodwill is ultimately derived from the Company's ability to generate net earnings. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill will be assessed for impairment at a reporting unit level at least annually. Management conducted its assessment of impairment during the fourth quarter of 2008 and based on its evaluation determined that there was no impairment. Due to the Company's net loss and the continued change in the business climate, management updated its assessment of impairment in the second quarter of 2009 and determined that there was no impairment.

Impairment of Investment Securities

Investment securities are evaluated for other-than-temporary impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, the financial condition of the issuer, rating agency changes related to the issuer's securities and the intent and ability of the Bank to retain its investment in the issues for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term "other-than-temporary" is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary and management has the ability and intent to hold the security to a forecasted recovery of cost, only the portion of the impairment loss representing credit exposure would be recognized as a charge to earnings, with the balance recognized a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that it will be required to sell the security before recovering its forecasted cost, the entire impairment loss would be recognized as a charge to earnings. See Note B - INVESTMENT SECURITIES to the Unaudited Condensed Consolidated Financial Statements in Item 1 - Financial Statements.

Fair Value

Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, which among other things, requires enhanced disclosures about financial instruments carried at fair value. SFAS No. 157 establishes a hierarchical disclosure framework associated with the level of observable pricing scenarios utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of the observable pricing scenario. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of observable pricing and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no observable pricing and a higher degree of judgment utilized in measuring fair value. Observable pricing scenarios are impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.

See Note J - FAIR VALUE MEASUREMENTS to the Unaudited Condensed Consolidated Financial Statements in Item 1 - Financial Statements for additional information about the financial instruments carried at fair value.

North Valley Bancorp (the "Company") is a bank holding company headquartered in Redding, California. The Company's wholly owned subsidiary, North Valley Bank ("NVB"), a California state-chartered banking corporation, operates out of its main office located at 300 Park Marina Circle, Redding, CA 96001, with twenty-six commercial banking offices, including two supermarket branches and seven Business Banking Centers, and a loan production office in Northern California. The Company's principal business consists of attracting deposits from the general public and using the funds to originate commercial, real estate and installment loans to customers, who are predominately small and middle market businesses and middle income individuals. The Company's primary source of revenues is interest income from its loan and investment securities portfolios. The Company is not dependent on any single customer for more than 10 percent of its revenues.

Operating Results


                                       Three months ended June 30,            Six months ended June 30,
(in thousands except per share
amounts)                                 2009                2008              2009               2008


Net interest income                 $        7,909      $        9,069     $      16,017      $      18,197
Provision for loan and lease
losses                                       9,000               5,200            16,000              7,600
Noninterest income                           3,438               3,477             6,602              6,968
Noninterest expense                         10,782               9,577            21,117             19,382
Benefit for income taxes                    (4,346 )              (722 )          (7,302 )             (588 )

Net loss                            $       (4,089 )    $       (1,509 )   $      (7,196 )    $      (1,229 )


Loss Per Share
Basic                               $        (0.55 )    $        (0.20 )   $       (0.96 )    $       (0.17 )
Diluted                             $        (0.55 )    $        (0.20 )   $       (0.96 )    $       (0.17 )

Annualized Return on Average
Assets                                       (1.81 %)            (0.65 %)          (1.63 %)           (0.26 %)
Annualized Return on Average
Equity                                      (21.74 %)            (7.35 %)         (18.98 %)           (2.98 %)

The Company had a net loss of $4,089,000, or $0.55 per diluted share, and $7,196,000, or $0.96 per diluted share, for the three and six months ended June 30, 2009, respectively. This compares with a net loss of $1,509,000, or $0.20 per diluted share, and $1,229,000, or $0.17 per diluted share for the three and six months ended June 30, 2008. The increase in net loss for the three and six months ended June 30, 2009 compared to the same periods in 2008 was principally driven by a $9,000,000 provision for loan and lease losses for the three months ended June 30, 2009 and a total provision of $16,000,000 for the six months ended June 30, 2009 compared to a $5,200,000 provision for loan and lease losses for the three months ended June 30, 2008 and a total provision of $7,600,000 for the six months ended June 30, 2008, and secondarily due to a decrease in net interest income of $1,160,000 for the three months ended June 30, 2009 and a total decrease of $2,180,000 for the six months ended June 30, 2009 compared to the same periods in 2008. Noninterest income decreased $39,000 and $366,000 for the three and six months ended June 30, 2009 compared to the same periods in 2008. Noninterest expense increased $1,205,000 and $1,735,000 for the three and six months ended June 30, 2009 compared to the same periods in 2008.

Net Interest Income

Net interest income is the principal source of the Company's operating earnings and represents the difference between interest earned on loans and leases and other investments and interest paid on deposits and other borrowings. The amount of interest income and expense is affected by changes in the volume and mix of earning assets and interest-bearing deposits and borrowings, along with changes in interest rates.

Schedule of Average Daily Balance and Average Yields and Rates
(Dollars in thousands)


                             Three months ended June 30, 2009            Three months ended June 30, 2008

                            Average         Yield/      Interest        Average         Yield/      Interest
                            Balance          Rate        Amount         Balance          Rate        Amount


Assets
Earning assets:
Federal funds sold       $       31,984         0.18 %  $      14    $          230         1.74 %  $       1
Investment
securities:
Taxable                         107,969         3.77 %      1,016            79,844         4.14 %        825
Non-taxable (1)                  15,850         6.78 %        268            20,189         6.85 %        345
FNMA preferred stock
(1)                                   -            -            -             3,284         9.89 %         81

Total investments               123,819         4.16 %      1,284           103,317         4.86 %      1,251
Loans and leases
(2)(3)                          658,068         6.11 %     10,029           747,414         6.57 %     12,246

Total earning assets            813,871         5.58 %     11,327           850,961         6.36 %     13,498

Non earning assets              108,298                                      97,708
Allowance for loan
and lease losses                (16,136 )                                   (13,103 )

Total non-earning
assets                           92,162                                      84,605

Total assets             $      906,033                              $      935,566


Liabilities and
Shareholders' Equity
Interest bearing
liabilities:
Transaction accounts     $      151,422         0.31 %  $     117    $      157,526         0.65 %  $     256
Savings and money
market                          172,001         1.01 %        435           184,164         1.62 %        743
Time certificates               320,512         2.82 %      2,254           247,988         3.87 %      2,391
Other borrowed funds             31,961         6.60 %        526            92,435         3.92 %        904

Total interest
bearing liabilities             675,896         1.98 %      3,332           682,113         2.52 %      4,294

Demand deposits                 144,334                                     159,403
Other liabilities                10,370                                      11,689

Total liabilities               830,600                                     853,205

Shareholders' equity             75,433                                      82,361

Total liabilities and
shareholders' equity     $      906,033                              $      935,566

Net interest income                                     $   7,995                                   $   9,204

Net interest spread                             3.60 %                                      3.84 %

Net interest margin                             3.94 %                                      4.34 %

(1) Tax-equivalent basis; non-taxable securities are exempt from federal taxation.

(2) Loans on nonaccrual status have been included in the computations of averages balances.

(3) Includes loan fees of $239 and $113 for the three months ended June 30, 2009 and 2008, respectively.

Schedule of Average Daily Balance and Average Yields and Rates
(Dollars in thousands)




                             Six months ended June 30, 2009             Six months ended June 30, 2008

                            Average        Yield/      Interest        Average        Yield/      Interest
                            Balance         Rate        Amount         Balance         Rate        Amount


Assets
Earning assets:
Federal funds sold       $      23,544         0.20 %  $      23    $         411         2.93 %  $       6
Investment
securities:
Taxable                         88,839         3.88 %      1,711           83,317         4.09 %      1,700
Non-taxable (1)                 15,874         6.78 %        534           20,364         6.75 %        685
FNMA preferred stock
(1)                                  -            -            -            3,284         9.65 %        158

Total investments              104,713         4.32 %      2,245          106,965         4.77 %      2,543
Loans and leases
(2)(3)                         669,390         6.20 %     20,565          745,209         6.79 %     25,222

Total earning assets           797,647         5.77 %     22,833          852,585         6.53 %     27,771

Non earning assets             108,432                                     97,786
Allowance for loan
and lease losses               (13,798 )                                  (11,929 )

Total non-earning
assets                          94,634                                     85,857

Total assets             $     892,281                              $     938,442

Liabilities and Shareholders'

Equity
Interest bearing
liabilities:
Transaction accounts     $     152,403         0.34 %  $     258    $     156,238         0.65 %  $     505
Savings and money
market                         169,913         1.04 %        875          182,916         1.70 %      1,553
Time certificates              303,183         2.95 %      4,441          248,095         4.17 %      5,161
Other borrowed funds            32,641         6.60 %      1,069           98,679         4.26 %      2,097

Total interest
bearing liabilities            658,140         2.04 %      6,643          685,928         2.72 %      9,316

Demand deposits                147,158                                    157,474
Other liabilities               10,521                                     12,292

Total liabilities              815,819                                    855,694

Shareholders' equity            76,462                                     82,748

Total liabilities and
shareholders' equity     $     892,281                              $     938,442

Net interest income                                    $  16,190                                  $  18,455

Net interest spread                            3.73 %                                     3.81 %

Net interest margin                            4.09 %                                     4.34 %

(1) Tax-equivalent basis; non-taxable securities are exempt from federal taxation.

(2) Loans on nonaccrual status have been included in the computations of averages balances.

(3) Includes loan fees of $476 and $292 for the six months ended June 30, 2009 and 2008, respectively.

Net interest income has been adjusted to a fully taxable equivalent basis (FTE) for tax-exempt investments included in earning assets. Net interest income, which represents the Company's largest component of revenues and is the difference between interest earned on loans and investments and interest paid on deposits and borrowings, decreased $1,209,000, or 13.1%, for the three months ended June 30, 2009 compared to the same period in 2008. Interest income decreased by $2,171,000, or 16.1%, primarily due to both lower yield on earning assets and a decrease in the average balance of earning assets and secondarily due to foregone interest income of $595,000 due to loans placed on nonaccrual status. Interest expense decreased $962,000, or 22.4%, primarily due to a decrease in the rates paid on deposits and secondarily due to a decrease in the average balance of borrowings for the three months ended June 30, 2009 compared to the same period in 2008. Average loans decreased $89,346,000 for the quarter ended June 30, 2009 compared to the same period in 2008, and the yield on the loan portfolio decreased 46 basis points to 6.11% for the quarter ended June 30, 2009 compared to the same quarter in 2008. Average earning assets decreased $37,090,000, for the quarter ended June 30, 2009 compared to the same quarter in 2008. Average yields on earning assets decreased 78 basis points from 6.36% for the quarter ended June 30, 2008 to 5.58% for the quarter ended June 30, 2009, and the average rate paid on interest bearing liabilities decreased 54 basis points to 1.98% over the same periods. The decrease in both yields earned and rates paid is reflective of the declining interest rate environment as the Federal Reserve Board has reduced interest rates 500 basis points since September 2007. As a result of the above, the Company's net interest margin for the quarter ended June 30, 2009 was 3.94%, a decrease of 40 basis points from the net interest margin of 4.34% for the quarter ended June 30, 2008 and a decrease of 29 basis points from the 4.23% net interest margin for the quarter ended March 31, 2009.

The following table sets forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. The change in interest due to both rate and volume has been allocated to the change in rate.

Changes in Volume/Rate
(Dollars in thousands)


                                      Three months ended June 30, 2009                Six months ended June 30, 2009
                                               compared with                                  compared with
                                      Three months ended June 30, 2008                Six months ended June 30, 2008

                                                                   Total                                         Total
                                  Average         Average         Increase        Average        Average        Increase
                                   Volume           Rate         (Decrease)       Volume          Rate         (Decrease)


Interest Income

Interest on Federal funds
sold                            $        138    $       (125 )  $         13    $       339    $      (322 )  $         17
Interest on investments:
Taxable securities                       291            (100 )           191            113           (102 )            11
Nontaxable securities                    (74 )            (3 )           (77 )         (152 )            1            (151 )
FNMA preferred stock                     (81 )             -             (81 )         (158 )            -            (158 )


Total investments                        136            (103 )            33           (197 )         (101 )          (298 )

Interest on loans and leases          (1,468 )          (749 )        (2,217 )       (2,574 )       (2,083 )        (4,657 )


Total interest income                 (1,194 )          (977 )        (2,171 )       (2,432 )       (2,506 )        (4,938 )


Interest Expense

Transaction accounts            $        (10 )  $       (129 )  $       (139 )  $       (12 )  $      (235 )  $       (247 )
Savings and money market                 (49 )          (259 )          (308 )         (111 )         (567 )          (678 )
Time deposits                            702            (839 )          (137 )        1,149         (1,869 )          (720 )
Other borrowed funds                    (593 )           215            (378 )       (1,407 )          379          (1,028 )


Total interest expense                    50          (1,012 )          (962 )         (381 )       (2,292 )        (2,673 )


Total change in net interest
income                          $     (1,244 )  $         35    $     (1,209 )  $    (2,051 )  $      (214 )  $     (2,265 )

Provision for Loan and Lease Losses

The Company recorded a provision for loan and lease losses of $9,000,000 for the three months ended June 30, 2009 and a total provision of $16,000,000 for the six months ended June 30, 2009, compared to a provision for loan and lease losses of $5,200,000 for the three months ended June 30, 2008 and a total provision of $7,600,000 for the six months ended June 30, 2008. The process for determining allowance adequacy and the resultant provision for loan losses includes a comprehensive analysis of the loan portfolio. Factors in the analysis include size and mix of the loan portfolio, nonperforming loan levels, charge-off/recovery activity and other qualitative factors including economic environment and activity. The decision to record the $9,000,000 and $16,000,000 provision for the three and six months ended June 30, 2009 reflects management's assessment of the overall adequacy of the allowance for loan and lease losses including the consideration of the increase in nonperforming loans and the . . .