UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

California (State or other jurisdiction of incorporation or organization) 1901 Churn Creek Road Redding, California		94-2823865 (I.R.S. Employer Identification No.)
		96002
(Address of principal executive offices)		(Zip code)

Registrant’s telephone number, including area code: (530) 722-3955

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

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share

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 þ No 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 the definition of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

Outstanding shares of Common Stock, no par value, as of June 30, 2008: 8,711,495

 

 

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Index to Form 10-Q

		Page:
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets June 30, 2008, December 31, 2007 and June 30, 2007			4
Condensed Consolidated Statements of Income Three and Six months ended June 30, 2008, and 2008			5
Consolidated Statement of Stockholders’ Equity			6
Condensed Consolidated Statements of Cash Flows Six months ended June 30, 2008 and 2007			7
Notes to Condensed Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Company Overview			16
Risk Factors			19
Economic Conditions and Geographic Concentration			19
Changes in interest rates could reduce the Company’s Net Interest Income and Earnings			19
Lending Risks Associated with Commercial Banking and Construction Activities			20
Adequacy of Allowance for Loan and Lease Losses (ALLL)			20
Potential Volatility of Deposits			20
Dividends			21
Government Regulation and Legislation			21
Certain Ownership Restrictions under California and Federal Law			22
Negative Publicity could Damage our Reputation			22
Environmental Risks			22
Shares Eligible for Future Sale			23
Technology and Computer Systems			23
Company Stock Price may be volatile due to Other Factors			23
Executive Overview			24
Sources of Income			24
Financial Highlights — Results of Operations			25
Net Interest Income and Net Interest Margin			25
Liquidity			26
Capital Management			26
Short term borrowings			27
Provision for loan and lease losses			27
Factors that may affect future results			28
Critical accounting policies			28
Average balances, Interest Income/Expense and yields/rates paid			31
Analysis of changes in net interest income and interest expense			32
Noninterest Income			33
Noninterest Expense			33
Income taxes			34
Asset quality			35
Allowance for loan and lease losses (ALLL)			37
Securities portfolio			39
Quarterly Income Statement			41
Item 3. Quantitative and Qualitative Disclosure about Market Risk			42
Item 4. Controls and Procedures			44
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Index to Form 10-Q

		Page:
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			44
Item 1a. Risk Factors			44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			44
Item 3. Defaults Upon Senior Securities			44
Item 4. Submission of Matters to a Vote of Security Holders			44
Item 5. Other Information			44
Item 6. Exhibits			44
SIGNATURES			45
EXHIBITS
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I. FINANCIAL INFORMATION

The following condensed balance sheet and income statement as of December 31, 2007, which has been derived from audited financial statements audited by Moss Adams, LLP, independent public accountants, as indicated in their report not included herein, and the unaudited condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.

Dollars in thousands		June 30, 2008				Dec. 31, 2007				June 30, 2007
ASSETS
Cash and due from banks		$	16,660			$	13,839			$	18,206
Federal funds sold and securities purchased under agreements to resell			11,585				8,395				14,115
Cash and cash equivalents			28,245				22,234				32,321
Securities available-for-sale (including pledged collateral of $68,165 at June 30, 2008, $61,329 at December 31, 2007 and $93,790 at June 30, 2007)			66,728				67,906				94,029
Securities held-to-maturity, at cost (estimated fair value of $10,285 at June 30, 2008, $10,632 at December 31, 2007 and $10,369 at June 30, 2007)			10,385				10,559				10,637
Loans, net of the allowance for loan losses of $5,017 at June 30, 2008, $8,233 at December 31, 2007 and $4,943 at June 30, 2007			507,651				486,283				437,821
Bank premises and equipment, net			11,068				10,964				10,329
Other assets			22,531				20,381				20,440
TOTAL ASSETS		$	646,608			$	618,327			$	605,577
LIABILITIES AND STOCKHOLDERS’ EQUITY
Demand — noninterest bearing		$	68,625			$	75,718			$	69,842
Demand — interest bearing			128,994				142,821				114,530
Savings accounts			52,453				41,376				45,082
Certificates of deposit			218,303				213,716				211,794
Total deposits			468,375				473,631				441,248
Securities sold under agreements to repurchase			14,343				15,513				46,655
Federal Home Loan Bank borrowings			95,000				60,000				50,000
Other liabilities			7,396				7,554				7,114
Junior subordinated debt payable to unconsolidated subsidiary grantor trust			15,465				15,465				15,465
Total Liabilities			600,579				572,163				560,482
Commitments and contingencies
Stockholders’ Equity:
Preferred stock, no par value, 2,000,000 authorized no shares issued and outstanding in 2008 and 2007			—				—				—
Common stock , no par value, 50,000,000 shares authorized; 8,711,495 shares issued and outstanding at June 30, 2008, 8,757,445 at December 31, 2007 and 8,908,880 at June 30, 2007			9,590				9,996				11,966
Retained earnings			37,344				36,605				34,997
Accumulated other comprehensive loss, net of tax			(905	)			(437	)			(1,868	)
Total stockholders’ equity			46,029				46,164				45,095
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	646,608			$	618,327			$	605,577

See accompanying notes to condensed consolidated financial statements.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

		Three Months Ended								Six Months Ended
Amounts in thousands, except for per share data		June 30, 2008				June 30, 2007				June 30, 2008				June 30, 2007
Interest income:
Interest and fees on loans		$	8,171			$	8,965			$	17,302			$	17,429
Interest on tax exempt securities			302				334				576				612
Interest on U.S. government securities			533				816				1,014				1,648
Interest on federal funds sold and securities purchased under agreements to resell			90				190				148				390
Interest on other securities			23				9				45				45
Total interest income			9,119				10,314				19,085				20,124
Interest expense:
Interest on demand deposits			498				587				1,248				1,144
Interest on savings deposits			360				355				650				526
Interest on time deposits			2,238				2,627				4,614				5,232
Securities sold under agreements to repurchase			35				381				119				723
Interest on FHLB and other borrowing expense			781				632				1,512				1,171
Interest on junior subordinated debt payable to unconsolidated subsidiary grantor trust			161				271				476				540
Total interest expense			4,073				4,853				8,619				9,336
Net interest income			5,046				5,461				10,466				10,788
Provision for loan and lease losses			1,000				0				1,600				6
Net interest income after provision for loan losses			4,046				5,461				8,866				10,782
Noninterest income:
Service charges on deposit accounts			50				76				112				145
Payroll and benefit processing fees			99				89				228				197
Earnings on cash surrender value -
Bank owned life insurance			85				99				168				194
Net gain on sale of securities available-for-sale			194				0				436				46
Net loss on sale of derivative swap transaction			0				0				(225	)			0
Merchant credit card service income, net			97				96				180				188
Mortgage brokerage fee income			5				29				15				35
Other income			187				229				368				311
Total non-interest income			717				618				1,282				1,116
Noninterest expense:
Salaries and related benefits			1,892				1,959				3,841				4,056
Occupancy and equipment expense			640				543				1,284				1,001
FDIC insurance premium			113				13				171				26
Data processing fees			65				90				143				145
Professional service fees			133				252				251				447
Payroll and benefit fees			27				25				60				56
Deferred compensation expense			113				101				224				198
Stationery and supplies			80				46				142				107
Postage			38				34				72				67
Directors’ expense			94				76				142				121
Other expenses			418				562				847				965
Total non-interest expense			3,613				3,701				7,177				7,189
Income before provision for income taxes			1,150				2,378				2,971				4,709
Provision for income taxes			244				778				835				1,622
Net Income		$	906			$	1,600			$	2,136			$	3,087
Basic earnings per share		$	0.10			$	0.18			$	0.25			$	0.35
Weighted average shares — basic			8,748				8,908				8,714				8,887
Diluted earnings per share		$	0.10			$	0.18			$	0.24			$	0.34
Weighted average shares — diluted			8,751				9,063				8,732				8,985

See accompanying notes to condensed consolidated financial statements.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Six months ended June 30, 2008

																		Accumulated
																		Other
																		Comprehensive
		Comprehensive				Common								Retained				Income (Loss),
		Income				Shares				Stock Amount				Earnings				net of tax				Total
Balance at December 31, 2007							8,757			$	9,996			$	36,605				($437	)		$	46,164
Comprehensive Income:
Net Income			1.229												1,229								1,229
Other Comprehensive Income:
Other Comprehensive Income, net of tax
Unrealized losses arising during the period on derivative transactions, net			(423	)
Less: reclassification adjustment for losses included in net income, net of tax			132
Net holding loss on derivatives			(291	)
Unrealized gains on securities			569
Net of reclassification adjustment for gains included in net income, net of tax			(142	)
Other Comprehensive Income			136																136				136
Total Comprehensive Income		$	1,365
Cash dividends ($0.08 per share)															(699	)							(699	)
Compensation expense associated with stock options											29												29
Share Repurchase							(59	)			(504	)											(504	)
Stock options exercised							9				29												29
Balance at March 31, 2008							8,707			$	9,550			$	37,135				($301	)		$	46,384
Comprehensive Income:
Net Income			906												906								906
Other Comprehensive Income:
Other Comprehensive Income, net of tax
Unrealized gains on securities			(538	)
Net of reclassification adjustment for gains included in net income, net of tax			(66	)
Other Comprehensive Income			(604	)															(604	)			(604	)
Total Comprehensive Income		$	302
Cash dividends ($0.08 per share)															(697	)							(697	)
Compensation expense associated with stock options											28												28
Stock options exercised							4				12												12
Balance at June 30, 2008							8,711			$	9,590			$	37,344				($905	)		$	46,029

See accompanying notes to condensed consolidated financial statements.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

Dollars in thousands		June 30, 2008				June 30, 2007
Cash flows from operating activities:
Net Income		$	2,136			$	3,087
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses			1,600				6
Provision for depreciation and amortization			598				469
Compensation expense associated with stock options			57				36
Tax benefits from the exercise of stock options			0				(118	)
Gain on sale of securities available for sale			(436	)			(46	)
Loss on sale of derivative			225				0
Amortization of investment premiums and accretion of discounts, net			18				(5	)
Gain on sale of fixed assets			(5	)			(16	)
Deferred income taxes			(707	)			(955	)
Changes in operating assets and liabilities:
Increase in Cash Surrender Value			(141	)			(176	)
Increase in Other Assets			(860	)			1,333
Changes in Deferred Compensation			219				207
Decrease in Deferred loan fees			(31	)			(47	)
Decrease in Other liabilities			(378	)			(331	)
Net cash provided by operating activities			2,295				3,444
Cash flows from investing activities:
Proceeds from maturities of available-for-sale securities			4,071				3,121
Proceeds from sales of available-for-sale securities			26,444				20,569
Proceeds from maturities of held-to-maturity securities			172				171
Purchases of available-for-sale securities			(30,052	)			(23,495	)
Loan originations, net of principal repayments			(22,938	)			(28,790	)
Purchases of premises and equipment			(697	)			(2,239	)
Net cash used by investing activities			(23,000	)			(30,663	)
Cash flows from financing activities:
Net (decrease) increase in deposits			(5,255	)			1,840
Net (decrease) increase in securities sold under agreement to repurchase			(1,170	)			9,538
Proceeds from Federal Home Loan Bank advances			65,000				10,000
Repayments of Federal Home Loan Bank advances			(30,000	)			(0	)
Cash dividends paid on common stock			(1,396	)			(1,517	)
Proceeds from stock options exercised			41				295
Common Stock Repurchased			(504	)			0
Excess tax benefits from the exercise of stock options			0				118
Net cash provided by financing activities			26,716				20,274
Net increase (decrease) in cash and cash equivalents			6,011				(6,945	)
Cash and cash equivalents, beginning of period			22,234				39,266
Cash and cash equivalents, end of period		$	28,245			$	32,321
Supplemental disclosures:
Cash paid during the period for:
Income taxes		$	—			$	1,618
Interest			8,970				8,836

See accompanying notes to condensed consolidated financial statements.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES

1. Consolidation and Basis of Presentation

The unaudited condensed consolidated financial statements include the accounts of Bank of Commerce Holdings (the “Holding Company”) and its subsidiaries Redding Bank of Commerce™, Roseville Bank of Commerce™ and Sutter Bank of Commerce™ (“BOC” or the “Bank”) and Bank of Commerce Mortgage™ (collectively the “Company”). All significant inter-company balances and transactions have been eliminated. The condensed balance sheet as of December 31, 2007, which has been derived from audited financial statements audited by Moss Adams, LLP, independent public accountants, as indicated in their report not included herein, and the unaudited condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. The financial information contained in this report reflects all adjustments that in the opinion of management are necessary for a fair presentation of the results of the interim periods. All such adjustments are of a normal recurring nature. Certain reclassifications have been made to the prior period condensed consolidated financial statements to conform to the current financial statement presentation with no effect on previously reported equity and net income.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts for prior periods have been reclassified to conform to the current financial statement presentation.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in Bank of Commerce Holdings 2007 Annual Report on Form 10-K. The results of operations and cash flows for the 2008 interim periods shown in this report are not necessarily indicative of the results for any future interim period or the entire fiscal year. For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and repurchase agreements. Generally, federal funds are sold for a one-day period and securities purchased under agreements to resell are for no more than a 90-day period.

2. Recent Accounting pronouncements

On September 15, 2006, the FASB issued FAS 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. FAS 157 is effective for the year beginning January 1, 2008. The adoption of FAS 157 did not have a material effect on our consolidated financial statements.

On February 15, 2007 the FASB issued FAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement 115. FAS 159 provides an alternative measurement treatment for certain financial assets and financial liabilities, under an instrument-by-instrument election, that permits fair value to be used for both initial and subsequent measurement, with changes in fair values recognized in earnings. FAS 159 is effective beginning January 1, 2008. The adoption of FAS 159 did not have a material impact on our consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an Amendment of FASB Statement No. 133.” SFAS No. 161 expands disclosure requirements regarding an entity’s derivative instruments and hedging activities. Expanded qualitative disclosures that will be required under SFAS No. 161 include: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and related interpretations; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 also requires several added quantitative disclosures in financial statements. SFAS No. 161 will be effective for the Company on January 1, 2009. Management is currently evaluating the effect that the provisions of SFAS No. 161 will have on the Company’s financial statements.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Continued) (Unaudited)

3. Earnings per Share

Basic earnings per share exclude dilution and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that subsequently shared in the earnings of the entity. The following table displays the computation of earnings per share for the three and six months ended June 30, 2008 and 2007.

(Amounts in thousands, except per share data)

		Three Months Ended								Six Months Ended
		June 30, 2008				June 30, 2007				June 30, 2008				June 30, 2007
Basic EPS Calculation:
Numerator (net income)		$	906			$	1,600			$	2,136			$	3,087
Denominator (average common shares outstanding)			8,748				8,908				8,714				8,887
Basic earnings per Share		$	0.10			$	0.18			$	0.25			$	0.35
Diluted EPS Calculation:
Numerator (net income)		$	906			$	1,600			$	2,136			$	3,087
Denominator:
Average common shares outstanding			8,748				8,908				8,714				8,887
Dilutive effect of Stock Options			3				155				18				98
Adjusted average common shares outstanding — diluted			8,751				9,063				8,732				8,985
Diluted earnings per Share		$	0.10			$	0.18			$	0.24			$	0.34

Stock options totaling 209,485 were outstanding at June 30, 2008 at an average exercise price of $6.31. 146,167 of these options were not included in the above EPS calculation as they were anti-dilutive.

4. Stock Option Plans

For the first six months of 2008, stock option compensation expense charged against income was $56,799 compared to $35,751 at June 30, 2007. At June 30, 2008, there was $275,197 of total unrecognized compensation costs related to non-vested share based payments which is expected to be recognized over a period of 3.3 years. No options were granted during the first six months of 2008.

During the six months ended June 30, 2008 and 2007 the Company realized income tax benefits of $0 and $117,925 respectively, related to the exercise of nonqualified stock options. The income tax benefit is reflected in net cash provided by financing activities in the consolidated statements of cash flow for the same period.

During the six months ended June 30, 2008 and 2007 the Company received cash of $41,506 and $294,506 respectively, upon exercise of stock-based compensation arrangements.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)

5. Comprehensive Income

The Company’s total comprehensive income was as follows:

		Three Months Ended								Six Months Ended
		June 30, 2008				June 30, 2007				June 30, 2008				June 30, 2007
Net income as reported		$	906			$	1,600			$	2,136			$	3,087
Other comprehensive income:
Holding gain (loss) arising during period on AFS securities, net of tax			(538	)			(1,076	)			(159	)			(931	)
Reclassification adjustment on AFS securities, net of tax			(66	)			0				(310	)			(27	)
Holding gain (loss) arising during period on derivative transactions, net of tax			0				(105	)			0				51
Reclassification adjustment on derivative transactions, net of tax			0				(24	)			3				(24	)
Total comprehensive income		$	302			$	395			$	1,667			$	2,156

6. Junior Subordinated Debt Payable to Unconsolidated Subsidiary Grantor Trust

During the first quarter 2003, Bank of Commerce Holdings formed a wholly-owned Delaware statutory business trust, Bank of Commerce Holdings Trust (the “grantor trust”), which issued $5.0 million of guaranteed preferred beneficial interests in Bank of Commerce Holdings’ junior subordinated debentures (the “trust notes”) to the public and $155,000 common securities to the Company. These debentures qualify as Tier 1 capital under Federal Reserve Board guidelines.

The proceeds from the issuance of the trust notes were transferred from the grantor trust to the Holding Company and from the Holding Company to the Bank as surplus capital. The trust notes accrue and pay distributions on a quarterly basis at 3 month London Interbank Offered Rate (“LIBOR”) plus 3.30%. The rate at June 30, 2008 was 6.01%. The rate increase is capped at 2.75% annually and the lifetime cap is 12.5%. The final maturity on the trust note is March 18, 2033, and the debt allows for prepayment after five years on the quarterly payment date.

On July 29, 2005, Bank of Commerce Holdings (the “Company”) participated in a private placement to an institutional investor of $10 million of fixed rate trust preferred securities (the “Trust Preferred Securities”); through a newly formed Delaware trust affiliate, Bank of Commerce Holdings Trust II (the “Trust”). The Trust Preferred Securities mature on September 15, 2035, and are redeemable at the Company’s option on any March 15, June 15, September 15 or December 15 on or after September 15, 2010.

In addition, the Trust Preferred Securities require quarterly distributions by the Trust to the holder of the Trust Preferred Securities at a rate of 6.12%, until September 10, 2010 after which the rate will reset quarterly to equal 3-Month LIBOR plus 1.58%. The Trust simultaneously issued $310,000 of the Trust’s common securities of beneficial interest to the Company.

The proceeds from the sale of the Trust Preferred Securities were used by the Trust to purchase from the Company the aggregate principal amount of $10,310,000 of the Company’s floating rate junior subordinate notes (the “Notes”). The net proceeds to the Company from the sale of the Notes to the Trust will be used by the Company for general corporate purposes, including funding the growth of the Company’s various financial services.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)

The Notes were issued pursuant to a Junior Subordinated Indenture (the “Indenture”), dated July 29, 2005, by and between the Company and J.P. Morgan Chase Bank, National Association, as trustee. Like the Trust Preferred Securities, the Notes bear interest at a floating rate, at 6.12% until September 10, 2010, after which the rate will reset on a quarterly basis to equal 3-Month LIBOR plus 1.58%. The interest payments by the Company will be used to pay the quarterly distributions payable by the Trust to the holder of the Trust Preferred Securities.

However, so long as no event of default, as described below, has occurred under the Notes, the Company may, at any time and from time to time, defer interest payments on the Notes (in which case the Trust will be entitled to defer distributions otherwise due on the Trust Preferred Securities) for up to twenty (20) consecutive quarters.

The Notes are subordinated to the prior payment of other indebtedness of the Company that, by its terms, is not similarly subordinated. Although the Notes will be recorded as a long term liability on the Company’s balance sheet, for regulatory purposes, the Notes are expected to be treated as Tier 1 or Tier 2 capital under rulings of the Federal Reserve Board, the Company’s primary federal regulatory agency.

The Notes mature on September 15, 2035, but may be redeemed at the Company’s option at any time on or after September 15, 2010, or at any time upon certain events, such as a change in the regulatory capital treatment of the Notes, the Trust being deemed to be an investment company or the occurrence of certain adverse tax events. In each case, the Company may redeem the Notes for their aggregate principal amount, plus accrued interest.

7. Commitments and contingent liabilities

Lease Commitments — The Company leases certain facilities at which it conducts its operations. Future minimum lease commitments under all non-cancelable operating leases as of June 30, 2008 are below:

(Dollars in thousands)

2008		$	282
2009		$	558
2010		$	524
2011		$	454
2012		$	279
Thereafter		$	761
Total		$	2,858
Minimum rental due in the future
Under non-cancelable subleases		$	24

Legal Proceedings — The Company is involved in various pending and threatened legal actions arising in the ordinary course of business. The Company maintains reserves for losses from legal actions, which are both probable and estimable. In the opinion of management, the disposition of claims, currently pending will not have a material adverse affect on the Company’s financial position or results of operations.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)

FHLB Advances — The Company has advances from the Federal Home Loan Bank of San Francisco (“FHLB”) totaling $95,000,000 as of June 30, 2008 and $50,000,000 as of June 30, 2007. The FHLB advances bear fixed and floating interest rates ranging from 2.82% to 3.97%. Interest is payable quarterly. The following table illustrates borrowings outstanding at the end of the period:

Amount		Interest Rate				Maturity
$15,000,000			2.87	%		01/26/2009
$15,000,000			2.89	%		01/22/2009
$35,000,000			3.97	%		11/23/2009
$15,000,000			2.82	%		01/22/2010
$15,000,000			3.41	%		04/29/2011
$95,000,000

These borrowings are secured by an investment in FHLB stock and certain real estate mortgage loans which have been specifically pledged to the FHLB pursuant to their collateral requirements. Based upon the level of FHLB advances, the Company was required to hold a minimum investment in FHLB stock of $4,755,800 and to pledge $71,682,101 of its real estate mortgage loans to the FHLB as collateral as of June 30, 2008. At June 30, 2008, the Bank had available borrowing lines at the FHLB of $15,018,689 and additional federal fund borrowing lines at two correspondent banks totaling $25,000,000.

Off-Balance Sheet Financial Instruments - In the ordinary course of business, the Company enters various types of transactions, which involve financial instruments with off-balance sheet risk. These instruments include commitments to extend credit and standby letter of credits, which are not reflected in the accompanying consolidated balance sheets. These transactions may involve, to varying degrees, credit and interest rate risk more than the amount, if any recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to customers.

These commitments have specified interest rates and generally have fixed expiration dates but may be terminated by the Company if certain conditions of the contract are violated. Although currently subject to draw down, many of the commitments do not necessarily represent future cash requirements. Collateral held relating to these commitments varies, but generally includes real estate, securities and cash. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Credit risk arises in these transactions from the possibility that a customer may not be able to repay the Bank upon default of performance.

Collateral held for standby letters of credit is based on an individual evaluation of each customer’s creditworthiness, but may include cash and securities. Commitments to extend credit and standby letters of credit bear similar credit risk characteristics as outstanding loans.

The Company’s commitments to extend credit are illustrated below:

		June 30, 2008				June 30, 2007
Unfunded loan commitments		$	150,784,540			$	170,281,351
Standby letters of credit			6,074,834				8,334,120
Guaranteed commitments outstanding			1,357,724				1,375,999
		$	158,217,098			$	179,991,470

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)

8. Accounting for Income Tax Uncertainties (FIN 48)

In June 2006, the FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the law is uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted this Statement on January 1, 2007. As a result of the implementation of Interpretation 48, it was not necessary for the Company to recognize any increase in the liability for unrecognized tax benefits.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and California state jurisdiction The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense.

6. Fair Value Measurement

SFAS No. 157 defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurement. Effective 1/1/08 the Company adopted SFAS No. 157, which enhances the disclosures about financial instruments carried at fair value.

In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.

The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2008, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)

(Dollars in thousands)

						Fair Value Measurements
						at June 30, 2008, Using
						Quoted Prices in				Significant Other				Significant
						Active Markets for				Observable				Unobservable
		Fair Value				Identical Assets				Inputs				Inputs
Description		June 30, 2008				(Level 1)				(Level 2)				(Level 3)
Available-for-sale securities		$	66,728			$	—			$	66,728
To Total assets measured at fair value		$	66,728			$	—			$	66,728			$	—
Derivative Liabilities		$	119								119
Total liabilities measured at fair value		$	119			$	—			$	119			$	—

The following methods were used to estimate the fair value of each class of financial instrument above:

Securities available-for-sale - Securities classified as available-for-sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions among other things.

Derivatives -Derivatives are valued using internal models, most of which are primarily based on market observable input including interest rate curves and both forward Derivatives are reported at fair value utilizing Level 2 inputs, and are provided to the Company by an independent pricing source. The fair market value of the derivative is based on the present value of the expected cash flows over the life of the instrument.

Expected cash flows are determined by evaluating transactions with a pricing model using a specific market environment. The fair values disclosed were estimated using the closing mid-market market/price environment as of June 30, 2008. These values do not take into account liquidity, hedging cost, bid/offer, credit or other considerations that are specific to each counterparty and transaction, and that vary over time.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.

BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(Unaudited)

(Dollars in thousands)

June 30, 2008		Total				Level 1				Level 2				Level 3
Impaired Loans		$	18,870			$	—			$	—			$	18,870
Total assets at fair value		$	18,870			$	—			$	—			$	18,870
Total liabilities at fair value		$	—			$	—			$	—			$	—

Impaired loans — When available, we use observable market data, including pricing on recent closed market transactions, to value loans. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan,” (SFAS 114).

The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2008, substantially all of the total impaired loans were evaluated based on the fair value of the collateral.

In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

The Company had outstanding balances of $18.9 and $12.4 million in impaired loans as of June 30, 2008 and December 31, 2007, respectively. Impairment allowances totaled $415,425 and $3.2 million at June 30, 2008 and December 31, 2007, respectively.

The fair value measurements recorded during the period

The Company recognized a $4.8 million write-down related to non-recurring fair value measurements of impaired loans during the six months of 2008. Interest reversed from income during this six month period due to impaired loans was $148,534.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements and Risk Factors

An investment in the Company has risk. The discussion below and elsewhere in this Report and in other documents the Company files with the SEC incorporates various risk factors that could cause the Company’s financial results and condition to vary significantly from period to period. Information in the accompanying financial statements contains certain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We caution the investor that such statements are subject to risks and uncertainties that could cause actual results to differ materially from those stated. These risks and uncertainties include the Company’s ability to maintain or expand its market share and net interest margins, or to implement its marketing and growth strategies. Further, actual results may be affected by the Company’s ability to compete on price and other factors with other financial institutions; customer acceptance of new products and services; and general trends in the banking and the regulatory environment, as they relate to the Company’s cost of funds and return on assets. The reader is advised that this list of risks is not exhaustive and should not be construed as any prediction by the Company as to which risks would cause actual results to differ materially from those indicated by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements.

For additional information concerning risks and uncertainties related to the Company and its operations please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 under the heading “Risk factors that may affect results.” Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

The following sections discuss significant changes and trends in the financial condition, capital resources and liquidity of the Company from December 31, 2007 to June 30, 2008. Also discussed are significant trends and changes in the Company’s results of operations for the three and six months ended June 30, 2008, compared to the same period in 2007. The consolidated financial statements and related notes appearing elsewhere in this report are condensed and unaudited. The following discussion and analysis is intended to provide greater detail of the Company’s financial condition and results.

Company Overview

Bank of Commerce Holdings (the “Holding Company”) is a corporation organized under the laws of California and a financial holding company (“FHC”) registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”). The Holding Company’s principal business is to serve as a holding company for Redding Bank of Commerce™, Roseville Bank of Commerce™, Sutter Bank of Commerce™ and Bank of Commerce Mortgage™, and for other banking or banking-related subsidiaries which the Holding Company may establish or acquire (collectively the “Company”). The Holding Company also has two unconsolidated subsidiaries, Bank of Commerce Holdings Trust and Bank of Commerce Holdings Trust II. The Company is listed on the NASDAQ National Market under the trading symbol BOCH (Bank of Commerce Holdings).

The Bank was incorporated as a California banking corporation on November 25, 1981, and received its certificate of authority to begin banking operations on October 22, 1982. The Bank operates five full service facilities in three diverse markets in Northern California. Bank of Commerce is proud of its reputation as Northern California’s premier bank for business. During 2007, the Company re-branded “Bank of Commerce| Bank of Choice™” reflecting a renewed commitment to making Bank of Commerce the bank of choice™ for local businesses with a fresh focus on family and personal finances.

The Mortgage subsidiary, Bank of Commerce Mortgage™, an affiliate of Bank of Commerce, principal business is mortgage brokerage services. The subsidiary has an affiliated business agreement with BWC Mortgage Services. Under the terms of the agreement, BWC Mortgage Services underwrites or brokers mortgage products, manages the independent contractors, supporting staff and broker relationships with secondary market lenders. Bank of Commerce Mortgage, through this agreement, provides office space, equipment, and marketing support for the mortgage brokerage business. All loans are sold in the secondary market. Bank of Commerce Mortgage™ pays ten percent of gross premiums earned to BWC Mortgage Services.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

The Company will provide free of charge upon request, or through links to publicly available filings accessed through its Internet website, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, if any, as soon as reasonably practical after such reports have been filed with the Securities and Exchange Commission. The Internet addresses of the Company are www.bankofcommerceholdings.com, www.reddingbankofcommerce.com, www.rosevillebankofcommerce.com, www.sutterbankofcommerce.com and www.bankofcommercemortgage.com. Reports may also be obtained through the Securities and Exchange Commission’s website at www.sec.gov.

The Holding Company’s principal source of income is dividends from its subsidiaries. The Holding Company conducts its corporate business operations at the administrative office of the Bank located at 1901 Churn Creek Road, Redding, California. The Company conducts its business operations in two geographic market areas, Redding and Roseville, California. The Company considers Upstate California to be the major market area of the Bank.

The Bank is principally supervised and regulated by the California Department of Financial Institutions (“DFI”) and the Federal Deposit Insurance Corporation (“FDIC”), and conducts a general commercial banking business in the counties of El Dorado, Placer, Shasta, Sacramento, Sutter and Yuba, California. Through the Bank and mortgage subsidiaries, the Company provides a wide range of financial services and products for business and consumer banking. The services offered by the Bank include those traditionally offered by banks of similar size and character in California. Products such as free checking, interest-bearing checking (“NOW”) and savings accounts, money market deposit accounts, sweep arrangements, commercial, construction, term loans, travelers checks, safe deposit boxes, collection services and electronic banking activities. The Bank currently does not offer trust services or international banking services.

The services offered by the Mortgage Company include single and multi-family residential new financing, refinancing and equity lines of credit. All mortgage products are brokered and are not maintained on the Bank’s books.

Most of the Bank’s customers are small to medium sized businesses, professionals and other individuals with medium to high net worth, and most of the Bank’s deposits are obtained from such customers. The primary business strategy of the Bank is to focus on its lending activities. The Bank’s principal lines of lending are (i) commercial, (ii) real estate construction and (iii) commercial real estate.

The majority of the loans of the Bank are direct loans made to individuals and small businesses in the major market area of the Bank. The Mortgage Company provides residential real estate new financing, refinancing and equity lines of credit, 100% sold in the secondary market. A relatively small portion of the loan portfolio of the Bank consists of loans to individuals for personal, family or household purposes. The Bank accepts the following as collateral for loans: real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery and equipment and other general business assets such as accounts receivable and inventory.

The commercial loan portfolio of the Bank consists of a mix of revolving credit facilities and intermediate term loans. The loans are generally made for working capital, asset acquisition, business-expansion purposes, and are generally secured by a lien on the borrowers’ assets. The Bank also makes unsecured loans to borrowers who meet the Bank’s underwriting criteria for such loans. The Bank manages its commercial loan portfolio by monitoring its borrowers’ payment performance and their respective financial condition, and makes periodic and appropriate adjustments, if necessary, to the risk grade assigned to each loan in the portfolio. The primary sources of repayment of the commercial loans of the Bank are the borrower’s conversion of short-term assets to cash and operating cash flow. The net assets of the borrower or guarantor and/or the liquidation of collateral are usually identified as a secondary source of repayment.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

The principal factors affecting the Bank’s risk of loss from commercial lending include each borrower’s ability to manage its business affairs and cash flows, local and general economic conditions and real estate values in the Bank’s service area. The Bank manages risk through its underwriting criteria, which includes strategies to match the borrower’s cash flow to loan repayment terms, and periodic evaluations of the borrower’s operations. The Bank’s evaluations of its borrowers are facilitated by management’s knowledge of local market conditions and periodic reviews by a consultant of the credit administration policies of the Bank.

The real estate construction loan portfolio of the Bank consists of a mix of commercial and residential construction loans, which are principally secured by the underlying projects. The real estate construction loans of the Bank are predominately made for projects, which are intended to be owner occupied. The Bank also makes real estate construction loans for speculative projects. The principal sources of repayment of the Bank’s construction loans are sale of the underlying collateral or permanent financing provided by the Bank or another lending source. The principal risks associated with real estate construction lending include project cost overruns that absorb the borrower’s equity in the project and deterioration of real estate values as a result of various factors, including competitive pressures and economic downturns.

The Bank manages its credit risk associated with real estate construction lending by establishing maximum loan-to-value ratios on projects on an as-completed basis, inspecting project status in advance of controlled disbursements and matching maturities with expected completion dates. Generally, the Bank requires a loan-to-value ratio of no more than 80% on single-family residential construction loans.

The commercial and construction loan portfolio of the Bank consists of loans secured by a variety of commercial and residential real property. The Mortgage Company makes real estate mortgage loans for both owner-occupied properties and investor properties. The Mortgage Company brokers and sells the residential real estate loans directly in the secondary market, servicing included. The Bank does not provide for warehouse funding.

The specific underwriting standards of the Bank and methods for each of its principal lines of lending include industry-accepted analysis and modeling, and certain proprietary techniques. The Bank’s underwriting criteria is designed to comply with applicable regulatory guidelines, including required loan-to-value ratios. The credit administration policies of the Bank contain mandatory lien position and debt service coverage requirements, and the Bank generally requires a guarantee from the owners of its private corporate borrowers.

The Company continuously searches for expansion possibilities, through internal growth, strategic alliances, acquisitions or new office and product opportunities. Systematically, the Company will reevaluate the short and long-term profitability of all lines of business, and will not hesitate to reduce or eliminate unprofitable locations or lines of business. The Company remains a viable, independent bank by enhancing stockholder value. This has been realized by proactive management and commitment to staff, customers, and the markets served.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

Risk Factors

An economic slowdown could reduce demand for the Company’s products and services and lead to lower revenues and lower earnings. A change in California’s economic and business conditions may adversely affect the ability of our borrowers to repay their loans, causing us to incur higher credit losses. The Company earns revenue from interest and fees charged on loans and financial services. When the economy slows, the demand for these products and services may fall, reducing our interest and fee income, and our earnings. In addition, during periods of economic slowdown or recession, the Bank may experience a decline in collateral values and an increase in delinquencies and defaults due to the borrower’s ability to repay their loans. Several factors could cause the economy to slow down or even recede, including higher energy costs, higher interest rates, reduced consumer or corporate spending, a slowdown in housing, natural disasters, terrorist activities, military conflicts, and the normal cyclical nature of the economy.

The Company’s primary lending focus has historically been commercial real estate, commercial lending and, to a lesser extent, construction lending. At June 30, 2008, all of the Company’s real estate mortgage, real estate construction loans, and commercial real estate loans, were secured fully or in part by deeds of trust on underlying real estate. The Company’s dependence on real estate increases the risk of loss in the loan portfolio of the Company and its holdings of other real estate owned if economic conditions in California deteriorate in the future. Deterioration of the real estate market in California has had an adverse effect on the Company’s business, financial condition and results of operations.

Changes in Interest Rates could reduce the Company’s Net Interest Income and Earnings

The Company’s net interest income is the interest earned on loans, debt securities and other assets minus the interest paid on deposits, long-term and short-term debt and other liabilities. Net interest income reflects both our net interest margin — the difference between the yield on earning assets and the interest paid on deposits and other sources of funding — and the amount (volume) of earning assets we hold. As a result, changes in either the net interest margin or the volume of earning assets could adversely affect our net interest income and earnings.

Changes in interest rates, up or down, could adversely affect the net interest margin. The yield we earn on our deposits and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other (timing differences). A significant portion of the Company’s assets are tied to variable rate pricing and the Company is considered to be asset sensitive. As a result, the Company is generally adversely affected by declining interest rates. In addition, changes in monetary policy, including changes in interest rates, influence the origination of loans, the purchase of investments and the generation of deposits, thereby affecting the rates received on loans and securities and paid on deposits, which could have a material adverse effect on the Company’s business, financial condition and results of operations. See “Quantitative and Qualitative Disclosure about Market Risk.”

Changes in the slope of the “yield-curve”, or the spread between short-term and long-term interest rates could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning that short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, the Company will experience pressure on the net interest margin as the cost of funds increases relative to the yield that can be earned on assets. The Company assesses interest rate risk by estimating the effect on earnings in various scenarios that differ based on assumptions about the direction, magnitude and speed of interest rate changes and the slope of the yield curve. The Company may hedge some interest rate risk with interest rate derivatives. The Company does not hedge all of its interest rate risk. There is risk that changes in interest rates could reduce our net interest income and earnings in material amounts, especially if actual conditions turn out to be materially different that the assumptions used in the model. One example: If interest rates rise or fall faster than assumed or the slope of the yield curve changes, the Company may incur losses on debt securities held as investments.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

To reduce the interest rate risk, the Company may choose to rebalance the investment and loan portfolio, refinance debt outstanding or take other strategic actions. The Company may incur losses or expenses when taking such actions.

Lending Risks Associated with Commercial Banking and Construction Activities

The business strategy of the Company is to focus on commercial, single family and multi-family real estate loans, construction loans and commercial business loans. Loans secured by commercial real estate are generally larger and involve a greater degree of credit and transaction risk than residential mortgage (one-to-four family) loans. Because payments on loans secured by commercial and multi-family real estate properties are often dependent on successful operation or management of the underlying properties, repayment of such loans may be subject to a greater extent to the then prevailing conditions in the real estate market or the economy. Moreover, real estate construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development compared to the estimated cost (including interest) of construction. If the estimate of value proves to be inaccurate, the Company may be confronted with a project which, when completed, has a value which is insufficient to assure full repayment of the construction loan. Although the Company manages lending risks through its underwriting and credit administration policies, no assurance can be given that such risks would not materialize, in which event the Company’s financial condition, results of operations, cash flows and business prospects could be materially adversely affected.

Adequacy of Allowance for Loan and Lease Losses (ALLL)

Higher credit losses could require the Company to increase the allowance for loan and lease losses through a charge to earnings. When the Company loans money or commits to loan money it incurs credit risk or the risk of losses if our borrowers do not repay their loans. The Company provides a reserve for credit risk by establishing an allowance through a charge to earnings. The amount of the allowance is based on an assessment of credit losses inherent in the loan portfolio (including unfunded credit commitments). The process for determining the amount of the allowance is critical to our financial results and condition. It requires difficult, subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair our borrower’s ability to repay their loans.

The Company might increase the allowance because of changing economic conditions or unexpected events. The Company’s allowance for loan and lease losses was approximately $5.0 million, or 0.98% of total loans at June 30, 2008.

Potential Volatility of Deposits

The Bank’s depositors could choose to take their money out of the bank and put it into alternative investments, causing an increase in funding costs and reducing net interest income. Checking, savings and money market account balances can decrease when customers perceive that alternative investments, such as the stock market, as providing a better risk/return tradeoff. When customers move funds out of bank deposits into other investments, the Bank will lose a relatively low cost source of funds, increasing funding costs.

At June 30, 2008, time certificates of deposit in excess of $100,000 represented approximately 28% of the dollar value of the total deposits of the Company. As such, these deposits are considered volatile and could be subject to withdrawal. Withdrawal of a material amount of such deposits could adversely affect the liquidity of the Company, profitability, business prospects, results of operations and cash flows. The Company monitors activity of volatile liability deposits on a quarterly basis.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

Dividends

Bank of Commerce Holdings, the parent holding company, is a separate and distinct legal entity from its subsidiaries. The Company conducts no other significant activity than the management of its investment in the Bank and Mortgage Company and as such, the Company is dependent on these subsidiaries for income. The ability of the Bank and Mortgage Company to pay cash dividends in the future depends on the profitability, growth and capital needs of the Bank and Mortgage Company. These dividends are used to pay dividends on common stock and interest and principal on debt. In addition, the California Financial Code restricts the ability of the Bank to pay dividends. No assurance can be given that the Company or the Bank will pay any dividends in the future or, if paid, such dividends will not be discontinued.

Changes in Accounting Policies or Accounting Standards, and Changes in How Accounting Standards are interpreted or applied, Could Materially Affect How the Company Reports its Financial Results and Condition

The Company’s accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Three of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amount would be reported under different conditions or using different assumptions (refer to “Critical Accounting Policies”).

From time to time the Financial Accounting Standards Board (“FASB”) and the SEC change the financial accounting and reporting standards that govern the preparation of financial statements. In addition, accounting standard setters and those who interpret the accounting standards (such as the FASB, SEC, banking regulators and outside auditors) may change or even reverse their previous interpretations or positions on how these standards should be applied. Changes in financial accounting and reporting standards and changes in current interpretations may be beyond the Company’s control, can be hard to predict and could materially impact how we report our financial results and condition. The Company could be required to apply a new or revised standard retroactively or apply an existing standard differently, also retroactively, in each case resulting in restating prior period financial statements.

Government Regulation and Legislation

The Company and the Bank are subject to extensive state and federal regulation, supervision and legislation, which govern almost all aspects of the operations of the Company and the Bank. The business of the Company is particularly susceptible to being affected by the enactment of federal and state legislation which may have the effect of increasing or decreasing the cost of doing business, modifying permissible activities or enhancing the competitive position of other financial institutions. Such laws are subject to change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds and not for the protection of shareholders of the Company. The Company cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on the business and prospects of the Company, but it could be material and adverse.

Recent high-profile events have resulted in additional regulations. For example, Sarbanes-Oxley limits the types of non-audit services our outside auditors may provide to the company in order to preserve the independence of our auditors. If our auditors were found not to be “independent” under SEC rules, we could be required to engage new auditors and file new financial statements and audit reports with the SEC.

The Patriot Act which was enacted in the wake of the September 2001 terrorist attacks, requires the Company to implement new or revised policies and procedures related to anti-money laundering, compliance, suspicious activities, currency transaction reports and due diligence on customers. The Patriot Act also requires federal bank regulators to evaluate the effectiveness of an applicant in combating money laundering in determining whether to approve a proposed bank acquisition.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

From time to time, Congress considers legislation that could significantly change our regulatory environment, potentially increasing the cost of doing business, limiting activities or affecting the competitive balance among banks, savings associations, credit unions and other financial institutions.

Certain Ownership Restrictions under California and Federal Law

Federal law prohibits a person or group of persons “acting in concert” from acquiring “control” of a bank holding company unless the FRB has been given 60 days prior written notice of such proposed acquisition and within that time period the FRB has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days, the period during which such a disapproval may be issued. An acquisition may be made before the expiration of the disapproval period if the FRB issues written notice of its intent not to disapprove the action.

Under a rebuttal presumption established by the FRB, the acquisition of more than 10% of a class of voting stock of a bank with a class of securities registered under Section 12 of the Exchange Act (such as the common stock), would, under the circumstances set forth in the presumption, constitute the acquisition of control. In addition, any “company” would be required to obtain the approval of the FRB under the BHCA, before acquiring 25% (5% in the case of an acquirer that is, or is deemed to be, a bank holding company) or more of the outstanding shares of the Company’s common stock, or such lesser number of shares as constitute control. See “Regulation and Supervision of Bank Holding Companies” in the Company’s 2007 Annual Report on Form 10-K.

Under the California Financial Code, no person shall, directly or indirectly, acquire control of a California licensed bank or a bank holding company unless the Commissioner has approved such acquisition of control. A person would be deemed to have acquired control of the Company and the Bank under this state law if such person, directly or indirectly, has the power (i) to vote 25% or more of the voting power of the Company or (ii) to direct or cause the direction of the management and policies of the Company. For purposes of this law, a person who directly or indirectly owns or controls 10% or more of the common stock would be presumed to direct or cause the direction of the management and policies of the Company and thereby control the Company.

Negative Publicity could Damage our Reputation

Reputation risk, or the risk to the Company’s earnings and capital from negative public opinion, is inherent in the financial services business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from actual or alleged conduct in any number of activities, including lending practices, corporate governance, acquisitions, and from actions taken by government regulators and community organizations in response to that conduct.

Environmental Risks

The Company, in its ordinary course of business, acquires real property securing loans that are in default, and there is a risk that hazardous substance or waste, contaminants or pollutants could exist on such properties. The Company may be required to remove or remediate such substances from the affected properties at its expense, and the cost of such removal or remediation may substantially exceed the value of the affected properties or the loans secured by such properties. Furthermore, the Company may not have adequate remedies against the prior owners or other responsible parties to recover its costs. Finally, the Company may find it difficult or impossible to sell the affected properties either before or following any such removal. In addition, the Company may be considered liable for environmental liabilities concerning its borrowers’ properties, if, among other things, it participates in the management of its borrowers’ operations. The occurrence of such an event could have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

Shares Eligible for Future Sale

As of June 30, 2008, the Company had 8,711,495 shares of Common Stock outstanding, of which 6,012,623 shares are eligible for sale in the public market without restriction and 2,819,975 shares are eligible for sale in the public market pursuant to Rule 144 under the Securities Act of 1933, as amended (the “Securities Act”). Future sales of substantial amounts of the Company’s common stock, or the perception that such sales could occur, could have a material adverse effect on the market price of the common stock. In addition, options to acquire 209,485 shares of the issued and outstanding shares of common stock at exercise prices ranging from $5.42 to $11.59 have been issued to directors and certain employees of the Company under the Company’s 1998 Stock Option Plan. No prediction can be made as to the effect, if any, that future sales of shares, or the availability of shares for future sale, will have on the market price of the Company’s common stock.

Technology and Computer Systems

Advances and changes in technology can significantly affect the business and operations of the Company. The Company faces many challenges including the increased demand for providing computer access to bank accounts and the systems to perform banking transactions electronically. The Company’s ability to compete depends on its ability to continue to adapt its technology on a timely and cost-effective basis to meet these requirements. In addition, the Company’s business and operations are susceptible to negative impacts from computer system failures, communication and energy disruption and unethical individuals with the technological ability to cause disruptions or failures of the Company’s data processing systems.

Company Stock Price may be volatile due to Other Factors

The Company’s stock price can fluctuate widely in response to a variety of factors, in addition to those described above, including:

	•		General business and economic conditions;
	•		Recommendations by securities analysts;
	•		New technologies introduced or services offered by our competitors;
	•		News reports relating to trends, concerns and other issues in the financial services industry;
	•		Natural disasters; and
	•		Geopolitical conditions, such as acts or threats of terrorism or military conflicts.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

Executive Overview

Our Company was established to make a profitable return while serving the financial needs of the communities of our markets. We are in the financial services business, and no line of financial services is beyond our charter as long as it serves the needs of businesses and professionals in our communities. The mission of our Company is to provide its stockholders with a safe, profitable return on their investment, over the long term. Management will attempt to minimize risk to our stockholders by making prudent business decisions, will maintain adequate levels of capital and reserves, and will maintain effective communications with stockholders. Our Company’s most valuable asset is its customers. We will consider their needs first when we design our products and services. The high-quality customer experience is an important mission of our Company, and how well we accomplish this mission will have a direct influence on our profitability.

Our vision is to embrace changes in the industry and develop profitable business strategies that allow us to maintain our customer relationships and build new ones. Our competitors are no longer just banks. We must compete with financial powerhouses that want our core business. The flexibility provided by the Financial Holding Company Act will become increasingly important. We have developed strategic plans that evaluate additional financial services and products that can be delivered to our customers efficiently and profitably. Producing quality returns is, as always, a top priority.

The Company’s long term success rests on the shoulders of the leadership team to effectively work to enhance the performance of the Company. As a financial services company, we are in the business of taking risk. Whether we are successful depends largely upon whether we take the right risks and get paid appropriately for the risks we take. Our governance structure enables us to manage all major aspects of the Company’s business effectively through an integrated process that includes financial, strategic, risk and leadership planning.

We define risks to include not only credit, market and liquidity risk — the traditional concerns for financial institutions — but also operational risks, including risks related to systems, processes or external events, as well as legal, regulatory and reputation risks.

Our management processes, structures and policies help to ensure compliance with laws and regulations and provide clear lines for decision-making and accountability. Results are important, but equally important is how we achieve those results. Our core values and commitment to high ethical standards is material to sustaining public trust and confidence in our Company. For additional information concerning risks and uncertainties related to the Company and its operations please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, under the heading “Risk Management”.

Sources of Income

The Company derives its income from two principal sources: (i) net interest income, which is the difference between the interest income it receives on interest-earning assets and the interest expense it pays on interest-bearing liabilities, and (ii) fee income, which includes fees earned on deposit services, income from SBA lending, electronic-based cash management services, mortgage brokerage fee income and merchant credit card processing services. The income of the Bank depends to a great extent on net interest income. These interest rate factors are highly sensitive to many factors, which are beyond the Company’s control, including general economic conditions, inflation, recession, and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Because of the Bank’s predisposition to variable rate pricing and non-interest bearing demand deposit accounts, the Bank is considered asset sensitive. As a result, the Company is adversely affected by declining interest rates.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

		June 30, 2008				June 30, 2007
Profitability Ratios
Net Interest Income to Average Assets			3.22	%			3.76	%
Net Income to Average Equity			9.05	%			13.69	%
Efficiency Ratio2			61.09	%			60.39	%
Capital Ratios
Leverage Ratio			8.81	%			9.74	%
Risk Based Capital		$	62,725,450			$	62,286,773
Tier 1 Capital			9.75	%			10.79	%
Total Capital			10.67	%			11.80	%
Per Common Share Data
Dividend Payout Ratio			65.40	%			38.75	%
Book Value		$	5.28			$	5.06
Market Price		$	6.96			$	10.82
High		$	11.64			$	11.63
Low		$	6.00			$	10.82

Financial Highlights — Results of Operations

Net income for the second quarter of 2008 totaled $906,000, a decrease of 43.3% from the $1,600,000 reported for the same quarterly period of 2007. On the same basis, diluted earnings per common share for the second quarter of 2008 were $0.10, compared to $0.18 for the same period of 2007, a decrease of 44.0%. Return on average assets (ROA) and return on average equity (ROE) for the second quarter of 2008 were 0.56% and 7.71%, respectively, compared with 1.10% and 14.00%, respectively, for the second quarter of 2007.

Net income for the six-month period ended June 30, 2008 totaled $2,136,000, a decrease of 30.8% over net income of $3,087,000 reported for the same six-month period ended June 30, 2007. On the same basis, diluted earnings per common share for the six-months ended June 30, 2008 was $0.24, compared to $0.34 for the same six-month period in 2007, a 26.0% decrease. ROA was 0.66% and ROE was 9.05% for the first six-months of 2008 compared with 1.07% and 13.69%, respectively, for the same six-month period of 2007.

Net Interest Income and Net Interest Margin

Net interest income is the primary source of the Company’s income. Net interest income represents the excess of interest and fees earned on interest-earning assets (loans, securities and Federal Funds sold) over the interest paid on deposits and borrowed funds. Net interest margin is net interest income expressed as a percentage of average earning assets. Net interest income for the quarter ended June 30, 2008 was $5.05 million compared with $5.46 million for the same period in 2007, a decrease of 7.6%. Net interest income for the six-months ended June 30, 2008 was $10.47 million compared with $10.79 million for the same six-month period in 2007, a decrease of 3.0%.

Average earning assets for the six-months ended June 30, 2008 increased $76.0 million or 14.2% compared with the same period in the prior year. Average loans, the largest component of average earning assets, increased $100.8 million or 24.2% on average compared with the prior year period. Average securities including federal funds sold decreased $23.4 million or 19.7% over the prior period. Investments were sold to fund loan growth. The yield on earning assets decreased to 6.23% for the six-month period ended June 30, 2008 compared to 7.50% for the same period in the prior year.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

The decrease is primarily due to multiple interest rate drops during the period.

Average interest-bearing deposits for the six-months ended June 30, 2008 increased $74.9 million or 16.4% compared with the prior year period. Average non-interest bearing deposits have decreased by $5.7 million or 7.9% over the prior year six-month period. Average borrowings have increased by $48.6 million or 112.4% when compared with the prior year period; the increase is directly related to the substantial loan growth and increase in FHLB borrowings to support such growth.

The overall cost of interest-bearing liabilities for the first six-months 2008 was 3.25% compared with 4.10% for the first six-months of 2007. The decreased cost was primarily a result of the drop in interest rates during the period coupled with refinancing of FHLB borrowings at lower interest rates. The net effect of the changes discussed above resulted in a decrease of $322,000 or 3.0% in net interest income for the six-month period ended June 30, 2008 from the same period in 2007. The net interest margin decreased 60 basis points to 3.42% from 4.02% over the same period a year ago.

Liquidity

The objective of liquidity management is to ensure that the Company can efficiently meet the borrowing needs of our customers, withdrawals of our depositors and other cash commitments under both normal operating conditions and under unforeseen and unpredictable circumstances of industry or market stress.

The Asset Liability Management Committee (“ALCO”) establishes and monitors liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. In addition to the immediately liquid resources of cash and due from banks and federal funds sold, asset liquidity is supported by debt securities in the available for sale security portfolio and wholesale lines of credit with the Federal Home Loan Bank and borrowing lines with other financial institutions. Customer core deposits have historically provided the Company with a source of relatively stable and low-cost funds.

The Company’s consolidated liquidity position remains adequate to meet short-term and long-term future contingencies. At June 30, 2008, the Company had overnight investments of $11.6 million and available lines of credit at the Federal Home Loan bank of approximately $15.0 million, and two federal funds borrowing line with correspondent banks of $25.0 million.

Capital Management

The Company has an active program for managing stockholder capital. Capital is used to fund organic growth, acquisitions, pay dividends and repurchase shares. The objective of effective capital management is to produce above market long-term returns by using capital when returns are perceived to be high and issuing capital when costs are perceived to be low.

Periodically, the Board of Directors authorizes the Company to repurchase shares. Share repurchase announcements are published in press releases and SEC 8-K filings. Typically we do not give any public notice before repurchasing shares. Various factors determine the amount and timing of our share repurchases, including our capital requirements, market conditions and legal considerations. These factors can change at any time and there can be no assurance as to the number of shares repurchased or the timing of the repurchases.

Our policy has been to repurchase shares under the ‘safe harbor’ conditions of Rule 10b-18 of the Exchange Act including a limitation on the daily volume of repurchases. The Company’s potential sources of capital include retained earnings, common and preferred stock issuance and issuance of subordinated debt and trust notes.

The Company and bank are subject to various regulatory capital adequacy requirements as prescribed by the Federal Reserve Bank. Risk-based capital guidelines establish a risk-adjusted ratio relating capital to difference categories of assets and off-balance sheet exposures.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

At June 30, 2008, the Company and Bank were “well capitalized” under applicable regulatory capital adequacy guidelines.

										Well				Minimum
						Actual				Capitalized				Capital
June 30, 2008		Capital				Ratio				Requirement				Requirement
The Company
Leverage		$	56,934,000				8.68	%			n/a				4.0	%
Tier 1 Risk-Based			56,934,000				9.68	%			n/a				4.0	%
Total Risk-Based			62,333,922				10.60	%			n/a				8.0	%
Redding Bank of Commerce
Leverage		$	57,325,528				8.81	%			5.0	%			4.0	%
Tier 1 Risk-Based			57,325,528				9.75	%			6.0	%			4.0	%
Total Risk-Based			62,725,450				10.67	%			10.00	%			8.0	%

Short and Long Term Borrowings

The Company actively uses Federal Home Loan Bank (“FHLB”) advances as a source of wholesale funding to support growth strategies as well as to provide liquidity. At June 30, 2008, the Company’s FHLB advances were a combination of fixed term and variable borrowings without call or put option features.

At June 30, 2008, the Bank had $95 million in FHLB term advances outstanding at an average rate of 3.50% compared to $50 million at an average rate of 5.42% at June 30, 2007.

Provision for Loan and Lease Losses

The Allowance for Loan and Lease Losses, which consists of the allowance for loan losses, is management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. The Company has established a process using several analytical tools and benchmarks, to calculate a range of probable outcomes and determine the adequacy of the allowance. No single statistic or measurement determines the adequacy of the allowance. Loan recoveries and the provision for credit losses increase the allowance, while loan charge-offs decrease the allowance.

The allowance for loan and lease losses is the Company’s most significant management accounting estimate. The Company follows a methodology for calculating the appropriate level for the allowance for loan and lease losses as discussed under “Asset Quality” and “Allowance for Loan and Lease Losses (ALLL)” in this document. The entire allowance is used to absorb credit losses inherent in the loan portfolio. The allowance includes an amount for imprecision or uncertainty to incorporate a range of probable outcomes inherent in estimates used for the allowance, which may change from period to period. This portion of the total allowance is the results of the Company’s judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends. The methodology used is refined to calculate a portion of the allowance for each portfolio type to reflect our view of the risk in these portfolios.

Changes in the estimate of the allowance for loan and lease losses and the related provision expense can materially affect net income. Determining the allowance for loan and lease losses requires management to make forecasts of losses that are highly uncertain and require a high degree of judgment.

Provision for loan and lease losses of $1,600,000 were provided for the six-months ended June 30, 2008 compared with $6,000 for the same period of 2007. The Company’s allowance for loan and lease losses was 0.98% of total loans at June 30, 2008 and 1.12% at June 30, 2007, while its ratio of non-performing assets to total assets was 2.88% at June 30, 2008, compared to 2.01% at December 31, 2007 and 0.00% at June 30, 2007. Provisions have increased due to weakening economic conditions, the continued downturn in housing and higher loan charge-offs during the period.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

Factors that may affect future results

As a financial services company, our earnings are significantly affected by general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the United States economy and local economies in which we operate. For example, an economic downturn, increase in unemployment, or other events that negatively impact household and/or corporate incomes could decrease the demand for the Company’s loan and non-loan products and services and increase the number of customers who fail to pay interest or principal on their loans. Geopolitical conditions can also affect our earnings. Acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and our military conflicts including the aftermath of the war with Iraq, could impact business conditions in the United States.

The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part our cost of funds for lending and investing and the return we earn on those loans and investments, both of which impact our net interest margin, and can materially affect the value of financial instruments we hold. Its policies can also affect our borrowers, potentially increasing the risk of failure to repay their loans. Changes in Federal Reserve Board policies are beyond our control and hard to predict or anticipate.

We operate in a highly competitive industry that could become even more competitive because of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can now merge creating a financial holding company that can offer virtually any type of financial service, including banking, securities underwriting, insurance (agency and underwriting) and merchant banking. Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and some have lower cost structures.

The holding company, subsidiary bank and non-bank subsidiary are heavily regulated at the federal and state levels. This regulation is to protect depositors, federal deposit insurance funds and the banking system as a whole, not investors. Congress and state legislatures and federal and state regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies including changes in interpretation and implementation could affect us in substantial and unpredictable ways including limiting the types of financial services and products we may offer. Our failure to comply with the laws, regulations or policies could result in sanctions by regulatory agencies and damage our reputation. For more information, refer to the “Supervision and Regulation” section in the Company’s 2007 Annual Report on Form 10-K.

Our success depends, in part, on our ability to adapt our products and services to evolving industry standards. There is increasing pressure on financial services companies to provide products and services at lower prices. This can reduce our net interest margin and revenues from fee-based products and services. In addition, the widespread adoption of new technologies, including internet-based services, could require us to make substantial expenditures to modify or adapt our existing products and services. Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people can be intense.

The holding company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenues from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on the holding company’s common stock and interest and principal on its debt. Various federal and state laws and regulations limit the amount of dividends that our bank may pay to the holding company. For more information, refer to “Dividends and Other Distributions” in the Company’s 2007 Annual Report on Form 10-K.

Critical Accounting Policies

The Securities and Exchange Commission (“SEC”) issued disclosure guidance for “critical accounting policies.” The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

Our accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 2 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS in the Company’s 2007 Annual Report on Form 10-K. Not all of the significant accounting policies presented in Note 2 to the Consolidated Financial Statements contained in the Company’s 2007 Annual Report on Form 10-K require management to make difficult, subjective or complex judgments or estimates.

Preparation of financial statements

The preparation of these financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used. Estimates are based upon historical experience, current economic conditions and other factors that management considers reasonable under the circumstances.

Use of estimates

These estimates result in judgments regarding the carrying values of assets and liabilities when these values are not readily available from other sources, as well as assessing and identifying the accounting treatments of contingencies and commitments. Actual results may differ from these estimates under different assumptions or conditions.

Accounting Principles Generally Accepted in the United States of America

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Company’s significant accounting policies are presented in Note 2 to the Consolidated Financial Statements contained in the Company’s 2007 Annual Report on Form 10-K.

The Company follows accounting policies typical to the commercial banking industry and in compliance with various regulations and guidelines as established by the Financial Accounting Standards Board (“FASB”), the American Institute of Certified Public Accountants (“AICPA”) and the Bank’s primary federal regulator, the Federal Deposit Insurance Corporation (“FDIC”). The following is a brief description of the Company’s current accounting policies involving significant management judgments.

Allowance for Loan and Lease Losses (“ALLL”)

The allowance for loan and lease losses is the Company’s most significant management accounting estimate. The allowance for loan and lease losses is management’s best estimate of the probable losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting. (1) SFAS No.5 which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS No. 114, which requires that losses on impaired loans be accrued based on the differences between that value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The Company’s allowance for loan and lease losses is the accumulation of various components that are calculated based upon independent methodologies. All components of the allowance for loan losses represent an estimation performed pursuant to Statement of Financial Accounting Standards (“SFAS”) Statement No. 5, Accounting for Contingencies or SFAS No. 114, Accounting by Creditors for Impairment of a Loan. Management’s estimate of each SFAS No. 5 component is based on certain observable data that management believes is the most reflective of the underlying credit losses being estimated. Changes in the amount of each component of the allowance for loan losses are directionally consistent with changes in the observable data, taking into account the interaction of the SFAS No. 5 components over time.

An essential element of the methodology for determining the allowance for loan and lease losses is the Company’s credit risk evaluation process, which includes credit risk grading individual, commercial, construction, commercial real estate, and consumer loans. Loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

That process includes reviewing borrower’s current financial information, historical payment experience, credit documentation, public information, and other information specific to each individual borrower. Loans are reviewed on an annual or rotational basis and/or as management become aware of information affecting the borrower’s ability to fulfill its obligations. Credit risk grades carry a dollar weighted risk percentage.

For individually impaired loans, SFAS No. 114 provides guidance on the acceptable methods to measure impairment. Specifically, SFAS No. 114 states that when a loan is impaired, we measure impairment based on the present value of expected future principal and interest cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price or the fair value of collateral, if the loan is collateral dependent. When developing the estimate of future cash flows for a loan, we consider all available information reflecting past events and current conditions, including the effect of existing environmental factors. In addition to the ALLL, an allowance for unfunded loan commitments and letters of credit is determined using estimates of the probability of funding. This reserve is carried as a liability on the consolidated balance sheet.

Revenue recognition

The Company’s primary source of revenue is interest income. Interest income is recorded on an accrual basis. Note 2 to the Consolidated Financial Statements contained in the Company’s 2007 Annual Report on Form 10-K offers an explanation of the process for determining when the accrual of interest income is discontinued on an impaired loan.

Stock-based Compensation

Statement of Financial Accounting Standards No. 123 (revised 2004); Accounting for Stock Based Compensation was adopted by the Company as of January 1, 2006, using the modified prospective transition method. Under the modified prospective transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards, for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement No. 123 for either recognition or pro forma disclosures.

The amount of the reduction for the fiscal years 2005 through 2007 is disclosed in Note 13 to the Consolidated Financial Statements contained in the Company’s 2007 Annual Report on Form 10-K, based upon the assumptions listed therein. Accounting principles generally accepted in the United States of America (GAAP), itself may change over time, having impact over the reporting of the Company’s financial activity. Although the economic substance of the Company’s transactions would not change, alterations in GAAP could affect the timing or manner of accounting or reporting.

Income Taxes

The Company files a consolidated federal and state income tax return. The Company accounts for income taxes under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using currently enacted tax rates applied to such taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If future income should prove non-existent or less than the amount of deferred tax assets within the tax years to which they may be applied, the asset may not be realized and our net income will be reduced. The Company’s deferred tax assets are described further in Note 12 of the Notes to Consolidated Financial Statements in the Company’s 2007 Annual Report on Form 10-K.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

The following table presents the Company’s daily average balance sheet information together with interest income and yields earned on average interest-bearing assets and interest expense and rates paid on average interest-bearing liabilities. Average balances are average daily balances.

Table 1. Average Balances, Interest Income/Expense and Yields/Rates Paid

						Six Months Ended									Six Months Ended
						June 30, 2008									June 30, 2007
		Average								Yield/					Average								Yield/
		Balance				Interest				Rate					Balance				Interest				Rate
Earning Assets
Portfolio Loans		$	516,938			$	17,302				6.69	%			$	416,141			$	17,429				8.38	%
Tax-exempt Securities			30,402				576				3.79	%				30,548				612				4.01	%
US Government Securities			45,561				1,014				4.45	%				72,937				1,648				4.52	%
Federal Funds Sold			17,561				148				1.69	%				14,823				390				5.26	%
Other Securities			2,000				45				4.50	%				2,000				45				4.50	%
Average Earning Assets		$	612,462			$	19,085				6.23	%			$	536,449			$	20,124				7.50	%
Cash & Due From Banks		$	13,252												$	13,473
Bank Premises			11,264													9,742
Allowance for Loan and Lease Losses			( 5,946	)												( 4,890	)
Other Assets			17,745													19,690
Average Total Assets		$	648,777												$	574,464
Interest Bearing Liabilities
Demand Interest Bearing		$	132,543			$	1,248				1.88	%			$	110,668			$	1,144				2.07	%
Savings Deposits			48,987				650				2.65	%				35,957				526				2.93	%
Certificates of Deposit			229,245				4,614				4.03	%				213,721				5,232				4.90	%
Repurchase Agreements			12,925				119				1.84	%				37,064				723				3.90	%
FHLB Borrowings			91,869				1,512				3.29	%				43,260				1,171				5.41	%
Trust Preferred Borrowings			15,000				476				6.35	%				15,000				540				7.20	%
Average Interest Bearing Liabilities			530,569			$	8,619				3.25	%				455,670			$	9,336				4.10	%
Non interest Demand			66,606													72,321
Other Liabilities			4,391													1,370
Shareholder Equity			47,211													45,103
Average Liabilities and Stockholders Equity		$	648,777												$	574,464
Net Interest Income and Net Interest Margin						$	10,466				3.42	%							$	10,788				4.02	%