SONOMA VALLEY BANCORP
An investment in the Company's common stock is subject to risks inherent to the Company's  business.  The material risks and  uncertainties  that management believes  affect the Company are  described  below.  Before making an investment decision,  you should carefully  consider the risks and uncertainties  described below together with all of the other  information  included or  incorporated  by reference in this report.  The risks and  uncertainties  described below are not the only ones  facing  the  Company.  Additional  risks and  uncertainties  that management  is not aware of or focused  on or that  management  currently  deems immaterial  may also impair the Company's  business  operations.  This report is qualified in its entirety by these risk factors.       If any of the following  risks  actually  occur,  the  Company's  financial condition and results of operations could be materially and adversely  affected. If this were to happen,  the value of the  Company's  common stock could decline significantly, and you could lose all or part of your investment.  Risks Related to the Company's Business  The Company is Subject to Interest Rate Risk       The Company's  earnings and cash flows are largely  dependent  upon its net interest income.  Net interest income is the difference  between interest income earned on  interest-earning  assets such as loans and  securities  and  interest expense  paid on  interest-bearing  liabilities  such as deposits  and  borrowed funds.  Interest rates are highly  sensitive to many factors that are beyond the Company's control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular,  the Board of Governors of the Federal Reserve System. Changes in monetary policy,  including changes in interest rates,  could  influence not only the interest the Company  receives on loans  and  securities  and the  amount  of  interest  it pays on  deposits  and borrowings,  but such  changes  could also affect (i) the  Company's  ability to originate  loans  and  obtain  deposits,  (ii) the fair  value of the  Company's financial  assets  and  liabilities,  and  (iii)  the  average  duration  of the Company's  mortgage-backed  securities portfolio.  If the interest rates paid on deposits and other borrowings  increase at a faster rate than the interest rates received on loans and other investments,  the Company's net interest income, and therefore  earnings,  could  be  adversely  affected.  Earnings  could  also  be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.       Although  management  believes  it  has  implemented  effective  asset  and liability  management  strategies to reduce the potential  effects of changes in interest  rates  on  the  Company's  results  of  operations,  any  substantial, unexpected,  prolonged  change in market  interest  rates  could have a material adverse effect on the Company's  financial  condition and results of operations. See Management's  Discussion and Analysis of Financial  Condition and Results of Operations  located elsewhere in this report for further  discussion  related to the Company's management of interest rate risk.  The Company is Subject to Lending Risk       There are inherent risks associated with the Company's lending  activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where the Company operates as well as those across the State of California and the United States. Increases in interest rates and/or  weakening  economic  conditions could adversely impact the  ability  of  borrowers  to  repay  outstanding  loans  or the  value of the collateral securing these loans. The Company is also subject to various laws and regulations  that  affect  its  lending  activities.   Failure  to  comply  with applicable  laws  and  regulations  could  subject  the  Company  to  regulatory enforcement  action that could result in the  assessment  of  significant  civil money penalties against the Company.                                           13           As of  December  31,  2005,  approximately  89.3%  of  the  Company's  loan portfolio  is  directly  or  indirectly  secured by real  property.  Because the Company's  loan  portfolio   contains  a  significant  number  of  construction, commercial and residential real estate loans, the  deterioration of one or a few of these loans could cause a significant  increase in  non-performing  loans. An increase in  non-performing  loans could  result in a net loss of earnings  from these  loans,  an  increase in the  provision  for  possible  loan losses and an increase in loan charge-offs,  all of which could have a material adverse effect on the Company's financial condition and results of operations. See Management's Discussion and Analysis of Financial Condition and Results of Operations located elsewhere  in this  report for  further  discussion  related to  commercial  and industrial, construction and commercial real estate loans.  The Company's Allowance for Possible Loan Losses may be Insufficient       The Company  maintains an allowance  for possible  loan losses,  which is a reserve  established  through a provision  for possible  loan losses  charged to expense, that represents management's best estimate of probable losses that have been incurred  within the existing  portfolio of loans.  The  allowance,  in the judgment of  management,  is necessary to reserve for estimated  loan losses and risks  inherent  in the loan  portfolio.  The  level of the  allowance  reflects management's continuing evaluation of industry  concentrations;  specific credit risks; loan loss experience;  current loan portfolio quality;  present economic, political and regulatory  conditions  and  unidentified  losses  inherent in the current  loan  portfolio.  The  determination  of the  appropriate  level of the allowance  for  possible  loan  losses  inherently  involves  a high  degree  of subjectivity and requires the Company to make  significant  estimates of current credit  risks and future  trends,  all of which may  undergo  material  changes. Changes in economic conditions  affecting borrowers,  new information  regarding existing loans,  identification  of additional  problem loans and other factors, both within and outside of the Company's control, may require an increase in the allowance  for possible  loan  losses.  In addition,  bank  regulatory  agencies periodically  review the Company's  allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan  charge-offs,  based on judgments  different than those of  management.  In addition,  if  charge-offs  in future  periods exceed the allowance for possible loan  losses;  the Company  will need  additional  provisions  to  increase  the allowance for possible loan losses.  Any increases in the allowance for possible loan losses will result in a decrease in net income and, possibly,  capital, and may have a material  adverse  effect on the  Company's  financial  condition and results of  operations.  See  Management's  Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion  related to the Company's  process for  determining  the  appropriate level of the allowance for possible loan losses.  The Company is Subject to  Environmental  Liability Risk Associated with Lending Activities       A significant  portion of the Company's  loan  portfolio is secured by real property.  During the ordinary course of business,  the Company may foreclose on and take title to properties  securing  certain  loans.  In doing so, there is a risk that hazardous or toxic substances could be found on these  properties.  If hazardous  or  toxic  substances  are  found,  the  Company  may be  liable  for remediation  costs,  as  well  as  for  personal  injury  and  property  damage. Environmental laws may require the Company to incur substantial expenses and may materially  reduce the affected  property's value or limit the Company's ability to use or sell the affected property. In addition, future laws or more stringent interpretations  or  enforcement  policies  with  respect to  existing  laws may increase the Company's exposure to environmental liability. Although the Company has policies and procedures to perform an environmental review before initiating any foreclosure action on real property,  these reviews may not be sufficient to detect all potential  environmental hazards. The remediation costs and any other financial  liabilities  associated  with an  environmental  hazard  could have a material  adverse  effect on the  Company's  financial  condition and results of operations.                                             14   The Company's  Profitability Depends Significantly on Economic Conditions in the State of California       The Company's success depends primarily on the general economic  conditions of the State of California  and the specific  local markets in which the Company operates.  Unlike  larger  national  or  other  regional  banks  that  are  more geographically diversified,  the Company provides banking and financial services to  customers  primarily  in Sonoma  and its  immediate  surrounding  towns (the "Sonoma  Valley").   The  local  economic  conditions  in  these  areas  have  a significant impact on the demand for the Company's products and services as well as the  ability of the  Company's  customers  to repay  loans,  the value of the collateral  securing  loans and the stability of the Company's  deposit  funding sources.  A  significant  decline  in  general  economic  conditions,  caused by inflation,  recession,  acts of  terrorism,  outbreak  of  hostilities  or other international  or  domestic  occurrences,  unemployment,  changes in  securities markets or other factors could impact these local  economic  conditions  and, in turn, have a material  adverse effect on the Company's  financial  condition and results of operations.  The Company Operates in a Highly Competitive Industry and Market Area       The Company faces  substantial  competition  in all areas of its operations from a variety of different  competitors,  many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and  community   banks  within  the  various   markets  the  Company   operates. Additionally,  various  out-of-state banks have begun to enter or have announced plans to enter the market  areas in which the Company  currently  operates.  The Company also faces competition from many other types of financial  institutions, including,  without  limitation,  savings  and  loans,  credit  unions,  finance companies,  brokerage firms, insurance companies,  factoring companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued  consolidation.  Banks,  securities firms and insurance  companies can merge  under  the  umbrella  of a  financial  holding  company,  which can offer virtually  any  type  of  financial  service,   including  banking,   securities underwriting,  insurance (both agency and  underwriting)  and merchant  banking. Also,  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 the  Company's competitors  have  fewer   regulatory   constraints  and  may  have  lower  cost structures.  Additionally,  due to their size,  many  competitors may be able to achieve  economies  of scale  and,  as a result,  may  offer a broader  range of products and services as well as better  pricing for those products and services than the Company can.       The  Company's  ability  to  compete  successfully  depends  on a number of factors, including, among other things:  |X|  The  ability  to  develop,  maintain  and  build  upon  long-term  customer      relationships  based on top quality  service,  high ethical  standards  and      safe, sound assets. |X|  The ability to expand the Company's market position. |X|  The scope,  relevance and pricing of products and services  offered to meet      customer  needs and demands. |X|  The rate at which the Company introduces new products and services relative      to its competitors. |X|  Customer satisfaction with the Company's level of service. |X|  Industry and general economic trends.       Failure to perform in any of these  areas  could  significantly  weaken the Company's  competitive  position,  which could  adversely  affect the  Company's growth and  profitability,  which, in turn, could have a material adverse effect on the Company's financial condition and results of operations.                                           15    The Company is Subject to Extensive Government Regulation and Supervision       The Company,  through its  subsidiary  Sonoma  Valley  Bank,  is subject to extensive federal and state regulation and supervision.  Banking regulations are primarily intended to protect depositors' funds, federal deposit insurance funds and the banking system as a whole, not shareholders.  These  regulations  affect the  Company's  lending  practices,  capital  structure,  investment  practices, dividend policy and growth, among other things.  Congress and federal regulatory agencies continually review banking laws,  regulations and policies for possible changes.  Changes to statutes,  regulations  or regulatory  policies,  including changes  in  interpretation  or  implementation  of  statutes,   regulations  or policies,  could affect the Company in substantial and unpredictable  ways. Such changes  could  subject  the  Company to  additional  costs,  limit the types of financial  services  and  products  the Company may offer  and/or  increase  the ability of non-banks to offer competing  financial services and products,  among other things.  Failure to comply with laws, regulations or policies could result in sanctions by regulatory  agencies,  civil money penalties  and/or  reputation damage,  which could have a material  adverse effect on the Company's  business, financial  condition and results of  operations.  While the Company has policies and  procedures  designed  to  prevent  any  such  violations,  there  can be no assurance  that such  violations  will not occur.  See the  section  captioned " Supervision and Regulation" in Item 1.  The Company's Controls and Procedures may fail or be Circumvented       Management  regularly reviews and updates the Company's  internal controls, disclosure  controls  and  procedures,  and  corporate  governance  policies and procedures. Any system of controls, however well designed and operated, is based in part on certain  assumptions and can provide only  reasonable,  not absolute, assurances   that  the  objectives  of  the  system  are  met.  Any  failure  or circumvention of the Company's controls and procedures or failure to comply with regulations  related to controls and  procedures  could have a material  adverse effect on the Company's business, results of operations and financial condition.  New Lines of Business or new  Products  and  Services may Subject the Company to Additional Risks       From time to time, the Company may implement new lines of business or offer new  products  and  services  within  existing  lines  of  business.  There  are substantial risks and uncertainties associated with these efforts,  particularly in  instances  where the  markets are not fully  developed.  In  developing  and marketing new lines of business and/or new products and services the Company may invest  significant time and resources.  Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors,  such as compliance with  regulations,  competitive  alternatives,  and shifting market preferences,  may also impact the successful implementation of a new line of business or a new product or service.  Furthermore,  any new line of business  and/or new product or service could have a  significant  impact on the effectiveness  of  the  Company's  system  of  internal  controls.   Failure  to successfully  manage these risks in the  development and  implementation  of new lines of business or new  products  or  services  could have a material  adverse effect on the Company's business, results of operations and financial condition.                                          16    The Company may not be able to Attract and Retain Skilled People       The Company's success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the  Company can be intense and the Company may not be able to hire people or to retain them. The unexpected  loss of services of one or more of the Company's key personnel  could have a material  adverse  impact on the Company's  business because of their skills,  knowledge of the Company's  market,  years of industry experience  and  the  difficulty  of  promptly  finding  qualified   replacement personnel.  The Company's  Information  Systems may Experience an  Interruption or Breach in Security       The Company relies heavily on  communications  and  information  systems to conduct its business.  Any failure,  interruption or breach in security of these systems  could  result in  failures or  disruptions  in the  Company's  customer relationship management,  general ledger, deposit, loan and other systems. While the Company has policies and procedures  designed to prevent or limit the effect of the failure,  interruption  or security  breach of its  information  systems, there can be no  assurance  that any such  failures,  interruptions  or security breaches  will not  occur or,  if they do  occur,  that they will be  adequately addressed. The occurrence of any failures, interruptions or security breaches of the Company's information systems could damage the Company's reputation,  result in a loss of customer  business,  subject the Company to  additional  regulatory scrutiny,  or expose the  Company to civil  litigation  and  possible  financial liability,  any of which could have a material  adverse  effect on the Company's financial condition and results of operations.  The Company Continually Encounters Technological Change       The  financial   services   industry  is   continually   undergoing   rapid technological  change  with  frequent  introductions  of  new  technology-driven products and services.  The effective use of technology increases efficiency and enables  financial  institutions  to better serve customers and to reduce costs. The Company's future success  depends,  in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands,  as well as to create additional  efficiencies in the Company's  operations.  Many of the Company's competitors have substantially greater resources to invest in technological  improvements.  The Company may not be able to effectively implement new technology-driven  products and services or be successful in marketing these products and services to its customers. Failure to  successfully  keep pace with  technological  change  affecting the financial services industry could have a material adverse impact on the Company's business and, in turn, the Company's financial condition and results of operations.  The  Company  is  Subject  to Claims  and  Litigation  Pertaining  to  Fiduciary Responsibility       From time to time,  customers make claims and take legal action  pertaining to the Company's performance of its fiduciary responsibilities. Whether customer claims and legal action  related to the Company's  performance  of its fiduciary responsibilities are founded or unfounded,  if such claims and legal actions are not resolved in a manner favorable to the Company they may result in significant financial liability and/or adversely affect the market perception of the Company and its  products  and  services  as well as impact  customer  demand  for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Company's business,  which, in turn, could have a material  adverse  effect on the  Company's  financial  condition and results of operations.                                          17    Severe Weather,  Natural Disasters,  Acts of War or Terrorism and Other External Events Could Significantly Impact the Company's Business       Severe  weather,  natural  disasters,  acts of war or  terrorism  and other adverse external events could have a significant impact on the Company's ability to conduct  business.  Such events could affect the  stability of the  Company's deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral  securing  loans,  cause  significant  property  damage, result in loss of revenue and/or cause the Company to incur additional expenses. Although  management has established  disaster recovery policies and procedures, the  occurrence  of any such event could have a material  adverse  effect on the Company's business,  which, in turn, could have a material adverse effect on the Company's financial condition and results of operations.  Risks Associated with the Company's Common Stock  The Company's Stock Price can be Volatile       Stock price  volatility  may make it more  difficult for you to resell your common  stock when you want and at prices  you find  attractive.  The  Company's stock  price can  fluctuate  significantly  in  response to a variety of factors including, among other things:       |X|  Actual or anticipated variations in quarterly results of operations.      |X|  Recommendations by securities analysts.      |X|  Operating  and  stock  price   performance  of  other  companies  that           investors deem comparable to the Company.      |X|  News  reports  relating to trends,  concerns  and other  issues in the           financial services industry.      |X|  Perceptions  in the  marketplace  regarding  the  Company  and/or  its           competitors.      |X|  New technology used, or services offered, by competitors.      |X|  Significant   acquisitions   or   business   combinations,   strategic           partnerships,  joint  ventures or capital  commitments by or involving           the Company or its competitors.      |X|  Failure to integrate acquisitions or realize anticipated benefits from           acquisitions.      |X|  Changes in government regulations.      |X|  Geopolitical  conditions  such as  acts or  threats  of  terrorism  or           military conflicts.       General  market  fluctuations,  industry  factors and general  economic and political  conditions  and events,  such as economic  slowdowns  or  recessions, interest  rate  changes or credit loss  trends,  could also cause the  Company's stock price to decrease regardless of operating results.  The  Trading  Volume in the  Company's  Common  Stock is Less than that of Other Larger Financial Services Companies       Although  the  Company's  common  stock is listed  for  trading  on the OTC Bulletin  Board,  the  trading  volume in its common  stock is less than that of other larger financial  services  companies.  A public trading market having the desired  characteristics  of depth,  liquidity  and  orderliness  depends on the presence  in the  marketplace  of willing  buyers and  sellers of the  Company's common  stock  at any  given  time.  This  presence  depends  on the  individual decisions of investors and general economic and market conditions over which the Company has no control.  Given the lower trading volume of the Company's  common stock,  significant  sales of the Company's  common stock, or the expectation of these sales, could cause the Company's stock price to fall.                                          18    An Investment in the Company's Common Stock is not an Insured Deposit       The  Company's  common stock is not a bank deposit and,  therefore,  is not insured  against loss by the FDIC,  any other deposit  insurance  fund or by any other public or private  entity.  Investment  in the  Company's  common stock is inherently  risky for the reasons  described in this "Risk Factors"  section and elsewhere  in this report and is subject to the same  market  forces that affect the price of  common  stock in any  company.  As a result,  if you  acquire  the Company's common stock, you may lose some or all of your investment.  Risks Associated with the Company's Industry  The Earnings of  Financial  Services  Companies  are  Significantly  Affected by General Business and Economic Conditions       The Company's operations and profitability are impacted by general business and  economic  conditions  in the United  States and  abroad.  These  conditions include  short-term  and  long-term  interest  rates,  inflation,  money supply, political issues, legislative and regulatory changes,  fluctuations in both debt and equity  capital  markets,  broad  trends in industry  and  finance,  and the strength  of the U.S.  economy  and the local  economies  in which  the  Company operates,  all of which are beyond the Company's  control.  A  deterioration  in economic  conditions  could  result in an  increase  in loan  delinquencies  and non-performing  assets,  decreases in loan  collateral  values and a decrease in demand for the Company's products and services, among other things, any of which could have a material  adverse impact on the Company's  financial  condition and results of operations.  Financial  Services  Companies  Depend  on  the  Accuracy  and  Completeness  of Information About Customers and Counterparties       In deciding whether to extend credit or enter into other transactions,  the Company  may rely on  information  furnished  by or on behalf of  customers  and counterparties,   including  financial  statements,  credit  reports  and  other financial  information.  The Company may also rely on  representations  of those customers,  counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information.  Reliance on inaccurate or  misleading   financial   statements,   credit  reports  or  other  financial information could have a material adverse impact on the Company's  business and, in turn, the Company's financial condition and results of operations.  Consumers may Decide not to use Banks to Complete Their Financial Transactions       Technology  and other  changes are allowing  parties to complete  financial transactions that historically have involved banks through alternative  methods. For example,  consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds.  Consumers can also complete  transactions such as paying bills and/or  transferring  funds directly without  the  assistance  of  banks.   The  process  of  eliminating   banks  as intermediaries,  known as  "disintermediation,"  could result in the loss of fee income,  as well as the  loss  of  customer  deposits  and  the  related  income generated from those  deposits.  The loss of these revenue streams and the lower cost deposits as a source of funds could have a material  adverse  effect on the Company's financial condition and results of operations.
None.                                          19
The Company is  headquartered  in Sonoma,  California.  At the present  time the Company's Bank has three branch offices.       The Sonoma  Branch is located at 202 W. Napa Street,  Sonoma.  The building contains  approximately  6800 square feet and has been  subleased on a long-term basis  (the  initial  term  expires  in 2009,  with  option  to  extend  for two additional  five-year terms).  The office is considered by management to be well maintained  and adequate for the purpose  intended.  Lease payments made in 2005 totaled  $243,337  compared to the $233,978 paid in 2004. The lease provides for future  annual  rents to be  adjusted  for changes in the  Consumer  Price Index ("CPI"), with a minimum annual increase of 4%, effective each March 1st.       The Glen Ellen Branch is located at 13751  Arnold  Drive,  Glen Ellen.  The facility  is 525  square  feet.  The  facility  is  leased  for a five year term expiring in 2008 with the option to extend for two  additional  five year terms. Lease  payments made in 2005 totaled  $14,140  compared to $13,596 in 2004.  The lease  provides  for future  annual rents to be adjusted for changes in the CPI, with a minimum annual increase of 4% effective April 1st of each year.       The Banco de Sonoma Branch, which opened in March 2004, is located at 18615 Sonoma Hwy,  Suite 108,  Boyes Hot  Springs,  California.  The  facility is 1200 square feet.  The facility is leased for a five year term  expiring in 2009 with options to extend for two  additional  five year terms.  Lease  payments in 2005 totaled  $19,704  compared  to $18,630 in 2004.  The lease  provides  for future annual  rents to be adjusted  for changes in the CPI  effective  February 1st of each year.       In July 1995, the Bank entered into a lease for the building located at 463 Second   Street  West  (the   "Operations   Center").   The  building   contains approximately  2400  square  feet and has been  leased on a long  term  basis to coincide  with the Sonoma  Branch  lease.  The initial term and the first option expired in 2000 and 2005,  respectively.  The lease  provides for an  additional option to extend for two additional five year terms and one additional four year term. Lease payments made in 2005 totaled $39,199 compared with the $38,016 paid in 2004.  The lease  provides for future annual rents to be adjusted for changes in the CPI effective each July 1st.       In September  1997,  the Bank purchased the building and land at 472 Second St. West. The building  contains  approximately  1013 square feet. The Bank paid $246,943 for the property. At present the Bank is utilizing the parking area for additional parking for Bank employees and until February 2005, the Bank had been renting out the building  premises.  At the present time,  the Bank is currently evaluating how to utilize the additional space to accommodate  additional growth or generate  additional  income.  Rental  income in 2005 was $1,519  compared to $18,051 in 2004.       In March 2005,  the Bank entered  into a lease for the building  located at 453  Second  Street  West  (the  "Finance   Center").   The  building   contains approximately  1200  square  feet.  The  facility is leased for a five year term expiring in February 2010 with the option to renew for two additional  five year terms.  Lease  payments  paid in 2005 totaled  $16,000.  The lease  provides for future annual rents to be adjusted for changes in the CPI  effective  March 15th of each year.                                          20
In the normal course of  operations,  the Company  and/or its Bank may have disagreements or disputes with vendors,  borrowers,  or employees,  which may or may  not  result  in  litigation.  These  disputes  are  seen  by the  Company's management as a normal part of business.  There are no pending actions  reported and no  threatened  actions that  management  believes  would have a significant material impact on the Company's  financial  position,  results of operations or cash flows.
The  Company  did not submit any  matters to  security  holders  during the fourth quarter of its last fiscal year ended December 31, 2005.                                         21                                         PART II
The  Company's  common stock is quoted on the OTC Bulletin  Board under the symbol  "SBNK".  The Company is not listed on any  exchange  or on the  National Association of Securities Dealers Automated Quotation System ("NASDAQ").  Several brokers act as facilitators in the trades of the Company's stock. They are:  A.G.Edwards                                 Monroe Securities 703 2nd Street Suite 100                    343 W. Erie Street Suite 410 Santa Rosa, CA 95409                        Chicago, IL 60610 Denise Gilseth                              Russ Feltes (800) 972-4800                              (312) 327-2535 Fax (707) 528-1117                          Fax (312) 327-2540  Baird, Patrick & Company                    UBS Financial Services 20 Exchange Place                           6570 Oakmont Drive R. J. Dragani                               Santa Rosa, CA 95409 New York, New York 10005                    John Rector (800) 421-0123                              (707) 539-1500 Fax (212) 493-6643                          Fax (707) 537-3553  Edward Jones                                Hoefer & Arnett 515 First Street East                       555 Market Street, 18th Floor Sonoma, CA 95476                            San Francisco, CA 94105 Gary Scott                                  Cherie Stokes     (415) 538-5727 (707) 935-1856                              Dave Bonaccorso (415) 538-5723 Fax (707) 935-1894                          Switchboard (800) 346-5544                                             Fax (415)398-4875  Wedbush Morgan Securities                   Seidler Companies 1300 S.W. Fifth Avenue Suite 2000           P.O.Box 1688 Joey Warmenhoven  X254                      42605 Moonridge Road Portland, Oregon 97201-5667                 Troy Norlander (503) 224-0480                              Big Bear, CA 92315 Fax (503) 224-7097                          (800) 288-2811                                             Fax (909) 585-7220                                             Tnorlander@seidlercos.com  Hill, Thompson, Magid & Co., Inc. 15 Exchange Place, Suite 800 Jersey City, NJ 07302 Lisa Lee 866-291-6316 or 201-369-2908 Fax 201-395-0624 Lisa.lee@hillthompson.com                                        22          The table below  summarizes those trades of the common stock as reported by OTC Bulletin Board, setting forth the high and low prices for the periods shown. The stock prices have been adjusted for stock dividends and stock splits.  These over the counter quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.     Quarter Ended:                  High           Low                             ----------     ----------       December 31, 2005      $    23.00     $    20.25      September 30, 2005          23.20          20.18      June 30, 2005               22.00          19.15      March 31, 2005              25.50          21.10       December 31, 2004      $    30.00     $    22.00      September 30, 2004          25.00          20.67      June 30, 2004               24.00          22.33      March 31, 2004              24.67          20.00        As of March 8, 2006 there were 1,052  registered  holders of the  Company's common stock, in addition to an unknown number of holders whose shares of common stock are held in street name.  Payment of Dividends       Under state law, the Board of Directors of a California state-licensed bank may  declare  a cash  dividend,  subject  to the  restriction  that  the  amount available  for the  payment of cash  dividends  shall be the lesser of  retained earnings  of the bank or the bank's net income for its last three  fiscal  years (less the amount of any distributions to shareholders made during such period).       However,  under the Financial  Institutions  Supervisory  Act, the FDIC has broad  authority to prohibit a bank from engaging in banking  practices which it considers to be unsafe or unsound. It is possible,  depending upon the financial condition  of the bank in question and other  factors,  that the FDIC may assert that the  payment of  dividends  or other  payments by a bank is  considered  an unsafe and unsound banking practice and therefore,  implement  corrective action to address such a practice.       The  Company  paid cash  dividends  of $0.25 per share to  shareholders  of record as of March 1, 2004 with payment  made on March 15, 2004,  $.25 per share to  shareholders  of record as of August 6, 2004 with payment made on August 26, 2004,  $.25 per share to shareholders of record as of March 1, 2005 with payment made on March 15, 2005, $.25 per share to shareholders of record as of August 1, 2005 with payment made on August 15, 2005 and $.25 per share to  shareholders of record as of March 1, 2006 with  payment  made on March 15,  2006.  The Board of Directors of the Company (the "Board") is currently reviewing our strategic plan to utilize our capital assets in order to enhance  shareholder value. One of the initiatives includes review of the declaration of future cash dividends. No plan has yet been finalized.                                          23         Historically,  the  Company  and the Bank  (prior to the  formation  of the Holding  Company)  have  declared  ten  stock  dividends  of 5% each,  two stock dividends of 10% in May 1996 and June 1997, a 2 for 1 stock split in March 1998, a 3 for 2 stock split in July 2004 and five cash  dividends  in  February  2004, July 2004, February 2005, July 2005 and February 2006 as detailed below:     Dividends Paid by the Bank          Date Declared             Record Date                 Date Paid                     Dividend Paid      May 13, 1992              May 31, 1992                June 15, 1992               5% Stock Dividend     June 26, 1993             July 15, 1993               July 31, 1993               5% Stock Dividend     July 20, 1994             August 1, 1994              August 15, 1994             5% Stock Dividend     January 18, 1995          February 5, 1995            February 20, 1995           5% Stock Dividend     August 16, 1995           September 11, 1995          September 29, 1995          5% Stock Dividend     May 22, 1996              June 14, 1996               June 28, 1996               10% Stock Dividend     June 18, 1997             July 15, 1997               August 1, 1997              10% Stock Dividend     March 18, 1998            April 15, 1998              April 30, 1998              2 for 1 Stock Split     July 21, 1999             August 16, 1999             August 31, 1999             5% Stock Dividend     August 16, 2000           September 8, 2000           September 25, 2000          5% Stock Dividend    Dividends Paid by the Company      Date Declared             Record Date                 Date Paid                     Dividend Paid      July 18, 2001             August 3, 2001              August 17, 2001             5% Stock Dividend     June 17, 2002             July 2, 2002                July 16, 2002               5% Stock Dividend     June 18, 2003             July 2, 2003                July 16, 2003               5% Stock Dividend     February 18, 2004         March 1, 2004               March 15, 2004              $.25 Cash Dividend     July 21, 2004             August 6, 2004              August 26, 2004             3 for 2 Stock Split &                                                                                       $.25 Cash Dividend     February 16, 2005         March 1, 2005               March 15, 2005              $.25 Cash Dividend     July 20, 2005             August 1, 2005              August 15, 2005             $.25 Cash Dividend     February 15, 2006         March 1, 2006               March 15, 2006              $.25 Cash Dividend                                          24         The following  chart  summarizes  the Company  repurchases of the Company's common stock during the fiscal year ended December 31, 2005.                           (a)                          (b)                     (c)                           (d)                                                                                                 Maximum Number                                                                                                (or Approximate                                                                    Total Number of              Dollar Value) of                                                                    Shares (or Units)           Shares (or Units)                                                                    Purchased as Part            that May Yet be               Total Number of                                         of Publicly               Purchased Under               Shares (or Units)             Average Price paid     Announced Plans or             the Plans or Period           Purchased                  per Share (or Unit)        Programs                     Programs - -----------------------------------------------------------------------------------------------------------------  9/1/05- 9/30/05   5,616                    $20.24                 5,616                          $419,832 10/1/05-10/31/05       0                    $ 0.00                     0                          $419,832 11/1/05-11/30/05       0                    $ 0.00                     0                          $419,832 12/1/05-12/31/05       0                    $ 0.00                     0                          $419,832 - ------------------------------------------------------------------------------------------------------------------ Total              5,616                    $20.24                 5,616                                           25
SONOMA VALLEY BANCORP                       Selected Consolidated Financial Data                        dollars in thousands, except share                                and per share data                                For the years ended:                                                   2005          2004          2003          2002          2001          2000                                      ----------    ----------    ----------    ----------    ----------    ----------  RESULTS OF OPERATIONS:        Net interest income           $   11,300    $   10,004    $    8,906    $    8,633    $    8,236    $    7,870        Provision for loan losses           (360)         (130)          (20)         (393)         (342)         (335)        Non-interest income                1,968         1,710         1,715         1,641         1,309           893        Non-interest expense              (7,848)       (7,225)       (6,244)       (5,862)       (5,224)       (5,061)        Provision for income tax          (1,711)       (1,451)       (1,446)       (1,275)       (1,379)       (1,160)                                      ----------    ----------    ----------    ----------    ----------    ----------        Net Income                    $    3,349    $    2,908    $    2,911    $    2,744    $    2,600    $    2,207                                      ==========    ==========    ==========    ==========    ==========    ========== SELECTED AVERAGE BALANCES:        Assets                        $  232,543    $  210,883    $  195,177    $  164,200    $  147,807    $  135,924        Loans, net of unearned           160,655       139,395       123,044       116,867       100,605        86,547        Deposits                         203,341       186,496       171,620       143,228       129,534       120,135        Shareholders' equity              21,935        20,799        20,232        17,964        15,121        12,984 PER SHARE DATA:        Basic net income              $     1.54    $     1.35    $     1.34    $     1.26    $     1.18    $     1.00        Fully diluted net income      $     1.45    $     1.25    $     1.23    $     1.16    $     1.10    $      .96        Period end book value         $    10.63    $     9.65    $     9.89    $     8.81    $     7.64    $     6.52        Weighted average shares           outstanding                 2,170,866     2,148,558     2,165,066     2,176,386     2,209,727     2,220,605 FINANCIAL RATIOS:        Return on average assets            1.44%         1.38%         1.49%         1.67%         1.76%         1.62%        Return on average           shareholders' equity            15.27%        13.98%        14.39%        15.27%        17.19%        17.00%        Net yield on earning           assets                           5.46%         5.48%         5.24%         6.06%         6.25%         6.49%        Efficiency ratio                   57.44%        59.52%        56.95%        55.07%        52.72%        55.06%        Average shareholders'           equity to average assets         9.43%         9.86%        10.37%        10.94%        10.23%         9.55% CAPITAL RATIOS:        Risk-based capital:        Tier I                             10.68%        10.77%        12.81%        12.31%        11.81%        12.78%        Total                              11.93%        12.02%        14.07%        13.57%        13.07%        14.04%        Leverage ratio                      9.61%         9.51%        10.50%        10.62%        10.38%        10.11% CREDIT QUALITY:        Net charge-offs to           average loans                    0.01%         0.24%         0.14%         0.02%         0.05%        -0.04%        Allowance for possible           loan losses to period           end loans                        1.62%         1.59%         2.15%         2.17%         2.25%         2.29%                                          26
The Year Ended December 31, 2005 versus December 31, 2004       The business operations of the Company continue to be conducted through the Bank, its wholly-owned subsidiary,  which began commercial lending operations on June  3,  1988.  Accordingly,  the  following  discussion  and  analysis  of the financial  condition and the results of operations should be read in conjunction with the  financial  statements  and notes  included  elsewhere  in this  annual report. Per share amounts for prior years have been adjusted for the Company's 3 for 2 stock split  declared  July 2004 and 5% stock  dividends  declared in June 2003, June 2002, July 2001,  August 2000 and July 1999. The continued growth and success of the company is dependent upon a stable economy, an increasing deposit base in the Sonoma Valley and economically viable technology to enhance customer service. Expansion of services in the Sonoma Valley such as the opening of a new branch, the placement of a remote ATM in the local hospital,  and the deployment of wire  transfer  services  through an  international  network  are some of the strategies  contributing to successful  performance.  It is management's opinion that community banking will continue to prosper, by providing useful services in niche markets, in spite of the consolidation taking place in the industry.  Critical Accounting Policies       The accounting and reporting policies of the Company conform to accounting principles  generally accepted in the United States and general practices within the financial  services  industry.  The  preparation of financial  statements in conformity with generally accepted accounting  principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements  and  accompanying  notes.  Actual  results  could  differ from those estimates.  A summary of the Company's most significant  accounting  policies is contained on page 54, in Note A to the consolidated  financial  statements.  The Company  considers  its most  critical  accounting  policies  to  consist of the allowance for loan and lease losses and the estimation of fair value,  which are separately discussed below.       Allowance  for Loan and  Lease  Losses.  The  allowance  for loan and lease losses represents  management's best estimate of inherent losses in the existing loan  portfolio.  The  allowance  for loan and lease  losses is increased by the provision for losses on loans and leases charged to expense and reduced by loans and leases  charged off, net of  recoveries.  The  provision  for loan and lease losses is  determined  based on  management's  assessment  of  several  factors: reviews and evaluations of specific loans and leases,  changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on  specific  borrowers  and  industry  groups,  historical  loan and lease loss experience,  the level of classified and nonperforming  loans and the results of regulatory examinations.       The  Company's  Audit  Committee  engages   experienced   independent  loan portfolio review professionals many of whom are former bank examiners. The Audit Committee  determines  the scope of such  reviews  and  provides  the  report of findings to the Board's  Loan  Committee  after it has reviewed and accepted the report.  These reviews are supplemented with periodic reviews  internally by the Company's  credit review function,  as well as the periodic  examination of both selected  credits and the credit  review  process by the  applicable  regulatory agencies.  The information  from these reviews assists  management in the timely identification  of problems  and  potential  problems  and  provides a basis for deciding  whether the credit  represents a probable  loss or risk that should be recognized.       Changes in the  financial  condition of individual  borrowers,  in economic conditions,  in historical  loss experience and in the conditions of the various markets in which collateral may be sold may all affect the required level of the allowance  for loan and lease losses and the  associated  provision for loan and lease losses. Estimation of Fair Value. Accounting principles generally accepted in the United States require that certain  assets and  liabilities be carried on the Consolidated Balance Sheet at fair value or at the lower of cost or                                          27  fair value. Furthermore,  the fair value of financial instruments is required to be disclosed as a part of the notes to the consolidated financial statements for other assets and liabilities (see Note R, page 78). Fair values are volatile and may be  influenced  by a number of factors,  including  market  interest  rates, prepayment  speeds,  discount  rates,  the shape of yield  curves and the credit worthiness of counterparties.       Fair values for the majority of the Company's available for sale investment securities are based on quoted market prices.  In instances  where quoted market prices are not available,  fair values are based on the quoted prices of similar instruments  with  adjustment  for relevant  distinctions.  For trading  account assets, fair value is estimated giving consideration to the contractual interest rates,  weighted  average  maturities and anticipated  prepayment  speeds of the underlying instruments and market interest rates.  Overview       The Company  reported net income of $3,348,529 for the year ending December 31, 2005 an increase of $440,908 over  $2,907,621  for the year ending  December 31, 2004. The increase in net income in 2005 is a result of loan growth of 11.8% over  loans at year end of 2004.  Deposits  have  grown  11.4%  over  2004,  but pressure  to  increase  deposit  rates has  reduced the benefit of the growth in interest  income.  The Banco de Sonoma Office,  although still showing a year to date loss of $94,027, is on track to show profitability sooner than anticipated. On a per share basis,  net income  equaled $1.54 in 2005 compared with $1.35 per share in 2004.       Return on average total assets for 2005, 2004 and 2003 was 1.44%, 1.38% and 1.49%, respectively.  Return on average shareholders' equity increased to 15.27% in 2005 compared to 13.98% in 2004. The increase in the return on average assets is a result  of the 15.2%  growth  in net  income  compared  to 10.3%  growth in average  assets.  The higher  return on equity is the result of the  increase in income  during 2005 offset by the $1.1 million  increase in average  equity from $20.8 million in 2004 to $21.9 million in 2005.       While the Company has enjoyed strong earning over the last three years,  in 2005,  the Company's  growth in earnings has exceeded both the growth in average assets and  average  equity.  Income at year end 2005 is higher than 2004 due to the increase in loan volume which generated  strong earnings in spite of the two basis  point  decline  in the  net  interest  margin  (see  the  table-  Average Balances/Yields  and Rates  Paid on page 31)  supplemented  by the growth in non interest income.       The Company continues to experience loan and deposit growth at the Banco de Sonoma Office from $6.2 million in deposits and $653,462 in loans as of December 31, 2004 to $11.6  million in deposits  and $2.7 million in loans as of December 31,  2005.  It is  anticipated  that for the first three or four years the costs associated  with  opening  a new  office  will  have a  negative  effect  on the Company's  Consolidated  Statement  of  Operations.  For the year  2005,  it was anticipated  that the additional  expense would  approximate  $200,000,  but the branch  seems to be  progressing  better  than  anticipated,  showing  a loss of $94,027 as of December 31, 2005. The Banco de Sonoma Office is offering services to the Latino  community in our market place.  Management  identified  this as a niche market which was  underserved  and an  opportunity  for  potential  future growth and profitability.  Most of the employees at the branch are bilingual and the Bank offers full service  banking.  An  additional  product,  which has been added, is the ability for customers to effect an immediate  transfer of funds to Mexico.  Management  anticipates  that the growth in the office will be slow and steady and profitable within two or three years.       Total  shareholders'  equity increased by $2.8 million or 13.3% at year end 2005. At December 31, 2005, the Company reported net income of $3.3 million.  In March the Company paid out $537,842 for cash dividends declared in February 2005 and in August the Company paid out $540,159 for cash dividends  declared in July 2005. In 2004 stock options were granted to senior employees with a fifth of the options  vesting  each year over a five year  period.  In 2005,  13,500  options vested which increased  equity by $103,680 at year end. The net income figure of $3.3  million  also  reflects  an expense  for the stock  options  of  $103,680,                                         28  therefore the net effect of the stock option transaction  relative to equity was zero.  Directors  exercised  68,461  options which added $532,635 to the capital accounts.  The tax benefit of these options was $132,337,  which also  increased equity.  In September 2005, the Company  repurchased  5,616 shares which lowered equity by $113,668.  The net effect of this activity was capital of  $23,439,793 as of December 31, 2005,  compared to capital of  $20,681,160 as of December 31, 2004. See page 51 for detail of changes in shareholders' equity.       At December 31, 2005,  total assets were $244.1 million,  an 11.8% increase over the $218.2 million at December 31, 2004. The Company showed loans of $171.2 million in 2005,  compared with $153.2  million at year-end 2004, an increase of 11.8%.  Deposits increased,  growing 11.4%, from $193.7 million at year-end 2004 to $215.8 million at year-end 2005. The loan-to-deposit ratio increased to 79.3% in 2005 from 79.1% in 2004.  In 2006,  management  anticipates  slower growth in assets, loans and deposits.       Section 404 of Sarbanes-Oxley requires the SEC to prescribe rules requiring the establishment, maintenance and evaluation of an issuer's internal control of financial  reporting.  Accordingly,  in the annual report for December 31, 2006, management   was  going  to  be  required  to  include  an   assessment  on  the effectiveness  of the Company's  internal  controls over financial  reporting in accordance with standards set by the Public Company Accounting  Oversight Board. On  September  21,  2005,  the SEC  extended  for another  year the deadline for non-accelerated  filers to first certify compliance with Section 404. This means that the Company will not have to certify  compliance  until  December 31, 2007, unless the  Company's  market cap  exceeds  $75  million at June 30,  2006.  The Company's external  independent auditors are required to attest to and report on management's  assessment  of internal  control  over  financial  reporting.  The Company's  management  and staff are working  diligently  toward  evaluating and documenting the internal  control systems in order to allow management to report on, and the Company's  independent auditors to attest to, the Company's internal control  over  financial  reporting.  The Company has retained the services of a consulting firm to assist  management and staff with this process and to address any material  weaknesses and plan  accordingly to maintain  adequate  processes. Even  so,  there  can  be  no  assurances   that  the  evaluation   required  by Sarbanes-Oxley  will not result in the  identification  of  significant  control deficiencies  or that  the  Company's  auditors  will be able to  attest  to the effectiveness of our internal controls over financial reporting.   RESULTS OF OPERATIONS  Net Interest Income       Net interest  income is the difference  between total  interest  income and total  interest  expense.  Net  interest  income,  adjusted  to a fully  taxable equivalent  basis,  increased $1.3 million to $11.7 million,  up 12.1% from 2004 net interest  income of $10.4  million.  Net interest  income on a fully taxable equivalent  basis,  as shown on the table - Average  Balances,  Yields and Rates Paid on page 31,  is  higher  than net  interest  income  on the  statements  of operations because it reflects adjustments  applicable to tax-exempt income from certain  securities and loans ($395,000 in 2005 and $424,000 in 2004, based on a 34% federal income tax rate).       The increase in net interest  income (stated on a fully taxable  equivalent basis) was the net effect of an  increase  of $2.1  million in  interest  income offset by a $848,000  increase in interest  expense for a 12.1%  increase in net interest  income to $1.3 million.  The  effective  interest cost for the Bank is expected to increase  further and the  increase in market  interest  rates could have a dramatic effect on the cost of deposits.  The increased rate  competition for loans and investments combined with the inability to keep deposit rates down will likely result in a flat to declining earnings environment.  Net interest income (stated on a fully taxable  equivalent basis) expressed as a percentage of average earning assets, is referred to as net interest margin. The Company's  net  interest  margin  decreased 2 basis points from 5.48% in 2004 to 5.46% in 2005.  The  decrease  in the net  interest  margin is the result of the                                          29     pressure  torenegotiate  loans from  floating  to fixed and market  pressure  to increase the rates on deposit accounts, offset by the loan growth in 2005, which allowed the margin to remain almost flat.  Interest Income       As previously stated, interest income (stated on a fully taxable equivalent basis) increased by $2.1 million to $14.1 million in 2005, a 17.7% increase over the $12.0 million realized in 2004.       The $2.1  million  increase  was the result of a 12.6%  increase in average earning  assets to $214.4  million  combined  with a 29 basis point  increase in average yield for the year. The yield on earning assets was 6.58% as of December 31,  2005  compared to 6.29% for the year end 2004.  The  increase in yield is a result of putting funds into loans rather than lower yielding investments or fed funds.       The gain in volume of average  earning  assets was  responsible  for a $1.6 million  increase in interest  income,  while the increase in yield  contributed $456,000 for a total increase of $2.1 million.  Interest Expense       Total interest expense increased $848,000 to $2.4 million. The average rate paid on all interest-bearing liabilities was 1.51% in 2005, compared to 1.09% in 2004. Average balances increased from $142.4 million to $158.7 million, an 11.5% gain.       The gain in volume of  average  balances  was  responsible  for a  $280,000 increase in interest expense in conjunction with a $568,000  increase related to higher interest rates paid for a net increase of $848,000. The higher rates paid on interest-bearing liabilities is a result of market pressures driving interest rates paid on deposit accounts higher.       Individual  components of interest income and interest expense are provided in the table - Average Balances, Yields and Rates Paid on page 31.  Provision for Loan Losses       The  provision  for  loan  losses  charged  to  operations  is based on the Company's  monthly  evaluation  of the loan  portfolio  and the  adequacy of the allowance for loan losses in relation to total loans outstanding. The provisions to the  allowance  for loan losses  amounted to $360,000 in 2005 and $130,000 in 2004. The increase in the provision is the result of management's evaluation and assessment  of  the  loan  portfolio  and  the  growth  in the  loan  portfolio. Management  anticipates  some loan  growth will  continue  in 2006,  which could necessitate  a further  increase  in the  provision  to the  allowance  for loan losses.       The economic  climate  continues to improve and the  non-performing  assets ratio at December  31, 2005 was .63%  compared to .72% as of year end 2004.  Non accrual  loans were $994,000 as of December 31, 2005 compared to $1.0 million as of December 31, 2004, a decline of .2%.  Loans  charged-off,  net of recoveries, resulted  in losses  totaling  $12,000  in 2005 and  $336,000  in 2004 (one loan represented  80.3% of this figure).  Refer to page 62, Note D for an analysis of the changes in the allowance for loan and lease losses.                                          30                                  SONOMA VALLEY BANCORP                      AVERAGE BALANCES/YIELDS AND RATES PAID                                    Rate/Volume                                                              2005                           2004                                2003                                                   ----                           ----                                ----      ASSETS                          Average      Income/    Yield/    Average    Income/     Yield/     Average     Income/   Yield/                                     Balance      Expense     Rate     Balance    Expense      Rate      Balance     Expense    Rate      Interest-earning assets:      Loans(2):       Commercial                  $109,030,040  $8,162,506  7.49%  $ 98,242,840  $6,998,669   7.12% $ 85,965,287  $6,493,303   7.55%       Consumer                      19,216,697   1,391,167  7.24%    14,223,761     963,223   6.77%   11,632,168     888,980   7.64%       Real estate construction      19,741,512   1,494,312  7.57%    19,134,305   1,470,918   7.69%   18,780,964   1,529,617   8.14%       Real estate mortgage          10,502,449     729,886  6.95%     5,178,002     372,145   7.19%    3,819,733     333,064   8.72%       Tax exempt loans (1)           2,604,858     215,215  8.26%     3,033,269     254,336   8.38%    3,147,333     263,318   8.37%       Leases                            37,486       3,677  9.81%        36,062       7,610  21.10%       67,689      21,813  32.23%       Tax exempt leases (1)                  0           0  0.00%           868           0   0.00%       46,496       9,511  20.46%       Unearned loan fees              (478,473)                        (453,892)                        (416,006)                                   ------------                     ------------                     ------------              Total loans           160,654,569  11,996,763  7.47%   139,395,215  10,066,901   7.22%  123,043,664   9,539,606   7.75%     Investment securities       Available for sale:              Taxable                33,559,731   1,049,442  3.13%    23,264,663     780,886   3.36%   11,092,907     352,593   3.18%       Hold to maturity:              Taxable                   370,518      10,149  2.74%       390,564      10,094   2.58%      392,092      12,866   3.28%              Tax exempt (1)         16,604,343     947,633  5.71%    17,187,291     993,470   5.78%   11,269,479     735,545   6.53%                                   ------------  ----------         ------------  ----------         ------------  ----------       Total investment securities   50,534,592   2,007,224  3.97%    40,842,518   1,784,450   4.37%   22,754,478   1,101,004   4.84%     Federal funds sold               2,291,052      59,256  2.59%     9,446,625     106,176   1.12%   30,317,575     318,430   1.05%     FHLB Stock                         814,701      33,032  4.05%       599,670      20,370   3.40%      288,415      13,269   4.60%     Total due from banks/       Interest-bearing                  61,200       1,453  2.37%       154,082       4,463   2.90%      201,833         368   0.18%       Total interest earning      ------------  ----------         ------------  ----------         ------------  ----------         assets                     214,356,114  14,097,728  6.58%   190,438,110  11,982,360   6.29%  176,605,965  10,972,677   6.21%     Noninterest-bearing assets:                 ==========                       ==========                       ==========       Reserve for loan losses       (2,668,550)                      (2,436,433)                      (2,772,365)       Cash and due from banks        6,732,111                        9,319,172                        9,090,433       Premises and equipment         1,282,313                        1,369,737                        1,120,199       Other assets                  12,841,170                       12,192,172                       11,132,894                                   ------------                     ------------                     ------------                    Total assets   $232,543,158                     $210,882,758                     $195,177,126                                   ============                     ============                     ============      LIABILITIES AND SHAREHOLDERS'       EQUITY     Interest-bearing liabilities:       Interest-bearing deposits             Interest-bearing               transaction           34,027,329     $57,905  0.17%    30,888,051     $51,744   0.17%  $29,818,802    $ 50,454   0.17%             Savings deposits        73,821,237     826,657  1.12%    67,113,731     434,671   0.65%   59,265,859     466,081   0.79%             Time deposits over               $100,000              27,300,404     851,427  3.12%    25,666,190     667,862   2.60%   25,209,478     729,758   2.89%             Other time deposits     20,600,270     568,772  2.76%    18,739,734     399,813   2.13%   19,794,227     477,061   2.41%                                   ------------  ----------         ------------  ----------         ------------  ----------      Total interest-bearing               Deposits             155,749,240   2,304,761  1.48%   142,407,706   1,554,090   1.09%  134,088,366   1,723,354   1.29%      Other short term borrowings     2,990,049      97,799  3.27%             0           0   0.00%        2,739          31   1.13%                                   ------------  ----------         ------------  ----------         ------------  ----------          Total interest-bearing            liabilities             158,739,289   2,402,560  1.51%   142,407,706   1,554,090   1.09%  134,091,105   1,723,385   1.29%                                                 ==========                       ==========                       ==========      Non interest-bearing liabilities:       Non interest-bearing demand         deposits                    47,591,442                       44,088,273                       37,531,430       Other liabilities              4,276,993                        3,587,536                        3,323,000       Shareholders'equity           21,935,434                       20,799,243                       20,231,591                                   ------------                     ------------                     ------------          Total liabilities and            shareholder' equity    $232,543,158                     $210,882,758                     $195,177,126                                   ============                     ============                     ============      Interest rate spread                                    5.07%                             5.20%                            4.93%     Interest income                            $14,097,728  6.58%               $11,982,360   6.29%              $10,972,677   6.21%     Interest expense                             2,402,560  1.12%                 1,554,090   0.81%                1,723,385   0.97%                                                -----------  -----                ----------   -----               ----------   -----     Net interest income/margin                 $11,695,168  5.46%               $10,428,270   5.48%               $9,249,292   5.24%                                                ===========                       ==========                       ==========    (1)  Fully tax equivalent  adjustments are based on a federal income tax rate of      34% in 2005 2004and 2003 (2)  Non accrual loans have been included in loans for the purposes of the above      presentation. Loan fees of approximately $367,000, 299,000 and $405,000 for      the twelve  months ended  December 31, 2005,  2004 and 2003,  respectively,      were amortized to the appropriate interest income categories.                                         31                                 SONOMA VALLEY BANCORP                               Rate/Volume Analysis                                                    2005 over 2004                                          2004 over 2003                                          --------------                                          --------------                                Volume        Rate      Vol/Rate      Total             Volume        Rate      Vol/Rate       Total ASSETS Interest-earning assets: Loans:   Commercial                   768,464      356,256       39,117    1,163,837         927,373     (369,268)     (52,739)    505,366   Consumer                     338,118       66,487       23,339      427,944         198,061     (101,258)     (22,560)     74,243   Real estate construction      46,678      (22,568)        (716)      23,394          28,778      (85,862)      (1,615)    (58,699)   Real estate mortgage         382,670      (12,291)     (12,638)     357,741         118,435      (58,538)     (20,816)     39,081   Tax exempt loans             (35,922)      (3,725)         526      (39,121)         (9,543)         582          (21)     (8,982)   Leases                           301       (4,073)        (161)      (3,933)        (10,192)      (7,529)       3,518     (14,203)   Tax exempt leases                  0            0            0            0          (9,333)      (9,511)       9,333      (9,511)   Unearned fee income                0            0            0            0               0            0            0           0                             ----------   ----------   ----------   ----------      ----------   ----------   ----------   ---------        Total loans           1,500,308      380,086       49,467    1,929,862       1,243,578     (631,383)     (84,900)    527,295 Investment securities:   Available for sale:     Taxable                    345,557      (53,380)     (23,622)     268,556         386,885       19,744       21,664     428,293     Tax-exempt                       0            0            0            0               0            0            0           0   Held to maturity:     Taxable                       (518)         604          (31)          55             (50)      (2,733)          11      (2,772)     Tax-exempt                 (33,696)     (12,567)         426      (45,837)        386,248      (84,140)     (44,183)    257,925                             ----------   ----------   ----------   ----------      ----------   ----------   ----------   ---------     Total investment           311,343      (65,343)     (23,226)     222,774         773,083      (67,128)     (22,508)    683,446       securities Federal funds sold             (80,426)     138,152     (104,647)     (46,920)       (219,211)      22,326      (15,370)   (212,254) FHLB Stock                       7,304        3,944        1,414       12,662          14,320       (3,472)      (3,747)      7,101 Due from banks-int bearing      (2,690)        (805)         485       (3,010)            (87)       5,478       (1,296)      4,095                             ----------   ----------   ----------   ----------      ----------   ----------   ----------   ---------     Total interest-earning       Assets                 1,735,840      456,035      (76,507)   2,115,368       1,811,683     (674,179)    (127,821)  1,009,683                             ==========   ==========   ==========   ==========      ==========   ==========   ==========  ==========           LIABILITIES Interest-bearing liabilities: Interest-bearing deposits:   Savings deposits               5,259          819           83        6,161           1,809         (501)         (18)      1,290   Interest-bearing demand     Deposits                    43,442      316,875       31,669      391,986          61,718      (82,238)     (10,890)    (31,410)   Time deposits over 100,000    42,524      132,598        8,443      183,565          13,221      (73,780)      (1,337)    (61,896)   Other time deposits           39,695      117,590       11,675      168,959         (25,414)     (54,750)       2,917     (77,248)                             ----------   ----------   ----------   ----------      ----------   ----------   ----------   ---------    Total interest-bearing      deposits                  130,920      567,882       51,870      750,671          51,333     (211,269)      (9,328)   (169,264) Federal funds purchased              0            0            0            0               0            0            0           0 Other borrowings                     0            0       97,799       97,799             (31)         (31)          31         (31)                             ----------   ----------   ----------   ----------      ----------   ----------   ----------   ---------    Total interest-bearing      Liabilities               130,920      567,882      149,669      848,470          51,302     (211,300)      (9,297)   (169,295)  Interest differential        1,604,921     (111,847)    (226,176)   1,266,898       1,760,381     (462,879)    (118,524)  1,178,978                             ==========   ==========   ==========   ==========      ==========   ==========   ==========  ==========   Volume/Rate variances were allocated in the following manner: a.   Changes affected by volume (change in volume times old rate) b.   Changes affected by rates (change in rates times old volume) c.   Changes  affected by  rate/volume  (change in volume times change in rates)      The total for each category was arrived at by totaling the individual items      in their respective categories.                                        32    Non-interest Income       Non-interest income of $2.0 million for 2005 increased 15.1% or $259,000 in comparison with the $1.7 million recorded in 2004. Of the increase 65.5% was due to increases in service charges on deposit accounts. In 2005 income from service charges on deposit  accounts  increased  15.6% or $169,000  from $1.1 million in 2004 to $1.3 million in 2005.  This  increase was a result of both  increases in service charges and growth of new accounts.       Other  fee  income  showed an  increase  in 2005 of 19.1% or  $58,000  from $306,000 in 2004 to $364,000 in 2005 and comprised 22.6% of the 2005 increase of $259,000.  The higher  income is a result of an  increase of 43.1% or $53,000 in income the bank earns from merchant credit card processing fees from $122,000 in 2004 to $175,000 in 2005.  Also  contributing to the increase was an increase of $9,000 or 49.3% in wire  transfer  fee income from $19,000 in 2004 to $28,000 in 2005.       Other  non-interest  income showed a 9.8% increase or $31,000 from $315,000 in 2004 to  $346,000  in 2004.  This is largely a result of an  increase  in the income  generated by bank owned life insurance  policies in 2005.  Income on the policies  was  $298,000 in 2004  compared to $326,000 in 2005 or yields of 6.47% and 6.28%,  respectively.  The earnings on these  policies  will increase as the balances  increase and if market rates  increase,  the income  produced by these policies should also increase.  Non-interest Expense       Total non-interest expense increased 8.6% to $7.8 million in 2005 from $7.2 million in 2004.  Non-interest expense represented 3.38% of average total assets in 2005 and  3.43% in  2004.  The  expense/asset  ratio is a  standard  industry measurement of a bank's ability to control its overhead or  non-interest  costs. During 2006,  the Company will  continue to emphasize  cost  controls,  although certain costs, such as professional fees associated with the  implementation and compliance  with  Sarbanes-Oxley,  costs of  company  insurance  and  salary and benefit expense  including workers  compensation  insurance and medical benefits are not  controllable  by  management.  Refer to Note I, page 66, for a detailed description of Non-Interest Income and Other Non-Interest Expense.  Salaries and Benefits       The most  significant  dollar  increase  was in the  salaries  and benefits category.  Salary and benefits  increased 6.9% from $4.1 million in 2004 to $4.4 million in 2005.  The increase is a result of  increases in employee  incentives paid as a result of the strong  earnings in 2005,  an increase of $162,000  from $328,000 in 2004 to $490,000 in 2005.  Additionally,  accrual  adjustments  were necessary to the Supplemental  Executive  retirement plan due to a deline in the discount rate. Other areas of increase were normal merit increases and increases in the costs of employee benefits. At December 31, 2005 and 2004 total full-time equivalent  employees  were 50 and 55,  respectively,  a decrease of 5 full time equivalent  employees.  Year-end  assets per employee  were $4.9 million in 2005 compared with $4.0 million in 2004.  Premises and Equipment       Expense  relative to premises and equipment  increased 10.9% to $999,000 in 2005 from $900,000 in 2004. The $99,000  increase in expense in 2005 is a result of  additional  lease  expense for the Finance  Center,  increased  expenses for maintenance  and repairs  both for  buildings  and fixed  assets,  increases  in property  tax  accruals,  increases in utility  costs and  increases in software expense.  The Bank continues to emphasize  security in its computer  operations. Equipment  and software are  monitored  and  upgraded as  appropriate  to ensure confidentiality   of  customer  and  Company  data  contributing  to  additional increases in expense.  The Company  continues to emphasize  the  utilization  of technology to accommodate customer and market demands.                                          33    Other Non-interest Expense       Other non-interest  expense increased by 10.9% to $2.4 million in 2005 from $2.2  million in 2004.  The  increase in other  non-interest  expense was due to increases  in  professional  fees  and data  processing  fees,  advertising  and marketing,  operational  losses and outages  and staff  related  expenses  which increased by 18.0%, 15.4%, 75.4% and 8.5%,  respectively.  Professional and data processing fees were $1.2 million in 2004 and increased to $1.4 million in 2005, an increase of $218,000.  The categories of  professional  fees which showed the most significant  increases were in the areas of accounting and taxes,  accruals for Sarbanes  Oxley  professional  assistance and other  professional  fees. The growth in professional fees is predominately  the result of additional  accruals for expenses  associated with the  implementation of  Sarbanes-Oxley,  Rule 404, regarding   internal   controls   over   financial   reporting.   The  delay  in implementation  could  mitigate or spread out the ongoing  expenses  relative to this  process.  Additionally,  with the  growth in the  Company,  time  spent by outside professionals increased, therefore, the costs increased.       Advertising  and  marketing  increased  $30,000  from  $195,000  in 2004 to $225,000 in 2005.  The  increases in this category are a result of the Company's involvement in the community, both through donations as well as participation in civic organizations.  Additionally,  shareholder relations showed an increase in 2005 over 2004.       Staff  related  expenses  grew $16,000 from $186,000 in 2004 to $202,000 in 2005.  These  increases  were a result of director and employee  involvement  in attending  meetings  and  seminars  and  related  costs.  It is  important  that directors and employee keep up with the many regulatory  changes in recent years and the regulators have increased their attention relative to the involvement of employees and directors in training.  Provision for Income Taxes       The provision for income taxes  increased to an effective tax rate of 33.8% in 2005 compared with 33.3% in 2004.  Unaudited Quarterly Statement of Operations Data                                                              (Dollars in thousands, except per share data)                                          Q4          Q3          Q2          Q1          Q4          Q3          Q2          Q1                                        2005        2005        2005        2005        2004        2004        2004        2004  Net interest income                 $ 2,947     $ 2,865     $ 2,784     $ 2,703     $ 2,705     $ 2,604     $ 2,473     $ 2,223 Provision for loan and  lease losses                           (15)        (95)       (160)        (90)        (60)        (40)        (30)          0 Other operating income                  525         498         487         459         446         452         391         421 Other operating expenses             (1,964)     (1,967)     (1,944)     (1,973)     (1,819)     (1,867)     (1,823)     (1,716)                                     -------     -------     -------     -------     -------     -------     -------     ------- Income before income taxes            1,493       1,301       1,167       1,099       1,272       1,149       1,011         928 Provision for income taxes             (494)       (453)       (396)       (368)       (446)       (405)       (319)       (282)                                     -------     -------     -------     -------     -------     -------     -------     ------- Net Income                              999         848         771         731         826         744         692         646 Per share:      Basic earnings per share       $   .46     $   .39     $   .36     $   .34     $   .38     $   .35     $   .32     $   .29      Diluted earnings per share     $   .43     $   .37     $   .34     $   .32     $   .35     $   .32     $   .29     $   .27                                              34    BALANCE SHEET ANALYSIS  Investment Securities       Investment  securities  were $50.4  million at December  31,  2005, a 33.8% increase  from the $37.7  million at December  31, 2004.  At year end 2005,  the overall portfolio had a market value of $50.5 million compared with an amortized cost of $50.9 million.  The Company  purchases  securities  rated A or higher by Standard and Poor's and/or Moody's Investors Service. In the event a security is downgraded,  the Company  will  monitor the  investment  more closely or sell if appropriate.  Local  tax-exempt bonds are  occasionally  purchased  without an A rating.       Securities are classified as held to maturity (HTM) if the Company has both the intent and the ability to hold these securities to maturity.  As of December 31, 2005, the Company had securities  totaling $16.5 million with a market value of $16.6 million categorized as held to maturity. Decisions to acquire municipal securities,  which  are  generally  placed  in this  category,  are based on tax planning needs and pledge requirements.       Securities  are  classified  as  available  for sale  (AFS) if the  Company intends to hold these debt securities for an indefinite  period of time, but not necessarily  to  maturity.   Investment  securities  which  are  categorized  as available  for sale are  acquired  as part of the  overall  asset and  liability management  function and serve as a primary  source of  liquidity.  Decisions to acquire  or dispose  of  different  investments  are based on an  assessment  of various economic and financial factors,  including, but not limited to, interest rate risk, liquidity and capital adequacy.  Securities held in the available for sale category are recorded at market value,  which is $33.9 million  compared to an amortized cost of $34.4 million as of December 31, 2005.       There were twenty nine Federal  Farm Credit  Bank,  Federal Home Loan Bank, Federal Home Loan Mortgage  Corporation or Federal National Mortgage Association securities  of $28.5 million and six U.S.  Treasury  security of $5.4 million in the AFS  portfolio and twenty nine  municipal  securities of $8.2 million in the HTM  portfolio  that are  temporarily  impaired as of December 31, 2005.  Of the above,  there were  twenty two  Federal  Farm  Credit  Bank,  Federal  Home Loan Mortgage  Agency,   Federal  Home  Loan  Bank  and  Federal  National   Mortgage Association  securities of $21.5  million and five U. S. Treasury  securities of $4.4 million in the AFS  portfolio  and fourteen  municipal  securities  of $4.8 million in the HTM portfolio that have been in a continuous loss position for 12 months or more as of December 31, 2005.  The primary cause of the  impairment of these  securities  is  interest  rate  volatility  inherent  in  a  rising  rate environment which causes the market value of the security to decline. Management understood the potential  market risks at the time of acquisition and determined the  benefit to the  Company of the higher  interest  rates  received  more than offset the potential deterioration in value. It is the Company's intent to carry the  securities  to maturity  date,  at which time the Company will receive face value for the securities at no loss.       Although the quoted  market values  fluctuate,  investment  securities  are generally  held to  maturity,  and  accordingly,  gains and losses to the income statement are  recognized  upon sale,  or at such time as management  determines that a permanent  decline in value exists.  In the opinion of management,  there was no investment in securities at December 31, 2005 that constituted a material credit risk to the Company.  The lower  market  value to  amortized  costs was a result of the increase in market  interest  rates and not an indication of lower credit quality.       The table on the  following  page shows the  components  of the  investment portfolio and average yields. For further  information  concerning the Company's total  securities  portfolio,  including  market values and unrealized gains and losses,  refer to Note C of the Notes to  Consolidated  Financial  Statements on page 59.                                          35                                                  Twelve months ended 12/31/05    Twelve months ended 12/31/04                                               Average      Average             Average       Average                                               Balance       Yield              Balance        Yield                                             -----------    -------           -----------     ------- U.S. Treasury securities                    $ 5,096,319       3.32%          $   516,056        2.25% U.S. federal agency issues                   28,463,382       3.09%           22,197,995        3.31% State, county and municipal issues           16,974,891       5.64%           17,577,855        5.71% Corporate securities                                  0       0.00%              550,612        6.46%                                             -----------                      ----------- Total investment securities                 $50,534,592       3.97%          $40,842,518        4.37%                                             ===========                      ===========    Loans       A  comparative  schedule of average loan balances is presented in the table on page  31;  year-end  balances  are  presented  in Note D to the  Consolidated Financial Statements on page 61.       Loan balances,  net of deferred loan fees at December 31, 2005, were $171.2 million, an increase of 11.8% over 2004.  Commercial loans,  comprising 69.3% of the portfolio,  increased  $9.3 million,  or 8.5% over 2004 showing the greatest change in volume of all categories.  Included in Commercial loans are loans made for commercial purposes and secured by real estate.       Consumer loans and Real Estate  Mortgage loans both showed growth over 2004 of 34.2% and 71.4% or $5.6  million and $5.5  million,  respectively.  Growth in home equity loans has contributed to the increase in Consumer loans in 2005 from $16.2 million in 2004 to $21.8 million at year end 2005. During 2005 the Company was able to continue to expand  their  conventional  real estate  mortgage  loan portfolio, as Real Estate Mortgage loans grew from $7.7 million in 2004 to $13.2 million in 2005. It is  anticipated  that the growth rate will be more modest in 2006 due to the increase in interest rates.                                         36          Real Estate Construction loans and Lease Financing  Receivables both showed declines over 2004.  Real Estate  Construction  loans show a decline of 11.3% or $2.3 million from $20.3 million in 2004 to $18.0  million in 2005.  This decline is not a result of fewer  construction  loans being on the books,  but is due to seasonality  and  timing  of  advances,  rather  than a drop  in  demand.  Lease Financing  Receivables  declined  by 45.9% or  $22,000  from  $48,000 in 2004 to $26,000 in 2005.  Customer interest in lease financing  receivables has declined in our  market,  therefore,  the  Bank  has not  been  generating  these  loans. Management  does not see this lack of  interest in lease  financing  receivables changing in the foreseeable future.  Risk Elements       The  majority of the  Company's  loan  activity is with  customers  located within Sonoma County. Approximately 89.3% of the total loan portfolio is secured by real estate located in the Company's service area. Significant concentrations of credit  risk may exist if a number of loan  customers  are engaged in similar activities and have similar  economic  characteristics.  The Company believes it has policies in place to identify problem loans and to monitor concentrations of credit  (see  Note  O,  on page  74 of the  Consolidated  Financial  Statements, Concentration of Credit Risk).       Based on its risk  management  review  and a review of its loan  portfolio, management  believes that its  allowance for loan losses for the quarter  ending December  31,  2005,  is  sufficient  to  absorb  losses  inherent  in the  loan portfolio. This assessment is based upon the best available information and does involve  uncertainty and matters of judgment.  Accordingly,  the adequacy of the loan loss  reserve  cannot be  determined  with  precision,  but is  subject  to periodic  review,  and  could be  susceptible  to  significant  change in future periods.  Loan Commitments and Letters of Credit       Loan commitments are written agreements to lend to customers at agreed upon terms,  provided  there are no violations of any  condition  established  in the contract. Commitments generally have fixed expiration dates or other termination clauses.  Loan  commitments  may have  variable  interest  rates and terms  that reflect current market conditions at the date of commitment. Because many of the commitments are expected to expire without being drawn upon, the amount of total commitments  does not  necessarily  represent the Company's  anticipated  future funding  requirements.  Unfunded loan commitments were $48.6 million at December 31, 2005 and $34.6  million at December 31, 2004.  The increase at 2005 year end is  partially  a  result  of  the  lag  in  advances  on  existing  Real  Estate Construction loans as mentioned in the "Loans" section above.       Standby  letters of credit commit the Company to make payments on behalf of customers when certain  specified  events occur.  Standby  letters of credit are primarily issued to support customers'  financing  requirements of twelve months or less and must meet the Company's normal policies and collateral requirements. Standby  letters of credit  outstanding  were  $348,000 at December 31, 2005 and $360,000 at December 31, 2004.  Nonperforming Assets       Management  classifies all loans as non-accrual loans when they become more than 90 days past due as to principal or interest, or when the timely collection of  interest  or  principal  becomes  uncertain,  if  earlier,  unless  they are adequately secured and in the process of collection.       A loan remains in a  non-accrual  status until both  principal and interest have been current for six months and meets cash flow or collateral criteria,  or when the loan is determined to be  uncollectible  and is charged off against the allowance for loan losses,  or in the case of real estate loans,  is transferred to other real estate owned. A loan is classified as a restructured loan when the interest rate is reduced, when the term is extended beyond the                                         37      original maturity date, or other concessions are made by the Company, because of the inability of the borrower to repay the loan under the original terms.       The Company had loans of $994,000  in  non-accrual  status at December  31, 2005 and $1.012  million at December 31, 2004.  There were  $259,189 in loans 90 days or more past due at December  31, 2005 and $1.006  million in loans 90 days or more past due at December 31, 2004. Occasionally,  the Company will have more loans in  non-accrual  status than are 90 days past due following the guidelines in the above  paragraph or if management  determines the collection of principal or interest is unlikely.  Allowance for Loan Losses       The allowance for loan losses is maintained at a level considered  adequate to provide for losses  that can be  reasonably  anticipated.  The  allowance  is increased by provisions charged to operating expense and reduced by charge-offs, net of recoveries.  The allowance is based on estimates, and ultimate losses may vary from the current  estimates.  These estimates are reviewed  monthly and, as adjustments  become  necessary,  they are reported in earnings in the periods in which they become known.       The review  process is  intended  to  identify  loan  customers  who may be experiencing financial difficulties. In these circumstances,  a specific reserve allocation  or  charge-off  may be  recommended.  Other  factors  considered  by management in evaluating  the adequacy of the  allowance  include:  loan volume, historical net loan loss experience,  the condition of industries and geographic areas  experiencing  or  expected to  experience  economic  adversities,  credit evaluations,  and current economic conditions.  The allowance for loan losses is not a precise amount,  but based on the factors above,  represents  management's best  estimate of losses that may be  ultimately  realized from the current loan portfolio.       Worsening conditions in certain economic sectors and geographic areas could adversely affect the loan portfolio,  necessitating  larger  provisions for loan losses than currently  estimated.  However, as of December 31, 2005, the Company believes its overall allowance for loan losses is adequate based on its analysis of conditions at that time.       At December 31, 2005,  the allowance  for loan losses was $2.8 million,  or 1.62% of year end loans,  compared  with $2.4 million or 1.59% of year end loans at December 31, 2004.  This slight  increase in the allowance is consistent with the loan growth experienced in 2005 and management's  review and analysis of the portfolio.       Net  charge-offs  to average loans  decreased  when compared with the prior year.  The Company  recorded  net losses of $12,000 or .01% of average  loans in 2005 compared to $336,000 or .24% of average  loans in 2004.  The decline in net charge offs in 2005 reflects the Company's  attention and effort in managing and collecting past due loans by encouraging the customer to bring them to a current status or to pay them off and  management's  desire to quickly charge off a loan when it is determined to be  uncollectible.  The prompt  charge-off of loans has increased the quality of the loan portfolio.  Deposits       A  comparative  schedule of average  deposit  balances is  presented in the table on page 31; year-end deposit balances are presented in the table below.       Total deposits  increased  $22.1 million (11.4%) in 2005, to $215.8 million compared  to $193.7  million  in 2004.  All  categories  of  deposits  showed an increase over 2004.  Demand  deposits  increased $4.9 million,  or 11.0% in 2005 to$49.5 million at year end 2005. Savings deposits increased by $4.0 million, or 5.6% to $74.2                                          38    million  at year  end,  while  Interest-bearing  checking  showed  the  smallest increase from $34.9 million in 2004 to $35.6 million in 2005,  growth of 1.9% or $674,000.       The deposits  showing the strongest  growth in 2005 both in growth rate and volume  were  Other  Time  Deposits  which  grew $5.9  million or 31.4% to $24.5 million at year end 2005,  and Time Deposits  Greater than  $100,000  which grew $6.7  million or 26.5% from $25.3  million at year end 2004 to $32.0  million in 2005. For both Other Time Deposits and Time Deposits Greater than $100,000,  all of the 2005 growth can be attributed to special rate  promotions  attracting new deposits.       The composition of deposits for the years ending December 31, 2005 and 2004 are as follows:                                                   December 31,   Percentage      December 31,    Percentage                                                2005        of Total          2004          of Total                                           ------------    ----------      ------------    ---------- Interest-bearing transaction deposits     $ 35,586,113          16.6%     $ 34,912,205          18.0% Savings deposits                            74,218,076          34.4%       70,254,926          36.3% Time deposits, $100,000 and over            32,011,640          14.8%       25,307,661          13.1% Other time deposits                         24,482,074          11.3%       18,630,846           9.6%                                           ------------    ----------      ------------    ---------- Total interest-bearing deposits            166,297,903          77.1%      149,105,638          77.0% Non-interest-bearing deposits               49,460,864          22.9%       44,557,377          23.0%                                           ------------    ----------      ------------    ---------- Total deposits                            $215,758,767         100.0%     $193,663,015         100.0%                                           ============                    ============    Capital       The Bank is subject to FDIC regulations  governing  capital  adequacy.  The FDIC has adopted  risk-based  capital guidelines which establish a risk-adjusted ratio relating capital to different  categories of assets and off-balance  sheet exposures.  Under the current guidelines,  as of December 31, 2005, the Bank was required to have minimum Tier I and total  risk-based  capital  ratios of 4% and 8%,  respectively.  To  be  well  capitalized  under  Prompt  Corrective  Action Provisions  requires minimum Tier I and total risk-based capital ratios to be 6% and 10%, respectively.       The FDIC has also adopted minimum  leverage ratio guidelines for compliance by banking organizations.  The guidelines require a minimum leverage ratio of 4% of Tier 1 capital to total average assets.  Banks experiencing high growth rates are expected to maintain  capital  positions well above the minimum levels.  The leverage ratio, in conjunction  with the risk-based  capital ratio,  constitutes the basis for determining the capital adequacy of banking organizations.       Based on the FDIC's  guidelines,  the Bank's total risk-based capital ratio at December  31,  2005 was 11.39% and its Tier 1  risk-based  capital  ratio was 10.14%.  The Bank's leverage ratio was 9.12%.  All the ratios exceed the minimum guidelines  of 8.00%,  4.00% and  4.00%,  respectively.  The  total  risk  based capital,  Tier 1 risk based  capital  and  leverage  ratios  for the  Company at December 31,  2004,  were 12.02%,  10.77% and 9.51%,  respectively.  The capital ratios for the Company at December  31,  2005,  were  11.93%,  10.68% and 9.61%, respectively.       In February  2001,  the  Company  approved a program to  repurchase  Sonoma Valley Bancorp stock up to $1.0 million and in August 2002 the Company  approved the repurchase of an additional  $1.0 million of Sonoma Valley Bancorp stock and in February  2006 the Company  approved the  repurchase  of an  additional  $1.1 million of Sonoma Valley Bancorp stock. As of December 31, 2005,  $1,580,162 had been  repurchased  and retired,  net of options  which were  exercised  and then subsequently  repurchased and retired. Refer to page 28, for a discussion of the changes  in  capital  and page 51 for the  table of  "Changes  in  Shareholders' Equity."                                         39           Management believes that the Bank's current capital position, which exceeds guidelines  established  by  industry  regulators,  is  adequate  to support its business.  Off Balance Sheet Commitments and Contractual Obligations       The Company's  off balance  sheet  commitments  consist of  commitments  to extend credit and standby letters of credit.  These  commitments are extended to customers in the normal  course of business  and are  described on page 37, Loan Commitments  and Letters of Credit and in Note N to the  Consolidated  Financial Statements on page 73. The Company also has contractual  obligations  consisting of operating  leases for various  facilities and payments to participants  under the Company's  supplemental  executive retirement plan and deferred compensation plan, which are described in Note H on page 63.       The following table summarizes the Company's contractual  obligations as of December 31, 2005.                                                                                 Payments due by period                                                                Less than 1                                    More than 5 Contractual Obligations                         Total            year        1-3 years       3-5 Years         years Operating Lease Obligations                   1,300,734        348,905        720,779         231,050                0 Executive Officer Supplemental Retirement     9,136,010              0         36,377         240,249        8,859,384 Deferred Compensation                         1,285,194          9,964         27,008          55,867        1,192,355   Liquidity Management       The Company's liquidity is determined by the level of assets (such as cash, federal  funds  sold  and   available-for-sale   securities)  that  are  readily convertible  to cash to meet customer  withdrawal and borrowing  needs.  Deposit growth also  contributes  to the Company's  liquidity.  The Company's  liquidity position  is  reviewed  by  management  on a regular  basis to verify that it is adequate to meet  projected  loan funding and potential  withdrawal of deposits. The Company has a  comprehensive  Asset and  Liability  Policy  which it uses to monitor  and  determine  adequate  levels of  liquidity.  At year end 2005,  the Company's  liquidity  ratio  (adjusted  liquid assets to deposits and short term liabilities) was 20.09% compared to 18.47% and 29.03% at year end 2004 and 2003, respectively.  Management expects that liquidity will remain adequate throughout 2006, as loans are not expected to grow  significantly  more than deposits,  and excess funds will continue to be invested in quality liquid assets, such as U.S. Treasury and Agency securities.  Market Risk Management       Overview.  Market risk is the risk of loss from  adverse  changes in market prices and rates.  The Company's market risk arises primarily from interest rate risk  inherent  in its loan,  investment  and  deposit  functions.  The goal for managing the assets and  liabilities  of the Company is to maximize  shareholder value and  earnings,  while  maintaining  a high quality  balance  sheet without exposing  the  Company  to undue  interest  rate  risk.  The Board  has  overall responsibility  for the interest rate risk  management  policies.  Sonoma Valley Bank has an Asset  and  Liability  Management  Committee  that  establishes  and monitors  guidelines  to  control  the  sensitivity  of  earnings  to changes in interest rates.                                         40          Asset/Liability   Management.   Activities   involved  in   asset/liability management  include  but are not  limited  to  lending,  accepting  and  placing deposits and investing in  securities.  Interest rate risk is the primary market risk  associated  with  asset/liability  management.  Sensitivity of earnings to interest rate changes  arises when yields on assets  change in a different  time period or in a different  amount from that of interest costs on liabilities.  To mitigate  interest rate risk, the structure of the balance sheet is managed with the goal  that  movements  of  interest  rates on  assets  and  liabilities  are correlated  and  contribute  to earnings  even in periods of  volatile  interest rates. When interest rates increase,  the market value of securities held in the investment portfolio declines.  Generally, this decline is offset by an increase in  earnings.  When  interest  rates  decline,  the market  value of  securities increases while earnings decrease due to the bank's asset sensitivity  caused by the variable  rate loans.  Usually the Company is able to mitigate its risk from changes in interest  rates with this  balance  sheet  structure.  At the present time, the market is experiencing an anomaly from historical  norms.  While short term rates have  increased  over the past year as a result of the  Federal  Open Market Committee increasing the Fed Funds target rate from 2.25% to 4.25%, a 200 basis point increase,  the long term interest rates have only increased about 20 basis points when  compared to December  2004.  The  asset/liability  management policy sets limits on the acceptable  amount of variance in net interest  margin and market value of equity under  changing  interest  environments.  The Company uses  simulation  models to forecast  earnings,  net interest  margin and market value of equity.       Simulation of earnings is the primary tool used to measure the  sensitivity of earnings to interest rate changes. Using  computer-modeling  techniques,  the Company is able to estimate the potential  impact of changing  interest rates on earnings.  A balance sheet forecast is prepared quarterly using inputs of actual loans,  securities and interest-bearing  liabilities (i.e.  deposits/borrowings) positions as the beginning base. The forecast balance sheet is processed against five interest  rate  scenarios.  The  scenarios  include 100 and 200 basis point rising rate forecasts, a flat rate forecast, and 100 and 200 basis point falling rate forecasts  which take place within a one year time frame.  The net interest income is measured  during the year assuming a gradual  change in rates over the twelve-month horizon. The Company's 2006 net interest income, as forecast below, was modeled  utilizing a forecast  balance  sheet  projected  from year-end 2005 balances. The following table summarizes the effect on net interest income (NII) of a +/-100  and a +/-200  basis  point  change in  interest  rates as  measured against a constant rate (no change) scenario.       Interest  Rate Risk  Simulation  of Net Interest  Income as of December 31, 2005 (In thousands)       Variation from a constant rate scenario            Change in NII                   +200bp                                   ($689)                   +100bp                                   ($345)                   -100bp                                   ($303)                   -200bp                                   ($576)        The  simulations of earnings do not  incorporate  any  management  actions, which might  moderate the negative  consequences  of interest  rate  deviations. Therefore,  they do not reflect likely actual results, but serve as conservative estimates of interest rate risk.       Since the primary tool used by  management  to measure and manage  interest rate  exposure is a simulation  model,  use of the model to perform  simulations reflecting  changes  in  interest  rates  over a twelve  month  horizon  enables management to develop and initiate  strategies for managing exposure to interest rate risks.  Management believes that both individually and in the aggregate its modeling  assumptions  are  reasonable,  but the  complexity  of the  simulation modeling process results in a sophisticated  estimate, not an absolutely precise calculation of exposure.                                          41         Interest Rate Sensitivity Analysis. Interest rate sensitivity is a function of the repricing  characteristics  of the  portfolio of assets and  liabilities. These   repricing   characteristics   are  the  time  frames  within  which  the interest-bearing  assets and liabilities are subject to change in interest rates either  at  replacement,   repricing  or  maturity.  Interest  rate  sensitivity management focuses on the maturity of assets and liabilities and their repricing during periods of changes in market interest rates. Interest rate sensitivity is measured as the difference  between the volumes of assets and liabilities in the current  portfolio that are subject to repricing at various time  horizons.  The differences are known as interest sensitivity gaps.       A positive cumulative gap may be equated to an asset sensitive position. An asset  sensitive  position in a rising  interest rate  environment  will cause a bank's interest rate margin to expand. This results as floating or variable rate loans reprice more rapidly than fixed rate  certificates of deposit that reprice as they mature over time. Conversely, a declining interest rate environment will cause the  opposite  effect.  A  negative  cumulative  gap may be  equated  to a liability  sensitive  position.  A  liability  sensitive  position  in a  rising interest rate  environment will cause a bank's interest rate margin to contract, while a declining  interest rate environment will have the opposite effect.  The table above shows net interest  income  declining  both when rates  increase and when rates  decline.  Although the Bank is usually asset  sensitive  which would cause the Bank's net interest margin to expand in a rising rate environment, the negative  change in net interest  income shows both in rising and declining rate environments.  The  decline  in the  rising  rate  environment  is a  result  of management's  conservative  evaluation  of the  pressure  to  increase  rates on deposits, which temporarily causes the decline in the net interest margin.       The  following  table  sets forth the dollar  amounts  of  maturing  and/or repricing assets and liabilities for various periods.  This does not include the impact of  prepayments or other forms of convexity  caused by changing  interest rates.  Historically,  this has been  immaterial  and estimates for them are not included.       The Company has more  liabilities  than  assets  repricing  during the next year.  Usually because the Company's asset rates change more than deposit rates, the Company's interest income will change more than the cost of funds when rates change.  For the  current  quarter,  the  Company is making a more  conservative assumption.  Historically, the Company has been able to raise deposit rates with a lag to loan rate  increases,  however loan rates have remained flat and market demands are creating pressure to raise interest rates. Therefore for a period of time the Company has chosen to use the  simulation  to forecast  deposits  rates rising  quite  rapidly.  This causes the net  interest  margin to shrink and net interest  income to decline in both a rising and falling rate  environment.  The table below  indicates  that the Company is liability  sensitive  throughout the next year.  At the end of the twelve month cycle,  the rate  sensitive gap shows $87.8 million more in liabilities than assets repricing.                                          42         The Company  controls its long term interest rate risk by keeping long term fixed  rate  assets  (longer  than 5 years)  less than its long term  fixed rate funding, primarily demand deposit accounts and capital. The following table sets forth  cumulative  maturity  distributions  as of  December  31,  2005  for  the Company's  interest-bearing  assets and  interest-bearing  liabilities,  and the Company's   interest   rate   sensitivity   gap  as  a   percentage   of   total interest-earning  assets.  Of the $153.0  million in fixed rate  assets  over 12 months,  shown in the table below,  $36.8 million are long term assets over five years. This $36.8 million compares  favorably to the $71.9 million in demand and core deposits and equity. With the 300 basis point increase in the Fed Funds and prime rate since July 2004, the loans which were at floors were  classified from the fixed rate  category to floating  rate and are now  repricing  with  greater frequency.   (dollars in thousands)                                          Immediate         Up to 3          4 to 6         7 to 12         Over December 31, 2005                 Reprice           Months          Months          Months      12 Months         Total                                  ---------        ---------       ---------       ---------     ---------       --------- ASSETS: Securities + Other Interest-  Bearing Balances                $       0        $   6,038       $   2,356       $   4,713     $  37,310       $  50,417 Loans                               35,597            4,769           4,326           8,034       115,692         168,418 Fed Funds Sold + Overnight  Interest-Bearing Balances           2,089                0               0               0             0           2,089                                  ---------        ---------       ---------       ---------     ---------       --------- Total Rate Sensitive Assets      $  37,686        $  10,807       $   6,682       $  12,747     $ 153,002       $ 220,924                                  =========        =========       =========       =========     =========       ========= LIABILITIES  MMDA/NOW/SAV                    $ 109,804        $       0       $       0       $       0     $       0       $ 109,804  CD's<$100                               0            4,524           7,387           7,387         5,184          24,482  CD's>$100                               0            5,111          17,203           4,301         5,397          32,012  Borrowings                              0                0               0               0             0               0                                  ---------        ---------       ---------       ---------     ---------       ---------    Total Rate Sensitive    Liabilities                   $ 109,804        $   9,635       $  24,590       $  11,688     $  10,581       $ 166,298                                  ---------        ---------       ---------       ---------     ---------       ---------    Rate Sensitivity Gap           $ (72,118)       $   1,172       $ (17,908)      $   1,059     $ 142,421       $  54,626   Cumulative Rate Sensitivity    Gap                           $ (72,118)       $ (70,946)      $ (88,854)      $ (87,795)    $  54,626   Cumulative Position to Total    Assets                           (29.5%)          (29.1%)         (36.4%)         (36.0%)        22.4%     Market risk in securities. Market risk in securities shows the amount of gain or loss  (before  tax)  in  the  securities  portfolio.  Portfolio  volume,  sector distribution,  duration,  and quality all affect market valuation.  The adjusted equity  ratio is tier 1 capital  adjusted  for the market  gain or loss less any applicable  tax effect  divided by average  total  assets for  leverage  capital purposes  for the most  recent  quarter.  The ratio is  designed  to show tier 1 capital  if the  securities  portfolio  had to be  liquidated  and all gains and losses  recognized.  If the ratio remains  strong after a +2% or +3% rate shock, market  risk is  reasonable  in  relation  to the level of  capital.  A bank has flexibility  and strength when the  securities  portfolio can be liquidated  for liquidity purposes without affecting capital adequacy.       The Bank has only moderate  market risk in investments  because the average maturity in the  portfolio is not very long,  except for  municipals,  which are held to  maturity.  The  portfolio  should  decline  in value only about 1.8% or $912,000  for a 1% increase  in rates.  The gain in value if rates fall would be somewhat  less,  because  there  are  some  callable  bonds.   Marking-to-market available for sale securities when rates change would add only modest volatility to a strong level of equity.  This market risk acts to offset the interest  rate risk (i.e.  if rates  decline and NIM is  squeezed,  there would be a concurrent gain in the value of securities).                                          43    Inflation       Assets and liabilities of a financial  institution are principally monetary in nature.  Accordingly,  interest rates,  which generally move with the rate of inflation,  have  potentially the most  significant  effect on the Company's net interest income.  The Company attempts to limit inflation's  impact on rates and net income margins by minimizing its effect on these margins through  continuing asset/liability management programs.  Management's Discussion and Analysis The Year Ended December 31, 2004 versus December 31, 2003  Summary       Net income for 2004 was  $2,907,621  compared  with  $2,911,007  million in 2003.  Basic earnings per share for 2004 were $1.35 compared with $1.34 in 2003. Return on average  assets  was 1.38% in 2004  compared  with 1.49% the  previous year,  while  return on  average  equity  was  13.98% in 2004 and 14.39% for the previous year.       Total  assets  reached  $218.2  million in 2004, a 6.4%  increase  over the $205.1  million at December 31, 2003. The Company showed loans of $153.2 million in 2004,  compared with $122.5  million at year-end  2003, an increase of 25.1%. Deposits increased, growing 7.5%, from $180.1 million at year-end 2003 to $193.7 million at year-end 2004. The  loan-to-deposit  ratio increased to 79.1% in 2004 from 68.0% in 2003.  Net Interest Income       Net  interest  income on a fully tax  equivalent  basis  increased  by $1.2 million to $10.4 million in 2004, up 12.7% from 2003 net interest income of $9.2 million.  The net interest margin for 2004 increased to 5.48% in 2004 from 5.24% for the previous  year.  Individual  components of interest  income and interest expense are provided in the table - Average  Balances,  Yields and Rates Paid on page 31.  Interest Income       Interest income  increased by $1.0 million,  or 9.2%, to $12.0 million over the $11.0 million  realized in 2003. The volume of earning  assets  increased by 7.8% to $190.4 million from $176.6  million in 2003,  while the yield on average earning assets increased 8 basis points.  Interest Expense       Interest  expense  decreased  by $169,000 to $1.6 million in 2004 from $1.7 million  in 2003.  The  average  rate paid on all  interest-bearing  liabilities decreased from 1.29% in 2003 to 1.09% in 2004 while average  balances  increased from $134.1 million to $142.4 million, a 6.2% gain over 2003. The gain in volume of average  balances was responsible for a $42,000  increase in interest expense offset by a  $211,000  decline  related to lower  interest  rates paid for a net decline of $169,000.  The lower rates paid on  interest-bearing  liabilities was the result of a declining rate environment.       Individual  components of interest income and interest expense are provided in the table - Average Balances, Yields and Rates Paid on page 31.                                          44    Provision for Loan Losses       The provision for loan losses was $130,000 in 2004 and $20,000 in 2003. The increase  in the  provision  was  the  result  of  management's  evaluation  and assessment of the loan portfolio. Loans charged off, net of recoveries, resulted in losses  totaling  $336,000  in 2004 and  $167,000  in 2003.  The  increase in charge-offs  reflects loan problems related to the economic  downturn.  Refer to Note D, page 62 for an  analysis of the  changes in the  allowance  for loan and lease losses.  Non-interest Income       Non-interest   income  of  $1.710  million  decreased  .29%  or  $5,000  in comparison with the $1.715 million recorded in 2003. In 2004 income from service charges on deposit accounts  increased 5.4% or $56,000 from $1.0 million in 2003 to $1.1  million in 2004.  This  increase  was a result of both an  increase  in service charges and growth in deposit accounts.       Other fee income  showed a small  decline  in 2004 of 5.6% or $18,000  from $324,000  in 2003 to  $306,000  in 2004.  The  lower  income  is a result of the decline  in loan  referral  income  from  $122,000  in 2003 to $35,000 in 2004 a decrease of $87,000.  Other categories of other fee income showed strong growth. Credit card merchant income was $71,000 in 2003 and grew to $129,000 in 2004, an increase  of  $58,000.  The  remaining  categories  of other fee income  include miscellaneous fees for Bank services which showed growth in 2004 over 2003.       Other non-interest  income showed an 11.8% decline or $42,000 from $357,000 in 2003 to $315,000 in 2004. This is largely a result of a decline in the income generated by bank owned life insurance  policies in 2004. Income on the policies was $343,000 in 2003 compared to $298,000 in 2004 or a yield of 7.56% and 6.47%, respectively.  Non-interest Expense       Total  non-interest  expense  increased  15.7% to $7.2 million in 2004 from $6.2 million in 2003.  Non-interest  expense  represented  3.4% of average total assets in 2004 and 3.2% in 2003. The expense/asset  ratio is a standard industry measurement of a bank's ability to control its overhead or  non-interest  costs. Refer to Note I, page 66, for a detailed  description of Non-Interest Income and Other Non-Interest Expense.       The most  significant  increase was in the salaries and benefits  category. Salary and benefits increased 18.2% from $3.5 million in 2003 to $4.1 million in 2004 of which $267,000 reflects the salary and benefits expenses associated with the  new  Banco  de  Sonoma  Office.  The  remainder  of the  increase  reflects additional  staffing in Sonoma,  normal merit increases and employee  incentives paid  as a  result  of the  Company's  earnings  in  2004.  Additionally,  there continues  to be  significant  increases  in workers  compensation  and employee medical  benefits.  At  December  31, 2004 and 2003 total  full-time  equivalent employees were 55 and 49,  respectively,  an increase of 6 full time  equivalent employees.  Year-end assets per employee were $4.0 million in 2004 compared with $4.2 million in 2003.       Expenses  related to premises and equipment  increased by 17.2% or $132,000 to $901,000 in 2004 from $769,000 in 2003. Of that  increase,  $67,000  resulted from additional costs associated with the opening of the Banco de Sonoma Office. Bank lease expense  increased $29,000 from $289,000 in 2003 to $318,000 in 2004. Banco de Sonoma was  responsible  for $19,000 of that increase and the remaining $10,000  represented the increase in lease expenses at the other three locations and rental  storage.  Lease  income in 2004 was  $18,000  compared to $17,000 in 2003.                                          45         Expenses  on fixed  assets were  $322,000  in 2003  compared to $395,000 in 2004,  with $30,000 of the $73,000  increase  attributable to the opening of the new office. The remaining increase is the result of equipment upgrades,  as well as the  amortization  of expenses  from the remodel of the Sonoma and Glen Ellen offices.       Other non-interest  expense increased by 10.8% to $2.2 million in 2004 from $2.0  million in 2003.  The  increase in other  non-interest  expense was due to increases in professional fees, advertising and marketing, stationery and office supplies and FDIC and other insurance.  Professional  fees were $680,000 in 2003 and  increased  to  $751,000  in 2004,  an  increase  of $71,000  or 10.5%.  The categories of professional fees which showed the most significant increases were in the areas of accounting and taxes, other exam fees, and accruals for Director Retirement  and legal fees.  The increases in accounting  and taxes,  other exam fees  and  legal  fees  are  a  result  of  complying  with  Sarbanes-Oxley  and examinations to audit compliance with many of the new consumer regulations, such as Customer Privacy,  USA Patriot Act and Bank Secrecy Act.  Additionally,  with the  growth in the  Company,  time  spent by  outside  professionals  increased, therefore,  the costs  increased.  The Director  Retirement costs increased as a result of a lower crediting rate when determining benefit expense.  Provision for Income Taxes       The provision for income taxes  increased to an effective tax rate of 33.3% in 2004 compared with 33.2% in 2003.
Information regarding Quantitative and Qualitative Disclosures about Market Risk appears on pages 40 through 43 under the caption  "Management's  Discussion and Analysis of  Consolidated  Financial  Condition  and Results of Operations - Market Risk Management" and is incorporated herein by reference.                                         46
Richardson & Company                                550 Howe Avenue, Suite 210                                                     Sacramento, California 95825                                                     Telephone: (916) 564-8727                                                     FAX: (916) 564-8728                               REPORT OF RICHARDSON & COMPANY                           INDEPENDENT REGISTERED PUBLIC                                  ACCOUNTING FIRM   Board of Directors and Shareholders Sonoma Valley Bancorp and Subsidiary Sonoma, California   We have audited the  accompanying  consolidated  balance sheets of Sonoma Valley Bancorp  and  Subsidiary  as of  December  31,  2005 and 2004,  and the  related consolidated  statements of operations,  changes in the shareholders' equity and cash flows for each of the three years in the period  ended  December  31, 2005. These financial  statements are the responsibility of the Company's  management. Our responsibility is to express an opinion on these financial  statements based on our audits.  We conducted our audits in accordance  with the standards of the Public  Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,  evidence  supporting  the amounts and  disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant  estimates  made by  management,  as well as evaluating  the overall financial  statement  presentation.   We  believe  that  our  audits  provide  a reasonable basis for our opinion.  In our opinion,  the financial  statements  referred to above present fairly, in all material  respects,  the  consolidated  financial  position of Sonoma Valley Bancorp and  Subsidiary as of December 31, 2005 and 2004,  and the  consolidated results of their  operations and their  consolidated  cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.                                                                [GRAPHIC OMITTED]  January 24, 2006                                          47                          SONOMA VALLEY BANCORP AND SUBSIDIARY                             CONSOLIDATED BALANCE SHEETS                             December 31, 2005 and 2004      ASSETS                                                                  2005               2004                                                                   --------------     --------------    Cash and due from banks                                        $    6,988,820     $    5,471,669    Federal funds sold                                                  2,050,000          9,840,000    Interest-bearing due from banks                                        39,521             35,551                                                                   --------------     --------------                             Total cash and cash equivalents            9,078,341         15,347,220    Investment securities available-for-sale, at fair value            33,917,094         20,253,490    Investment securities held-to-maturity (fair value        of $16,634,519 and $17,842,432, respectively)                  16,499,865         17,418,303    Loans and lease financing receivables, net                        168,418,085        150,732,087    Premises and equipment, net                                         1,178,666          1,364,879    Accrued interest receivable                                         1,400,255          1,138,607    Cash surrender value of life insurance                              9,239,439          8,913,136    Other assets                                                        4,331,172          3,079,740                                                                   --------------     --------------                                                Total assets       $  244,062,917     $  218,247,462                                                                   ==============     ============== LIABILITIES    Noninterest-bearing demand deposits                            $   49,460,864     $   44,557,377    Interest-bearing transaction deposits                              35,586,113         34,912,205    Savings and money market deposits                                  74,218,076         70,254,926    Time deposits, $100,000 and over                                   32,011,640         25,307,661    Other time deposits                                                24,482,074         18,630,846                                                                   --------------     --------------                                              Total deposits          215,758,767        193,663,015    Accrued interest payable    And other liabilities                                               4,864,357          3,903,287                                                                   --------------     --------------                                            Total liabilities          220,623,124        197,566,302    Commitments and contingencies ( see accompanying notes )  SHAREHOLDERS' EQUITY    Common stock, no par value; 10,000,000 shares        authorized; 2,204,949 shares in 2005 and 2,142,104 in        2004 issued and outstanding                                    16,256,427         15,528,940    Retained earnings                                                   7,493,757          5,295,732    Accumulated other comprehensive loss                                 (310,391)          (143,512)                                                                   --------------     --------------                                  Total shareholders' equity           23,439,793         20,681,160                                                                   --------------     --------------                   Total liabilities and shareholders' equity       $  244,062,917     $  218,247,462                                                                   ==============     ==============   The accompanying notes are an integral part of these financial statements.                                           48                          SONOMA VALLEY BANCORP AND SUBSIDIARY                        CONSOLIDATED STATEMENTS OF OPERATIONS                For the years ended December 31, 2005, 2004 and 2003                                                           2005                 2004                 2003                                                -----------          -----------          ----------- INTEREST INCOME  Loans and leases                              $11,923,589          $ 9,980,424          $ 9,446,841  Taxable securities                              1,059,592              790,980              365,459  Tax-exempt securities                             625,438              655,689              485,460  Federal funds sold and other                       60,710              110,639              318,798  Dividends                                          33,031               20,370               13,269                                                -----------          -----------          -----------              Total interest income              13,702,360           11,558,102           10,629,827  INTEREST EXPENSE  Interest-bearing transaction deposits              57,905               51,744               50,454  Savings and money market deposits                 826,657              434,671              466,081  Time deposits, $100,000 and over                  851,427              667,862              729,758  Other time deposits                               568,772              399,813              477,061  Other                                              97,799                                        31                                                -----------          -----------          -----------             Total interest expense               2,402,560            1,554,090            1,723,385                                                -----------          -----------          -----------                NET INTEREST INCOME              11,299,800           10,004,012            8,906,442  Provision for loan and lease losses               360,000              130,000               20,000                                                -----------          -----------          -----------           NET INTEREST INCOME AFTER             PROVISION FOR LOAN AND                       LEASE LOSSES              10,939,800            9,874,012            8,886,442  NON-INTEREST INCOME                              1,968,394            1,709,771            1,715,123 NON-INTEREST EXPENSE  Salaries and employee benefits                  4,410,604            4,124,120            3,489,007  Premises and equipment                            999,019              900,465              768,789  Other                                           2,438,886            2,200,104            1,986,365                                                -----------          -----------          -----------         Total non-interest expense               7,848,509            7,224,689            6,244,161                                                -----------          -----------          -----------   Income before provision for income taxes        5,059,685            4,359,094            4,357,404   Provision for income taxes                     1,711,156            1,451,473            1,446,397                                                -----------          -----------          -----------                         NET INCOME             $ 3,348,529          $ 2,907,621          $ 2,911,007                                                ===========          ===========          ===========               NET INCOME PER SHARE             $      1.54          $      1.35          $      1.34               NET INCOME PER SHARE             ===========          ===========          ===========                  ASSUMING DILUTION             $      1.45          $      1.25          $      1.23                                                ===========          ===========          ===========     The accompanying notes are an integral part of these financial statements.                                          49                          SONOMA VALLEY BANCORP AND SUBSIDIARY             CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY                For the years ended December 31, 2005, 2004 and 2003                                                                                                               Accumulated                                                                                                         Other                                    Comprehensive             Common Stock             Retained       Comprehensive                                       Income            Shares       Amount           Earnings          Income           Total BALANCE AT                         -------------      ---------    ------------     ------------     -------------    ------------  JANUARY 1, 2003                                      1,401,146    $ 12,936,225     $  6,215,790     $      88,295    $ 19,240,310 5% stock dividend                                        68,665       1,997,422       (1,997,422) Fractional shares                                                                        (14,193)                          (14,193) Redemption and retirement  of stock                                               (38,987)       (361,296)        (729,099)                       (1,090,395) Stock options exercised and  related tax benefits                                    26,770         489,285                                            489,285 Net income for the year            $ 2,911,007                                         2,911,007                         2,911,007 Other comprehensive  income, net of tax:  Unrealized holding losses   on securities available-   for-sale arising during   the year, net of taxes   of $45,274                           (64,735) Other comprehensive income,        -----------  net of taxes                          (64,735)                                                            (64,735)        (64,735)                                    -----------        ---------    ------------     ------------     -------------    ------------ Total comprehensive income         $ 2,846,272                                    =========== BALANCE AT  DECEMBER 31, 2003                                    1,457,594      15,061,636        6,386,083            23,560      21,471,279 Redemption and retirement  of stock                                                  (601)         (6,218)         (11,839)                          (18,057) Stock options exercised and  related tax benefits                                    97,494       1,786,065                                          1,786,065 Redemption of stock  under tender offer                                    (126,208)     (1,416,223)      (3,071,903)                       (4,488,126) Cash dividends                                                                          (906,732)                         (906,732) Stock options granted                                                   103,680                                            103,680 3 for 2 stock split                                     713,825 Fractional shares                                                                         (7,498)                           (7,498) Net income for the year            $ 2,907,621                                         2,907,621                        2,907,,621 Other comprehensive  income, net of tax:  Unrealized holding losses   on securities available-   for-sale arising during   the year, net of taxes   of $116,844                         (167,072) Other comprehensive                ----------- income, net of taxes                  (167,072)                                                           (167,072)       (167,072)                                    -----------        ---------    ------------     ------------     -------------    ------------  Total comprehensive income         $ 2,740,549 BALANCE AT                         ===========  DECEMBER 31, 2004                                    2,142,104      15,528,940        5,295,732          (143,512)      20,681,160                                     (Continued)                                        50                          SONOMA VALLEY BANCORP AND SUBSIDIARY             CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY                                    (Continued)                For the years ended December 31, 2005, 2004 and 2003                                                                                                                Accumulated                                                                                                         Other                                    Comprehensive             Common Stock             Retained       Comprehensive                                       Income            Shares       Amount           Earnings          Income           Total                                    -------------      ---------    ------------     ------------     -------------    ------------ Redemption and retirement  of stock                                                (5,616)   $    (41,165)    $    (72,503)                     $   (113,668) Stock options exercised and  related tax benefits                                    68,461         664,972                                            664,972 Cash dividends                                                                        (1,078,001)                       (1,078,001) Stock options granted                                                   103,680                                            103,680 Net income for the year            $   3,348,529                                       3,348,529                         3,348,529 Other comprehensive income,  net of tax:  Unrealized holding losses   on securities available-   for-sale arising during   the year, net of taxes   of $116,709                           (166,879)                                    ------------- Other comprehensive income,  net of taxes                           (166,879)                                                    $    (166,879)       (166,879)                                    -------------      ---------    ------------     ------------     -------------    ------------ Total comprehensive income         $   3,181,650                                    ============= BALANCE AT  DECEMBER 31, 2005                                    2,204,949    $ 16,256,427     $  7,493,757     $    (310,391)   $ 23,439,793                                                       =========    ============     ============     =============    ============      The accompanying notes are an integral part of these financial statements.                                            51                          SONOMA VALLEY BANCORP AND SUBSIDIARY                        CONSOLIDATED STATEMENTS OF CASH FLOWS                For the years ended December 31, 2005, 2004 and 2003                                                                2005               2004               2003 OPERATING ACTIVITIES                                ------------       ------------       ------------  Net income                                         $  3,348,529       $  2,907,621       $  2,911,007  Adjustments to reconcile net income   to net cash provided by operating activities:    Provision for loan and lease losses                   360,000            130,000             20,000    Depreciation                                          307,202            306,747            224,774    Loss on sale of equipment                                 306                206                 23    Amortization and other                                166,269            153,510            115,551    Stock options granted                                 103,680            103,680    Net change in interest receivable                    (261,648)          (231,649)          (107,676)    Net change in cash surrender value     of life insurance                                   (326,303)          (297,536)          (342,888)    Net change in other assets                         (1,002,386)           942,827            (47,325)    Net change in interest payable     and other liabilities                                961,070            383,045            146,078                                                     ------------       ------------       ------------                            NET CASH PROVIDED BY                            OPERATING ACTIVITIES        3,656,719          4,398,451          2,919,544 INVESTING ACTIVITIES  Purchases of securities held-to-maturity               (399,570)        (2,519,972)       (10,718,156)  Purchases of securities available-for-sale          (15,014,859)        (8,653,217)       (17,216,738)  Proceeds from maturing securities held-to   maturity                                             1,219,406          1,551,900          4,028,400  Proceeds from maturing securities available-   for-sale                                             1,000,000          8,190,000            750,000  Proceeds from sales of securities available-   for-sale  Net (increase) decrease in loans and leases         (18,045,998)       (31,028,098)         5,415,192  Purchases of premises and equipment                    (122,095)          (361,506)          (663,645)  Purchases of life insurance                                               (885,000)  Proceeds from disposal of equipment                         800              3,669                550                                                     ------------       ------------       ------------                               NET CASH USED FOR                            INVESTING ACTIVITIES      (31,362,316)       (33,702,224)       (18,404,397)                                         (Continued)                                         52                           SONOMA VALLEY BANCORP AND SUBSIDIARY                  CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)                For the years ended December 31, 2005, 2004 and 2003                                                               2005               2004               2003                                                     ------------       ------------       ------------ FINANCING ACTIVITIES  Net change in demand, interest-bearing   transaction and savings deposits                  $  9,540,545       $ 15,628,556       $ 18,904,842  Net change in time deposits                          12,555,207         (2,080,157)         1,221,521  Stock repurchases                                      (113,668)        (4,506,183)        (1,090,395)  Stock options exercised                                 532,635          1,168,805            299,681  Fractional shares purchased                                                 (7,498)           (14,193)  Cash dividends paid                                  (1,078,001)          (906,732)                                                     ------------       ------------       ------------                           NET CASH PROVIDED BY                           FINANCING ACTIVITIES        21,436,718          9,296,791         19,321,456                                                     ------------       ------------       ------------                         NET CHANGE IN CASH AND                               CASH EQUIVALENTS        (6,268,879)       (20,006,982)         3,836,603  Cash and cash equivalents   at beginning of year                                15,347,220         35,354,202         31,517,599                       CASH AND CASH EQUIVALENTS                                 AT END OF YEAR      $  9,078,341       $ 15,347,220       $ 35,354,202                                                     ============       ============       ============  SUPPLEMENTAL DISCLOSURES OF  CASH FLOW INFORMATION:   Cash paid during the year for:   Interest expense                                  $  2,367,482       $  1,550,556       $  1,731,256   Income taxes                                      $  2,340,000       $    219,200       $  1,375,000  SUPPLEMENTAL DISCLOSURES OF  NONCASH ACTIVITIES:   Stock dividends                                                                          $  1,997,422  Net change in unrealized gains and losses   on securities                                     $   (283,588)      $   (283,916)      $   (110,009)  Net change in deferred income taxes on unrealized   gains and losses on securities                    $    116,709       $    116,844       $     45,274   The accompanying notes are an integral part of these financial statements.                                            53                          SONOMA VALLEY BANCORP AND SUBSIDIARY                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                          December 31, 2005, 2004 and 2003   NOTE A--SIGNIFICANT ACCOUNTING POLICIES  Business: Sonoma Valley Bancorp (the Company), formed in 2000, is a bank holding company  whose  principal  activity  is  the  ownership  and  management  of its wholly-owned subsidiary, Sonoma Valley Bank. Sonoma Valley Bank was organized in 1987 and commenced  operations  on June 3, 1988 as a California  state-chartered bank. The Bank is subject to regulation,  supervision and regular examination by the State  Department of Financial  Institutions  and Federal Deposit  Insurance Corporation. The regulations of these agencies govern most aspects of the Bank's business.  Principles of Consolidation:  The consolidated  financial statements include the accounts of the Company and the Bank.  All material  inter-company  accounts and transactions have been eliminated.  Nature of  Operations:  The Bank  provides  a variety  of  banking  services  to individuals and businesses in its primary service area of Sonoma, California and the immediate  surrounding area. The Bank offers depository and lending services primarily to meet the needs of its business and  professional  clientele.  These services  include a variety of demand deposit,  savings and time deposit account alternatives  and special  merchant and business  services.  The Bank's  lending activities  are  directed  primarily  towards  granting  short  and  medium-term commercial  loans,  customized  lines of credit,  for such purposes as operating capital, business and professional start-ups,  inventory, equipment and accounts receivable and interim construction financing.  Use of Estimates:  The  preparation of financial  statements in conformity  with generally accepted  accounting  principles requires management 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 financial statements  and the  reported  amounts  of  revenues  and  expenses  during  the reporting period. Actual results could differ from those estimates.  Cash and Cash  Equivalents:  For the purposes of reporting cash flows,  cash and cash  equivalents  are defined as those  amounts  included in the balance  sheet captions "Cash and due from banks" and "Federal funds sold." Generally,  federal funds are sold or purchased for one-day periods.  Investment  Securities:  Securities  are classified as  held-to-maturity  if the Company  has both the intent  and  ability  to hold  those  debt  securities  to maturity regardless of changes in market conditions,  liquidity needs or changes in general  economic  conditions.  These securities are carried at cost adjusted for amortization of premium and accretion of discount,  computed by the interest method over their contractual lives.  Securities are classified as  available-for-sale  if the Company intends to hold those debt  securities for an indefinite  period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors,  including significant movements in interest rates, changes in the maturity mix of the Company's assets and  liabilities,  liquidity needs,  regulatory capital considerations and other similar factors.  Securities available-for-sale are carried at fair value. Unrealized holding gains or losses are  reported as increases or  decreases  in  shareholders'  equity,  net of the related deferred tax effect.  Realized gains or losses,  determined on the basis of the cost of specific securities sold, are included in earnings.                                          54                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued)  Loans and Lease Financing Receivables:  Loans are stated at the amount of unpaid principal,  less the  allowance  for loan  losses  and net  deferred  loan fees. Interest  on loans is accrued  and  credited  to income  based on the  principal amount  outstanding.  Loan  origination fees and certain direct loan origination costs  are  capitalized  and  recognized  as an  adjustment  of the yield on the related loan.  However,  loan origination  costs in excess of fees collected are not  deferred  but this  treatment  has an  immaterial  impact on the  financial statements. Amortization of net deferred loan fees is discontinued when the loan is placed on nonaccrual status.  All of the Company's leases are classified and accounted for as direct financing leases.  Under the direct financing  method of accounting for leases,  the total net rentals  receivable under the lease contracts,  net of unearned income,  are recorded as a net investment in direct financing leases, and the unearned income is  recognized  each month as it is earned so as to produce a constant  periodic rate of return on the unrecovered investment.  Allowance  for Loan and Lease  Losses:  The  allowance is  maintained at a level which,  in the opinion of  management,  is adequate  to absorb  probable  losses inherent  in  the  loan  and  lease   portfolio.   Credit   losses   related  to off-balance-sheet  instruments  are included in the allowance for loan and lease losses  except if the loss meets the  criteria  for accrual  under  Statement of Financial Accounting Standards (SFAS) No. 5, in which case the amount is accrued and reported  separately as a liability.  Management  determines the adequacy of the  allowance  based upon reviews of individual  loans and leases,  recent loss experience, current economic conditions, the risk characteristics of the various categories  of loans and leases and other  pertinent  factors.  The allowance is based on  estimates,  and ultimate  losses may vary from the current  estimates. These estimates are reviewed monthly and, as adjustments become necessary,  they are  reported in earnings in the periods in which they become  known.  Loans and leases deemed  uncollectible  are charged to the allowance.  Provisions for loan and lease losses and recoveries on loans previously charged off are added to the allowance.  Commercial  loans are  considered  impaired,  based on current  information  and events,  if it is  probable  that the  Company  will be  unable to  collect  the scheduled   payments  of  principal  or  interest  when  due  according  to  the contractual  terms of the loan  agreement.  Allowances  on  impaired  loans  are established  based on the present value of expected future cash flows discounted at the loan's historical  effective  interest rate or, for  collateral-dependent loans, on the fair value of the collateral.  Cash receipts on impaired loans are used to reduce principal.                                            55                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued)  Income  Recognition  on Impaired  and  Nonaccrual  Loans and  Leases:  Loans and leases, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of  principal or interest for a period of more than 90 days,  unless  such loans are  well-secured  and in the  process of collection.  If a loan or lease or a portion of a loan or lease is classified as doubtful  or is  partially  charged  off,  the loan or lease  is  classified  as nonaccrual.  Loans and leases that are on a current  payment  status or past due less than 90 days may also be  classified  as nonaccrual if repayment in full of principal and/or interest is in doubt.  Loans and leases  may be  returned  to accrual  status  when all  principal  and interest amounts contractually due (including arrearages) are reasonably assured of  repayment  within an  acceptable  period of time,  and there is a  sustained period  of  repayment  performance  by the  borrower,  in  accordance  with  the contractual terms of interest and principal.  While a loan or lease is classified as nonaccrual and the future  collectibility of the recorded  balance is doubtful,  collections of interest and principal are generally  applied as a  reduction  to  principal  outstanding.  When the future collectibility  of the  recorded  balance is  expected,  interest  income may be recognized  on a cash basis.  In the case where a  nonaccrual  loan or lease had been partially  charged off,  recognition of interest on a cash basis is limited to that  which  would  have  been  recognized  on the  recorded  balance  at the contractual  interest rate. Cash interest  receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior  charge-offs have been fully recovered.  Premises  and  Equipment:  Premises  and  equipment  are  stated  at cost,  less accumulated depreciation. The provision for depreciation is computed principally by the  straight-line  method  over the  estimated  useful  lives of the related assets.  Leasehold  improvements  are amortized over the shorter of their useful life or the lease term.  Income Taxes:  Provisions for income taxes are based on amounts  reported in the statements of operations (after exclusion of non-taxable income such as interest on state and  municipal  securities)  and include  deferred  taxes on  temporary differences  in the  recognition  of income and  expense  for tax and  financial statement  purposes.  Deferred  taxes are computed using 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 assets and  liabilities  and their  respective  tax bases. Deferred  tax  assets and  liabilities  are  measured  using  enacted  tax rates expected  to apply to  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.  Deferred tax assets are recognized for deductible  temporary  differences  and tax  credit  carryforwards,  and  then a valuation  allowance is  established  to reduce that deferred tax asset if it is "more likely than not" that the related tax benefits will not be realized.  Advertising:  Advertising costs are charged to operations in the year incurred.                                            56                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued)  Net Income Per Share of Common  Stock:  Net income per share of common  stock is computed  by dividing  net income by the  weighted  average  number of shares of common stock outstanding during the year, after giving retroactive effect to the stock dividends and splits. Net income per share--assuming  dilution is computed similar to net income per share  except that the  denominator  is  increased  to include the number of additional  common shares that would have been outstanding if the  dilutive  potential  common  shares  had been  issued.  Included  in the denominator is the dilutive effect of stock options  computed under the treasury method.  Stock Option  Accounting:  At December 31, 2005,  the Company has a  stock-based employee and director  compensation  plan, which is described more fully in Note L. Prior to 2003,  the Company  accounted for those plans under the  recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related  Interpretations.  Effective January 1, 2003, the Company adopted the fair value  recognition  provisions of SFAS No. 123,  Accounting for Stock-Based   Compensation,   prospectively  to  all  employee  awards  granted, modified,  or settled after January 1, 2003. No options were granted in 2003 and 2005.  Awards under the Company's plan vest over five years. The cost related to stock-based  employee  compensation  included in the determination of net income for 2003 and 2004 is less than that which would have been recognized if the fair value based method had been  applied to all awards since the original  effective date of SFAS No. 123. The following  table  illustrates the effect on net income and  earnings  per share if the fair value based  method had been applied to all outstanding and unvested awards in each period.                                                                       2005                 2004                  2003                                                            ---------------     -----------------     ---------------- Net income, as reported                                    $     3,348,529     $       2,907,621     $      2,911,007 Add:  Stock-based employee compensation expense    included in reported net income, net of related tax    effects                                                          61,011                61,011 Deduct:  Total stock based employee compensation    expense determined under fair value based method    for all awards, net of related tax effects                      (61,011)             (185,012)            (179,899)                                                            ---------------     -----------------     ---------------- Pro forma net income                                       $     3,348,529     $       2,783,620     $      2,731,108                                                            ===============     =================     ================                                               57                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE A--SIGNIFICANT ACCOUNTING POLICIES (Continued)                                         2005                   2004                   2003                             ------------------    -------------------     -------------------  Earnings per share:    Basic--as reported       $             1.54    $              1.35     $              1.34    Basic--pro forma                       1.54                   1.30                    1.26    Diluted--as reported                   1.45                   1.25                    1.23    Diluted--pro forma                     1.45                   1.20                    1.16     Off-Balance-Sheet  Financial Instruments: In the ordinary course of business the Company has entered into  off-balance-sheet  financial instruments consisting of commitments  to extend  credit and  standby  letters of credit.  Such  financial instruments are recorded in the financial statements when they become payable.  Operating  Segments:  Reportable  segments are based on products  and  services, geography,  legal structure,  management structure and any other manner in which management  desegregates a company for making operating  decisions and assessing performance.  The Company has  determined  that its  business is  comprised of a single operating segment.  New  Accounting  Pronouncements:  In December  2004,  the  Financial  Accounting Standards  Board  (FASB)  issued a  revision  of SFAS No.  123,  Accounting  for Stock-Based  Compensation  establishing revised standards for the accounting for transactions  in which an entity  exchanges its equity  instruments for goods or services.  This Statement no longer allows as an alternative  the use of APB No. 25's  intrinsic  value  method  of  accounting  for stock  options,  as had been provided  under the  original  SFAS No.  123.  Under APB No. 25,  issuing  stock options generally resulted in no recognition of compensation expense.  Under the revised SFAS No. 123,  entities  are required to recognize  the cost of services received in exchange for awards of equity  instruments  based on the  grant-date fair value.  This revised SFAS is effective  for the Company  beginning in 2006. All options  issued after the  effective  date of this SFAS,  as well as options granted in the past for which the  requisite  services have not been provided as of the effective date of this SFAS, are required to be recorded as  compensation expense.  The  implementation  of this SFAS  will have no impact on the  Company since the Company recorded  compensation expense for stock options granted after January 1, 2004 and there are no remaining  requisite services for stock options granted prior to January 1, 2004.   NOTE B--RESTRICTIONS ON CASH AND DUE FROM BANKS  Cash and due from banks include amounts the Bank is required to maintain to meet certain average  reserve and  compensating  balance  requirements of the Federal Reserve.  The total  requirement  at December 31, 2005 and 2004 was $586,000 and $424,000, respectively.                                              58                               SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE C--INVESTMENT SECURITIES  The amortized cost and approximate fair value of investment securities are summarized as follows:                                                            Amortized             Unrealized             Unrealized                                                        Cost                   Gain                   Losses          Fair Value December 31, 2005:                                  ------------          ------------          ------------       ------------  Securities Available-For-Sale  U.S. Treasury securities                           $  5,462,455                                $    (89,799)      $  5,372,656  U.S. Government agency   securities                                          28,982,106                                    (437,668)        28,544,438                                                     ------------                                ------------       ------------                                                     $ 34,444,561                                $   (527,467)     $  33,917,094 Securities Held-to-Maturity                         ============                                ============      =============  Municipal securities                               $ 16,499,865          $    295,863          $   (161,209)     $  16,634,519                                                     ============          ============          ============      ============= December 31, 2004: Securities Available-For-Sale  U.S. Treasury securities                           $    498,959                                $     (2,709)     $     496,250  U. S. Government agency   securities                                          19,998,410                                    (241,170)        19,757,240                                                     ------------                                ------------      -------------                                                    $  20,497,369                                $   (243,879)     $  20,253,490 Securities Held-to-Maturity                        =============                                ============      =============  Municipal Securities                              $  17,418,303          $    485,044          $    (60,915)     $  17,842,432                                                    =============          ============          ============      =============   Contractual maturities of investment securities at December 31, 2005 were as follows:                                                            Securities Available-For-Sale              Securities Held-To-Maturity                                                      -----------------------------              ---------------------------                                                      Amortized                                  Amortized                                                        Cost            Fair Value                 Cost          Fair Value                                                      -----------------------------              -------------------------- Due in one year or less                              $11,219,100       $11,120,036              $   987,354    $   982,077 Due after one year through  five years                                           22,225,461        21,798,029                3,337,364      3,332,080 Due after five years through  ten years                                             1,000,000           999,029                8,554,139      8,579,084 Due after ten years                                                                               3,621,008      3,741,278                                                       $34,444,561       $33,917,094              $16,498,865    $16,634,519                                                      ===========       ===========              ===========    ===========                                            59                               SONOMA VALLEY BANCORP AND SUBSIDIARY              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE C--INVESTMENT SECURITIES (Continued)  During  2005,   2004  and  2003,   the  Company  did  not  sell  any  securities available-for-sale.  As of  December  31,  2005,  investment  securities  with a  carrying  amount of $7,675,665  and an  approximate  fair  value  of  $7,854,363  were  pledged,  in accordance  with  federal  and state  requirements,  as  collateral  for  public deposits.  Investment  securities  with a  carrying  amount  and  fair  value of $5,284,008  at December  31, 2005 were pledged to meet the  requirements  of the Federal  Reserve and the U.S.  Department  of Justice.  As of December 31, 2004, investment  securities  with a carrying  amount of $5,212,119 and an approximate fair value of  $5,551,269  were pledged,  in  accordance  with federal and state requirements,  as collateral for public deposits.  Investment  securities with a carrying  amount and fair value of  $4,975,141 at December 31, 2004 were pledged to meet the  requirements  of the  Federal  Reserve and the U.S.  Department  of Justice.  The following  table shows the  investments'  gross  unrealized  losses and fair value,  aggregated  by  investment  category and length of time that  individual securities have been in a continuous unrealized loss position, at December 31.                                                                                           2005                                                    -------------------------------------------------------------------                                                           Less Than 12 Months                12 Months or Greater                                                    -------------------------------     -------------------------------                                                         Fair           Unrealized           Fair           Unrealized Description of Securities                               Value            Losses             Value            Losses - -------------------------                          -------------     -------------     -------------     -------------  U.S. Treasury securities                           $     982,969     $      12,614     $   4,389,687     $      77,185 U.S. Government agency securities                      7,018,348            46,292        21,526,090           391,376 Municipal securities                                   3,380,940            37,025         4,771,878           124,184                                                    -------------     -------------     -------------     ------------- Total temporarily impaired securities              $  11,382,257     $      95,931     $  30,687,655     $     592,745                                                    =============     =============     =============     =============                                                                                     2004                                                    -------------------------------------------------------------------                                                           Less Than 12 Months                12 Months or Greater                                                    -------------------------------     -------------------------------                                                         Fair           Unrealized           Fair           Unrealized Description of Securities                               Value            Losses             Value            Losses - -------------------------                          -------------     -------------     -------------    --------------  U.S. Treasury securities                           $     496,250     $       2,709 U.S. Government agency securities                     17,510,048           188,362     $   2,247,192    $       52,808 Municipal securities                                   5,835,964            40,747           867,178            20,168                                                    -------------     -------------     -------------    -------------- Total temporarily impaired securities              $  23,842,262     $     231,818     $   3,114,370    $       72,976                                                    =============     =============     =============    ==============                                            60                          SONOMA VALLEY BANCORP AND SUBSIDIARY                      NOTES TO FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE C--INVESTMENT SECURITIES (Continued)  There were 22 U.S.  government agency  securities,  5 U.S. Treasury Notes and 14 municipal  securities in a continuous  unrealized  loss position at December 31, 2005 for 12 months or more. There were 20 U.S. government agency securities, one U.S. Treasury Note and 15 municipal securities that were temporarily impaired as of December 31, 2004. The unrealized  losses on these  securities were caused by interest rate  increases.  The  contractual  terms of these  investments  do not permit the issuer to settle the securities at a price less than the par value of the  investment.  Because  the  Company has the ability and intent to hold these investments until a recovery of fair value,  which may be maturity,  the Company does not consider  these  investments to be  other-than-temporarily  impaired at December 31, 2005 and 2004.   NOTE D--LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES  The composition of the loan and lease portfolio was as follows at December 31:                                                           2005                      2004                                         -----------------------      ------------------------  Commercial                              $ 118,590,731      69.1%     $ 109,324,569      71.2% Consumer                                   21,804,507      12.7%        16,249,913      10.6% Real estate mortgage                       13,251,137       7.7%         7,732,177       5.0% Real estate construction                   18,004,805      10.5%        20,291,506      13.2% Lease financing receivables, net of    unearned income of $4,357 in    2005 and $8,034 in 2004                     25,822       0.0%            47,717       0.0%                                         -------------     -----      -------------     -----                                           171,677,002     100.0%       153,645,882     100.0%                                                           =====                        ===== Deferred loan fees and costs,  net           (482,410)                    (485,223) Allowance for loan and lease losses                                     (2,776,507)                  (2,428,572)                                         -------------                -------------                                         $ 168,418,085                $ 150,732,087                                         =============                =============    At December 31, 2005, the recorded  investment in loans for which impairment has been  recognized  in  accordance  with SFAS No. 114 totaled  $1,137,000,  with a corresponding  valuation  allowance  of  $250,000.  At December  31,  2004,  the recorded  investment  in loans  for  which  impairment  has been  recognized  in accordance  with  Statement  No. 114 totaled  $1,233,000,  with a  corresponding valuation allowance of $223,000. For the years ended December 31, 2005, 2004 and 2003,  the  average  recorded  investment  in impaired  loans was  approximately $1,060,000,  $1,263,000 and $843,000, respectively.  During 2005, 2004 and 2003, $8,000,  $7,000 and $8,000 of interest was received and  recognized  on impaired loans, respectively.                                            61                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE D--LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)  In  addition,  at  December  31,  2005 and 2004,  the Company did not have other nonaccrual loans for which impairment had not been recognized.  The Company has no  commitments  to loan  additional  funds to the  borrowers of impaired or nonaccrual loans.  The  maturity  and  repricing  distribution  of the loan and lease  portfolio at December 31:                                                          2005                2004 Fixed rate loan maturities                      -------------      -------------   Three months or less                          $  10,168,260      $   3,913,861   Over three months to twelve months               12,279,697         12,329,431   Over one year to five years                      90,625,410         57,186,925   Over five years                                  23,608,069         31,403,430 Floating rate loans repricing   Quarterly or more frequently                     30,197,653         45,816,022   Quarterly to annual frequency                        79,850            381,109   One to five years frequency                       3,724,175          1,603,134                                                 -------------      -------------                                                   170,683,145        152,633,912 Nonaccrual loans                                      993,888          1,011,970                                                 -------------      -------------                                                 $ 171,677,002      $ 153,645,882                                                 =============      =============   An analysis of the changes in the allowance for loan and lease losses is as follows for the years ended December 31:                                                     2005           2004           2003                                             ----------     ----------     ----------  Beginning balance                           $2,428,572     $2,634,625     $2,781,962 Provision for loan and lease losses            360,000        130,000         20,000 Loans charged off:    Commercial                                  (53,337)      (290,000)      (142,572)    Consumer                                    (16,976)       (63,007)       (41,161)                                             ----------     ----------     ----------                                                (70,313)      (353,007)      (183,733) Recoveries:    Commercial                                   55,055         15,416          8,320    Consumer                                      3,193          1,538          8,076                                             ----------     ----------     ----------                                                 58,248         16,954         16,396                                             ----------     ----------     ---------- Ending balances                             $2,776,507     $2,428,572     $2,634,625                                             ==========     ===========    ==========                                            62                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE E--PREMISES AND EQUIPMENT  Premises and equipment consisted of the following at December 31:                                                           2005                   2004                                                 -----------------     ------------------        Land                                      $         175,000     $          175,000       Building                                             71,943                 71,943       Leasehold improvements                              797,191                768,334       Furniture, fixtures and equipment                 1,961,130              1,893,372                                                 -----------------     ------------------                                                         3,005,264              2,908,649       Less: Accumulated depreciation                   (1,826,598)            (1,543,770)                                                 -----------------     ------------------                                                  $       1,178,666     $        1,364,879                                                 =================     ==================    NOTE F--TIME DEPOSITS  The maturities of time deposits at December 31, 2005 are as follows:           Maturing within one year                  $45,913,000       Maturing in one year to two years           6,673,000       Maturing two years through five years       3,908,000                                                 -----------                                                 $56,494,000                                                 ===========     NOTE G--FEDERAL FUNDS CREDIT LINES  The Company has uncommitted  federal funds lines of credit agreements with other banks. The maximum borrowings available under these lines totaled $22,000,000 at December 31, 2005. The Company pledged loans totaling $108,872,000 as collateral to secure advances from the Federal Home Loan Bank of up to  $44,678,580.  There were no  borrowings  outstanding  under the  agreements at December 31, 2005 and 2004.   NOTE H--EMPLOYEE BENEFIT PLANS  The Company has a 401(k)  Employee  Savings Plan (the Plan) in which the Company matches a portion of the employee's  contribution each payday. All employees are eligible  for  participation  following  three  months  of  employment.  Bancorp contributions  are 100%  vested at all times.  The  Company  made  contributions totaling $131,549 in 2005, $109,628 in 2004 and $92,012 in 2003.                                             63                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE H--EMPLOYEE BENEFIT PLANS (Continued)  The Company purchased single premium life insurance  policies in connection with the  implementation  of retirement plans for four key officers and for the Board of Directors.  The policies  provide  protection  against the adverse  financial effects  from the death of a key officer and provide  income to offset  expenses associated with the plans. The officers are insured under the policies,  but the Company is the owner and  beneficiary.  At December 31, 2005 and 2004,  the cash surrender   value  of  these  policies   totaled   $9,239,439  and   $8,913,136, respectively.  The  retirement  plans are  unfunded  and  provide  for the  Company  to pay the officers and directors  specified amounts for specified periods after retirement and allow them to defer a portion of current  compensation  in exchange  for the Company's  commitment to pay a deferred  benefit at retirement.  If death occurs prior to or during retirement, the Company will pay the officer's beneficiary or estate the benefits set forth in the plans.  Deferred  compensation is vested as to the amounts  deferred.  Liabilities  are recorded for the  estimated  present value of future salary continuation benefits and for the amounts deferred by the officers and directors.  At December 31, 2005 and 2004,  the liability  recorded for the executive officer  supplemental  retirement plan totaled  $1,701,811 and $1,494,540, respectively. The amount of pension expense related to this plan for 2005 and 2004 was $207,271 and $54,570,  respectively.  At December 31, 2005 and 2004,  the  liability  recorded for the director  supplemental  retirement  plan totaled  $476,001  and  $396,696,  respectively.  The amount of pension  expense related to this plan for 2005 and 2004 was $79,305 and  $103,043,  respectively. At  December  31,  2005  and  2004,  the  liability  recorded  for the  deferred compensation plan totaled $1,285,194 and $1,129,334, respectively. The amount of expense  related  to this  plan  for 2005 and  2004  was  $86,103  and  $84,785, respectively.  The  following  are the  components  of the  accumulated  benefit obligation related to the executive officer and director supplemental retirement plans as of December 31:                                                                      Directors                           Officers                                                    ----------------------------        ------------------------------                                                       2005              2004              2005              2004                                                    ----------        ----------        -----------        -----------  Projected benefit obligation                       $  567,281        $  500,810        $ 1,630,908        $ 1,405,912 Unamortized net transition obligation                 (91,280)         (104,114)            70,903             88,628                                                    ----------        ----------        -----------        -----------  Benefit obligation included in other               $  476,001        $  396,696        $ 1,701,811        $ 1,494,540     Liabilities                                    ==========        ==========        ===========        ===========     The  weighted-average  discount rate used in determining  the actuarial  present value of the projected  benefit  obligation was 6.75% for both 2005 and 2004. No compensation  increases were assumed.  The entire accumulated benefit obligation was fully vested at December 31, 2005 and 2004.                                           64                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE H--EMPLOYEE BENEFIT PLANS (Continued)  The following is a  reconciliation  of the beginning and ending  balances of the benefit obligation for the years ended December 31:                                                                      Directors                                     Officers                                              ----------------------------------------   ------------------------------------------                                                 2005           2004           2003           2005          2004           2003                                              ------------   -----------   -----------   ------------   ------------   ------------    Benefit obligation at beginning of year      $    396,696   $   293,653   $   208,626   $  1,494,540   $  1,439,970   $  1,223,570 Net periodic pension cost:     Service cost                                    30,469        39,201        71,387        134,943         35,454        319,856    Interest cost on projected benefit       Obligation                                   35,679        36,975        13,640         90,054         10,630        122,265    Amortization of unrecognized       liability at transition                       7,990        36,201                      (17,726)         8,486        (56,811)    Amendments                                       5,167        (9,334)                                                  (168,910)                                              -------------  -----------   -----------   ------------   ------------   ------------    Net periodic pension cost recognized            79,305       103,043        85,027        207,271         54,570        216,400                                              -------------  -----------   -----------   ------------   ------------   ------------ Benefit obligation at end of year            $    476,001   $   396,696   $   293,653   $  1,701,811   $  1,494,540   $  1,439,970                                              =============  ===========   ===========   ============   ============   ============    The following  benefit  payments,  which reflect  expected  future  service,  as appropriate, are expected to be paid:                                            Directors         Officers                                       ----------        ---------        2007                            $    1,750       2008                                 7,035       $   27,592       2009                                10,676           27,592       2010                                24,389          177,592       2011 to 2015                       341,981        1,501,140                                              65                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE I--NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE  Non-interest income is comprised of the following for the years ended December 31:                                                                            2005                2004                 2003                                                                  ----------------    ----------------    ----------------  Service charges on deposit accounts                              $      1,258,728    $      1,089,315    $      1,033,990 Other fee income                                                          364,157             305,847             323,780 Life insurance earnings                                                   326,303             297,536             342,888 Investment securities gains (losses)                                        5,094                   -                   - Other (none exceeding 1% of revenues)                                      14,112              17,073              14,465                                                                  ----------------    ----------------    ----------------                                                                  $      1,968,394     $     1,709,771     $     1,715,123                                                                  ================    ================    ================  Other non-interest expense is comprised of the following for the years ended December 31:                                                                        2005                2004                2003                                                                  ---------------    ----------------    ----------------  Professional and consulting fees                                 $       952,681     $       750,846     $       679,460 Data processing                                                          478,991             462,709             473,932 Stationary and supplies                                                  122,578             168,496             160,992 Staff related                                                            173,777             167,026             175,801 Advertising and business development                                     245,063             201,409             165,142 Postage and telephone                                                    111,429             112,276             123,269 Assessments and insurance                                                150,049             152,172              30,948 Other (none exceeding 1% of revenues)                                    204,318             185,170             176,821                                                                  ---------------    ----------------    ----------------                                                                  $     2,438,886     $     2,200,104         $ 1,986,365                                                                  ===============    ================    ================                                               66                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE J--INCOME TAXES  The provision for income taxes is comprised of the following:                                      2005                 2004                 2003                           -----------------     ----------------    -----------------  Current      Federal              $       1,589,736     $        475,585    $         779,365      State                          594,732              283,965              384,330                           -----------------     ----------------    -----------------                                   2,184,468              759,550            1,163,695 Deferred      Federal                       (382,682)             520,909              228,634      State                          (90,630)             171,014               54,068                           -----------------     ----------------    -----------------                                    (473,312)             691,923              282,702                           -----------------     ----------------    ----------------- Provision for income      $       1,711,156     $      1,451,473    $       1,446,397  taxes                    =================     ================    =================     The following is a reconciliation of income taxes computed at the Federal   statutory income tax rate of 34% to the effective income tax rate used for the   provision for income taxes:                                                          2005                2004                  2003                                             -----------------    -----------------     -----------------   Income tax at Federal statutory rate       $       1,720,293    $       1,482,092     $       1,481,517        State franchise tax, less Federal             income tax benefit                        361,990              311,867               311,746       Interest on municipal obligations exempt                                                                             )             from Federal tax                         (247,467)            (269,872)             (217,541)       Life insurance earnings                        (134,288)            (122,449)             (141,113)       Incentive stock option expense                   42,669               42,669       Meals and entertainment                           5,452                7,050                 8,175       Other differences                               (37,493)                 116                 3,613                                             -----------------    -----------------     -----------------  Provision for income taxes                 $       1,711,156    $       1,451,473     $       1,446,397                                             =================    =================     =================                                                 67                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE J--INCOME TAXES (Continued)  The tax effects of temporary differences that give rise to the components of the net deferred tax asset recorded as an other asset as of December 31 were as follows:                                                                                2005                 2004                 2003                                                                     -----------------     ----------------    -----------------       Deferred tax assets:          Nonqualified benefit plans                                 $       1,427,237     $      1,244,196    $       1,125,765          Allowance for loan losses                                            979,526              840,827              959,890          Unrealized securities holding losses                                 217,076              100,407          Accrued liabilities                                                  210,374              111,035               80,611          State franchise taxes                                                202,481               96,810              130,672          Other                                                                 64,389               21,038               13,773                                                                     -----------------     ----------------    -----------------                                       Total deferred tax assets             3,101,083            2,414,313            2,310,711       Deferred tax liabilities:          Depreciation                                                         128,231              143,513               74,347          Unrealized securities holding gains                                                                             16,477          Other                                                                 62,809               49,269               40,956                                                                     -----------------     ----------------    -----------------                                  Total deferred tax liabilities               191,040              192,782              131,780                                                                     -----------------     ----------------    -----------------                                         Net deferred tax assets     $       2,910,043     $      2,221,531    $       2,178,931                                                                     =================     ================    =================   Amounts  presented for the tax effects of temporary  differences  are based upon estimates and  assumptions and could vary from amounts  ultimately  reflected on the Company's tax returns.  Accordingly, the variances from amounts reported for prior  years are  primarily  the  result of  adjustments  to  conform to the tax returns as filed.  Income tax  receivable  was $219,573 at December 31, 2005 and income tax payable was $4,006 at December 31, 2004.                                             68                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE K--EARNINGS PER SHARE  The following is the computation of basic and diluted earnings per share for the years ended December 31:                                                            2005                 2004              2003                                                   -----------           -----------        ----------- Basic:  Net income                                        $ 3,348,529           $ 2,907,621        $ 2,911,007                                                   ===========           ===========        =========== Weighted-average common shares outstanding          2,170,866             2,148,558          2,165,066                                                   ===========           ===========        =========== Earnings per share                                $      1.54           $      1.35        $      1.34                                                   ===========           ===========        ===========  Diluted:  Net income                                        $ 3,348,529           $ 2,907,621        $ 2,911,007                                                   ===========           ===========        =========== Weighted-average common shares outstanding          2,170,866             2,148,558          2,165,066  Net effect of dilutive stock options - based   on the treasury stock method using average   market price                                        132,773               179,825            199,367                                                   -----------           -----------        -----------  Weighted-average common shares outstanding   and common stock equivalents                      2,303,639             2,328,383          2,364,433                                                   ===========           ===========        =========== Earnings per share - assuming dilution            $      1.45           $      1.25        $      1.23                                                   ===========           ===========        ===========    NOTE L--STOCK OPTION PLAN  The Company has a stock  option  plan (the Plan),  effective  March 31, 1996 and terminated on May 14, 2002 under which incentive and nonstatutory stock options, as  defined  under  the  Internal  Revenue  Code,  were  granted.  The  Plan was administered by a Committee  appointed by the Board.  No additional  options are available for granting under this plan. The options  granted under this plan may have an exercise period of no more than 10 years, a portion of which are subject to a graded vesting schedule of 20% per year.                                              69                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE L--STOCK OPTION PLAN (Continued)  The Company approved an equity incentive plan (the Plan), effective May 14, 2002 and terminating May 14, 2012, under which stock options, restricted stock, stock appreciation  rights and stock bonuses may be granted.  The Plan is administered by a Committee appointed by the Board.  Options  representing  123,555 shares of the Company's authorized and unissued common stock may be granted under the Plan by the  Committee  to  directors  and  employees of the Company at a price to be determined  by the  Committee but shall not be less than 100% of the fair market value of the  shares on the date the  incentive  stock  option is  granted.  The options may have an  exercise  period of no more than 10 years and vesting is at the discretion of the Committee.  The number of options  granted in January 2004 was 67,500. No options were granted in 2005 and 2003.  The fair value of options  granted is  estimated  on the date of grant using the Black-Scholes   option   pricing  model  with  the  following   weighted-average assumptions used for grants in 2004: dividend yield of zero; expected volatility of 37.76 percent;  risk-free  interest rate of 4.39 percent and expected life of 10 years.  A summary of stock option  activity,  adjusted to give effect to stock dividends and stock splits follows for the years ended December 31:                                                                           Incentive Stock Options                             --------------------------------------------------------------------------------------------------                                           2005                              2004                            2003                             ------------------------------    ------------------------------    ------------------------------                                Weighted-         Shares          Weighted-        Shares          Weighted-         Shares                                 Average                           Average                          Average                             Exercise Price                    Exercise Price                    Exercise Price                             ---------------    -----------    ---------------   ------------    --------------    ------------  Shares under option at    beginning of year        $         12.94        179,730    $          8.27        147,269    $         8.24         170,435  Options granted                                                         20.71         67,500  Options exercised                      7.70        (45,295)              8.29        (35,039)             8.07         (23,166)  Options cancelled                     20.71         (1,350)                                                -----------                      ------------                      ------------  Shares under option at    end of year                        14.64        133,085              12.94        179,730              8.27         147,269                                                ===========                      ============                      ============ Options exercisable at    end of year                                      93,935                           125,730                           142,635  Weighted-average fair  value of options  granted during the  year                                                                    7.68                                             70                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE L--STOCK OPTION PLAN (Continued)                                                                          Nonstatutory Stock Options                                   ------------------------------------------------------------------------------------------                                                 2005                           2004                              2003                                   --------------------------      --------------------------      --------------------------                                     Weighted-                       Weighted-                       Weighted-                                      Average                         Average                         Average                                   Exercise Price     Shares       Exercise Price     Shares       Exercise Price      Shares                                   --------------    --------      --------------    --------      --------------     --------  Shares under option at  beginning of year                $         8.05     208,465      $         8.00     319,670      $         7.89      338,145 Options exercised                           7.94     (23,165)               7.90    (111,205)               6.09      (18,475)                                                     --------                        --------                         -------- Shares under option at  end of year                                8.07     185,300                8.05     208,465                8.00      319,670                                                     ========                        ========                         ========  Options exercisable at  end of year                                         185,300                         208,465                          273,341    The following table summarizes information about fixed stock options outstanding at December 31, 2005:                                                  Options Outstanding                           ------------------------------------------------------------                                             Weighted-Average       Range of                  Number          Remaining           Weighted-Average    Exercise Prices           Outstanding     Contractual Life        Exercise Price - ------------------        --------------    -------------------    ----------------- $ 5.46  to  $ 6.53                 6,735             1.27 years    $            5.79 $ 7.83  to  $ 7.97               211,916             3.29 years                 7.96 $ 9.73  to  $10.77                31,930             2.18 years                10.17 $14.51  to  $20.71                67,804             8.02 years                20.56                           --------------                                  318,385             5.08 years                10.81 $ 5.46  to  $20.71        ==============                                               71                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE L--STOCK OPTION PLAN (Continued)                                    Options Exercisable                       -----------------------------------     Range of               Number        Weighted-Average  Exercise Prices         Outstanding      Exercise Price - ------------------    --------------   ------------------ $ 5.46  to  $ 6.53             6,735   $            5.79 $ 7.83  to  $ 7.97           211,916                7.96 $ 9.73  to  $10.77            31,930               10.17 $14.51  to   20.71            28,654               20.35                       --------------  $5.46 to $20.71              279,235                9.43                       ==============    NOTE M--RELATED PARTY TRANSACTIONS  The Company has entered into transactions with its directors, executive officers and their  affiliates  (related  parties).  Such  transactions  were made in the ordinary  course of business  on  substantially  the same terms and  conditions, including  interest rates and collateral,  as those  prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management,  involve more than normal credit risk or present  other  unfavorable features. The following is a summary of the aggregate activity involving related party borrowers at December 31, 2005 and 2004:                                                     2005                 2004                                           ----------------    ------------------ Loans outstanding at beginning of year    $      3,474,000    $        3,095,000 Loans disbursements                              1,730,000             1,040,000 Loan repayments                                 (2,547,000)             (661,000)                                           ----------------    ------------------       Loans outstanding at end of year    $      2,657,000    $        3,474,000                                           ================    ==================    At December 31, 2005, commitments to related parties of approximately $2,220,000 were  undisbursed.   Deposits  received  from  directors  and  officers  totaled $8,351,000 and $6,841,000 at December 31, 2005 and 2004, respectively.  The Company  leases its Glen Ellen office from a director of the Company under a noncancellable  operating lease.  Lease expense for the years ended December 31, 2005 and  2004 was  $14,140  and  $13,596,  respectively.  The  remaining  lease commitment is approximately $33,860 through March 2008 including a                                            72                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE M--RELATED PARTY TRANSACTIONS (Continued)  minimum inflationary increase of 4% per year. The monthly lease payments will be increased  annually  based upon the Consumer  Price Index,  but not less than 4% annually.  The term of the lease is 5 years  with an option to extend  the lease term  for  two  additional  5  year  terms  at the  same  Consumer  Price  Index limitations.   NOTE N--COMMITMENTS AND CONTINGENT LIABILITIES  Lease Commitments:  The Company leases its three Sonoma offices,  the Glen Ellen office and the Banco de Sonoma office under noncancelable  operating leases with remaining terms of approximately four years, five years, five years, three years and three years, respectively. All of the leases require adjustments to the base rent for changing price indices and two have a minimum  annual  increase of four percent.  The Sonoma main office lease and the Sonoma  Finance Center lease have the option to renew for two  consecutive  five-year  terms and the Sonoma  annex office has an option to renew for one five-year period and one four-year period. The Glen Ellen  office and the Banco de Sonoma  office lease each have an option to renew for two additional  five-year  terms.  The following  table  summarizes future minimum commitments under the noncancelable operating leases.        Year ended December 31:                     2006           $   348,905                     2007               360,842                     2008               359,937                     2009               205,687                     2010                25,363                                    -----------                                    $ 1,300,734                                    ===========    Rental expense was $347,000 in 2005, $318,000 in 2004 and $289,000 in 2003.  Financial  Instruments  with  Off-Balance-Sheet  Risk:  The Company's  financial statements do not reflect various  commitments and contingent  liabilities which arise in the normal  course of  business  and which  involve  elements of credit risk,  interest rate risk and liquidity risk.  These  commitments and contingent liabilities are  commitments to extend credit and standby  letters of credit.  A summary of the Company's  commitments and contingent  liabilities at December 31 is as follows:                                                      Contractual Amounts                                              2005               2004                                          -------------     -------------            Commitments to extend credit   $  48,643,000     $  34,574,000           Standby letters of credit            348,000           360,000                                             73                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE N--COMMITMENTS AND CONTINGENT LIABILITIES (Continued)  Commitments to extend credit and standby  letters of credit include  exposure to some credit loss in the event of nonperformance  of the customer.  The Company's credit policies and procedures for credit  commitments and financial  guarantees are the same as those for  extensions of credit that are recorded on the balance sheet.  Because these instruments have fixed maturity dates, and because many of them  expire  without  being  drawn  upon,  they do not  generally  present  any significant liquidity risk to the Company.  Commitments  to extend  credit are  agreements  to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally  have fixed  expiration  dates or other  termination  clauses  and may require  payment  of  a  fee.  The  Company  evaluates  each  customer's  credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company  upon  extension  of credit,  is based on  management's credit  evaluation  of the  customer.  Collateral  held  varies but may  include accounts receivable,  inventory, property, plant, and equipment, certificates of deposits and income-producing commercial properties.  Standby letters of credit are conditional  commitments  issued by the Company to guarantee the performance of a customer to a third party.  Those  guarantees are primarily  issued to support  public and  private  borrowing  arrangements.  The credit risk  involved in issuing  letters of credit is  essentially  the same as that involved in extending facilities to customers.  The Company has not  incurred  any losses on its  commitments  in 2005,  2004 or 2003.  As  a  guarantor  of  its  customer's  credit  card  accounts,  the  Company  is contingently  liable  for  credit  card  receivable  balances  held  by  another financial  institution should the customers default. The total amount guaranteed as of December 31, 2005 and 2004 was $207,000 and $210,500, respectively.   NOTE O--CONCENTRATIONS OF CREDIT RISK  Most of the Company's  business  activity is with  customers  located within the State of California,  primarily in Sonoma  County.  The economy of the Company's primary service area is heavily  dependent on the area's major  industries which are tourism and agriculture,  especially wineries, dairies and cheese producers. General economic  conditions or natural disasters  affecting the primary service area or its major  industries  could  affect the ability of  customers  to repay loans and the value of real property used as collateral. While the Company has a diversified loan portfolio, approximately 89% of these loans are secured by real estate in its service area.  The  concentrations  of  credit  by type of loan  are set  forth  in Note D. The distribution of commitments to extend credit  approximates  the  distribution of loans  outstanding.  In  addition,  the  Company  has  loan  commitments  in the wine/agricultural   industry,   tourism   industry   and   construction   loans, representing  6%,  13% and 18%,  of  outstanding  loans,  respectively.  Standby letters of credit were granted primarily to commercial                                           74                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE O--CONCENTRATIONS OF CREDIT RISK (Continued)  borrowers.  The Company,  as a matter of policy,  does not extend  credit to any single  borrower or group of related  borrowers on a secured  basis in excess of 25% of its  unimpaired  capital  (shareholders'  equity plus the  allowance  for credit  losses)  and on an  unsecured  basis in excess of 15% of its  unimpaired capital.  The  concentrations  of investments  are set forth in Note C. The Company places its investments primarily in financial instruments backed by the U.S. Government and its agencies or by high quality  financial  institutions,  municipalities or corporations.   The  Company  has   significant   funds   deposited   with  four correspondent banks. In addition,  deposits with two correspondent banks were in excess of the federally  insured limit by $1,804,027 at December 31, 2005. While management  recognizes the inherent risks involved in such concentrations,  this concentration provides the Company with an effective and cost efficient means of managing its liquidity  position and item processing needs.  Management  closely monitors the financial  condition of their  correspondent  banks on a continuous basis.  The  Company  also  maintains  additional  deposit  accounts  with other correspondent   banks  should   management   determine  that  a  change  in  its correspondent banking relationship would be appropriate.  At  December  31,  2005,  the  Company  had life  insurance  policies  with cash surrender values of $2,404,926,  $1,979,911, $1,796,550 and $1,782,142 with four insurance companies, which represented 11%, 9%, 8% and 8%, respectively,  of the Company's net worth.  Management  closely  monitors the financial  condition and rating of these insurance companies on a regular basis.   NOTE P--REGULATORY MATTERS  Banking  regulations limit the amount of cash dividends that may be paid without prior approval of the Bank's  regulatory  agency.  Cash dividends are limited to the lesser of retained earnings, if any, or net income for the last three years, net of the amount of any other  distributions  made to shareholders  during such periods.  As of December 31, 2005,  $3,872,811  was  available for cash dividend distribution without prior approval.  The Bank is subject to various regulatory capital  requirements  administered by its primary federal regulator, the Federal Deposit Insurance Corporation (FDIC). Failure to meet minimum capital requirements can initiate certain mandatory--and possibly  additional  discretionary--actions  by regulators that, if undertaken, could have a direct material effect on the Bank's  financial  statements.  Under capital adequacy  guidelines and the regulatory  framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities,  and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank's capital amounts and classification  are also subject to qualitative  judgments by the regulators about components, risk weightings, and other factors.                                               75                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE P--REGULATORY MATTERS (Continued)  Quantitative  measures  established  by  regulation to ensure  capital  adequacy require the Bank to maintain  minimum amounts and ratios (set forth in the table below)  of  total  and  Tier  I  capital  (as  defined  in the  regulations)  to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2005, that the Bank meets all capital adequacy requirements to which it is subject.  As of December 31, 2005, the most recent  notification from the FDIC categorized the  Bank  as  well  capitalized  under  the  regulatory  framework  for  prompt corrective  action. To be categorized as well capitalized the Bank must maintain minimum total  risk-based,  Tier I risk-based and Tier I leverage  ratios as set forth in the table.  There are no conditions  or events since that  notification that management  believes have changed the  institution's  category.  The Bank's actual capital amounts and ratios are also presented in the table.                                                                                                         To Be Well                                                                                             Capitalized Under                                                                       For Capital           Prompt Corrective                                                Actual               Adequacy Purposes       Action Provisions                                          Amount      Ratio       Amount       Ratio     Amount        Ratio                                         --------     ------     --------     ------    -------        -----                                                                         (in thousands)  As of December 31, 2005:    Total Capital       (to Risk Weighted Assets)         $ 24,514     11.4%     >$ 17,211     >8.0%     >$ 21,513     > 10.0%                                                                -             -         -             -    Tier I Capital       (to Risk Weighted Assets)         $ 21,824     10.1%     >$  8,605     >4.0%     >$ 12,908     >  6.0%                                                                -             -         -             -    Tier I Capital       (to Average Assets)               $ 21,824      9.1%     >$  9,576     >4.0%     >$ 11,970     >  5.0%                                                                -             -         -             -  As of December 31, 2004:    Total Capital         (to Risk Weighted Assets)       $ 21,934     11.3%     >$ 15,468     >8.0%     >$ 19,335     > 10.0%                                                                -             -         -             -    Tier I Capital         (to Risk Weighted Assets)       $ 19,517     10.1%     >$  7,734     >4.0%     >$ 11,601     >  6.0%                                                                -             -         -             -    Tier I Capital         (to Average Assets)             $ 19,517      8.9%     >$  8,732     >4.0%     >$ 10,915     >  5.0%                                                                -             -         -             -                                                 76                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE Q--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY  A  condensed  balance  sheet as of  December  31,  2005 and 2004 and the related condensed  statement of operations  and cash flows for the years ended  December 31, 2005,  2004 and 2003 for Sonoma  Valley  Bancorp  (parent  company only) are presented as follows:                              Condensed Balance Sheets                            December 31, 2005 and 2004                                                                  2005             2004                                                           -----------     ----------- Assets      Cash                                                 $   911,439     $   662,310      Other assets                                             289,877         706,597      Investment in common stock of subsidiary              22,459,620      19,373,503                                                           -----------     -----------                                      Total assets         $23,660,936     $20,742,410                                                           ===========     =========== Liabilities      Accrued expenses                                     $   221,143     $    61,250  Shareholders' equity      Common stock                                          16,256,427      15,528,940      Retained earnings and other equity                     7,183,366       5,152,220                                                           -----------     -----------         Total liabilities and shareholders' equity        $23,660,936     $20,742,410                                                           ===========     ===========                            Condensed Statements of Operations               For the years ended December 31, 2005, 2004 and 2003                                                               2005          2004           2003                                                      ----------    ----------     ---------- Dividend from subsidiary                             $  500,000    $4,000,000     $1,500,000 Expenses                                                601,886       303,690        145,553                                                      ----------    ----------     ---------- Income (loss) before income taxes and equity           (101,886)    3,696,310      1,354,447      in undistributed income of subsidiary Equity in undistributed net income of subsidiary      3,252,996      (877,370)     1,497,186 Income tax benefit                                      197,419        88,681         59,374                                                      ----------    ----------     ---------- Net income                                           $3,348,529    $2,907,621     $2,911,007                                                      ==========    ==========     ==========                                              77                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE Q--CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (Continued)                            Condensed Statements of Cash                   Flows For the years ended December 31, 2005,                                   2004 and 2003                                                                   2005            2004             2003                                                           -----------     -----------     ----------- Operating activities:     Net income                                            $ 3,348,529     $ 2,907,621     $ 2,911,007     Adjustments to reconcile net income to net cash        Provided by operating activities:        Equity in undistributed net income of                                                                          )           subsidiary                                       (3,252,996)        877,370      (1,497,186)        Stock options granted                                  103,680         103,680        Net change in other assets                             549,057         169,526          20,292        Net change in accrued expenses                         159,893         (14,210)         (8,707)                                                           -----------     -----------     -----------              Net cash provided by operating activities        908,163       4,043,987       1,425,406                                                           -----------     -----------     ----------- Financing activities:     Stock repurchases                                        (113,668)     (4,506,183)     (1,090,395)     Stock options exercised                                   532,635       1,168,805         299,681     Cash dividends paid                                    (1,078,001)       (906,732)     Fractional shares purchased                                                (7,498)        (14,193)                                                           -----------     -----------     -----------                  Net cash used by financing activities       (659,034)     (4,251,608)       (804,907)                                                           -----------     -----------     -----------                Net change in cash and cash equivalents        249,129        (207,621)        620,499          Cash and cash equivalents at beginning of year        662,310         869,931         249,432                                                           -----------     -----------     -----------               Cash and cash equivalents at end of year    $   911,439     $   662,310     $   869,931                                                           ===========     ===========     =========== Supplemental Disclosures of Noncash Activities:     Stock Dividends                                                                       $ 1,997,422    NOTE R--FAIR VALUES OF FINANCIAL INSTRUMENTS  Statement of Financial  Accounting  Standards  No. 107,  Disclosures  about Fair Value of Financial  Instruments,  requires  disclosure of fair value information about financial instruments,  whether or not recognized in the balance sheet. In cases where quoted  market  prices are not  available,  fair values are based on estimates using present value or other valuation  techniques.  Those  techniques are significantly  affected by the assumptions used, including the discount rate and  estimates  of future cash flows.  In that  regard,  the derived  fair value estimates cannot be  substantiated by comparison to independent  markets and, in many cases could not be                                         78                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE R--FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)  realized in immediate settlement of the instruments.  Statement No. 107 excludes certain  financial  instruments  and  all  nonfinancial   instruments  from  its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company as a whole.  The estimated fair values of the Company and Subsidiary's  financial instruments are as follows at December 31:                                                                  2005                                   2004                                              ---------------------------------     ----------------------------------                                              Carrying Amount    Estimated Fair     Carrying Amount     Estimated Fair                                                                     Value                                  Value                                              ---------------    -------------      ---------------     -------------- Financial assets:      Cash and due from banks                 $  6,988,820       $  6,988,820       $  5,471,669        $  5,471,669      Federal funds sold                         2,050,000          2,050,000          9,840,000           9,840,000      Interest-bearing due from  banks              39,521             39,521             35,551              35,551      Investment securities          available-for-sale                    33,917,094         33,917,094         20,253,490          20,253,490      Investment securities held-          to-maturity                           16,499,865         16,634,518         17,418,303          17,842,432      Loans and lease financing       receivable, net                         168,418,085        168,520,446        150,732,087         151,518,077      Accrued interest receivable                1,400,255          1,400,255          1,138,607           1,138,607      Cash surrender value of life       insurance                                 9,239,439          9,239,439          8,913,136           8,913,136  Financial liabilities:      Deposits                                 215,758,767        216,317,041        193,663,015         193,663,015      Accrued interest payable                      90,664             90,664             55,586              55,586    The carrying  amounts in the  preceding  table are included in the balance sheet under the applicable captions.  The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:       Cash,  due from banks and federal  funds  sold:  The  carrying  amount is a      reasonable estimate of fair value.       Investment  securities:  Fair values for investment securities are based on      quoted  market  prices,  where  available.  If quoted market prices are not      available,  fair  values are based on quoted  market  prices of  comparable      instruments.   The   carrying   amount  of  accrued   interest   receivable      approximates its fair value.                                           79                          SONOMA VALLEY BANCORP AND SUBSIDIARY               NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)                          December 31, 2005, 2004 and 2003   NOTE R--FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)  Loans and lease financing  receivables,  net: For variable-rate loans and leases that reprice  frequently and fixed rate loans and leases that mature in the near future,  with no  significant  change in credit  risk,  fair values are based on carrying  amounts.  The fair  values  for other  fixed rate loans and leases are estimated using discounted cash flow analysis, based on interest rates currently being  offered for loans or leases with  similar  terms to  borrowers of similar credit quality.  Loan and lease fair value estimates include judgments regarding future  expected loss experience and risk  characteristics  and are adjusted for the allowance for loan and lease losses. The carrying amount of accrued interest receivable approximates its fair value.  Cash surrender value of life insurance:  The carrying  amount  approximates  its fair value.  Deposits:   The  fair  values   disclosed  for  demand  deposits  (for  example, interest-bearing  checking  accounts and passbook  accounts) are, by definition, equal to the amount  payable  on demand at the  reporting  date (that is,  their carrying  amounts).  The fair values for  certificates  of deposit are estimated using a discounted cash flow  calculation  that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on  such  time  deposits.  The  carrying  amount  of  accrued  interest  payable approximates fair value.  Off-balance  sheet  instruments:   Off-balance  sheet  commitments   consist  of commitments  to extend  credit and standby  letters of credit.  The  contract or notional amounts of the Company's financial  instruments with  off-balance-sheet risk are  disclosed  in Note N.  Estimating  the fair  value of these  financial instruments  is not  considered  practicable  due to  the  immateriality  of the amounts of fees  collected,  which are used as a basis for  calculating the fair value, on such instruments.  NOTE S--SUBSEQUENT EVENTS  On February 15, 2006,  the Board of Directors  declared a cash dividend of $0.25 per share to  shareholders  of record on March 1, 2006 and  payable on March 15, 2006.                                             80     ITEM  9.  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND FINANCIAL DISCLOSURE           None
The Company  carried out an evaluation,  under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, about the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e).  Based upon that evaluation,  the Chief Executive  Officer and the Chief Financial Officer concluded that the disclosure controls and procedures,  as of the end of the period covered by this Form 10-K, are effective in alerting them to material  information  required to be included in this Form 10-K.
None                                     PART III
The  information  called  for in  Item 10 of Part  III is  incorporated  by reference  from the definitive  proxy  statement of the Company to be filed with the Securities and Exchange Commission within 120 days from fiscal year end.  ITEM. 11. EXECUTIVE COMPENSATION.       The  information  called  for in  Item 11 of Part  III is  incorporated  by reference  from the definitive  proxy  statement of the Company to be filed with the Securities and Exchange Commission within 120 days from fiscal year end.
The  information  called  for in  Item 12 of Part  III is  incorporated  by reference  from the definitive  proxy  statement of the Company to be filed with the Securities and Exchange Commission within 120 days from fiscal year end.
The  information  called  for in  Item 13 of Part  III is  incorporated  by reference  from the definitive  proxy  statement of the Company to be filed with the Securities and Exchange Commission within 120 days from fiscal year end.
The  information  called  for in  Item 14 of Part  III is  incorporated  by reference  from the definitive  proxy  statement of the Company to be filed with the Securities and Exchange Commission within 120 days from fiscal year end.                                           81                                          PART IV
Financial Statements       The following financial statements of the Company are filed as part of this Annual Report:                                                                             Page                                                                           Number      1.  Independent Auditor's Report ........................................47        2.  Consolidated Balance Sheets as of December 31, 2005 and 2004 ........48       3.  Consolidated Statements of Operations for the three years ended          December 31, 2005, 2004 and 2003.....................................49       4.  Consolidated Statements of Changes in Shareholders' Equity          for the three years ended December 31, 2005, 2004 and 2003....50 and 51       5.  Consolidated Statements of Cash Flows for the three years ended          December 31, 2005, 2004 and 2003..............................52 and 53       6.  Notes to Consolidated Financial Statements ..........................54  Financial Statement Schedules       All other schedules have been omitted since the required information is not present or is not present in  sufficient  amounts to require  submission  of the schedules or because the information is included in the financial  statements or the notes thereto.                                          82    Exhibits            The following Exhibits are attached or incorporated herein by reference:  3.1  Sonoma Valley Bancorp  Articles of  Incorporation,  filed as Exhibit 3.1 to      the Registrant's Registration Statement on Form S-8 filed on June 5, 2001.  3.3  Sonoma Valley  Bancorp  By-laws,  filed as Exhibit 3.2 to the  Registrant's      Registration Statement on Form S-8 filed on June 5, 2001.  4.2  Agreement  for the sale of Sonoma  Valley  Bank Stock dated  September  23,      1992,  filed as  Exhibit  4.2  (formerly  A-1) to the Form F-2 for the year      ended December 31, 1992.  10.1 Lease for Sonoma branch office, filed as Exhibit 10.1 (formerly 7.1) to the      Registrant's Registration Statement on Form F-1 filed on May 1, 1989.  10.2 Sonoma  Valley  Bank Chief  Executive  Officer  Severance  Agreement  dated      January 4,  1995,  filed as  Exhibit  10.2 to the Form  10-KSB for the year      ended December 31, 1997.  10.3 Sonoma Valley Bank  Supplemental  Executive  Retirement Plan, as amended on      March 20, 1996, filed as Exhibit 10.3 to the Form 10-KSB for the year ended      December 31, 1997.  10.4 Sonoma Valley Bank Deferred Compensation Plan, filed as Exhibit 10.4 to the      Form 10-KSB for the year ended December 31, 1997.  10.5 Sonoma Valley Bank Master Trust  Agreement for  Executive  Deferral  Plans,      filed as Exhibit  10.5 to the Form 10-KSB for the year ended  December  31,      1997.  10.6 Sonoma  Valley Bank 1996 Stock  Option  Plan,  filed as Exhibit 10.6 to the      Form 10-KSB for the year ended December 31, 1997.  10.7 Sonoma Valley Bank Severance Agreement with Mel Switzer,  Jr. dated October      21,  1998,  filed as  Exhibit  10.7 to the From  10-KSB  for the year ended      December 31, 1998.  10.8 Sonoma Valley Bank  Severance  Agreement with Mary Dieter dated October 21,      1998,  filed as Exhibit 10.8 to the From 10-KSB for the year ended December      31, 1998.  10.10Sonoma Valley Bancorp  Assumption of Severance  Agreement [Form of], filed      as Exhibit 10.1 to the Form 10-KSB for the year ended December 31, 2001.  10.11Sonoma Valley Bancorp 2002 Equity  Incentive  Plan,  filed as Exhibit A to      the Company's Proxy Statement for the Annual Meeting held on May 14, 2002.  10.12Sonoma Valley Bank Severance  Agreement with Sean Cuttings dated March 18,      2004,  filed as Exhibit 10.12 to the Form 10-K for the year ended  December      31, 2003.  23.1 Consent of Richardson and Co., Independent Auditors.  31.1 Certification  of Chief  Executive  Officer  pursuant to Section 302 of the      Sarbanes-Oxley Act  31.2 Certification  of Chief  Financial  Officer  pursuant to Section 302 of the      Sarbanes-Oxley Act                                           83     32   Certification  of Chief  Executive  Officer  and  Chief  Financial  Officer      pursuant to Section 906 of the Sarbanes-Oxley Act                                          84                                        SIGNATURES       Pursuant to the  requirements  of Section 13 or 15(d) of the Securities Act of 1934,  the  registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  SONOMA VALLEY BANCORP, A California corporation   /s/ Mel Switzer, Jr.                                             March 15, 2006 - --------------------------------------------- Mel Switzer, Jr. President and Chief Executive Officer (Principal Executive Officer)    /s/ Mary Dieter Smith                                             March 15, 2006 - --------------------------------------------- Mary Dieter Smith Executive Vice President and Chief Operating Officer (Principal Finance and Accounting Officer)       In  accordance  with the Exchange Act, this report has been signed below by the following  persons on behalf of the  registrant and in the capacities and on the dates indicated.    /s/ Suzanne Brangham                                              March 15, 2006 - --------------------------------------------- Suzanne Brangham, Secretary of the Board and Director    /s/ Dale T. Downing                                               March 15, 2006 - --------------------------------------------- Dale T. Downing, Director    /s/ Frederick H. Harland                                          March 15, 2006 - --------------------------------------------- Frederick H. Harland, Director    /s/ Robert B. Hitchcock                                           March 15, 2006 - --------------------------------------------- Robert B. Hitchcock, Director                                           85    /s/ Gerald J. Marino                                              March 15, 2006 - --------------------------------------------- Gerald J. Marino, Director    /s/ Gary D. Nelson                                                March 15, 2006 - --------------------------------------------- Gary D. Nelson, Director    /s/ Robert J. Nicholas                                            March 15, 2006 - --------------------------------------------- Robert J. Nicholas, Chairman of the Board and Director    /s/ Angelo C. Sangiacomo                                          March 15, 2006 - --------------------------------------------- Angelo C. Sangiacomo, Director    /s/ Jesse R. Stone                                                March 15, 2006 - --------------------------------------------- Jesse R. Stone, Director    /s/ Mel Switzer, Jr.                                              March 15, 2006 - --------------------------------------------- Mel Switzer, Jr., President, Chief Executive Officer and Director (Principal Executive Officer)    /s/ Harry Weise                                                   March 15, 2006 - --------------------------------------------- Harry Weise, Director     /s/ Mary Dieter Smith                                             March 15, 2006 - --------------------------------------------- Mary Dieter Smith, Executive Vice President, Chief Operating Officer and Chief Financial Officer (Principal Finance and Accounting Officer)                                           86    EX-32 2 ex32_1205.txt SARBANES OXLEY 2002                                                                         EXHIBIT 32.1                              CERTIFICATION PURSUANT TO                  18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO                    SECTION 906 OF THE SARBANES-OXLEY ACT 2002       In  connection  with the  annual  report  of  Sonoma  Valley  Bancorp  (the "Company")  on Form 10-K for the period  ending  December 31, 2005 as filed with the Securities and Exchange  Commission on the date hereof (the  "Report"),  We, Mel Switzer, Jr., Chief Executive Officer and Mary Dieter Smith, Chief Financial Officer, of the Company certify,  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 for the Sarbanes-Oxley Act of 2002 , that to the best of our knowledge and belief:       (1)  the Report fully  complies with the  requirements  of section 13(a) or           15(d) of the Securities Exchange Act of 1934; and       (2)  the  information  contained  in the  Report  fairly  presents,  in all           material respects, the financial condition and result of operations of           the Company.  Dated: March 15, 2006               /s/ Mel Switzer, Jr.        --------------               -------------------------------------------                                     Mel Switzer, Jr.,                                     Chief Executive Officer                                    (Principal Executive Officer)  Dated: March 15, 2006               /s/ Mary Dieter Smith        --------------               -------------------------------------------                                     Mary Dieter Smith,                                     Chief Financial Officer                                    (Principal Financial and Accounting Officer)       EX-23 3 ex23_1205.txt CONSENT OF RICHARDSON & COMPANY                                                                      EXHIBIT 23.1     Richardson & Company                                550 Howe Avenue, Suite 210                                                     Sacramento, California 95825                                                     Telephone: (916) 564-8727                                                     FAX: (916) 564-8728                             CONSENT OF RICHARDSON & COMPANY        We consent to the incorporation by reference in the Registration  Statement (Form S-8) (SEC File Number 333-62294) pertaining to the Sonoma Valley Bancorp's 1996 Stock Option Plan as amended in April 1999 and the  Registration  Statement (Form S-8) (SEC File Number 333-88610) pertaining to the Sonoma Valley Bancorp's 2002 Equity  Incentive Plan of our report dated January 24, 2006 with respect to the  consolidated  financial  statements of Sonoma Valley Bancorp and Subsidiary included in its Annual Report (Form 10-K) for the year ended  December 31, 2005, filed with the Securities and Exchange Commission.                                                         /s/ Richardson & Company                                                        -------------------------                                                        Richardson & Company   Sacramento, California March 24, 2006      EX-31 4 ex31_1205.txt MEL AND MARY CERTIFICATIONS                                                                          EXHIBIT 31.1                                   CERTIFICATION  I, Mel Switzer,  Jr., Chief Executive Officer of Sonoma Valley Bancorp,  certify that:  1.   I have reviewed this annual report on Form 10-K of Sonoma Valley Bancorp;  2.   Based on my knowledge, this report does not contain any untrue statement of      a material  fact or omit to state a  material  fact  necessary  to make the      statements made, in light of the circumstances  under which such statements      were made,  not  misleading  with  respect  to the  period  covered by this      report;  3.   Based on my  knowledge,  the  financial  statements,  and  other  financial      information  included  in  this  report,  fairly  present  in all  material      respects the financial  condition,  results of operations and cash flows of      the registrant as of, and for, the periods presented in this report;  4.   The  registrant's  other  certifying  officer(s) and I are  responsible for      establishing and maintaining disclosure controls and procedures (as defined      in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:            (a)  Designed such disclosure controls and procedures,  or caused such                disclosure  controls  and  procedures  to be  designed  under our                supervision,  to ensure that material information relating to the                registrant,  including  its  consolidated  subsidiaries,  is made                known to us by others within those entities,  particularly during                the period in which this report is being prepared;            (b)  Omitted.;            (c)  Evaluated  the  effectiveness  of  the  registrant's   disclosure                controls  and   procedures  and  presented  in  this  report  our                conclusions  about the  effectiveness of the disclosure  controls                and  procedures,  as of the  end of the  period  covered  by this                report based on such evaluation; and            (d)  Disclosed in this report any change in the registrant's  internal                control  over  financial   reporting  that  occurred  during  the                registrant's most recent fiscal quarter (the registrant's  fourth                fiscal  quarter  in  the  case  of an  annual  report)  that  has                materially  affected,  or  is  reasonably  likely  to  materially                affect,   the   registrant's   internal  control  over  financial                reporting; and  5.   The registrant's other certifying officer(s) and I have disclosed, based on      our most recent evaluation of internal control over financial reporting, to      the registrant's auditors and the audit committee of the registrant's board      of directors (or persons performing the equivalent functions):            (a)  All  significant  deficiencies  and  material  weaknesses  in the                design or operation of internal control over financial  reporting                which are reasonably  likely to adversely affect the registrant's                ability  to  record,  process,  summarize  and  report  financial                information; and            (b)  Any fraud,  whether or not material,  that involves management or                other employees who have a significant  role in the  registrant's                internal control over financial reporting.  Dated: March 15, 2006              /s/ Mel Switzer, Jr.        ------------------------    --------------------------------------------                                    Mel Switzer, Jr.                                    Chief Executive Officer                                   (Principal Executive Officer)                                                                                                                EXHIBIT 31.2                                   CERTIFICATION  I, Mary Dieter Smith, Chief Financial Officer for Sonoma Valley Bancorp, certify that:  1.   I have reviewed this annual report on Form 10-K of Sonoma Valley Bancorp;  2.   Based on my knowledge, this report does not contain any untrue statement of      a material  fact or omit to state a  material  fact  necessary  to make the      statements made, in light of the circumstances  under which such statements      were made,  not  misleading  with  respect  to the  period  covered by this      report;  3.   Based on my  knowledge,  the  financial  statements,  and  other  financial      information  included  in  this  report,  fairly  present  in all  material      respects the financial  condition,  results of operations and cash flows of      the registrant as of, and for, the periods presented in this report;  4.   The  registrant's  other  certifying  officer(s) and I are  responsible for      establishing and maintaining disclosure controls and procedures (as defined      in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:            (a)  Designed such disclosure controls and procedures,  or caused such                disclosure  controls  and  procedures  to be  designed  under our                supervision,  to ensure that material information relating to the                registrant,  including  its  consolidated  subsidiaries,  is made                known to us by others within those entities,  particularly during                the period in which this report is being prepared;            (b)  Omitted.;            (c)  Evaluated  the  effectiveness  of  the  registrant's   disclosure                controls  and   procedures  and  presented  in  this  report  our                conclusions  about the  effectiveness of the disclosure  controls                and  procedures,  as of the  end of the  period  covered  by this                report based on such evaluation; and            (d)  Disclosed in this report any change in the registrant's  internal                control  over  financial   reporting  that  occurred  during  the                registrant's most recent fiscal quarter (the registrant's  fourth                fiscal  quarter  in  the  case  of an  annual  report)  that  has                materially  affected,  or  is  reasonably  likely  to  materially                affect,   the   registrant's   internal  control  over  financial                reporting; and  5.   The registrant's other certifying officer(s) and I have disclosed, based on      our most recent evaluation of internal control over financial reporting, to      the registrant's auditors and the audit committee of the registrant's board      of directors (or persons performing the equivalent functions):            (a)  All  significant  deficiencies  and  material  weaknesses  in the                design or operation of internal control over financial  reporting                which are reasonably  likely to adversely affect the registrant's                ability  to  record,  process,  summarize  and  report  financial                information; and            (b)  Any fraud,  whether or not material,  that involves management or                other employees who have a significant  role in the  registrant's                internal control over financial reporting.  Dated: March 15, 2006               /s/ Mary Dieter Smith        --------------               -------------------------------------------                                     Mary Dieter Smith                                     Chief Financial Officer                                    (Principal Finance and Accounting Officer)      -----END PRIVACY-ENHANCED MESSAGE-----