UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission File Number: 000-50950

VALLEY BANCORP

(702) 221-8600

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock Issued and Outstanding: 2,797,873 shares as of April 30, 2005.

VALLEY BANCORP

Table of Contents

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Part I. Financial Information

ITEM 1. FINANCIAL STATEMENTS

See Notes to Consolidated Financial Statements.

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See Notes to Consolidated Financial Statements.

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See Notes to Consolidated Financial Statements.

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Valley Bancorp

1. Nature of Business and Basis of Presentation

Valley Bancorp is a bank holding company whose primary subsidiary, Valley Bank, is a Nevada State chartered bank that provides a full range of banking services to commercial and consumer customers through three branches located in Las Vegas, Henderson and Pahrump, Nevada. These entities are collectively referred to herein as the Company. The Company’s business is concentrated in southern Nevada and is subject to the general economic conditions of this area. Segment information is not presented since all of the Company’s revenues are attributable to one operating segment.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general industry practices. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses.

The information as of and for the periods ended March 31, 2005 and 2004 has not been audited and is presented in a condensed format which does not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for each respective period presented. Such adjustments are of a recurring nature unless otherwise disclosed. The results of operations for the three months ended March 31, 2005 are not necessarily indicative of results to be anticipated for the full year ending December 31, 2005.

2. Earnings Per Share

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding options, and are determined using the treasury stock method.

Earnings per common share have been computed based on the following:

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3. Stock Options

The Company has two stock-based compensation plans, which are described more fully in Note 12 of the Company’s December 31, 2004 Annual Report on Form 10-K as filed with the SEC. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the estimated fair value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:

4. Loans

The composition of the Company’s loan portfolio was as follows:

Impaired and nonaccrual loans were approximately $146,000 and $170,000 as of March 31, 2005 and December 31, 2004, respectively. Net recoveries for the three months ended March 31, 2005 and 2004 were $90,000 and $200,000, respectively.

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5. Commitments and Contingencies

Contingencies

In December 2003 the Company reached a settlement in connection with certain loan losses it incurred during the year ended December 31, 2002. The Company received $300,000 in January 2004. In addition, the terms of the settlement provide for twelve quarterly payments of $20,000 starting April 2004, and a final payment of $10,000 on April 1, 2007. The Company is recognizing these payments as recoveries to the allowance for loan losses as they are received.

In the normal course of business, the Company is involved in various other legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements.

Financial instruments with off-balance-sheet risk

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit. They involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the balance sheets.

The Company’s exposure to credit loss in the event of nonperformance by the other parties to the financial instruments for these commitments is represented by the contractual amounts of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

A summary of the contract amount of the Company’s exposure to off-balance-sheet risk as of March 31, 2005 and December 31, 2004 is as follows:

Commitments to extend credit

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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness 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 party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate and income-producing commercial properties.

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Standby letters of credit

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 loan facilities to customers.

Lease commitments

In 2001, the Company entered into a non-cancelable operating lease with respect to its Pahrump branch office, expiring in five years. The lease includes two renewal option periods of five years each. The agreement requires monthly rental payments of approximately $7,120 for the first year with an escalation clause for subsequent years. At March 31, 2005, the future annual lease payments due under this lease commitment totaled approximately $86,000.

Financial instruments with concentrations of credit risk

Concentration by geographic location

The Company makes commercial, commercial real estate, residential real estate and consumer loans to customers primarily in southern Nevada. At March 31, 2005 and December 31, 2004, real estate loans accounted for approximately 85% and 83%, respectively of the total loans. Substantially all of these loans are secured by first liens with an initial loan to value ratio of generally not more than 75%. The Company’s policy for requiring collateral is to obtain collateral whenever it is available or desirable; depending upon the degree of risk the Company is willing to take. The Company’s loans are expected to be repaid from cash flow or from proceeds from the sale of selected assets of the borrowers. Approximately 3% of the Company’s loan portfolio was unsecured at March 31, 2005 and December 31, 2004.

A substantial portion of the Company’s customers’ ability to honor their contracts is dependent on the economy in the area. The Company’s goal is to continue to maintain a diversified loan portfolio, which requires the loans to be well collateralized and supported by cash flows.

Employment and severance agreements

The Company entered into a three-year employment agreement with its president commencing on March 22, 2000. In the event the Company terminates the employment of the president without cause, or upon change in control of the Company, the Company may be liable for a payment as outlined in the employment agreement. The employment agreement was amended in October 2002 to extend the agreement for an additional 3 years, through March 2006. The employment agreement was amended again in May 2004 to extend the agreement for an additional 3 years, through March 2009. In addition, the Company entered into severance agreements with three executive officers, whereby upon change in control of the Company, the Company may be liable for a payment as outlined in the severance agreements.

6. Reclassifications

The reserve for unfunded commitments of approximately $88,000 at March 31, 2005 and $82,000 at December 31, 2004 has been reclassified from the allowance for loan losses to the other liability category on the consolidated balance sheets for the respective period pursuant AICPA Statement of Position 01-6 “Accounting by Certain Entities that Lend to or Finance Activities of Others”. There was no change to previously reported net income or stockholders equity as a result of this reclassification.

7. Subsequent Events

At the Company’s 2005 Annual Shareholders Meeting that was held on April 19, 2005, the following amendments to the Employee Stock Option Plan as outlined in the Proxy Statement as filed with the Securities and Exchange Commission were approved:

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	•	Increase the number of shares available for grant under the Employee Plan by 100,000 shares, which will be available for future option grants;
	•	Extend the term of the Employee Plan by 10 years from the date of the Board approval of the amendment, so that the Employee Plan will terminate on March 23, 2015; and
	•	Permit the grant of restricted stock awards under the Employee Plan.

8. Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) published FASB Statement No. 123 (revised 2004), “Share-Based Payment” (“FAS 123(R)” or the “Statement”). FAS 123(R) requires that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. Modifications of share-based payments will be treated as replacement awards with the cost of the incremental value recorded in the financial statements.

The Statement is effective at the beginning of the first quarter of 2006. As of the effective date, the Company will apply the Statement using a modified version of prospective application. Under that transition method, compensation cost will be recognized for (1) all awards granted after the required effective date and to awards modified, cancelled, or repurchased after that date and (2) the portion of awards granted subsequent to the completion of our IPO and prior to the effective date for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated for pro forma disclosures under SFAS 123.

The impact of this Statement on the Company in 2006 and beyond will depend upon various factors, among them being the future compensation strategy.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report contains forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts, but rather are statements based on the Company’s current expectations regarding its business strategies and their intended results and its future performance. Forward-looking statements are preceded by terms such as “expects,” ”feels,” “believes,” “anticipates,” “intends,” and similar expressions. Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause the Company’s actual results, performance, and achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to these differences include, without limitation, general economic conditions, including changes in market interest rates and changes in monetary and fiscal policies of the federal government; changes in market conditions in the Company’s principal market area; adverse changes in the financial condition of the loan loss reserves; competitive pressures on loan or deposit terms; legislative and regulatory changes; and other factors disclosed periodically in the Company’s filings with the Securities and Exchange Commission. Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on them, whether included in this report or made elsewhere from time to time by the Company or on its behalf. The Company assumes no obligation to update any forward-looking statements.

Overview of Operating Results for the Three Months Ended March 31, 2005 and 2004

Net income increased from $622,000 or $0.35 per diluted share for the quarter ended March 31, 2004 to $1.1 million or $0.37 per diluted share for the quarter ended March 31, 2005. This represents an increase of 76% in net income from prior period. The increase was primarily the result of higher interest income from loans and other earning assets due to increased outstanding totals as well as an improved interest margin. A rising interest rate environment has contributed to the improvement in the interest margin. The efficiency ratio, which represents total non-interest expense divided by the sum of net interest income and total non-interest income excluding provision for loan losses and gain or loss on sales of securities, has also improved, decreasing to 50% at March 31, 2005 as compared to 54% at March 31, 2004. Weighted average shares outstanding on a fully diluted basis at March 31, 2005 were 2,953,762 shares as compared to 1,784,979 shares at March 31, 2004. This represents an increase of 1,168,783 shares or 65% and was due primarily to the successful completion of the Company’s Initial Public Offering that closed on September 28, 2004. This large increase in the number of shares outstanding resulted in a smaller increase in the earnings per share for the three months ended March 31, 2005 as compared to the same period in 2004. These items are discussed in further detail below.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with generally accepted accounting principles. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified the allowance for loan losses as its most critical accounting policy.

Allowance for Loan Loss Methodology. The Company’s allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience, peer group experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements. Qualitative factors include the general economic environment in markets, including economic conditions and in particular, the state of certain industries. Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. Changes in the factors themselves are driven by perceived risk in pools of homogenous loans classified by collateral type, purpose, terms, etc. Management monitors local trends and peer experiences to anticipate future delinquency potential on a quarterly basis.

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Since the Company has neither extensive loss history with segregation nor a large sample of loans from inception to charge off, the Company does not use migration analysis to accurately anticipate future losses through that method. The Company relies heavily on the statistics provided through the FDIC regarding loss percentages experienced by banks in the Western United States to establish potential risk based on collateral type securing each loan. As additional comparison, the Company examines local peer group banks to determine the nature and scope of their losses to date. Finally, the Company closely examines each credit graded Special Mention and below to individually assess the appropriate loan loss reserve for that particular credit.

The Company periodically reviews the assumptions and formulae by which additions are made to the specific and general valuation allowances for losses in an effort to refine such allowances in light of the current status of the factors described above.

As the Company adds new products and increase the diversity of our loan portfolio, we will enhance our methodology accordingly. We may report a materially different amount for the provision for loan losses in the statement of income to change the allowance for loan losses if our assessment of the above factors were different.

Although the Company believes the levels of the allowance as of March 31, 2005 was adequate to absorb probable losses in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.

Comparison of Financial Condition at March 31, 2005 and December 31, 2004

Total Assets. Total assets increased 14%, from $274 million at December 31, 2004 to $311 million at March 31, 2005. This overall increase reflects a $27 million or 14% increase in net loans receivable, a $5 million or 20% increase in cash and cash equivalents, and a $3 million or 8% increase in investments. Fixed assets also increased by $2 million or 41% due to a purchase of the new headquarters for the Company to be occupied in the third quarter of 2005. The increase in net loans receivable is primarily due to a $26 million increase in construction and land lending. Federal funds sold increased $8 million from December 31, 2004 to March 31, 2005 to accommodate the loan funding needs as well as the liquidity needs for the next 30-45 days.

The Company’s commercial loan growth was centered in commercial real estate loans, specifically in construction of commercial retail, industrial, and office properties. Additionally, the Las Vegas real estate market drove an increase in land and land development loans.

The following table sets forth the composition of our loan portfolio by the type of loan at the dates indicated:

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The following table sets forth the composition of the securities portfolio at the periods indicated. The securities are shown at fair value and unrealized gains and losses are excluded from earnings and are reported net of deferred taxes in accumulated other comprehensive income as a component of stockholders’ equity.

Deposits. Total deposits increased $36 million or 15%, from $236 million at December 31, 2004 to $272 million at March 31, 2005. Non-interest-bearing deposits increased $2 million or 5%, primarily due to an increase in business demand deposit accounts. Interest-bearing deposits increased $33 million or 17%, primarily due to a $31 million or 28% increase in time deposits, a $4 million or 6% increase in money market accounts, and a $1 million or 10% decrease in savings accounts. The significant increase in time deposits was due to the promotion that was run during the quarter to generate the funds needed for loan originations. Transaction accounts, which include both interest-bearing and non-interest-bearing accounts, increased $5 million, from $126 million at December 31, 2004 to $131 million at March 31, 2005. The increase in business demand deposits and business money market accounts is due to increased business relationships and marketing efforts focused on gaining and retaining core deposit accounts.

The following table reflects deposit ending balances by category as of the dates indicated.

Stockholders’ Equity. Stockholders’ equity increased from $36.3 million at December 31, 2004 to $37.1 million at March 31, 2005. This increase was primarily due to the $1.1 million net income earned during the first quarter of 2005 offset by an increase in unrealized losses on available for sale securities of approximately $300,000.

Non-Performing Assets. The Company had only one non-accrual loan of approximately $146,000 and one loan of approximately $1.5 million that was past due 90 days or more as of March 31, 2005. Management increased the

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allowance for loan losses $135,000, or 6%, from $2.1 million at December 31, 2004 to $2.2 million at March 31, 2005 primarily due to the growth in loans. The allowance for loan losses reflected the current risk in the loan portfolio and represented about 1.0% of total loans as of March 31, 2005.

The following table sets forth information concerning the allocation of allowance for loan losses by loan category at the dates, indicated.

Comparison of Operating Results for the Three Months Ended March 31, 2005 and 2004.

Net Income. Net income was $1.1 million for the three months ended March 31, 2005 as compared to $622,000 for the same period in 2004. This represents an increase of $470,000 or 76%. Diluted earnings per share increased 6%, from $0.35 for the three months ended March 31, 2004 to $0.37 for the same period in 2005. Return on average assets increased from 1.23% for the quarter ended March 31, 2004 to 1.51% for the same period in 2005. Return on average equity, however, decreased, from 15.16% for the quarter ended March 31, 2004 to 11.86% for the same period in 2005 due to a higher average equity balance during the quarter resulting from the successful completion of the Initial Public Offering that closed on September 28, 2004. Higher net income for the quarter was due to expanded loan portfolio and earning assets, increased net interest margin and improved efficiency ratio.

Net Interest Income. Net interest income increased $1.2 million or 55%, from $2.2 million for the three months ended March 31, 2004 to $3.4 million for the same period in 2005. The Company’s average interest-earning assets increased $83 million or 43%, exceeding the increase in average interest-bearing liabilities of $52 million or 33% for quarter ended March 31, 2005 as compared to the quarter ended March 31, 2004. Interest rate spread for the same period improved by 0.21%, increasing from 4.24% for the three months ended March 31, 2004 to 4.45% for the same period in 2005. Net interest margin also increased 0.42%, from 4.55% for the quarter ended March 31, 2004 to 4.97% for the same period in 2005. The ratio of average interest-earning assets to average interest-bearing liabilities increased 9.19%, from 123.05% for the three months ended March 31, 2004 to 132.24% for the same period in 2005. Improvements in the interest rate spread and the net interest margin can be attributed to the Company’s asset sensitive balance sheet in a rising interest rate environment.

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The following tables set forth, for the periods indicated, information regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rate; (iii) net interest income; (iv) interest rate spread (the difference between the average yield earned on our earning assets and the rate paid on interest bearing liabilities); and (v) net interest margin.

Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential

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Interest Income. For the three months ended March 31, 2005, interest income increased $1.6 million or 58%, primarily due to an increase of $1.3 million or 50% in loan interest income as compared to the same period in 2004. This increase is the result of an increase of $59 million or 40% in average loans receivable. The average yield on these loans increased, from 7.07% for the three months ended March 31, 2004 to 7.65% for the same period in 2005. Interest income on all other investments increased by $332,000 or 166%. The average yield for these investments increased 1.34%, from 1.87% for the three months ended March 31, 2004 to 3.21% for the same period in 2005. Larger investment portfolio and a rising rate environment contributed to the increase in investment income as well as investment yield for the quarter ended March 31, 2005 as compared to the same period in 2004.

Interest Expense. For the three months ended March 31, 2005, total interest expense increased $447,000 or 70% as compared to the same period last year. This increase is primarily due to an increase in the average deposit balances as well as the cost of those deposits. Average deposits increased $52 million or 33%, from $157 million for the three months ended March 31, 2004 to $208 million for the same period in 2005. The total cost of funds increased 0.47%, from 1.65% for the quarter ended March 31, 2004 to 2.12% for the same period in 2005.

Provision for Loan Losses. The provision for loan losses totaled $51,000 for the three months ended March 31, 2005 as compared to $105,000 for the same period in 2004. Net recoveries for the first quarter 2005 were $90,000 as compared to $200,000 for the first quarter 2004. Net recoveries for the quarter ended March 31, 2004 included $300,000 received from the equipment lease loan that was charged off for $1.3 million due to an alleged fraud in 2002 (see Note 7 to the Consolidated Financial Statements for more details). Management feels that their evaluations and estimations were reasonable for determining the provision, and the allowance for loan losses is deemed to be adequate as of March 31, 2005. However, a decline in economic conditions or other factors beyond management’s control could significantly alter the amount of losses the Company recognizes in the future.

The following table sets forth the activity in allowance for loan losses for the periods indicated.

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Non-Interest Income. Non-interest income was $75,000 for the three months ended March 31, 2005, as compared to $101,000 for the same period in 2004. The decrease of $26,000 was due primarily to a gain on the sale of securities of $14,000 in the first quarter of 2004 while there was none in the first quarter of 2005 and lower service charge income.

The following table sets forth information regarding noninterest income for the periods shown.

Non-Interest Expense. Non-interest expense increased $510,000 or 41%, from $1.2 million for the three months ended March 31, 2004 to $1.7 million for the same period in 2005. The increase was primarily a result of increased compensation and employee benefits costs due to increasing staff levels, higher professional fees associated with being a publicly traded company, higher data processing expenses due to increased number of customers’ accounts and transactions being processed, and higher marketing and advertising costs. For the quarter ended March 31, 2005, non-interest expense as a percentage of average earning assets on annualized basis was 2.53% as compared to 2.56% for the same period in 2004. The Company also achieved an efficiency ratio of 50.5% for quarter ended March 31, 2005 as compared to 54.3% for the same period in 2004. The efficiency ratio represents total non-interest expense divided by the sum of net interest income and total non-interest income excluding provision for loan losses and gain or loss on sales of securities. Lower efficiency ratio is good. Full time equivalent employees at March 31, 2005 were 53 as compared to 44 at March 31, 2004. This represents an increase of 9 FTEs or 20%.

The following table sets forth information regarding noninterest expenses for the periods shown.

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Liquidity and Capital Resources

The Company’s primary sources of funds are customer deposits, proceeds from loan principal and interest payments, sale of loans, and maturing securities. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loans prepayments are influenced greatly by general interest rates, other economic conditions, and competition. The Company generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At March 31, 2005, cash and cash equivalents and interest-bearing deposits at other financial institutions totaled $41 million or 13% of total assets, and investment securities available for sale totaled $39 million or 12% of total assets, for a total of $80 million in liquid assets.

The Company’s liquidity is comprised of three primary classifications: cash flows from operating activities; cash flows used in investing activities; and cash flows provided by financing activities. Net cash provided by operating activities has consisted primarily of net income adjusted for certain non-cash income and expense items such as the loan loss provision, investment and other amortizations and depreciation. For the three months ended March 31, 2005 net cash provided by operating activities was $2 million, as compared to net cash provided by operating activities of $308,000 for the same period of 2004. This variance from the prior period was due primarily to an increase in net income as well as increases in interest payable and other liabilities.

The Company’s primary investing activities are the origination of real estate, commercial and consumer loans and purchase and sale of securities and interest-bearing deposits at other financial institutions. For the three months ended March 31, 2005, total net loans increased by $27 million or 14% from December 31, 2004. Investment securities and interest-bearing deposits increased to $49 million at March 31, 2005 from $46 million at December 31, 2004.

Net cash used in all investing activities was $33 million and $24 million for the three months ended March 31, 2005 and 2004, respectively. At March 31, 2005 the Company had outstanding loan commitments of approximately $78 million and outstanding letters of credit of approximately $1 million. The Company anticipates that it will have sufficient funds available to meet current loan commitments through its own liquid assets and borrowing capability from Federal Home Loan Bank of San Francisco.

Net cash provided by financing activities has been impacted significantly by increases in deposit levels, especially time deposits during the first quarter of 2005. For the three months ended March 31, 2005, total deposits increased by $36 million or 15% while time deposits increased by $31 million or 28% from December 31, 2004.

Capital adequacy refers to the level of capital required to sustain asset growth over time and to absorb losses. The Company’s objective is to maintain a level of capitalization that is sufficient to take advantage of profitable growth opportunities while meeting regulatory requirements. This is achieved by improving profitability through effectively allocating resources to more profitable businesses, improving asset quality, strengthening service quality, and streamlining costs.

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As of March 31, 2005, the Company and the Bank’s regulatory capital ratios were in excess of all applicable regulatory requirements. The following tables reflect the Company’s and the Bank’s actual levels of regulatory capital as of March 31, 2005 and the applicable minimum regulatory capital requirements as well as the regulatory capital requirements that apply to be deemed “well capitalized” pursuant to the prompt corrective action requirements.

At March 31, 2005, the Company had off-balance sheet loan commitments of approximately $79 million. Of this amount, the unused portion of lines of credit extended by the Company was approximately $78 million and $1 million for standby letters of credit. Standby letters of credit and financial guarantees 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, including commercial paper, bond financing, and similar transactions. Most guarantees extend from one to two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

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Impact of Inflation and Changing Prices

The consolidated financial statements of the Company and notes thereto, presented elsewhere herein, have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial condition and operating results in terms of historical dollars without considering the change in relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are financial. As a result, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. As a financial institution, the Company’s market risk exposure is primarily that of interest rate risk. The Company has established policies and procedures to monitor and limit earnings and balance sheet exposure to changes in interest rates. The Company does not engage in trading of financial instruments and does not have any exposure to exchange rates.

The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to result in a decrease in net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to result in a decrease in net interest income.

Interest rate risk is managed in accordance with policies approved by the Company’s Board of Directors. Management formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, management considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economy, liquidity, business strategies and other factors. Management meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market value of assets and liabilities, unrealized gains and losses, purchase and sales activities, commitments to originate loans and the maturities of investments. Management uses an analysis of relationships between interest-earning assets and interest-bearing liabilities to manage interest rate risk.

The following table presents the Company’s repricing gap at March 31, 2005. The table indicates that at March 31, 2005 the Company was liability sensitive up to twelve months. This would indicate a decrease in earnings in a rising rate environment.

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Although gap analysis as reflected in the table above is a useful measurement device available to management to determine the existence of interest rate exposure, its static focus as of a particular date makes it necessary for management to utilize other techniques to measure exposure to changes in interest rates. For example, gap analysis is limited in its ability to predict trends in future earnings and includes no assumptions regarding changes in prepayment tendencies, deposit or loan maturity preferences or repricing time lags that may occur in response to a change in interest rates.

As a result of the limitations inherent in gap analysis, the Company also uses the “FinServ” asset liability management model, a proprietary dynamic system that incorporates data regarding the Company’s loans, investments, deposits and borrowings into an interest sensitivity analysis designed for financial institutions. This analysis measures interest rate risk by computing changes in net interest income and net interest margin in the event of assumed changes in interest rates. The analysis assesses the effect on net interest income and net interest margin in the event of an increase or decrease in interest rates, assuming that such increase or decrease occurs ratably over the next 12 months and remains constant over the subsequent 12 months. The Company’s sensitivity to gains or losses in future earnings due to hypothetical increases or decreases in the Federal Funds rate as measured by this model as of March 31, 2005 is as follows :

Accordingly, a rise of 1.00% in interest rates would result in an increase in our net interest income of $270,000, while a decline of 1.00% in interest rates would result in a decrease of $329,000 in our net interest income, in each case over the 12 months following March 31, 2005.

Management believes that the assumptions used in its interest sensitivity analysis to evaluate the vulnerability of its net interest income to changes in interest rates are reasonable. However, the interest rate sensitivity of the

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Company’s assets and liabilities, and the estimated effects of changes in interest rates on net interest income, could vary substantially if different assumptions were used or if actual experience differs from the projections upon which they are based.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), an evaluation was carried out with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon their evaluation of these disclosure controls and procedures, the Chief Executive Officer and the Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that material information relating to the Company, including its consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this quarterly report on Form 
10-Q was being prepared.

Changes in Internal Controls

In the quarter ended March 31, 2005, the Company did not make any significant changes in, or take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls.

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Part II. Other Information

Item 1. Legal Proceedings

None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits

	31.1	CEO Certification Pursuant Rule 13a-14(a)/15d-14(a)
	31.2	CFO Certification Pursuant Rule 13a-14(a)/15d-14(a)
	32	CEO and CFO Certification Pursuant 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes – Oxley Act of 2002

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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.

	VALLEY BANCORP
Date: May 13, 2005	By:	/s/ Barry L. Hulin
		Barry L. Hulin
		President and Chief Executive Officer

Date: May 13, 2005	By:	/s/ Dick Holtzclaw
		Dick Holtzclaw
		Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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