** **

**FORM 10-KSB**

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20429**

 
| **ý** |   | **ANNUAL REPORT UNDER SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                            |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                           |
|       |   | **For the annual period ending December 31, 2003**                                                                                                                                                                             |
|       |   |                                                                                                                                                                                                                           |
| **o**      |   | **TRANSITION REPORT UNDER SECTION  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                        |
|       |   |                                                                                                                                                                                                                           |
|       |   | **For the transition period from                   to                 ** |

 

**CommissionFile No. 000-32827**

 

| **COAST  BANCORP**                                                                  |
|-------------------------------------------------------------------------------------|
| (Exact Name of Registrant as Specified in its Charter)                              |
|                                                                                |   |   |
| **California**                                                                      |   | **77-0567091** |
| (State of incorporation or organization)                                            |   | (IRS Employer Identification Number) |
|                                                                                |   |   |
| **500 Marsh  Street, San Luis Obispo, CA 93401**                                    |
| (Address of principal executive offices)                                            |
|                                                                                |   |   |
| **(805)  541-0400**                                                                 |
| (Registrant’s telephone number, including area code)                           |
|                                                                                |   |   |
|                                                                                |
| (Former name, former address and former fiscal year, if changed since  last report) |

 

Check whether the issuer (1) filed all reports required to be filed bySection 13 or 15 (d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90days.          Yes ý     No o

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B is not contained in this form, and no disclosurewill be contained, to the best of registrant’s knowledge, in definitive proxyor information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB.     ý

 

Registrant’srevenues of fiscal year ended December 31, 2003 were $8,522,000.

 

Theaggregate market value of the voting stock held by non-affiliates computed byreference to the average bid and asked prices of such stock, as of March 15,2004:  $17,074,525.

 

Numberof registrant’s shares of Common Stock outstanding as of March 15, 2004 was638,300.

 

Documentsincorporated by reference:     **None**

 

TransitionalSmall Business Disclosure Format (Check one)                                              Yes: o    No: ý

 

 

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**FORWARD LOOKING STATEMENTS**

 

**CERTAIN STATEMENTS WITHIN THISANNUAL REPORT ON FORM 10-KSB INCLUDE FORWARD LOOKING INFORMATION WITHIN THEMEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AND ARE SUBJECT TO THE“SAFE HARBOR” CREATED BY THOSE SECTIONS. THESE FORWARD-LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND UNCERTAINTIESTHAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THEFORWARD-LOOKING STATEMENTS.  SUCH RISKSAND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, THE FOLLOWING FACTORS:COMPETITIVE PRESSURE IN THE BANKING INDUSTRY INCREASES SIGNIFICANTLY; CHANGESIN THE INTEREST RATE ENVIRONMENT REDUCE MARGINS; GENERAL ECONOMIC CONDITIONS,EITHER NATIONALLY OR REGIONALLY, ARE LESS FAVORABLE THAN EXPECTED, RESULTINGIN, AMONG OTHER THINGS A DETERIORATION IN CREDIT QUALITY AND AN INCREASE IN THEPROVISION FOR POSSIBLE LOAN LOSSES; CHANGES IN THE REGULATORY ENVIRONMENT;CHANGES IN BUSINESS CONDITIONS, PARTICULARLY IN SAN LUIS OBISPO COUNTY;VIOLATILITY OF RATE SENSITIVE DEPOSITS; OPERATIONAL RISKS INCLUDING DATAPROCESSING SYSTEMS FAILURES OR FRAUD; ASSET/LIABILITY MATCHING RISKS ANDLIQUIDITY RISKS;  CHANGES IN THESECURITIES MARKETS; AND THE POTENTIAL ECONOMIC EFFECT OF THE WAR ON TERRORISMAND THE WAR IN IRAQ.**

 

**THEREFORE, THE INFORMATIONCONTAINED IN THIS ANNUAL REPORT SHOULD BE CAREFULLY CONSIDERED WHEN EVALUATINGTHE BUSINESS PROSPECTS OF COAST BANCORP AND COAST NATIONAL BANK.**

 

**MOREOVER, WHEREVER PHRASES SUCHAS/OR SIMILAR TO, “IN MANAGEMENT’S OPINION”, “MANAGEMENT BELIEVES”, OR“MANAGEMENT CONSIDERS” ARE USED, SUCH STATEMENTS ARE AS OF, AND BASED UPON THEKNOWLEDGE OF MANAGEMENT, AT THE TIME MADE AND ARE SUBJECT TO CHANGE BY THEPASSAGE OF TIME AND/OR SUBSEQUENT EVENTS, AND ACCORDINGLY SUCH STATEMENTS ARESUBJECT TO THE SAME RISKS AND UNCERTAINTIES NOTED ABOVE WITH RESPECT TOFORWARD-LOOKING STATEMENTS.**

 

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**INDEX**

 
| **PART I**   |      |                                                                                        |
|--------------|-----------|---------------------------------------------------------------------------------------------|
|         |      |                                                                                        |   |
|         | Item 1 -  | DESCRIPTION OF BUSINESS                                                                     |   |
|         |      |                                                                                        |   |
|         | Item 2 -  | DESCRIPTION OF PROPERTIES                                                                   |   |
|         |      |                                                                                        |   |
|         | Item 3 -  | LEGAL PROCEEDINGS                                                                           |   |
|         |      |                                                                                        |   |
|         | Item 4 -  | SUBMISSION OF MATTERS TO A VOTE OF  SECURITY HOLDERS                                        |   |
|         |      |                                                                                        |   |
| **PART II**  |      |                                                                                        |
|         |      |                                                                                        |   |
|         | Item 5 -  | MARKET FOR REGISTRANT’S COMMON  EQUITY AND RELATED STOCKHOLDER MATTERS                 |   |
|         |      |                                                                                        |   |
|         | Item 6 -  | MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |
|         |      |                                                                                        |   |
|         | Item 7 -  | FINANCIAL STATEMENTS AND  SUPPLEMENTARY DATA                                                |   |
|         |      |                                                                                        |   |
|         | Item 8 -  | CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE       |   |
|         |      |                                                                                        |   |
|         | Item 8a - | CONTROLS AND  PROCEDURES                                                                    |   |
|         |      |                                                                                        |   |
| **PART III** |      |                                                                                        |
|         |      |                                                                                        |   |
|         | Item 9 -  | DIRECTORS AND EXECUTIVE OFFICERS  OF REGISTRANT                                             |   |
|         |      |                                                                                        |   |
|         | Item 10 - | EXECUTIVE COMPENSATION                                                                      |   |
|         |      |                                                                                        |   |
|         | Item 11 - | SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT                             |   |
|         |      |                                                                                        |   |
|         | Item 12 - | CERTAIN RELATIONSHIPS AND  RELATED TRANSACTIONS                                             |   |
|         |      |                                                                                        |   |
| **PART IV**  |      |                                                                                        |
|         |      |                                                                                        |   |
|         | Item 13 - | EXHIBITS, FINANCIAL STATEMENT  SCHEDULES, AND REPORTS ON FORM 8-K                           |   |
|         |      |                                                                                        |   |
|         | Item 14 - | AUDIT FEES AND  SERVICES                                                                    |   |
|         |      |                                                                                        |   |
|         |      | EXHIBIT INDEX                                                                               |   |
|         |      |                                                                                        |   |
|         |      | SIGNATURES                                                                                  |   |

 

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**PART I**

 

**Item 1****.**           **Description ofBusiness**

 

*Coast Bancorp*

 

CoastBancorp (the “Bancorp” or “Coast Bancorp”), headquartered in San Luis Obispo,California, and is a California corporation incorporated in 2001.  Coast Bancorp became the bank holdingcompany of Coast National Bank on May 31, 2001 through a corporatereorganization.  In the reorganization,Coast National Bank became the wholly-owned subsidiary of Coast Bancorp and theshareholders of the Bank became shareholders of Coast Bancorp.  Coast Bancorp is operated through atwo-tiered corporate structure.  At theholding company level the affairs of Coast Bancorp are overseen by a Board ofDirectors elected by the shareholders of Coast Bancorp at the annual meeting ofshareholders.  The business of the Bankis overseen by a Board of Directors elected by Coast Bancorp, the sole owner ofthe Bank.  As of the date of this Form10-KSB, the respective members of the Board of Directors of the Bank and theBoard of Directors of Coast Bancorp are identical.  Coast Bancorp is subject to the regulations of, and examinationby, the Board of Governors of the Federal Reserve System.  At present, Coast Bancorp does not engage inany material business activities other than the ownership of the Bank.

 

*Coast National Bank*

 

CoastNational Bank (the “Bank”) was chartered June 16, 1997, (charter #23222) by TheOffice of the Comptroller of the Currency as a national bank.  The Bank commenced operations on that datewith two offices, 16 employees and $6,250,000 in capital.  The original branch offices were located at486 Marsh Street, San Luis Obispo and 1199 Grand Avenue, Arroyo Grande,California.  Since that time, an additionalbranch office was opened in June, 1998, at 948 Morro Bay Boulevard in Morro Bay,California and another branch office was opened in July, 1999, at 1193 Los OsosValley Road in Los Osos, California.  InJuly 2002, a loan production office was opened at 930 South Broadway Street inSanta Maria, California and in May 2003 the Bank opened another loan productionoffice in Bakersfield, California.

 

Whenthe Bank opened for business in June 1997, it purchased the real estate andbuilding that housed the Arroyo Grande branch office.  On October 14, 1999, the Bank purchased an adjacent lot next tothe San Luis Obispo main office on Marsh Street.  A few months later on February 1, 2000, the Bank also purchasedthe contiguous property and building that was home to the San Luis Obispo mainoffice at 486 Marsh Street. Construction of a new head office building on the adjacent lot began onOctober 11, 2001 and was completed on November 25, 2002.  The new main office, located at 500 MarshStreet is approximately 10,700 square feet with the San Luis Obispo branchoperation occupying the ground floor and the administrative offices occupyingthe second floor.  The original mainoffice at 486 Marsh Street now houses the Bank’s Government Guaranteed LendingCenter and the Bank’s Note Department.

 

OnMarch 29, 2002, the Bank purchased a vacant site on Morro Bay Boulevard inMorro Bay that is approximately one block from the existing branch with theintention of eventually relocating the Morro Bay branch.  In October 2003 construction began on thenew Morro Bay facility with an anticipated completion date in the summer of2004. The new branch will consist of approximately 2700 square feet with twodrive through lanes.

 

Asof December 31, 2003, the Bank had a total of 63 employees.  A number of these employees are part-timehowever. Part-time employees are converted to full-time equivalent employees onthe percentage of their weekly hours worked compared to 40 hours.  On a full-time equivalent basis, employeesrepresent 56 positions.  The Bank valuesits employees and feels that it enjoys satisfactory working relations withthem.  The employees are activelyengaged individually and as a team in contributing to the Bank’s realization ofits vision and mission.

 

TheBank faces competition in the market area for all of its banking products frombranches of most of the major California money center banks, other communitybanks, savings & loans and credit unions. The Bank also faces competition for some of our deposit products fromlarge securities firms.  The Bank’sprimary market focus is to provide commercial bank services to businesses,professionals, and individuals.  TheBank emphasizes the development of meaningful customer relationships and a highlevel of service. Its employees are well-trained banking professionals who arecommitted to these objectives.

 

*Deposits, Liquidity and LiabilityManagement*

 

Depositsrepresent the Bank’s primary source of funds. As of December 31, 2003, the Bank had approximately $34.6 million innon-interest bearing deposit accounts. Also, as of that date, the Bank had approximately $35.8 million ininterest bearing deposit accounts, $7.0 million in savings accounts and $50.6million in time certificates of deposits. Of the total time certificates of deposits, approximately $32.4 million werein amounts of $100,000 or more, or 64.0% of all time certificates and

 

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25.3% of all deposits.  Most of the Bank’s deposits are obtainedfrom individuals, professionals and small and medium sized businesses.  A material portion of the Bank’s depositshas not been obtained from a single person or a few persons.

Depositproducts include regular checking accounts, savings accounts, certificates ofdeposit, money-market accounts and IRA accounts.  The Bank offers an ATM/ debit card as well as a VISA credit cardas part of its retail banking services.

 

Inorder to attract loan and deposit business, the Bank maintains lobby hours from9:00 a.m. to 4:00 p.m., Monday through Thursday and 9:00 a.m. to 6:00 p.m. onFridays.  Walk-up window service is alsoavailable at the San Luis Obispo office beginning at 8:00 a.m. until 9:00 a.m.and again from 4:00 p.m. until 6:00 p.m., Monday through Friday.  Drive-through service is available at theArroyo Grande office beginning at 8:00 a.m. until 5:00 p.m., Monday throughThursday and 8:00 a.m. until 6:00 p.m. on Friday.  The Bank also provides 24-hour automated teller service at all ofits branch locations.

 

Liquidityis the Bank’s ability to meet fluctuations in deposit levels and to provide forthe credit needs of its customers.  Theobjective in liquidity management is to maintain a balance between the sourcesand uses of funds.  Principal sources ofliquidity include interest and principal payments on loans and investments,proceeds from the maturity of investments and growth in deposits.  The Bank holds overnight Fed Funds Sold as acushion for temporary liquidity needs. For 2003, Fed Funds Sold averaged $13.3 million representing 9.77% ofaverage assets.  In addition, the Bankmaintains Federal Funds lines of $7.0 million with major correspondents,subject to customary terms for such arrangements.  The Bank has also been approved for membership in the FederalHome Loan Bank of San Francisco (FHLBSF).  At December 31, 2003, the Bank had no borrowings under its Federal Fundslines.  Also at December 31, 2003, theBank’s internally calculated liquidity ratio, which measures the percentage oftotal liabilities (excluding equity) which are used to fund cash, cashequivalents and non-pledged marketable securities, was within the Bank’s policyguidelines.

 

*Lending Activities, Underwritingand Credit Administration*

 

Thelending activities of Coast National Bank are guided by the lending policiesestablished by the Bank’s Board of Directors. The loan policy is managed through periodic reviews and approvedannually by the Board.  The Bank’s LoanCommittee is made up of all members of the Bank’s Board of Directors.

 

TheBank considers its underwriting practices to be conservative in nature.  Each loan must meet minimum underwritingcriteria established in the Bank’s loan policy.  Lending authority is granted to lending officers of the Bank on alimited basis, dependent upon individual knowledge and experience.  Loan requests exceeding individual officerapproval limits are approved by the Board Loan Committee.  The Board meets weekly in order to providetimely responses to the Bank’s clients. Concerning matters of credit administration oversight, the Board’s AuditCommittee also schedules the services of an outside loan review firm on abi-monthly basis to monitor the quality of all loans originated by the Bank’slending officers.

 

Nomaterial portion of the Bank’s loans are concentrated within a single industryor group of related industries. However, as of December 31, 2003 and 2002, 58.8% of total loans aresecured by real estate.  The interestrates charged by the Bank vary with the degree of risk and the size andmaturity of the loans involved and are generally affected by competition,governmental regulation and current money market rates.

 

TheBank concentrates its lending activities in the following areas:

 

*CommercialLoans*.     The Bank provides financial services todiverse commercial and professional businesses in its primary serviceareas.  Commercial loans consistprimarily of short term loans (normally with a maturity of one year or less)for working capital and business expansion. Commercial loans typically includerevolving lines of credit collateralized by inventory, accounts receivable andequipment.  Emphasis is placed on theborrower’s earnings history, capitalization, secondary sources of repayment,and in some instances, third-party guarantees or highly liquid collateral (suchas time deposits and investment securities). Commercial loan pricing is generally at a variable rate tied to theprime rate as quoted in the Wall Street Journal.

 

TheBank also participates in several government-guaranteed loan programsadministered by the Small Business Administration (SBA).  These programs include the 7-A program, theLow-Doc program, the Cap-Line program, the Builder Cap-Line program and theExpress program.  The SBA’s 7-A programpresently constitutes the largest volume of government guaranteed lendingengaged in by the Bank and is primarily used for the financing of real estate,equipment, inventory and working capital needs of eligible businesses,generally over a seven-to-twenty five year term.  The government guarantees extended by the SBA to the Bank inconjunction with these transactions substantially reduces the Bank’s creditrisk.  Based upon the Bank’s expertisein this type of lending, the SBA designated the Bank as a Preferred Lender inSeptember 2001.  Under the SBA’s PreferredLender program, the Bank enjoys a significant degree of delegated approval authoritywhich in turn allows the Bank to process customer loan requests morequickly.  This Preferred Lenderauthority covers loan transactions originated by the Bank in the geographicareas defined by the SBA as their Fresno district (which serves the counties ofAlpine,

 

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Fresno, Inyo, Kern, Kings,Madera, Mariposa, Merced, Mono, Monterey, San Benito, San Luis Obispo,Stanislaus, Tulare and Tuolumne) and the Los Angeles district (which serves LosAngeles County, Santa Barbara County and Ventura County).  The Small Business Administration has putsome of their programs on hold due to budgetary constraints which may affectour income,

 

*RealEstate Construction and Development Loans*.                                      The Bank’s real estate construction loanactivity has always focused on providing short-term (maturity of one year orless) loans to individuals and developers with whom the Bank has establishedrelationships, primarily for the construction of single family residences inthe Bank’s service area.

 

Residentialreal estate construction loans are typically secured by first deeds of trustand require guarantees of the borrower, when applicable.  The economic viability of the project andthe borrower’s credit-worthiness are primary considerations in the loanunderwriting decision.  The Bankutilizes independent local real estate appraisers that have been pre-approvedby the Bank’s Loan Committee to evaluate the projects.  Loan-to-value ratios generally do not exceed80% of the appraised value of the property. The Bank monitors projects during the construction phase through regularconstruction inspections and a disbursement program tied to the percentage ofcompletion of each project.

 

TheBank also occasionally makes land loans to individuals who intend to constructa single-family residence on a residential parcel, generally within 24months.  In addition, the Bank makescommercial real estate construction loans to qualified applicants with adequateliquidity for the construction of office and warehouse properties.  Such loans are typically secured by firstdeeds of trust and require guarantees of the borrowers.

 

*ResidentialMortgage Loans.*                               In January, the Bank entered into anoperating agreement with Fremont Bank’s *Community Bank Lending Exchange* (CBLX)division, to be the exclusive residential loan referring agent for San LuisObispo County and the City of Santa Maria. Under the directives of this agreement, the Bank staff refers loans byinputting them into the online system of CBLX. The loans are underwritten and processed by CBLX, with the Bankparticipating in the gathering of financial data and signing loandocuments.  The Bank does not have anyresponsibility for the underwriting or documentation requirements.  For these services the Bank receives areferral fee equivalent to 75 basis points for the dollar amount funded on allloans.  The program was very successfulin the first year, allowing the Bank to earn over $250,000 in new revenue.

 

*CommercialReal Estate Term Loans*.                          The Bank provides medium-term commercial realestate loans secured by commercial or industrial buildings where the propertyis either used by the owner for business purposes (owner-user properties) orhas income derived from tenants (investment properties).  The Bank’s loan policies require theprincipal balance of the loan to be no more than 75% of the stabilizedappraised value of the underlying real estate collateral, with a minimum 1.25%debt service coverage ratio.  The loans,which are typically secured by first trust deeds, generally have terms of nomore than ten years and are amortized over 25 to 30 years.  Some of these loans have fixed rates butmost have variable rates that are tied to an independent index such as the WallStreet Journal prime rate, or the Federal Home Loan Bank’s Eleventh Districtcost of funds index.

 

*Consumerand Other Loans*.                        The Bank’s consumer and other loan portfoliois divided between installment loans secured by automobiles, personal loans,other consumer purposes and revolving, unsecured consumer debt, such as creditcard lines of credit and overdraft lines of credit.  Installment loans tend to be fixed rate and longer term(one-to-five year maturity).  The Bank’sportfolio of revolving credit plans tend to be small in size and meant to be anaccommodation to our customers.

 

*Employees*

 

Asof December 31, 2003, we employed 56 full-time equivalent employees.  Part-time employees are converted tofull-time equivalent employees based on the percentage of their weekly hoursworked compared to 40 hours.  The Bankvalues its employees.  They are activelyengaged individually and as a team in contributing to the Bank’s realization ofits vision and mission.  We believe thatwe enjoy satisfactory working relations with our employees.

 

*Competition*

 

TheBank competes for both loans and deposits with other commercial banks, savings& loan associations, credit unions and other entities, both governmentaland corporate, which raise operating capital through the issuance of debtsecurities.  With regard to loans, theBank competes with other commercial banks, savings & loan associations,consumer finance companies, mortgage companies, credit unions and other lendinginstitutions.

 

TheBank relies substantially on local promotional activity, personal contacts byits officers, directors and employees, referrals by its shareholders,personalized service and its reputation in the community it serves to competeeffectively.

 

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Thebanking business in California generally, and in the Bank’s primary servicearea specifically, is highly competitive with respect to both loans anddeposits, and is dominated by a relatively small number of major banks withoffices operating over a wide geographic area. Among the advantages such major banks have over the Bank are theirability to finance wide-ranging advertising campaigns and to allocate theirinvestment assets, including loans, to regions of higher yield and demand.  Such banks offer certain services such as internationalbanking and trust services which are not offered directly by the Bank, butwhich the Bank has offered indirectly through correspondent institutions whenits customers sought these services.  Inaddition, by virtue of their greater total capitalization, such banks havesubstantially higher lending limits than the Bank.  (Legal lending limits to an individual customer are limited to apercentage of a bank’s total capital accounts plus reserves for loan losses.)  As of December 31, 2003, the Bank’s loanlimits to individual customers were $2,148,191 for unsecured loans, and$3,580,318 for unsecured and secured loans combined.  For borrowers desiring loans in excess of the Bank’s lendinglimits, the Bank may, in the future, make such loans on a participation basiswith its correspondent banks taking the amount of loans in excess of the Bank’slending limits.  In other cases, theBank may refer such borrowers to larger banks or other lending institutions.

 

*Trust Preferred Securities*

 

OnSeptember 26, 2002, the Bancorp completed its offering of trust preferredsecurities (“TPS”) in the amount of $5.0 million.  Under current Federal Reserve guidelines, TPS qualify asregulatory capital for the Bancorp. More specifically, under current Federal Reserve guidelines, TPS qualifyas capital up to 25% of the Bancorp’s total Tier 1 Capital, with the remainderqualifying as Tier 2 Capital.  TheBancorp is reflecting the trust preferred securities as junior subordinated debtsecurities on its consolidated balance sheet.

 

Thesecurities were issued by a special purpose trust formed by the Bancorp andwere sold to a pooled investment vehicle sponsored by Keefe, Bruyette &Woods and FTN Financial, in a private transaction.  The securities were sold pursuant to an applicable exemption fromregistration under the Securities Act of 1933, as amended (the “Act”), and havenot been registered under the Act.  FTNFinancial assisted the Bancorp in the placement of the trust preferred securities.  The securities may not be offered or sold inthe United States absent registration or an applicable exemption fromregistration requirements.

 

The$5.1 million in trust preferred securities have a floating rate of interest,which is reset quarterly, equal to the 3-month LIBOR plus 3.40%.  As of December 31, 2003, the floating rateof interest was 4.57%.  The floatingrate, however, may not exceed 11.95% for the first five years.

 

Ifthe Bancorp elects to defer interest payments pursuant to the terms of theagreement, then the Bancorp may not (i) declare or pay any dividends ordistributions on, or redeem, purchase, acquire or make a liquidation paymentwith respect to any of the Bancorp’s capital stock, or (ii) make any payment ofprincipal or premium, if any, or interest on or repay, repurchase or redeem anydebt securities of the Bancorp that rank pari passu with or junior in interestto the debt securities, other than, among other items, a dividend in theform of stock, warrants, options or other rights in the same stock as that onwhich the dividend is being paid or ranks pari passu with or junior to suchstock.  The prohibition on payment ofdividends and payments on pari passu or junior debt also applies in the case ofan event of default under the agreements.

 

Asof December 31, 2003, the Coast Bancorp has down-streamed a total of $3.6million to the Bank in the form of Tier I capital where it will finance futuredeposit and asset growth.

 

*Other Information*

 

TheBank holds no material patents, trademarks, licenses, franchises or concessions.  No expenditures have been made by the Bank,during the last two fiscal years, on material research activities relating tothe development of services or the improvement of existing services.

 

Basedupon present business activities, compliance with federal, state and localprovisions regulating discharge of materials into the environment will have nomaterial effects upon the capital expenditures, earnings and competitiveposition of the Bank.

 

Therehave been no significant changes in the kinds of services rendered, theprincipal markets for or the methods of distribution of such services by theBank during the last four (5) fiscal years.

 

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TheBank’s business is not seasonal.  TheBank intends to continue with the same basic commercial banking activities thathave characterized the Bank’s operations since its inception.  The Bank anticipates continued profitablegrowth while maintaining sound credit and management policies.

 

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***Critical Accounting Policies***

 

**Ouraccounting policies are integral to understanding the results reported.  Accounting policies are described in detailin Note 1 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.  In preparing its consolidated financialstatements, the Company is required to make judgments and estimates that mayhave a significant impact upon its financial results.  Certain accounting policies require the Company to make significantestimates and assumptions, which have a material impact on the carrying valueof certain assets and liabilities, and are considered critical accountingpolicies.  The estimates and assumptionsused are based on the historical experiences and other factors, which arebelieved to be reasonable under the circumstances.  Actual results could differ significantly from these estimatesand assumptions, which could have a material impact on the carrying value ofassets and liabilities at the balance sheet dates and results of operations forthe reporting periods.  For example, theCompany’s determination of the adequacy of its allowance for loan losses isparticularly susceptible to management’s judgment and estimates.  The following is a brief description of ourcurrent accounting policies involving significant management valuationjudgments.**

 

Allowance for Loan Losses

 

Theallowance for loan losses represents management’s best estimate of lossesinherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loanlosses charged to expense and reduced by loans charged off, net ofrecoveries.  The allowance for loanlosses is determined based on management’s assessment of several factors:reviews and evaluation of individual loans, changes in the nature and volume ofthe loan portfolio, current economic conditions and the related impact onspecific borrowers and industry groups, historical loan loss experiences andthe levels of classified and nonperforming loans.

 

Loansare considered impaired if, based on current information and events, it isprobable that we will be unable to collect the scheduled payments of principalor interest when due according to the contractual terms of the loanagreement.  The measurement of impairedloans is generally based on the present value of expected future cash flowsdiscounted at the historical effective interest rate stipulated in the loanagreement, except that all collateral-dependent loans are measured forimpairment based on the fair value of the collateral.  In measuring the fair value of the collateral, management usesassumptions and methodologies consistent with those that would be utilized byunrelated third parties.

 

Changesin the financial condition of individual borrowers, in economic conditions, inhistorical loss experience and in the condition of the various markets in whichcollateral may be sold may all affect the required level of the allowance forloan losses and the associated provision for loan losses.

 

Available for Sale Securities

 

Thefair value of most securities classified as available for sale are based onquoted market prices.  If quoted marketprices are not available, fair values are extrapolated from the quoted pricesof similar instruments.

 

Deferred Tax Assets

 

Weuse an estimate of future earnings to support our position that the benefit ofour deferred tax assets will be realized. If future income should prove non-existent or less than the amount ofthe deferred tax assets within the tax years to which they may be applied, theasset may not be realized and our net income will be reduced.  Our deferred tax assets are describedfurther in Note 8 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

 

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**SUPERVISIONAND REGULATION**

 

***Bancorp***

 

CoastBancorp, as a bank holding company, is subject to regulation under the BankHolding Company Act of 1956, as amended, and is registered with and subject tothe supervision of the Board of Governors of the Federal Reserve System.  It is the policy of the Federal Reserve thateach bank holding company serves as a source of financial and managerialstrength to its subsidiary banks.  TheFederal Reserve has the authority to examine Coast Bancorp.

 

TheBank Holding Company Act requires Coast Bancorp to obtain the prior approval ofthe Federal Reserve before acquisition of all or substantially all of theassets of any bank or ownership or control of the voting shares of any bank if,after giving effect to such acquisition, Coast Bancorp would own or control,directly or indirectly, more than 5% of the voting shares of such bank.  Recent amendments to the Bank HoldingCompany Act expand the circumstances under which a bank holding company mayacquire control of or all or substantially all of the assets of a bank locatedoutside the State of California.

 

CoastBancorp may not engage in any business other than managing or controlling banksor furnishing services to its subsidiaries, with the exception of certainactivities which, in the opinion of the Federal Reserve, are so closely relatedto banking or to managing or controlling banks as to be incidental tobanking.  The Gramm-Leach-Bliley Act,federal legislation enacted in 2000, offers bank holding companies anopportunity to broaden the scope of activities engaged in by electing to betreated as a financial holding company. A financial holding company enjoys broader powers than a bank holdingcompany, specifically including the ability to own securities and insurancecompanies in addition to financial institutions.  Coast Bancorp has not determined whether or not to become afinancial holding company.  CoastBancorp is generally prohibited from acquiring direct or indirect ownership orcontrol of more than 5% of the voting shares of any company unless that companyis engaged in such authorized activities and the Federal Reserve approves theacquisition.

 

CoastBancorp and its subsidiaries are prohibited from engaging in certain tie-inarrangements in connection with any extension of credit, sale or lease ofproperty or provision of services.  Forexample, with certain exceptions the Bank may not condition an extension ofcredit on a customer obtaining other services provided by it, Coast Bancorp orany other subsidiary, or on a promise by the customer not to obtain otherservices from a competitor.  Inaddition, federal law imposes certain restrictions on transactions betweenCoast National Bank and its affiliates. As affiliates, Coast National Bank and Coast Bancorp are subject withcertain exceptions, to the provisions of federal law imposing limitations onand requiring collateral for extensions of credit by Coast National Bank to anyaffiliate.

 

***The Bank***

 

TheBank is regulated and supervised by the Comptroller of the Currency and subjectto periodic examination by the Comptroller. Deposits of the Bank’s customers are insured by the FDIC up to themaximum limit of $100,000, and, as an insured bank, the Bank is subject tocertain regulations of the FDIC.  As anational bank, the Bank is a member of the Federal Reserve System and is alsosubject to the regulations of the Federal Reserve Board (the “FRB”).

 

Theregulations of those federal bank regulatory agencies govern most aspects ofthe Bank’s business and operations, including but not limited to, requiring themaintenance of non-interest bearing reserves on deposits, limiting the natureand amount of investments and loans which may be made, regulating the issuanceof securities, restricting the payment of dividends and regulating bankexpansion and bank activities and the maximum rates of interest allowed oncertain deposits.  The Bank also issubject to requirements and restrictions of various consumer laws andregulations.

 

Thefollowing description of selected statutory and regulatory provisions andproposals is not intended to be a complete description of these provisions orof the many laws and regulations to which the Bank is subject, and is qualifiedin its entirety by reference to the particular statutory or regulatoryprovisions discussed.

 

***Effect of State Law***

 

Thelaws of the State of California also affect the Bank’s business andoperations.  For example, under 12U.S.C. 36, as amended by the Riegle-Neal Interstate Banking and BranchingEfficiency Act of 1994, state laws regarding community reinvestment, consumerprotection, fair lending and establishment of intrastate branches may affectthe operations of national banks in states other than their home states.  On a similar basis, 12 U.S.C. 85 providesthat state law, in most circumstances, determines the maximum rate of interestwhich a national bank may charge on a loan. As California law exempts all state-chartered and national banks fromthe application of its usury laws, national banks are also provided such anexemption by 12 U.S.C. 85.

 

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***Change in Bank Control***

 

TheBank Holding Company Act of 1956, as amended and the Change in Bank Control Actof 1978, as amended, together with regulations of the FRB and the Comptroller,require that, depending on the particular circumstances, either FRB approvalmust be obtained or notice must be furnished to the Comptroller and notdisapproved prior to any person or company acquiring “control” of a nationalbank, such as the Bank, subject to exemptions for some transactions.  Control is conclusively presumed to exist ifan individual or company acquires 25% or more of any class of voting securitiesof the Bank.  Control is rebuttablypresumed to exist if a person acquires 10% or more but less than 25% of anyclass of voting securities and either the company has registered securitiesunder Section 12 of the Securities Exchange Act of 1934, as amended (the“Exchange Act”), or no other person will own a greater percentage of that classof voting securities immediately after the transaction.

 

***Payment of Dividends***

 

CoastBancorp

 

Theshareholders of Coast Bancorp are entitled to receive dividends when and asdeclared by its Board of Directors, out of funds legally available, subject tothe dividends preference, if any, on preferred shares that may be outstandingand also subject to the restrictions of the California Corporations Code.  At December 31, 2003, Coast Bancorp had nooutstanding shares of preferred stock.

 

Thepayment of dividends to shareholders by Coast Bancorp may be affected if theBancorp elects to defer interest payments pursuant to the terms of the TrustPreferred Securities agreement that was entered into on September 26,2002.  If such an event occurs, then theBancorp may not (i) declare or pay any dividends or distributions on, orredeem, purchase, acquire or make a liquidation payment with respect to any ofthe Bancorp’s capital stock, or (ii) make any payment of principal or premium,if any, or interest on or repay, repurchase or redeem any debt securities ofthe Bancorp that rank pari passu with or junior in interest to the debtsecurities, other than, among other items, a dividend in the form ofstock, warrants, options or other rights in the same stock as that on which thedividend is being paid or ranks pari passu with or junior to such stock.  The prohibition on payment of dividends andpayments on pari passu or junior debt also applies in the case of an event ofdefault under the agreements.

 

Seealso the section that follows titled “Part II – Item 5: Market for CommonEquity and Related Stockholder Matters – Dividends”.

 

Theprincipal sources of cash revenue to Coast Bancorp will be dividends andmanagement fees received from Coast National Bank.  The Bank’s ability to make dividend payments to Coast Bancorp issubject to federal regulatory restrictions.

 

CoastNational Bank

 

Theability of the Bank to make dividend payments is subject to statutory andregulatory restrictions.  After thefirst three years of operations, the Board of Directors of a national bank maydeclare the payment of dividends depending upon earnings, financial conditionand cash needs of the Bank and general business conditions.  A national bank may not pay dividends fromits capital.   All dividends must bepaid out of net profits then on hand, after deducting losses and baddebts.  A national bank is furtherprohibited from declaring a dividend on its shares of common stock until itssurplus fund equals the amount of capital stock or until 10% of the Bank’s netprofits of the preceding half-year in the case of quarterly or semiannualdividends, or the preceding two consecutive half-year periods in the case of anannual dividend, are transferred to the surplus fund.  The approval of the Comptroller is required for the payment ofdividends if the total of all dividends declared by the Bank in any calendaryear would exceed the total of its net profits of that year combined with itsretained net profits of the two preceding years, less any required transfers tosurplus or a fund for the retirement of any preferred stock.

 

Inaddition to the above requirements, guidelines adopted by the Comptroller setforth factors which are to be considered by a national bank in determining thepayment of dividends.  A national bank,in assessing the payment of dividends, is to evaluate the Bank’s capitalposition, its maintenance of an adequate allowance for loan and lease losses,and the need to revise or develop a comprehensive capital plan.  See “Capital Standards” below.

 

TheComptroller also has broad authority to prohibit a national bank from engagingin banking practices which it considers to be unsafe or unsound.  It is possible, depending upon the financialcondition of the national bank in question and other

 

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factors, that the Comptrollermay assert that the payment of dividends or other payments by a bank isconsidered an unsafe or unsound banking practice and therefore, implementcorrective action to address such a practice.

 

Accordingly,the future payment of cash dividends by the Bank will not only depend upon theBank’s earnings during any fiscal period but will also depend upon theassessment of its Board of Directors of capital requirements and other factors,including dividend guidelines and the maintenance of an adequate allowance forloan and lease losses.

 

***Capital Standards***

 

TheBoard of Governors, the Comptroller and other federal banking agencies haverisk based capital adequacy guidelines intended to provide a measure of capitaladequacy that reflects the degree of risk associated with a bankingorganization’s operations for both transactions reported on the balance sheetas assets, and transactions, such as letters of credit and recoursearrangements, which are reported as off-balance-sheet items.  Under these guidelines, nominal dollaramounts of assets and credit equivalent amounts of off-balance-sheet items aremultiplied by one of several risk adjustment percentages, which range from 0%for assets with low credit risk, such as certain U. S. government securities,to 100% for assets with relatively higher credit risk, such as business loans.

 

Abanking organization’s risk based capital ratios are obtained by dividing itsqualifying capital by its total risk-adjusted assets and off-balance-sheetitems.  The regulators measurerisk-adjusted assets and off-balance-sheet items against both total qualifyingcapital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) andTier 1 capital.  Tier 1 capital consistsof common stock, retained earnings, non-cumulative perpetual preferred stockand minority interests in certain subsidiaries, less most other intangibleassets.  Tier 2 capital may consist of alimited amount of the allowance for possible loan and lease losses and certainother instruments with some characteristics of equity.  The inclusions of elements of Tier 2 capitalare subject to certain other requirements and limitations of the federalbanking agencies.  Since December 31,1992, the federal banking agencies have required a minimum ratio of qualifyingtotal capital to risk-adjusted assets and off-balance-sheet item of 8%, and aminimum ratio of Tier 1 capital to risk-adjusted assets and off-balance-sheetitems of 4%.  At least one-half of thequalifying capital must be in the form of Tier 1 capital.

 

Inaddition to the risk-based guidelines, federal banking regulators requirebanking organizations to maintain a minimum amount of Tier 1 capital to totalassets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categoriesused by the regulators to rate banking organizations, the minimum leverageratio of Tier 1 capital to total assets is 3%. It is improbable however, that an institution with a 3% leverage ratiowould receive the highest rating by the regulators since a strong capitalposition is a significant part of the regulators’ rating.  For all banking organizations not rated inthe highest category, the minimum leverage ratio is at least 100 to 200 basispoints above the 3% minimum.  Thus, theeffective minimum leverage ratio, for all practical purposes, is at least 4% or5%.  In addition to these uniformrisk-based capital guidelines and leverage ratios that apply across theindustry, the regulators have the discretion to set individual minimum capitalrequirements for specific institutions at rates significantly above the minimumguidelines and ratios.

 

Inaddition to evaluating capital ratios, an overall assessment of capitaladequacy must take account of each of these other factors including, inparticular, the level and severity of problem and adversely classifiedassets.  For this reason, thesupervisory judgment on a bank’s capital adequacy may differ significantly fromthe conclusions that might be drawn solely from the absolute level of theBank’s risk-based capital ratio.  TheComptroller has stated that banks generally are expected to operate above theminimum risk-based capital ratio.  Bankscontemplating significant expansion plans, as well as those institutions withhigh or inordinate levels of risk, should hold capital consistent with thelevel and nature of the risks to which they are exposed.

 

Further,the banking agencies have adopted modifications to the risk-based capitalregulations to include standards for interest rate risk exposures.  Interest rate risk is the exposure of abank’s current and future earnings and equity capital arising from movements ininterest rates.  While interest raterisk is inherent in a bank’ role as a financial intermediary, it introducesvolatility to bank earnings and to the economic value of the Bank.  The banking agencies have addressed thisproblem by implementing changes to the capital standards to include a bank’sexposure to declines in the economic value of its capital due to changes ininterest rates as a factor that the banking agencies consider in evaluating aninstitution’s capital adequacy.  Bankexaminers consider a bank’s historical financial performance and its earnings exposureto interest rate movements as well as qualitative factors such as the adequacyof a bank’s internal interest rate risk management.

 

Finally,institutions with significant trading activities must measure and hold capitalfor exposure to general market risk arising from fluctuations in interestrates, equity prices, foreign exchange rates and commodity prices and exposureto specific risk associated with debt and equity positions in the tradingportfolio.  General market risk refersto changes in the market value of on-balance-sheet assets and off-balance-sheetitems resulting from broad market movements. Specific market risk refers to changes in the market value of individualpositions due to factors other than broad market movements and includes

 

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such risks as the credit riskof an institution’s issuer.  Theadditional capital requirements apply effective January 1, 1998, toinstitutions with trading assets and liabilities equal to 10% or more of totalassets or trading activity of $1 billion or more.  The federal banking agencies may apply the market riskregulations on a case by case basis to institutions not meeting the eligibilitycriteria if necessary for safety and soundness reasons.

 

Thefederal banking agencies will evaluate an institution in its periodicexamination on the degree to which changes in interest rates, foreign exchangerates, commodity prices or equity prices can affect a financial institution’searnings or capital.  In addition, theagencies focus in the examination on an institution’s ability to monitor andmanage its market risk, and will provide management with a clearer and morefocused indication of supervisory concerns in this area.

 

Undercertain circumstances, the Comptroller may determine that the capital ratiosfor a national bank shall be maintained at levels which are higher than theminimum levels required by the guidelines. A national bank which does not achieve and maintain adequate capitallevels as required may be subject to supervisory action by the Comptroller,through the issuance of a capital directive to ensure the maintenance ofrequired capital levels.  In addition,the Bank is required to meet certain guidelines of the Comptroller concerningthe maintenance of an adequate allowance for loan and lease losses.  The regulatory capital guidelines as well asthe actual capitalization for the Bank and the company on a consolidated basisas of December 31, 2003 follow:

 

Setforth below is the Bank and the company’s risk based and leverage capitalratios as of December 31, 2003:

 
|                            |   | **Requirement**             |   | **Actual**            |   |
|---------------------------------|--------|-----------------------------|--------|-----------------------|--------|
|                            |   | **Adequately  Capitalized** |   | **Well  Capitalized** |   | **Bank** |   | **Company** |   |
| Total risk-based capital ratio  |   | 8.00                        | %      | 10.00                 | %      | 12.51 | % | 13.00 | % |
| Tier 1 risk-based capital ratio |   | 4.00                        | %      | 6.00                  | %      | 11.54 | % | 10.20 | % |
| Tier 1 leverage capital ratio   |   | 4.00                        | %      | 5.00                  | %      | 9.49 | % | 8.92 | % |

 

***Prompt Corrective Action and Other Enforcement Mechanisms***

 

Federal banking agenciespossess broad powers to take corrective and other supervisory actions toresolve the problems of insured depository institutions, including, but notlimited to those institutions that fall below one or more prescribed minimumcapital ratios described above.  Aninstitution that, based upon its capital levels, is classified as wellcapitalized, adequately capitalized, or undercapitalized may be treated asthough it were in the next lower capital category if the appropriate federalbanking agency, after notice and opportunity for hearing, determines that anunsafe or unsound condition or an unsafe or unsound practice warrants such treatment.  At each successive lower capital category,an insured depository institution is subject to more restrictions.  The federal banking agencies, however, maynot treat a significantly undercapitalized institution as criticallyundercapitalized, unless its capital ratio actually warrants such treatment.

 

In addition to measurestaken under the prompt corrective action provisions, commercial bankingorganizations may be subject to potential enforcement actions by the federalregulators for unsafe or unsound practices in conducting their businesses orfor violations of any law, rule, regulation, or any condition imposed inwriting by the agency, or any written agreement with the agency.  Enforcement actions may include theimposition of a conservator or receiver, the issuance of a cease-and-desistorder that can be judicially enforced, the termination of insurance of deposits(in the case of a depository institution), the imposition of civil moneypenalties, the issuance of directives to increase capital, the issuance offormal and informal agreements, the issuance of removal and prohibition ordersagainst institution-affiliated parties and the enforcement of such actionsthrough injunctions or restraining orders based upon a judicial determinationthat the agency would be harmed if such equitable relief was not granted.  Additionally, a holding company’s inabilityto serve as a source of strength to its subsidiary banking organizations couldserve as an additional basis for a regulatory action against the holdingcompany.

 

***Safety and Soundness Standards***

 

The Federal DepositInsurance Corporation Improvement Act (“FDICIA”) imposes certain specificrestrictions on transactions and requires federal banking regulators to adoptoverall safety and soundness standards for depository institutions related tointernal control, loan underwriting and documentation and asset growth.  Among other things, FDICIA limits theinterest rates paid on deposits by undercapitalized institutions, restricts theuse of brokered deposits, limits the aggregate

 

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extensions of credit by adepository institution to an executive officer, director, principal shareholderor related interest, and reduces deposit insurance coverage for depositsoffered by undercapitalized institutions for deposits by certain employeebenefit accounts.  The federal bankingagencies may require an institution to submit to an acceptable compliance plan,as well as have the flexibility to pursue other more appropriate or effectivecourses of action given the circumstances and severity of an institution’snoncompliance with one or more standards.

 

***Premiums for Deposit Insurance***

 

Through the Bank InsuranceFund (“BIF”), the FDIC insures the deposits of the Bank up to prescribed limitsfor each depositor.  The amount of FDICassessments paid by each BIF member institution is based on its relative riskof default as measured by regulatory capital ratios and other factors.  Specifically, the assessment rate is basedon the institution’s capitalization risk category and supervisory subgroupcategory.  An institution’scapitalization risk category is based on the FDIC’s determination of whetherthe institution is well capitalized, adequately capitalized or less thanadequately capitalized.  Aninstitution’s supervisory subgroup category is based on the FDIC’s assessmentof the financial condition of the institution and the probability that FDICintervention or other corrective action will be required.

 

The assessment rate currentlyranges from zero to 27 cents per $100 of domestic deposits.  The FDIC may increase or decrease theassessment rate schedule on a semi-annual basis.  Due to continued growth in deposits and some recent bankfailures, the BIF is nearing its minimum ratio of 1.25% of insured deposits asmandated by law.  If the ratio dropsbelow 1.25%, it is likely the FDIC will be required to assess premiums on allbanks for the first time since 1996. Any increase in the assessments or the assessment rate could have a materialadverse effect on the Bank’s earnings, depending on the amount of the increase.

 

The FDIC is authorized toterminate a depository institution’s deposit insurance upon a finding by theFDIC that the institution’s financial condition is unsafe, or unsound, or thatthe institution has engaged in unsafe, or unsound practices, or has violatedany applicable rule, regulation, order or condition enacted or imposed by theinstitution’s regulatory agency.  Thetermination of deposit insurance for the Bank would have a material adverseeffect on the Bancorp’s condition since it would result in the revocation ofthe Bank’s charter and the cessation of its operations as a going concern.

 

***Extensions of Credit to Insiders andTransactions with Affiliates***

 

TheFederal Reserve Act and FRB Regulation O, which are applicable to nationalbanks, place limitations and conditions on loans or extensions of credit to: abank’s or bank holding company’s executive officers, directors and principalshareholders (i.e., in most cases, those persons who own, control or have powerto vote more than 10% of any class of voting securities); any companycontrolled by such an executive officer, director or principal shareholder; orany political or campaign committee controlled by such an executive officer,director or principal shareholder.

 

Loansextended to any of the above persons must comply with loan-to-one-borrowerlimits, require prior full board approval when aggregate extensions of creditto such persons exceed specified amounts, must be made on substantially thesame terms (including interest rates and collateral) as, and followcredit-underwriting procedures that are not less stringent than, thoseprevailing at the time for comparable transactions with non-insiders, and mustnot involve more than the normal risk of repayment or present other unfavorablefeatures.  Regulation O also prohibits abank from paying an overdraft on an account of an executive officer ordirector, except pursuant to a written pre-authorized interest-bearingextension of credit plan that specifies a method of repayment or a writtenpre-authorized transfer of funds from another account of the officer ordirector at the Bank.

 

Theprovisions of Regulation O summarized above reflect substantial strengtheningas a result of the adoption of FDICIA. FDICIA also resulted in an amendment to Regulation O which provides thatthe aggregate limit on extensions of credit to all insiders of a bank as agroup cannot exceed the Bank’s unimpaired capital and unimpaired surplus.  An exception to this limitation is providedfor banks with less than $100,000,000 in deposits.  The aggregate limit applicable to such banks is two times theBank’s unimpaired capital and unimpaired surplus, provided the Bank meets orexceeds all applicable capital requirements.

 

***Consumer Protection Laws and Regulations***

 

Thebank regulatory agencies are focusing greater attention on compliance withconsumer protection laws and their implementing regulations.  Examination and enforcement have become moreintense in nature, and insured institutions have been advised to monitorcarefully compliance with various consumer protection laws and theirimplementing regulations.  The Bank issubject to many federal consumer protection statutes and regulations, includingthe Community Reinvestment Act, the Equal Credit Opportunity Act, the Truth inLending Act, the Fair Housing Act, the Home Mortgage Disclosure Act and the

 

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Real Estate SettlementProcedures Act.  Penalties under thesestatutes may include fines, reimbursements and other penalties.  Due to heightened regulatory concern relatedto compliance with these and other statutes generally, the Bank may incuradditional compliance costs.

 

**Recent and Proposed Legislation**

 

**Sarbanes-Oxley Act**

 

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Actof 2002 implementing legislative reforms intended to address corporate andaccounting fraud.  In addition to theestablishment of a new accounting oversight board which will enforce auditing,quality control and independence standards and will be funded by fees from allpublicly traded companies, the bill restricts provision of both auditing andconsulting services by accounting firms. To ensure auditor independence, any non-audit services being provided toan audit client will require pre-approval by the company’s audit committeemembers.  In addition, the auditpartners must be rotated.  The Actrequires chief executive officers and chief financial officers, or theirequivalent, to certify to the accuracy of periodic reports filed with the SEC,subject to civil and criminal penalties if they knowingly or willfully violatethis certification requirement.  In addition,under the Act, legal counsel will be required to report evidence of a materialviolation of the securities laws or a breach of fiduciary duty by a company toits chief executive officer or its chief legal officer, and, if such officerdoes not appropriately respond, to report such evidence to the audit committeeor other similar committee of the board of directors or the board itself.

 

Longer prison terms and increased penalties will also be applied tocorporate executives who violate federal securities laws, the period duringwhich certain types of suits can be brought against a company or its officershas been extended, and bonuses issued to top executives prior to restatement ofa company’s financial statements are now subject to disgorgement if suchrestatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirementplan “blackout” periods, and loans to company executives are restricted.  The Act accelerates the time frame fordisclosures by public companies, as they must immediately disclose any materialchanges in their financial condition or operations.  Directors and executive officers must also provide informationfor most changes in ownership in a company’s securities within two businessdays of the change.

 

The Act also prohibits any officer or director of a company or anyother person acting under their direction from taking any action tofraudulently influence, coerce, manipulate or mislead any independent public orcertified accountant engaged in the audit of the company’s financial statementsfor the purpose of rendering the financial statement’s materiallymisleading.  The Act also requires theSEC to prescribe rules requiring inclusion of an internal control report andassessment by management in the annual report to stockholders.  In addition, the Act requires that eachfinancial report required to be prepared in accordance with (or reconciled to)accounting principles generally accepted in the United States of America andfiled with the SEC reflect all material correcting adjustments that areidentified by a “registered public accounting firm” in accordance withaccounting principles generally accepted in the United States of America andthe rules and regulations of the SEC.

 

Effective for filings due after August 29, 2002, as directed by Section302(a) of Sarbanes-Oxley, the Company’s chief executive officer and chieffinancial officer were each required to certify that the Company’s Quarterlyand Annual Reports do not contain any untrue statement of a material fact.  The rules have several requirements,including having these officers certify that: they are responsible forestablishing, maintaining and regularly evaluating the effectiveness ofCompany’s internal controls; they have made certain disclosures to Bancorp’sauditors and the audit committee of the Board of Directors about the Company’sinternal controls; and they have included information in the Company’sQuarterly and Annual Reports about their evaluation and whether there have beensignificant changes in the Company’s internal controls or in other factors thatcould significantly affect internal controls subsequent to the evaluation.

 

**USA PATRIOT Act**

 

In the wake of the tragic events of September 11th, on October 26,2001, President Bush signed the Uniting and Strengthening America by ProvidingAppropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT)Act of 2001.  Under the USA PATRIOT Act,financial institutions are subject to prohibitions against specified financialtransactions and account relationships as well as enhanced due diligence and“know your customer” standards in their dealings with foreign financialinstitutions and foreign customers. For example, the enhanced due diligencepolicies, procedures, and controls generally require financial institutions totake reasonable steps:

 

•                                          Toconduct enhanced scrutiny of account relationships to guard against moneylaundering and report any suspicious transaction;

 

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•                                          Toascertain the identity of the nominal and beneficial owners of, and the sourceof funds deposited into, each account as needed to guard against moneylaundering and report any suspicious transactions;

 

•                                          Toascertain for any foreign bank, the shares of which are not publicly traded, theidentity of the owners of the foreign bank, and the nature and extent of theownership interest of each such owner; and

 

•                                          Toascertain whether any foreign bank provides correspondent accounts to otherforeign banks and, if so, the identity of those foreign banks and related duediligence information.

 

Under the USA PATRIOT Act, financial institutions were given 180 daysfrom enactment to establish anti-money laundering programs.  The USA PATRIOT Act sets forth minimumstandards for these programs, including:

 

• Thedevelopment of internal policies, procedures, and controls;

 

• Thedesignation of a compliance officer;

 

• Anongoing employee training program; and

 

• Anindependent audit function to test the programs.

 

On June 20, 2002, the Board of Directors of the Bank adoptedcomprehensive policies and procedures to address the requirements of the USAPATRIOT Act, and management believes that both of the Bank are currently infull compliance with the Act.

 

**Financial ServicesModernization Legislation**

 

On November 12, 1999, President Clinton signed into law theGramm-Leach-Bliley Act. This legislation eliminated many of the barriers thathave separated the insurance, securities and banking industries since the GreatDepression. The federal banking agencies (the Board of Governors, FDIC and theOffice of the Comptroller of the Currency) among others, continue to draftregulations to implement the Gramm-Leach-Bliley Act.  The Gramm-Leach-Bliley Act is the result of a decade of debate inthe Congress regarding a fundamental reformation of the nation’s financialsystem. The law is subdivided into seven titles, by functional area.

 

The major provisions of the Gramm-Leach-Bliley Act are:

 

*Financial HoldingCompanies and Financial Activities*

 

Title I establishes a comprehensive framework to permit affiliationsamong commercial banks, insurance companies, securities firms, and otherfinancial service providers by revising and expanding the BHC Act framework topermit a holding company system to engage in a full range of financialactivities through qualification as a new entity known as a financial holdingcompany.

 

Activities permissible for financial subsidiaries of national banks,and, also permissible for financial subsidiaries of state member banks,include, but are not limited to, the following:  (a) Lending, exchanging, transferring, investing for others, orsafeguarding money or securities; (b) Insuring, guaranteeing, or indemnifyingagainst loss, harm, damage, illness, disability, or death, or providing and issuingannuities, and acting as principal, agent, or broker for purposes of theforegoing, in any State; (c) Providing financial, investment, or economicadvisory services, including advising an investment company; (d) Issuing orselling instruments representing interests in pools of assets permissible for abank to hold directly; and (e) Underwriting, dealing in, or making a market insecurities.

 

*SecuritiesActivities*

 

Title II narrows the exemptions from the securities laws previouslyenjoyed by banks.  The Board ofGovernors and the SEC continue to work together to draft rules governingcertain securities activities of banks and creates a new, voluntary investmentbank holding company.

 

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*Insurance Activities*

 

Title III restates the proposition that the states are the functionalregulators for all insurance activities, including the insurance activities offederally-chartered banks, and bars the states from prohibiting insuranceactivities by depository institutions.

 

*Privacy*.

 

As required under Title V of the Gramm-Leach-Bliley Act, federalbanking regulators issued final rules on May 10, 2000 to implement the privacyprovisions of Title V. Pursuant to the rules, financial institutions mustprovide (i) initial notices to customers about their privacy policies,describing the conditions under which they may disclose nonpublic personalinformation to nonaffiliated third parties and affiliates; (ii) annual noticesof their privacy policies to current customers; and (iii) a reasonable methodfor customers to “opt out” of disclosures to nonaffiliated third parties.

 

Compliance with the rules was optional until July 1, 2001.  As of July 1, 2001 the Bank was incompliance with the privacy provisions of the Gramm-Leach-Bliley Act and theimplementing regulations promulgated by the FDIC, and subsequently, asnecessary, has updated and enhanced its procedure and practice in this criticalarea.

 

*SafeguardingConfidential Customer Information*.

 

Under Title V of the Gramm-Leach-Bliley Act, federal banking regulatorswere required to adopt rules requiring financial institutions to implement aprogram to protect confidential customer information.  In January 2000, the federal banking agencies adopted guidelinesrequiring financial institutions to establish an information security programto:

 

•                  identify andassess the risks that may threaten customer information;

•                  develop awritten plan containing policies and procedures to manage and control theserisks;

•                  implement andtest the plan; and

•                  adjust the planon a continuing basis to account for changes in technology, the sensitivity ofcustomer information and internal or external threats to information security.

 

The guidelines were effective July 1, 2001.  The Bank implemented a security program appropriate to its sizeand complexity and the nature and scope of its operations in advance of theJuly 1, 2001 effective date, and subsequently, as necessary, has refined andimproved its security program.

 

*CommunityReinvestment Act Sunshine Requirements*.

 

In February 2001, the federal banking agencies adopted finalregulations implementing Section 711 of Title VII, the CRA SunshineRequirements.  The regulations requirenongovernmental entities or persons and insured depository institutions andaffiliates that are parties to written agreements made in connection with thefulfillment of the institution’s CRA obligations to make available to thepublic and the federal banking agencies a copy of each such agreement.  The regulations impose annual reportingrequirements concerning the disbursement, receipt and use of funds or otherresources under each such agreement. The effective date of the regulations was April 1, 2001.

 

The Bank is not a party to any agreement that would be subject ofreporting pursuant to the CRA Sunshine Requirements.

 

The Bank intends to comply with all provisions of theGramm-Leach-Bliley Act and all implementing regulations.

 

**California FinancialInformation Privacy Act/Fair Credit Reporting Act**

 

In 1970, the federal Fair Credit Reporting Act (the “FCRA”) was enactedto insure the confidentiality, accuracy, relevancy and proper utilization ofconsumer credit report information. Under the framework of the FCRA, the United States has developed ahighly advanced and efficient credit reporting system.  The information contained in that broadsystem is used by financial institutions, retailers and other creditors ofevery size in making a wide variety of decisions regarding financialtransactions.  Employers and law enforcementagencies have also made wide use of the information collected and maintained indatabases made possible by the FCRA. The FCRA affirmatively preempts state law in a number of areas,including the ability of entities affiliated by common ownership to share andexchange information freely, and the requirements on credit bureaus toreinvestigate the contents of reports in response to consumer complaints, amongothers.

 

The California Financial Information Privacy Act, which was enacted in2003, requires a financial institution to provide specific information to aconsumer related to the sharing of that consumer’s nonpublic personalinformation.  The Act would allow aconsumer to direct the financial institution not to share his or her nonpublicpersonal information with affiliated or

 

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nonaffiliated companies with which a financial institution hascontracted to provide financial products and services, and would require thatpermission from each such consumer be acquired by a financial institution priorto sharing such information.  Theseprovisions are much more restrictive than the privacy provisions of theFinancial Services Modernization Act, and would require the Bank to adopt newpolicies, procedures and disclosure documentation if implemented asenacted.  The cost of complying withthis legislation is not predictable at this time.

 

Congress enacted the FACT Act, (“Fair and Accurate Credit TransactionAct”) of 2003, which will have the effect of avoiding the sunset preemptionprovision of the Fair Credit Reporting Act (FCRA) that were due to expire onDecember 31, 2003.  The President signedthe FACT Act into law on December 4, 2003. In general, the FACT Act amends the FCRA and, in addition, providesthat, when the implementing regulations have been issued and become effective,the FACT Act will preempt elements of the California Financial InformationPrivacy Act.   The FACT Act requires theBoard of Governors and the Federal Trade Commission to issue final regulationswithin nine months of the effectiveness of the FACT Act, and that thoseregulations must become effective within six months of issuance.  The provisions of the regulations that willimplement the FACT Act, and the timing of their effect on the Bank, cannot bedetermined at this time.

 

**Check 21 Act**

 

On December 22, 2003, the Board of Governors approved a proposed ruleto amend Regulation CC and its commentary to implement the Check Clearing forthe 21st Century Act (“Check 21 Act”). The Check 21 Act was enacted on October 28, 2003 and becomes effectiveon October 28, 2004.

 

To facilitate check truncation and electronic check exchange, the Check21 Act authorizes a new negotiable instrument called a “substitute check” andprovides that a properly prepared substitute check is the legal equivalent ofthe original check for all purposes.  Asubstitute check is a paper reproduction of the original check that can beprocessed just like the original check. The Check 21 Act does not require any bank to create substitute checksor to accept checks electronically.  TheBoard’s proposed amendments: 1) set forth the requirements of the Check 21 Actthat apply to banks; 2) provide a model disclosure and model notices relatingto substitute checks; and 3) set forth bank indorsement and identificationrequirements for substitute checks.  Theproposed amendments also clarify some existing provisions of the rule andcommentary.

 

**Other**

 

Various other legislation, including proposals to overhaul the bank regulatorysystem and to limit the investments that a depository institution may make withinsured funds, is introduced into Congress or the California Legislature fromtime to time.  The Bancorp and the Bankcannot determine the ultimate effect that any potential legislation, ifenacted, or regulations promulgated thereunder, would have upon the financialcondition or operations of the Bancorp or the Bank .

 

**Impact of Government MonetaryPolicy**

 

Theearnings of the Bank are and will be affected by the policies of regulatoryauthorities, including the Federal Reserve. An important function of the Federal Reserve is to regulate the nationalsupply of bank credit.  Among the instrumentsused to implement these objectives are open market operations in U.S. Governmentsecurities, changes in reserve requirements against bank deposits, and changesin the discount rate which banks pay on advances from the Federal ReserveSystem.  These instruments are used invarying combinations to influence overall growth and distribution of bankloans, investments and deposits, and their use may also affect interest rateson loans or interest rates paid for deposits. The monetary policies of the FRB have had a significant effect on theoperating results of commercial banks in the past and are expected to continueto do so in the future.  The effect, ifany, of such policies upon the future business earnings of the Bank cannot bepredicted

 

***Additional Factors That May Affect FutureResults of Operations***

 

Dependenceon Real Estate.                   A significant portion of the loan portfolioof the Bank is dependent on real estate. At December 31, 2003, real estate served as the principal source ofcollateral with respect to approximately 70.2% percent of the Bank’s loanportfolio.  A decline in currenteconomic conditions or rising interest rates could have an adverse effect onthe demand for new loans, the ability of borrowers to repay outstanding loans,the value of real estate and other collateral securing loans and the value ofreal estate owned by the Bank, as well as the Bancorp’s financial condition andresults of operations in general and the market value of the Bancorp’s commonstock.  Acts of nature, includingearthquakes and floods, which may cause uninsured damage and other loss ofvalue to real estate that secures these loans, may also negatively impact theBancorp’s financial condition.

 

18

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EnvironmentalLiability Associated with Real Estate Ownership Could Result in Losses.     In the course of business, the Bank haspurchased real property.  In the future,the Bancorp and the Bank may acquire additional real properties, throughpurchase, foreclosure or otherwise.  Inreal estate ownership, as well as in commercial real estate lending, there is arisk that hazardous substances could be discovered on these properties.  In this event, the Bank might be required toremove these substances from the affected properties at its sole cost andexpense.  The cost of this removal couldsubstantially exceed the value of the affected properties.  The Bancorp or the Bank, as the case may be,may not have adequate remedies against the prior owner or other responsibleparties or could find it difficult or impossible to sell the affectedproperties.  This could have a materialadverse effect on the Bancorp’s and the Bank’s business, financial conditionand operating results.

 

Interest Rate Changes.                                The earnings of the Bancorp and the Bank are substantially affected bychanges in prevailing interest rates.  Changesin interest rates affect the demand for new loans, the credit profile ofexisting loans, the rates received on loans and securities and the rates theBank must pay on deposits and borrowings. The difference between the rates the Bank receives on loans andsecurities and the rates it must pay on deposits and borrowings is known as theinterest rate spread.  Given the Bank’scurrent volume and mix of interest-bearing assets, the Bank’s interest ratespread can be expected to increase when market interest rates are rising, andto decline when market interest rates are declining.  Although the Bank believes its current level of interest ratesensitivity is reasonable, significant fluctuations in interest rates may havean adverse impact on its business, financial condition and result ofoperations.

 

Competition.                            Competition may adversely affect the Bank’sperformance.  The financial servicesbusiness in the Bank’s market area is highly competitive and becoming more sodue to changes in regulation, technological advances and the accelerating paceof consolidation among financial service providers.  The Bank faces competition both in attracting deposits and makingloans.  The Bank competes for loansprincipally through competitive interest rates and the efficiency and qualityof the services provided.  Increasinglevels of competition in the banking and financial services businesses mayreduce the market share or cause the prices charged for services to fall.  Results may differ in future periodsdepending on the nature or level of competition.

 

Regulation.                             Both the Bancorp and the Bank are subject togovernment regulation that could limit or restrict their activities, adverselyaffecting operations.  The financialservices industry is heavily regulated. Federal and state regulation is designed to protect the deposits ofconsumers, not to benefit shareholders. The regulations impose significant limitations on operations, and may bechanged at any time, possibly causing results to vary significantly from past results.  Government policy and regulation,particularly as implemented through the Federal Reserve System, significantlyaffects credit conditions.

 

Borrower’s Failure to Perform.                              In the event of an economic downturn, a significant number of theBank’s borrowers and guarantors may fail to perform their obligations asrequired by the terms of their loans, which could result in larger thanexpected losses.  This risk increaseswhen the economy is weak, as it has been recently.  The Bank has adopted underwriting and credit policies, and loanmonitoring procedures, including the establishment and monitoring of allowancefor credit losses.  Management believesthese provisions are reasonable and adequate, and should keep credit losseswithin expected limits by assessing the likelihood of nonperformance, trackingloan performance and diversifying the credit portfolio.  However, these policies and procedures maynot be adequate to prevent unexpected losses that could materially andadversely affect the results of operations.

 

OperationsRisks.                          The Bank is subject to certain operationsrisks, including, but not limited to, data processing system failures anderrors, customers or employee fraud and catastrophic failures resulting fromterrorist acts or natural disasters. The Bank maintains a system of internal controls to mitigate againstsuch occurrences and maintains insurance coverage when available to protectagainst such risks, but should such an event occur that is not prevented ordetected by the Bank’s internal controls, or is uninsured or in excess ofapplicable insurance limits, it could have a significant adverse impact on theBancorp’s business, financial condition or results of operations.

 

GeographicConcentration.                       The Company’s operations are located almostentirely in the Central Coast region of California.  As a result of this geographic concentration, our results dependlargely upon economic and business conditions in this region.  Deterioration in economic and businessconditions in our market area could have a material adverse impact on thequality of our loan portfolio and the demand for our products and services,which in turn may have a material adverse effect on our results of operations.

 

Waron Terrorism.                       The terrorist attacks of September 11, 2001and ensuing worldwide war on terrorism may lead to unexpected shifts in cashflows, deposit levels, and general economic activity.  Banking agencies in the United States have warned of the possibleimpact of such events on the capital ratios of banks.  In addition, the USA PATRIOT Act, which became effective December25, 2001 as part of the war on terrorism, imposes substantial newresponsibilities on banks for preventing, detecting and reporting flows offunds to terrorist organizations.  Theact also directs the Treasury Department to

 

19

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prepare detailed regulationsfor these purposes, such as new record-keeping requirements, verificationstandards for customer identification and sharing information with thegovernment.  The full impact of the newlaw and its ongoing implementation on the Bancorp and the Bank cannot bepredicted at this time.

 

***Other Information***

 

Variousother legislation, including proposals to overhaul the bank regulatory systemand to limit the investments that a depository institution may make withinsured funds, is introduced into the Congress or the California Legislaturefrom time to time.  The Bancorp and theBank cannot determine the ultimate effect that any potential legislation, ifenacted, or regulations promulgated there under, would have upon the financialcondition or operations of the Bancorp or the Bank.

 

TheBancorp holds no material patents, trademarks, licenses, franchises orconcessions.  No expenditures have beenmade by the Bancorp, during the last two fiscal years, on material research.

 

**Item 2****.  Description of Properties**

 

Constructionof the new San Luis Obispo head office was completed on November 25, 2002, andoccupancy began on that date.  In thenew building, the branch operation is located on the first floor and theadministrative offices are located on the second floor.  The new head office address is 500 MarshStreet, San Luis Obispo, California, and is across the parking lot from theprevious San Luis Obispo branch office at 486 Marsh Street.  The previous San Luis Obispo branch officeis now home to the Bank’s Government Guaranteed Lending Center and the Bank’sNote Department.  Additional surplusoffice space in the building at 486 Marsh Street is currently being leased bythe Bank to unrelated third party tenants. Leased office space that previously housed the Bank’s administrativeoffices at 553 B Higuera Street in San Luis Obispo has been vacated.  The lease on this space expired in February2003.  The Bank did not to renew thislease.  Office space that previouslyhoused the Bank’s Government Guaranteed Lending Center at 545 Higuera Street inSan Luis Obispo has been leased to an unrelated third party.  The Bank is currently leasing this propertyon a short term basis, but it is the intention of the Bank to hold thisproperty for future development and expansion. The San Luis Obispo real estate identified as 500 Marsh Street, 486Marsh Street and 545 Higuera Street is owned by the Bank.

 

TheArroyo Grande location is also owned by the Bank and is located at 1199 GrandAvenue, Arroyo Grande, California.  TheBank leases a lot that is contiguous to the Arroyo Grande branch on GrandAvenue for additional parking.  Thislease expired in March 2003, and has been extended for five years.

 

TheMorro Bay branch is currently located at 948 Morro Bay Boulevard, Morro Bay,California, in a leased facility.  Thecurrent lease expires in March 2004 and will continue on a month to month basisuntil the new facility is completed. Recognizing that the Morro Bay facility had become too small toaccommodate the growth of that branch, in March 2002, the Board of Directorsauthorized the purchase of a vacant site nearby at the corner of Kern Avenueand Morro Bay Boulevard for construction of a larger facility withdrive-through capability.  Constructionon the new branch at 898 Morro Bay Boulevard commenced in October 2003, with anapproximate completion date of summer 2004.

 

TheLos Osos branch located at 1193 Los Osos Valley Road, Los Osos, California, isa leased facility.  The current leaseexpires in July 2007, with two five-year options to renew.

 

InJuly 2002, the Bank entered into a lease to establish a loan production officeat 930 South Broadway in Santa Maria, California.  The original lease on this facility expires May 31, 2004 and hasbeen renewed at substantially the same terms on a month to month basis.  The loan production office was opened toenhance the Bank’s government guaranteed lending opportunities in northernSanta Barbara County.

 

**Item 3****.  Legal Proceedings**

 

Coast Bancorp and CoastNational Bank may be, from time to time, subject to various pending andthreatened legal actions which arise out of the normal course of itsbusiness.  The Bancorp and the Bank arenot a party to any pending legal or administrative proceedings (includingordinary routine litigation incidental to their business) and no suchproceedings are known to be contemplated.

 

There are no materialproceedings adverse to the Bancorp to which any director, officer, affiliate ofthe Bancorp, or 5% shareholder of the Bancorp, or any associate of any suchdirector, officer, affiliate or 5% shareholder of the Bancorp is a party, andnone of the above persons has a material interest adverse to the Bancorp.

 

20

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**Item 4****.  Submission of Matters to a Vote of SecurityHolders**

 

None

 

21

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**PART II**

 

**Item 5****.  Market for Common Equity and RelatedStockholder Matters**

 

Asof December 31, 2003, the equity of the Bancorp consisted of Preferred Stock10,000,000 shares authorized, none outstanding and 10,000,000 shares authorizedwith 638,300 shares of the Bancorp’s Common Stock (having no par value)outstanding.  The stock is not listed onany exchange, but is traded over the counter under the symbol CTBP.OB.  The following high and low bid informationas reported and may not represent actual transactions.

 
|                 |   | **High** |   | **Low** |   |
|----------------------|--------|----------|--------|---------|--------|
| First Quarter, 2003  |   | $        | 16.25  |    | $      | 15.15 |   |
| Second Quarter, 2003 |   | $        | 16.50  |    | $      | 15.00 |   |
| Third Quarter, 2003  |   | $        | 19.25  |    | $      | 16.00 |   |
| Fourth Quarter, 2003 |   | $        | 24.00  |    | $      | 18.00 |   |

 
|                  |   | **High** |   | **Low** |   |
|-----------------------|--------|----------|--------|---------|--------|
| First  Quarter, 2002  |   | $        | 16.65  |    | $      | 15.00 |   |
| Second  Quarter, 2002 |   | $        | 15.00  |    | $      | 14.00 |   |
| Third  Quarter, 2002  |   | $        | 17.40  |    | $      | 14.88 |   |
| Fourth  Quarter, 2002 |   | $        | 19.00  |    | $      | 16.00 |   |

 

Asof December 31, 2003, there were approximately 415 shareholders of record.

 

TheBancorp declared and paid a cash dividend on December 5, 2003, of $0.10 pershare on its Common Stock, to shareholders of record as of the close ofbusiness on November 1, 2003.  Thedividend paid on its Common Stock on November 22, 2002 to its stockholders ofrecord on November 1, 2002, was $0.075 per share.

 

Thefollowing chart provides information as of December 31, 2003, concerning theBancorp’s Stock Option Plans, which represent the Bancorp’s only equitycompensation plans:

 
| **Plan Categories:  Employee  and Director  Stock Option  Plans** |   | **Number of  Securities  to be Issued Upon  Exercise of  Outstanding Options,  Warrants, and Rights  [a]** |   | **Weighted-average  Exercise Price of  Outstanding Options,  Warrants and Rights  [b]** |   | **Number of  Securities  Remaining Available for  Future Issuance Under  Equity Compensation  Plans (excluding securities  Reflected in column [a]  [c]** |    |
|-------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
| Equity Compensation Plans Approved by  Security Holders           |   | 147,500                                                                                                    |   | $                                                                                       | 12.74  |                                                                                                                                                      | 267,000 |   |
| Equity Compensation Plans Not Approved by  Security Holders       |   | 0                                                                                                          |   |                                                                                    |   |                                                                                                                                                      |    |
| Total                                                             |   | 147,500                                                                                                    |   | $                                                                                       | 12.74  |                                                                                                                                                      | 267,000 |   |

 

**Dividends**

 

TheBancorp is regulated by the Board of Governors of the Federal ReserveSystem.  Federal Reserve Boardregulations prohibit cash dividends, except under limited circumstances, if thedistribution would result in a withdrawal of capital or exceed the Bancorp’snet profits then on hand after deducting its losses and bad debts.  Furthermore, cash dividends cannot be paidwithout the prior written approval of the Federal Reserve Board if the total ofall dividends declared in one year exceeds the total of net profits for thatyear, plus the preceding two calendar years, and less any required transfers tosurplus under state or federal law.

 

Forthe impact of Trust Preferred Securities on the payment of dividends, see thepreceding section titled “Part I – SUPERVISION AND REGULATION, *Payment ofDividends* – Coast Bancorp”.

 

22

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Theshareholders of Coast Bancorp are entitled to receive dividends when and asdeclared by its Board of Directors out of funds legally available, subject tothe restrictions set forth in the California General Corporation Law.  The Corporation Law provides that acorporation may make a distribution to its shareholders if the corporation’sretained earnings equal at least the amount of the proposed distribution.  The Corporation Law further provides that, inthe event that sufficient retained earnings are not available for the proposeddistribution, a corporation may nevertheless make a distribution to itsshareholders if it meets two conditions, which generally stated are as follows:  1) the corporation’s assets equal at least1.25 times its liabilities; and 2) the corporation’s current assets equal atleast its current liabilities or, if the average of the corporation’s earningsbefore taxes on income and before interest expense for the two preceding fiscalyears was less than the average of the corporation’s interest expense for suchfiscal years, then the corporation’s current assets must equal at least 1.25times its current liabilities.

 

Oneof the primary sources of income for the Bancorp, on a stand-alone basis, isthe receipt of dividends from the Bank. The availability of dividends from the Bank is limited by variousstatutes and regulations.

 

**Item 6****.  Management Discussion & Analysis ofAnalysis of Financial Condition and Results of Operations**

 

Thefollowing sections set forth a discussion of the significant operating changes,business trends, financial condition, earnings, capital position, and liquiditythat have occurred in the two-year period ended December 31, 2003, togetherwith an assessment, when considered appropriate, of external factors that mayaffect us in the future.  Thisdiscussion should be read in conjunction with our consolidated financialstatements and notes.

 

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**OVERVIEW**

 

**Earnings Summary**

 

Consolidatednet income in 2003 was $982,169, an increase of $211,102 or 27.3%, compared to$771,067 in 2002.  Diluted earnings pershare in 2003 were $1.46, compared to $1.17 in 2002.  The increase in earnings in 2003 was due primarily to the gain onsale of guaranteed portions of government loans, fees from the mortgage loanprogram and to the increase in the net interest margin.

 

Consolidatednet income in 2002 was $771,067, an increase of $123,479 or 19.1%, compared to$647,588 in 2001.  Diluted earnings pershare in 2002 were $1.17, compared to $0.99 in 2001.  The increase in earnings in 2002 was also due to the decrease ininterest expense and the gains on sale of securities and guaranteed portions ofgovernment loans.

 

**Balance Sheet Summary**

 

Totalassets at December 31, 2003 were $142.2 million, a $20.2 million or 16.5%increase from $122.1 million at December 31, 2002.  Average assets for 2003 were $136.1 million, compared to $108.4million for 2002.  Total depositsincreased $20.2 million or 18.7% to $128.0 million at December 31, 2003.  Gross loans increased $18.1 million or20.1%, to $107.8 million at December 31, 2003. Stockholder’s equity increased $1 million or 12.8%, to $8.8 million atDecember 31, 2003.

 

Thefollowing table sets forth several key operating ratios for 2003 and 2002:

 
|                                                       |   | **For the  Year Ended  December 31,** |   |
|------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                       |   | **2003**                              |   | **2002** |   |
| Return on Average Assets                                   |   | 0.72                                  | %      | 0.71 | % |
| Return on Average Equity                                   |   | 12                                    | %      | 10.27 | % |
| Average Stockholder’s Equity to Average  Total Assets |   | 6.10                                  | %      | 6.93 | % |

 

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**Distribution of Assets,Liabilities, and Shareholders’ Equity**

 

Thefollowing table presents, for the years indicated, the distribution of averageassets, liabilities and shareholders’ equity, as well as the total amounts ofinterest income from average interest-earning assets and the resultant yields,and the dollar amounts of interest expense and average interest-bearingliabilities, expressed both in dollars and in rates.  Non-accrual loans are included in the calculation of the averagebalances of loans, and interest not accrued is excluded (dollar amounts inthousands).

 
|                                            |   | **For the  Year Ended December 31,** |    |
|-------------------------------------------------|--------|--------------------------------------|---------|
|                                            |   | **2003**                             |    | **2002** |   |
|                                            |   | **Average  Balance**                 |    | **Interest  Earned  or Paid** |   | **Average  Yield or  Rate Paid** |   | **Average  Balance** |   | **Interest  Earned  or Paid** |   | **Average  Yield or  Rate Paid** |   |
| **Assets**                                      |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Interest-Earning Assets:                        |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Investment Securities                           |   | $                                    | 5,756   |   | $ | 148 |   | 2.57 | % | $ | 7,400 |   | $ | 311 |   | 4.20 | % |
| Federal Funds Sold                              |   | 13,269                               |    | 139 |   | 1.05 | % | 8,465 |   | 128 |   | 1.51 | % |
| Other Earning Assets                            |   | 1,224                                |    | 27 |   | 2.21 | % | 276 |   | 14 |   | 6.25 | % |
| Loans                                           |   | 100,558                              |    | 7,136 |   | 7.10 | % | 81,572 |   | 5,955 |   | 7.30 | % |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Total Interest-Earning Assets                   |   | 120,807                              |    | 7,450 |   | 6.17 | % | 97,713 |   | 6,408 |   | 6.56 | % |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Cash and Due from Bank                          |   | 8,335                                |    |   |   |   |   | 5,633 |   |   |   |   |   |
| Premises and Equipment                          |   | 6,905                                |    |   |   |   |   | 5,024 |   |   |   |   |   |
| Other Real Estate Owned                         |   | —                               |    |   |   |   |   | — |   |   |   |   |   |
| Accrued Interest and Other Assets               |   | 1,186                                |    |   |   |   |   | 1,005 |   |   |   |   |   |
| Allowance For Loan Losses                       |   | (1,044                               | )       |   |   |   |   | (925 | )  |   |   |   |   |
| Total Assets                                    |   | $                                    | 136,189 |   |   |   |   |   | $ | 108,450 |   |   |   |   |   |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**   |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing Liabilities:                   |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Money Market and NOW:                           |   | $                                    | 34,120  |   | $ | 238 |   | 0.70 | % | $ | 28,408 |   | $ | 330 |   | 1.16 | % |
| Savings                                         |   | 6,831                                |    | 56 |   | 0.82 | % | 5,125 |   | 55 |   | 1.07 | % |
| Time Deposits under $100,000                    |   | 18,074                               |    | 376 |   | 2.08 | % | 16,908 |   | 464 |   | 2.74 | % |
| Time Deposits of $100,000 or More               |   | 31,250                               |    | 731 |   | 2.34 | % | 21,848 |   | 648 |   | 2.97 | % |
| Trust Preferred Securities                      |   | 5,155                                |    | 270 |   | 5.24 | % | 1,719 |   | 80 |   | 4.65 | % |
| Other                                           |   | 398                                  |    | 29 |   | 7.29 | % | 728 |   | 39 |   | 5.36 | % |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Total Interest-Bearing Liabilities              |   | 95,828                               |    | 1,700 |   | 1.76 | % | 74,736 |   | 1,614 |   | 2.16 | % |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Non-Interest Bearing Liabilities                |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Demand Deposits                                 |   | 31,730                               |    |   |   |   |   | 25,927 |   |   |   |   |   |
| Other Liabilities                               |   | 324                                  |    |   |   |   |   | 278 |   |   |   |   |   |
| Shareholders’ Equity                       |   | 8,307                                |    |   |   |   |   | 7,509 |   |   |   |   |   |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Total Liabilities and Shareholders’ Equity |   | $                                    | 136,189 |   |   |   |   |   | $ | 108,450 |   |   |   |   |   |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Net Interest Income                             |   |                                 |    | $ | 5,750 |   |   |   |   |   | $ | 4,792 |   |   |   |
|                                            |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Net Yield on Interest-Earning Assets            |   |                                 |    |   |   | 4.76 | % |   |   |   |   | 4.91 | % |

 

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**EARNINGS ANALYSIS**

 

NetInterest Income

 

Asignificant component of our earnings is net interest income.  Net interest income is the differencebetween the interest we earn on our loans and investments and the interest wepay on deposits and other interest-bearing liabilities.

 

Ournet interest income is affected by changes in the amount and mix of ourinterest-earning assets and interest-bearing liabilities, referred to as a“volume change”.  It is also affected bychanges in the yields we earn on interest-earning assets and rates we pay oninterest-bearing deposits and other borrowed funds, referred to as a “ratechange”.

 

Thefollowing table sets forth changes in interest income and interest expense foreach major category of interest-earning asset and interest-bearing depositaccounts, and the amount of change attributable to volume and rate changes forthe years indicated.  Changes not solelyattributable to rate or volume have been allocated to volume and rate changesin proportion to the relationship of the absolute dollar amounts of the changesin each (dollar amounts in thousands).

 
|                             |   | **Year Ended  December 31, 2003  versus  Year Ended December 31, 2002** |   |
|----------------------------------|--------|-------------------------------------------------------------------------|--------|
|                             |   | **Increase  (Decrease) due to change in**                               |   |
|                             |   | **Volume**                                                              |   | **Rate** |   | **Total** |   |
| **Interest-Earning Assets:**     |   |                                                                    |   |   |   |   |   |
| Investment Securities            |   | $                                                                       | (59    | ) | $ | (104 | ) | $ | (163 | ) |
| Federal Funds Sold               |   | 58                                                                      |   | (47 | ) | 11 |   |
| Other Earning Assets             |   | 25                                                                      |   | (12 | ) | 13 |   |
| Loans                            |   | 1,351                                                                   |   | (170 | ) | 1,181 |   |
| **Total Interest Income**        |   | 1,375                                                                   |   | (333 | ) | 1,042 |   |
|                             |   |                                                                    |   |   |   |   |   |
| **Interest-Bearing Liabilities** |   |                                                                    |   |   |   |   |   |
| Transaction Accounts             |   | 57                                                                      |   | (149 | ) | (92 | ) |
| Savings                          |   | 16                                                                      |   | (15 | ) | 1 |   |
| Time Deposits                    |   | 30                                                                      |   | (118 | ) | (88 | ) |
| Time Deposits $100,000 or more   |   | 239                                                                     |   | (156 | ) | 83 |   |
| Trust Preferred                  |   | 179                                                                     |   | 11 |   | 190 |   |
| Other                            |   | (21                                                                     | )      | 11 |   | (10 | ) |
| **Total Interest Expense**       |   | 500                                                                     |   | (416 | ) | 84 |   |
| **Net Interest Income**          |   | $                                                                       | 875    |   | $ | 83 |   | $ | 958 |   |

 

**2003 Compared to 2002**

 

Netinterest income for 2003 was $5.75 million, an increase of 20.0% compared tothe $4.79 million reported in 2002. This increase was primarily due to the increase in loans and thedownward pricing in the rates paid by the Bank on interest bearing liabilities.

 

Interestincome in 2003 was $7.4 million, representing an increase of $1.0 million or16.3% over the $6.4 million recorded in 2002.  The increase in interest income was primarily due to the averageincrease in loan balances.  The Bank wasable to increase loans significantly while maintaining quality.  The reduction in the prime rate to 4.00%renewed interest in refinancing activities and encouraged businesses to upgradesystems and facilities. While net interest income was greater, the net yield onaverage earning assets declined 15 basis points from 4.91% in 2002 to 4.76% in2003.

 

Interestexpense increased in 2003 due to the Trust Preferred Securities, but this wasoffset by a decrease in interest paid on deposit accounts, resulting in a netdecline of the average rate paid of .40 basis points from 2.16% in 2002 to1.76% in 2003.

 

26

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**Non-interestIncome**

 

TheBank receives non-interest income primarily from service charges and fees on accounts,as well as from the sale of government guaranteed loans and realized gains onthe sale of investment securities.  In2003, non-interest income was $1,071,596, an increase of $96,535 or 9.90%compared to the 2002 amount of $975,061.

 

Theincrease in non-interest income can be substantially attributed to feesreceived from the mortgage loan program which were $251,056 compared to $23,750in 2002.  In 2002, the majority of ournon-interest income was derived from the gain on the sale of securities and thegain on sale of loans.  Gain on the saleof loans and servicing fees totaled $497,968 in 2003, down 4%.  Gain on the sale of securities decreased($201,989 in 2002 versus $25,190 in 2003) by 87.53%.

 

Themortgage loan program, through the Community Bank Lending Exchange (CBLX),enabled the Bank to facilitate long term mortgage loans for our customers.  The Bank submitted the applications to CBLX,by whom the loans were underwritten and processed.  The Bank had no responsibility for underwriting or documentation.  For these services the Bank was paid afee.   Our participation in this programbegan in January 2003 and will continue in 2004 although there is no assurancethat the income realized in 2003 will be repeated.

 

Regardingthe realized gains on the sale of loans, the most common reason for the Bank tosell the guaranteed portion of a loan is to also meet the liquidity needs ofthe Bank and to maintain the Bank’s loan-to-deposit ratio within acceptableranges.  The Bank also enjoys theopportunity to supplement its fee income from the sale of thegovernment-guaranteed portions of certain loans.  In 2001 the Bank developed a government guaranteed lending centerto originate loans that are partially guaranteed by the U.S. Small BusinessAdministration or the U.S. Department of Agriculture.  Given the volume of lending in this department during 2002 and2003, the Bank has been able to realize gains when the guaranteed portions ofthese loans have been sold.  Funding forthe Small Business Administration loan program has been reduced and hearingsare being held as of this date. While we hope this non-interest incomeopportunity to continue into the future, there is no assurance that the levelof loan sales and the subsequent realization of fee income enjoyed by the Bankin the past will continue at prior levels.

 

**Non-interest Expense**

 

Non-interestexpense reflects our costs of products and services related to systems,facilities and personnel.  The majorcomponents of non-interest expense stated as a percentage of average assets areas follows:

 
|                             |   | **2003** |   | **2002** |   |
|----------------------------------|--------|----------|--------|----------|--------|
| Salaries and Employee Benefits   |   | 2.05     | %      | 2.14     | %      |
| Occupancy Expenses               |   | 0.25     | %      | 0.29     | %      |
| Furniture and Equipment          |   | 0.19     | %      | 0.17     | %      |
| Data Processing                  |   | 0.27     | %      | 0.33     | %      |
| Marketing and Business Promotion |   | 0.28     | %      | 0.32     | %      |
| Other Professional Expenses      |   | 0.20     | %      | 0.25     | %      |
| Office Expenses                  |   | 0.14     | %      | 0.15     | %      |
| Other                            |   | 0.27     | %      | 0.32     | %      |
|                             |   | 3.64     | %      | 3.97     | %      |

 

Non-interest expense was$4.9 million in 2003, an increase of $0.6 million or 15.1% over the $4.3million reported in 2002.  The majority ofthis increase is attributable not only to our growth in earning assets anddeposit accounts, but also to expand staff to provide service to ourcustomers.   Salaries for 2003 and 2002respectively were $2,795,592 and $2,318,075

 

**Income Taxes**

 

Incometax expense was $677,500 and $542,520 for the years ended December 31, 2003,and 2002 respectively, an increase of $134,980 or 24.9%.  These expenses resulted in an effective taxof 40.8% in 2003, and 41.3% in 2002. The increase in income tax expense in 2003 was due to increasedprofitability in 2003 over 2002.

 

27

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**BALANCE SHEET ANALYSIS**

 

**Investment Portfolio**

 

Thefollowing table summarizes the amounts and distribution of our investmentsecurities held as of the dates indicated, and the weighted average yields asof December 31, 2003 (dollar amounts in thousands):

 
|                                      |   | **December  31,** |       |
|-------------------------------------------|--------|-------------------|------------|
|                                      |   | **2003**          |       | **2002** |   |
|                                      |   | **Book  Value**   |       | **Market  Value** |   | **Weighted  Average  Yield** |   | **Book  Value** |   | **Market  Value** |   |
| **Available-for-Sale Securities**         |   |              |       |   |   |   |   |   |   |   |   |
| **U.S. Treasuries:**                      |   |              |       |   |   |   |   |   |   |   |   |
| Within One Year                           |   | $                 | —     |   | $ | — |   | 0.00 | % | $ | — |   | $ | — |   |
| One to Five Years                         |   | 1,987,107         |       | 1,994,062 |   | 1.32 | % | — |   | — |   |
| Five to Ten Years                         |   | —            |       | — |   | 0.00 | % | — |   | — |   |
| After Ten Years                           |   | —            |       | — |   | 0.00 | % | — |   | — |   |
| Total U.S. Treasury Securities            |   | 1,987,107         |       | 1,994,062 |   | 0.00 | % | — |   | — |   |
|                                      |   |              |       |   |   |   |   |   |   |   |   |
| **U.S. Government and Agency Securities** |   |              |       |   |   |   |   |   |   |   |   |
| Within One Year                           |   | —            |       | — |   | 0.00 | % | — |   | — |   |
| One to Five Years                         |   | 10,033,801        |       | 10,078,520 |   | 2.86 | % | 2,009,427 |   | 2,092,179 |   |
| Five to Ten Years                         |   | —            |       | — |   | 0.00 | % | — |   | — |   |
| After Ten Years                           |   | —            |       | — |   | 0.00 | % | — |   | — |   |
| Total U.S. Treasury Securities            |   | 10,033,801        |       | 10,078,520 |   | 2.86 | % | 2,009,427 |   | 2,092,179 |   |
|                                      |   |              |       |   |   |   |   |   |   |   |   |
| **Mutual Funds**                          |   | —            |       | — |   |   |   | — |   | — |   |
| **Mortgage Backed Securities**            |   | —            |       | — |   |   |   | — |   | — |   |
| **Total Available-for-Sale Securities**   |   | $                 | 12,020,908 |   | $ | 12,072,582 |   | 2.51 | % | $ | 2,009,427 |   | $ | 2,092,179 |   |

 

28

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 No securities were held to maturity.

 

Securitiesmay be pledged to meet security requirements imposed as a condition to receiptof deposit of public funds and for other purposes.  At December 31, 2003, the carrying values of securities pledgedto secure public deposits and other purposes were $1,032,394.

 

**Loan Portfolio**

 

Thefollowing table sets forth the components of total net loans outstanding ineach category at the date indicated (dollar amounts in thousands):

 
|                                              |   | **December** |    |
|---------------------------------------------------|--------|--------------|---------|
|                                              |   | **2003**     |    | **2002** |   |
| **Loans**                                         |   |         |    |   |   |
| Commercial                                        |   | $            | 28,244  |   | $ | 30,530 |   |
| Real Estate - Construction                        |   | 13,501       |    | 6,055 |   |
| Real Estate - Other                               |   | 62,282       |    | 45,765 |   |
| Consumer                                          |   | 3,849        |    | 7,420 |   |
| **Total Loans**                                   |   | 107,876      |    | 89,770 |   |
| Net Deferred Loan Costs (Fees)                    |   | (414         | )       | (355 | ) |
| Allowance for Loan Losses                         |   | (1,109       | )       | (1,000 | ) |
| **Net Loans**                                     |   | $            | 106,353 |   | $ | 88,415 |   |
|                                              |   |         |    |   |   |
| **Commitments**                                   |   |         |    |   |   |
| Standby Letters of Credit                         |   | $            | 1,946   |   | $ | 2,583 |   |
| Undisbursed Loans and Commitments to Grant  Loans |   | 36,708       |    | 25,721 |   |
| **Total Commitments**                             |   | $            | 38,654  |   | $ | 28,304 |   |

 

**Risk Elements**

 

Bankmanagement assesses and manages credit risk on an ongoing basis through ourlending policies.  The Bank strives tocontinue its historically low level of credit losses by continuing its emphasison credit quality in the loan approval process, active credit administrationand regular monitoring.  However,inherent in the lending function is the fact that loan losses will beexperienced and that the risk of loss will vary with the type of loan beingmade, the credit-worthiness of the borrower and the term of the loan.  To reflect the currently perceived risks ofloss associated with its loan portfolio, additions are made to the Bank’sallowance for loan losses.  The Bank’sentire allowance is a valuation allowance; that is, it has been created bydirect charges against operations through the provision for loan losses.

 

Commitmentsto extend credit are agreements to lend to a customer as long as establishedconditions of the contract have been met. Standby Letters of Credit are used to guarantee the performance of acustomer to a third party.  Many ofthese commitments expire without being drawn upon.  These unfunded commitments are included in risk basedcalculations and the effect is not material.

 

Inextending credit and commitments to borrowers, the Bank generally requirescollateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or fromproceeds from the sale of selected assets of the borrower.  Our requirement for collateral and/orguarantees is determined on a case-by-case basis in connection with its evaluationof the credit worthiness of the borrower. Collateral held varies but may include accounts receivable, inventory,property, plant and equipment, income-producing properties, residences andother real property.  The Bank securesits collateral by perfecting its interest in business assets, obtaining deedsof trust, or outright possession among other means.

 

TheBank believes that its lending policies and underwriting standards will tend tominimize losses in an economic downturn, however, there is no assurance thatlosses will not occur under such circumstances.

 

29

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Thefollowing table shows the maturity distribution of the fixed rate portion ofthe loan portfolio in the amount of $13,299 as well as the maturitydistribution of variable rate loans of $37,113 currently fixed at their floorrate at December 31, 2003 (dollar amounts in thousands):

 
|                                       |   | **3 Months  or Less** |   | **Over 3  Months  through 12  Months** |   | **Due after  one year to  five years** |   | **Due after  five years** |   | **Total** |   |
|--------------------------------------------|--------|-----------------------|--------|----------------------------------------|--------|----------------------------------------|--------|---------------------------|--------|-----------|--------|
|                                       |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
| **Loans**                                  |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
|                                       |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
| Commercial                                 |   | $                     | 2,688  |                                   | $      | 3,664                                  |   | $                         | 1,040  |      | $      | 3,633 |   | $ | 11,025 |   |
| Real Estate - Construction                 |   | 2,713                 |   | 5,954                                  |   | 1,432                                  |   |                      |   | 10,099    |   |
| Real Estate - Other                        |   | 2,121                 |   | 4,936                                  |   | 5,299                                  |   | 14,679                    |   | 27,035    |   |
| Consumer                                   |   | 90                    |   | 353                                    |   | 1,042                                  |   | 595                       |   | 2,080     |   |
| Total Loans                                |   | $                     | 7,612  |                                   | $      | 14,907                                 |   | $                         | 8,813  |      | $      | 18,907 |   | 50,239 |   |
|                                       |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
| Loans on Non-Accrual                       |   |                  |   |                                   |   |                                   |   |                      |   | 10        |   |
| Total Loans, including Loans Held for Sale |   |                  |   |                                   |   |                                   |   |                      |   | $         | 50,249 |   |
|                                            |        |                       |        |                                        |        |                                        |        |                           |        |           |        |  |  |  |  |  |  |

 

Thefollowing table shows the maturity distribution of the remaining variable rateportion of the loan portfolio at December 31, 2003 (dollar amounts inthousands):

 

 
|                                       |   | **3 Months  or Less** |   | **Over 3  Months  through 12  Months** |   | **Due after  one year to  five years** |   | **Due after  five years** |   | **Total** |   |
|--------------------------------------------|--------|-----------------------|--------|----------------------------------------|--------|----------------------------------------|--------|---------------------------|--------|-----------|--------|
|                                       |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
| **Loans**                                  |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
|                                       |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
| Commercial                                 |   | $                     | 13,154 |                                   | $      | 3,630                                  |   | $                         | 435    |      | $      | — |   | $ | 17,219 |   |
| Real Estate - Construction                 |   | 379                   |   | 3,023                                  |   | —                                 |   | —                    |   | 3,402     |   |
| Real Estate - Other                        |   | 19,250                |   | 7,709                                  |   | 7,703                                  |   | 585                       |   | 35,247    |   |
| Consumer                                   |   | 1,700                 |   | 37                                     |   | —                                 |   | —                    |   | 1,737     |   |
| Total Loans                                |   | $                     | 34,483 |                                   | $      | 14,399                                 |   | $                         | 8,138  |      | $      | 585 |   | 57,605 |   |
|                                       |   |                  |   |                                   |   |                                   |   |                      |   |      |   |
| Loans on Non-Accrual                       |   |                  |   |                                   |   |                                   |   |                      |   | 22        |   |
| Total Loans, including Loans Held for Sale |   |                  |   |                                   |   |                                   |   |                      |   | $         | 57,627 |   |

 

30

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**Non-performing Assets**

 

Thefollowing table provides information with respect to the components of ournon-performing assets at the dates indicated (dollar amounts in thousands):

 
|                                                             |   | **For the  Year Ended** |   |
|------------------------------------------------------------------|--------|-------------------------|--------|
|                                                             |   | **2003**                |   | **2002** |   |
| Loans 90 Days Past Due and Still Accruing                        |   | $                       | — |   | $ | — |   |
| Non-Accrual Loans                                                |   | 32                      |   |   |   |
| Total Non-performing Loans                                       |   | $                       | 32     |   | $ | — |   |
|                                                             |   |                    |   |   |   |
| Other Real Estate Owned                                          |   | $                       | — |   | $ | — |   |
| Total Non-performing Assets                                      |   | $                       | 32     |   | $ | — |   |
|                                                             |   |                    |   |   |   |
| Non-performing Loans as a Percentage of  Total Loans             |   | 0.03                    | %      | 0.00 | % |
| Allowance for Loan Loss as a Percentage of  Non-performing Loans |   | 3464.74                 | %      | N/A |   |
| Non-performing Assets as a Percentage of  Total Assets           |   | 0.02                    | %      | 0.00 | % |

 

AtDecember 31, 2003, in addition to loans disclosed above as past due,non-accrual or restructured, management also identified $$1,236,132 of loans,where the ability to comply with present loan payment terms in the future isquestionable.  However, the inability ofthe borrowers to comply with repayment terms was not sufficiently probable toplace the loan on non-accrual status at December 31, 2003.  This amount was determined based on analysisof information known to management about the borrowers’ financial condition andcurrent economic conditions.  Estimatedpotential losses from these problem loans have been provided for in determiningthe allowance for loan losses at December 31, 2003.

 

Forreference, the Bank’s financial statements are prepared on the accrual basis ofaccounting, including the recognition of interest income on the loanportfolio.  The Bank follows the policyof non-accrual of interest on a loan at the time the loan is past due ninety(90) days or more, as to interest or principal, unless the loan is well securedand in the process of collection. Interest from non-accrual loans is not accrued on the books.  Payments received while the loan is onnon-accrual are typically applied against principal.  When a loan is placed on a non-accrual basis, any previouslyaccrued but unpaid interest is reversed and charged against current incomeunless there is adequate collateral to assure recovery of the accrued interest.

 

**Provision and Allowance for LoanLosses**

 

Aspreviously discussed under Critical Accounting Policies, the Allowance for LoanLosses represents management’s best estimate of losses inherent in the existingloan portfolio.  Management of the Bankbelieves that the allowance for loan losses is adequate.  The Bank has established a monitoring systemfor loans in order to identify impaired loans and potential problem loans andto permit periodic evaluation of impairment and adequacy of the allowance forloan losses in a timely manner.  Themonitoring system and allowance for loan losses methodology have evolved over aperiod of years, and loan classifications have been incorporated into thedetermination of the allowance for loan losses.  This monitoring system and allowance methodology includes aloan-by-loan analysis for all classified loans as well as loss factors for thebalance of the unclassified portfolio. Classified loans are reviewed individually to estimate the amount ofprobable losses that needs to be included in the allowance.  These reviews include analysis of financialinformation as well as evaluation of collateral securing the credit.  Loss factors on the unclassified portion ofthe portfolio are based on such factors as historical loss experience, currentportfolio delinquency and trends, and other inherent risk factors such aseconomic conditions, concentrations in the portfolio, risk levels of particularloan categories, internal loan review and management oversight.

 

TheBank made a contribution of $204,345 to the allowance for loan losses for thetwelve months ended December 31, 2003, compared to $145,412 for the same periodin 2002.  Management believes that theallowance, which equals 1.03% of net loans at December 31, 2003, is adequate tocover future losses.  The allowance atDecember 31, 2002, was 1.11% of total loans.

 

31

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Theprovision for loan losses charged against operations is based upon the actualnet loan loss expensed plus an amount for other such factors which, inmanagement’s judgment, deserve recognition in estimating possible loan losses,including: specific loan conditions as determined by management and regulatoryagencies, the historical relationship between charge-offs and the level ofallowances, and prevailing economic conditions.  While these factors are essentially judgmental and may not bereduced to a mathematical formula, it is management’s view that the $1,108,716allowance, or 1.03% of total loans at December 31, 2003, was adequate.  However, there can be no assurance that inany given period the Bank might not sustain charge-offs, which are substantialin relation to the size of the allowance. It is the policy of management to make additions to the allowance sothat it remains adequate to cover all anticipated loan charge-offs.  Periodic fluctuations in the provision forloan losses result from management’s assessment of the adequacy of theallowance for loan losses: however, actual loan losses may vary from currentestimates.

 

32

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Thefollowing table summarizes, for the years indicated, changes in the allowancefor loan losses arising from loans charged-off, recoveries on loans previouslycharged-off, and additions to the allowance which have been charged tooperating expenses and certain ratios relating to the allowance for loan losses(dollar amounts in thousands):

 
|                                                          |   | **For the  Year Ended  December 31,** |    |
|---------------------------------------------------------------|--------|---------------------------------------|---------|
|                                                          |   | **2003**                              |    | **2002** |   |
| **Outstanding Loans**                                         |   |                                  |    |   |   |
| Average for the Year                                          |   | $                                     | 100,546 |   | $ | 81,572 |   |
| End of the Year                                               |   | $                                     | 107,461 |   | $ | 89,770 |   |
|                                                          |   |                                  |    |   |   |
| **Allowance for Loan Losses:**                                |   |                                  |    |   |   |
| Balance at Beginning of Year                                  |   | $                                     | 1,000   |   | $ | 850 |   |
| Actual Charge-Offs:                                           |   |                                  |    |   |   |
| Commercial                                                    |   | 92                                    |    | — |   |
| Consumer                                                      |   | 18                                    |    | 7 |   |
| Real Estate                                                   |   | —                                |    | — |   |
| Total Charge-Offs                                             |   | 110                                   |    | 7 |   |
|                                                          |   |                                  |    |   |   |
| Less Recoveries:                                              |   |                                  |    |   |   |
| Commercial                                                    |   | 8                                     |    | — |   |
| Consumer                                                      |   | 7                                     |    | 11 |   |
| Real Estate                                                   |   | —                                |    | — |   |
| Total Recoveries                                              |   | 15                                    |    | 11 |   |
|                                                          |   |                                  |    |   |   |
| Net Loans Charged-Off                                         |   | 95                                    |    | (5 | ) |
| Provision for Loan Losses                                     |   | 204                                   |    | 145 |   |
| Balance at End of Year                                        |   | $                                     | 1,109   |   | $ | 1,000 |   |
|                                                          |   |                                  |    |   |   |
| **Ratios:**                                                   |   |                                  |    |   |   |
| Net Loans Charged-Off to Average Loans                        |   | 0.09                                  | %       | -0.01 | % |
| Allowance for Loan Losses to Total Loans                      |   | 1.03                                  | %       | 1.11 | % |
| Net Loans Charged-Off to Beginning Allowance  for Loan Losses |   | 9.50                                  | %       | -0.54 | % |
| Net Loans Charged-Off to Provision for Loan  Losses           |   | 46.57                                 | %       | -3.17 | % |
| Allowance for Loan Losses to Non-performing  Loans            |   | n/a                                   |    | n/a |   |

 

Thefollowing table summarizes the allocation of the allowance for loan losses byloan type for the years indicated and the percent of loans in each category tototal loans (dollar amounts in thousands):

 
|                        |   | **December  31,  2003** |   | **December  31,  2002** |   |
|-----------------------------|--------|-------------------------|--------|-------------------------|--------|
|                        |   | **Amount**              |   | **Loan  Percent**       |   | **Amount** |   | **Loan  Percent** |   |
| Commercial                  |   | $                       | 96     |                    | 8.66   | % | $ | 68 |   | 6.80 | % |
| Construction                |   | 86                      |   | 7.75                    | %      | 54 |   | 5.40 | % |
| Real Estate                 |   | 323                     |   | 29.13                   | %      | 497 |   | 49.70 | % |
| Consumer                    |   | 19                      |   | 1.71                    | %      | 21 |   | 2.10 | % |
| Government Guaranteed Loans |   | 566                     |   | 51.04                   | %      | 317 |   | 31.70 | % |
| General Economic Conditions |   | 19                      |   | 1.71                    | %      | 43 |   | 4.30 | % |
|                        |   | $                       | 1,109  |                    | 100.00 | % | $ | 1,000 |   | 100.00 | % |

 

33

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**Funding**

 

Depositsare our primary source of funds.  AtDecember 31, 2003, we had a deposit mix of 45.02% in time and savings deposits,27.93% in money market and NOW deposits, and 27.05% in non-interest-bearingdemand deposits.  Our net interestincome is enhanced by our percentage of non-interest-bearing deposits.

 

Thefollowing table summarizes the distribution of average deposits and the averagerates paid for the years indicated (dollar amounts in thousands):

 
|                                 |   | **December  31,  2003** |    | **December  31,  2002** |   |
|--------------------------------------|--------|-------------------------|---------|-------------------------|--------|
|                                 |   | **Average  Balance**    |    | **Average  Rate**       |   | **Average  Balance** |   | **Average  Rate** |   |
| Money Market and NOW Accounts        |   | $                       | 34,120  |                    | 0.71   | % | $ | 28,408 |   | 1.16 | % |
| Savings Deposits                     |   | 6,831                   |    | 0.82                    | %      | 5,125 |   | 1.07 | % |
| TCD less than $100,000               |   | 18,074                  |    | 2.08                    | %      | 16,908 |   | 2.74 | % |
| TCD $100,000 or more                 |   | 31,250                  |    | 2.34                    | %      | 21,848 |   | 2.97 | % |
| Total Interest-Bearing Deposits      |   | 90,275                  |    | 1.56                    | %      | 72,274 |   | 2.07 | % |
|                                 |   |                    |    |                    |   |   |   |   |   |
| Non-Interest-Bearing Demand Deposits |   | 31,730                  |    | n/a                     |   | 26,562 |   | n/a |   |
| Total Average Deposits               |   | $                       | 122,005 |                    | 1.15   | % | $ | 98,836 |   | 1.52 | % |

 

Thescheduled maturity distribution of our time deposits of $100,000 or greater, asof December 31, 2003, were as follows (dollar amounts in thousands):

 

| Three months or less          |   | $ | 11,444 |   |
|-------------------------------|--------|---|--------|--------|
| Over three months to one year |   | $ | 19,855 |   |
| Over one year to three years  |   | $ | 1,119  |   |
|                          |   | $ | 32,418 |   |

 

34

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**Liquidity and Interest Rate****Sensitivity**

 

Theobjective of the Bank’s asset/liability strategy is to manage liquidity and interestrate risk to ensure the safety and soundness of the Bank and its capital base,while maintaining adequate net interest margins and spreads to provide anappropriate return to our shareholders.

 

TheBank manages its interest rate risk exposure by limiting the amount oflong-term fixed rate loans we hold for investment, by increasing emphasis onshorter-term, higher yield loans, and increasing or decreasing the relativeamounts of deposits.

 

Thetable below sets forth the interest rate sensitivity of our interest-earningassets and interest-bearing liabilities as of December 31, 2003, using theinterest rate sensitivity gap ratio. For purposes of the following table, an asset or liability is consideredrate-sensitive within a specified period when it can be repriced or matureswithin its contractual terms, (dollar amounts in thousands):

 
|                                         |   | **Within  Three  Months** |    | **After  Three Months  But Within  One Year** |   | **After One  Year But  Within  Five Years** |   | **After  Five Years** |   | **Total** |   |
|----------------------------------------------|--------|---------------------------|---------|-----------------------------------------------|--------|---------------------------------------------|--------|-----------------------|--------|-----------|--------|
|                                         |   |                      |    |                                          |   |                                        |   |                  |   |      |   |
| **Interest-Earning Assets:**                 |   |                      |    |                                          |   |                                        |   |                  |   |      |   |
| Interest Bearing Deposits                    |   | $                         | —  |                                          | $      | —                                      |   | $                     | — |      | $      | — |   | $ | — |   |
| Federal Funds Sold                           |   | 5,400                     |    | —                                        |   | 0                                           |   | —                |   | 5,400     |   |
| Investment Securities and FRB Stock          |   | —                    |    | —                                        |   | 12,073                                      |   | —                |   | 12,073    |   |
| Gross Loans                                  |   | 95,132                    |    | 2,242                                         |   | 4,652                                       |   | 5,850                 |   | 107,876   |   |
|                                         |   | $                         | 100,532 |                                          | $      | 2,242                                       |   | $                     | 16,725 |      | $      | 5,850 |   | $ | 125,349 |   |
|                                         |   |                      |    |                                          |   |                                        |   |                  |   |      |   |
| **Interest-Bearing Liabilities:**            |   |                      |    |                                          |   |                                        |   |                  |   |      |   |
| Money Market and NOW Deposits                |   | $                         | 35,754  |                                          | $      | —                                      |   | $                     | — |      | $      | — |   | $ | 35,754 |   |
| Savings                                      |   | 7,016                     |    | —                                        |   | —                                      |   | —                |   | 7,016     |   |
| Time Deposits                                |   | 20,058                    |    | 29,092                                        |   | 1,468                                       |   | —                |   | 50,618    |   |
|                                         |   | $                         | 62,828  |                                          | $      | 29,092                                      |   | $                     | 1,468  |      | $      | — |   | $ | 93,388 |   |
|                                         |   |                      |    |                                          |   |                                        |   |                  |   |      |   |
| **Interest Rate Sensitivity Gap**            |   | $                         | 37,704  |                                          | $      | (26,850                                     | )      | $                     | 15,257 |      | $      | 5,850 |   | $ | 31,961 |   |
| **Cumulative Interest Rate Sensitivity Gap** |   | $                         | 37,704  |                                          | $      | 10,854                                      |   | $                     | 26,111 |      | $      | 31,961 |   | $ | 31,961 |   |
|                                         |   |                      |    |                                          |   |                                        |   |                  |   |      |   |
| **Ratios Based on Total Assets:**            |   |                      |    |                                          |   |                                        |   |                  |   |      |   |
| Interest Rate Sensitivity Gap                |   | 36.05                     | %       | -25.67                                        | %      | 14.59                                       | %      | 5.59                  | %      | 30.56     | %      |
| Cumulative Interest Rate Sensitivity Gap     |   | 36.05                     | %       | 10.38                                         | %      | 24.96                                       | %      | 30.56                 | %      |      |   |

 

Liquidityrefers to our ability to maintain a cash flow that is adequate to fund bothon-balance sheet and off-balance sheet requirements on a timely andcost-effective basis.  Potentiallysignificant liquidity requirements include funding of commitments to loanclients and withdrawals from deposit accounts. The Gap ratio is the ability to reprice assets and liabilities in thechanging economic environment.  Forinstance, the Bank is asset sensitive within three months, allowing the Bank toincrease income in a rising interest rate environment.  The Bank then becomes liability sensitivebetween four months and one year, which will increase interest expense in arising interest rate environment.

 

Itshould also be noted that during 2002, the Bank began to institute interestrate floors on certain variable rate loans. Once the interest rates on these variable rate loans reach the floorrate, they temporarily take on the attributes of a fixed rate loan.  This action has helped the Bank increase itsnet interest margin as the rates on our interest-bearing liabilities havecontinued to fall.  However, wheninterest rates begin to rise again in the future, the interest rates on ourinterest-bearing liabilities will also begin to rise while the interest rateson those variable rate loans with floors will remain at the floor rate.  This may cause the Bank’s net interestmargins to shrink until the rates on those loans with interest rate floors riseabove their floor rates.

 

Finally,the Bank feels that it faces no material liquidity impact from the undisbursedloans in the loan portfolio.

 

35

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**Capital Resources**

 

Shareholders’equity at December 31, 2003 was $8.8 million, an increase of $1.0 million or12.8% over $7.8 million at December 31, 2002. Average shareholders’ equity for 2003 was $8.3 million, compared to $7.5million in 2002.  Shareholders’ equityincreased primarily from net income of $982,000 in 2003.

 

In1990, the banking industry began to phase in new regulatory capital adequacyrequirements based on risk-adjusted assets. These requirements take into consideration the risk inherent ininvestments, loans, and other assets for both on-balance sheet and off-balancesheet items.  Under these requirements,the regulatory agencies have set minimum thresholds for Tier 1 Capital, TotalCapital and Leverage ratios.  AtDecember 31, 2003, the Bank’s capital exceeded the Tier 1 Capital, TotalCapital and Leverage ratio’s minimum regulatory requirements.  The Bank was considered to be well-capitalizedat December 31, 2003, as defined in the regulations issued by the OCC.  The Bank’s risk-based capital ratios, shownbelow as of December 31, 2003, have been computed in accordance with regulatoryaccounting policies.  The Bancorp isalso subject to capital requirements that are within well-capitalized ranges asdefined by the Federal Reserve Bank.

 
|                            |   | **Requirement**             |   | **Actual**            |   |
|---------------------------------|--------|-----------------------------|--------|-----------------------|--------|
|                            |   | **Adequately  Capitalized** |   | **Well  Capitalized** |   | **Bank** |   | **Company** |   |
| Total risk-based capital ratio  |   | 8.00                        | %      | 10.00                 | %      | 12.51 | % | 13.00 | % |
| Tier 1 risk-based capital ratio |   | 4.00                        | %      | 6.00                  | %      | 11.54 | % | 10.20 | % |
| Tier 1 leverage capital ratio   |   | 4.00                        | %      | 5.00                  | %      | 9.49 | % | 8.92 | % |

 

**Effects of Inflation**

 

Thefinancial statements and related financial information presented herein havebeen prepared in accordance with GAAP, which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering changes in the relative purchasing power of money over time due toinflation.  Unlike most industrialcompanies, virtually all of the assets and liabilities of a financialinstitution are monetary in nature.  Asa result, interest rates have a more significant impact on a financialinstitution’s performance than the effects of general levels of inflation.  Interest rates do not necessarily move inthe same direction or same magnitude as the price of goods and services.

 

**Item 7****.  FinancialStatements are presented on the following pages.**

 

36

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**INDEPENDENTAUDITORS’ REPORT**

 

Board of Directors and Stockholders of

Coast Bancorp and Subsidiary

 

We have audited the accompanying consolidated balance sheets of CoastBancorp and Subsidiary as of December 31, 2003 and 2002 and the relatedconsolidated statements of income, changes in stockholders’ equity, and cashflows for the years then ended.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of Coast Bancorp andSubsidiary as of December 31, 2003 and 2002, and the results of its operationsand its cash flows for each of the years then ended, in conformity withaccounting principles generally accepted in the United States of America.

 

 

Laguna Hills, California

January 6, 2004

 

25231 Paseo De Alicia, Suite 100   Laguna Hills, CA  92653    Tel: 949.768.0833    Fax: 949.768.8408    www.vtdcpa.com

 

***FRESNO ******•  LAGUNA HILLS ******•  PLEASANTON ******•  RANCHO CUCAMONGA ******•  SAN JOSE***

 

37

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# **COASTBANCORP AND SUBSIDIARY**

 

# **CONSOLIDATEDBALANCE SHEETS**

 

**DECEMBER31, 2003 and 2002**

 
|                                                                                                                                                  |   | **2003**    |        | **2002**    |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|-------------|------------|
| **ASSETS**                                                                                                                                            |   |        |        |        |       |
|                                                                                                                                                  |   |        |        |        |       |
| Cash and due from banks                                                                                                                               |   | $           | 9,272,503   |        | $          | 7,741,559 |   |
| Federal funds sold                                                                                                                                    |   | 5,400,000   |        | 15,470,000  |       |
| **TOTAL CASH AND CASH EQUIVALENTS**                                                                                                                   |   | 14,672,503  |        | 23,211,559  |       |
|                                                                                                                                                  |   |        |        |        |       |
| Investment securities available for sale                                                                                                              |   | 12,072,582  |        | 2,092,179   |       |
| Loans:                                                                                                                                                |   |        |        |        |       |
| Commercial                                                                                                                                            |   | 28,244,407  |        | 30,530,131  |       |
| Real estate - construction                                                                                                                            |   | 13,500,870  |        | 6,055,250   |       |
| Real estate - other                                                                                                                                   |   | 62,281,542  |        | 45,764,675  |       |
| Consumer                                                                                                                                              |   | 3,849,258   |        | 7,419,754   |       |
| **TOTAL LOANS**                                                                                                                                       |   | 107,876,077 |        | 89,769,810  |       |
| Net deferred loan fees                                                                                                                                |   | (414,115    | )           | (354,607    | )          |
| Allowance for credit losses                                                                                                                           |   | (1,108,717  | )           | (1,000,000  | )          |
| **NET LOANS**                                                                                                                                         |   | 106,353,245 |        | 88,415,203  |       |
| Premises and equipment                                                                                                                                |   | 7,091,566   |        | 6,684,366   |       |
| Deferred taxes                                                                                                                                        |   | 382,693     |        | 286,000     |       |
| Federal Reserve Bank and Federal Home Loan  Bank stock, at cost                                                                                       |   | 415,150     |        | 286,650     |       |
| Accrued interest and other assets                                                                                                                     |   | 1,141,427   |        | 980,959     |       |
| **TOTAL ASSETS**                                                                                                                                      |   | $           | 142,129,166 |        | $          | 121,956,916 |   |
|                                                                                                                                                  |   |        |        |        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                         |   |        | ** **  |        | ** ** |
| Deposits:                                                                                                                                             |   |        |        |        |       |
| Noninterest-bearing demand                                                                                                                            |   | $           | 34,635,873  |        | $          | 26,495,862 |   |
| Money market and NOW                                                                                                                                  |   | 35,753,653  |        | 29,580,814  |       |
| Savings                                                                                                                                               |   | 7,015,613   |        | 5,906,114   |       |
| Time deposits of $100,000 or more                                                                                                                     |   | 32,412,154  |        | 28,269,337  |       |
| Other time deposits                                                                                                                                   |   | 18,206,105  |        | 17,584,336  |       |
| **TOTAL DEPOSITS**                                                                                                                                    |   | 128,023,398 |        | 107,836,463 |       |
| Notes payable                                                                                                                                         |   | 164,387     |        | 720,766     |       |
| Company obligated mandatorily redeemable  preferred securities of subsidiary trust holding solely junior subordinated  debentures                     |   | 5,000,000   |        | 5,000,000   |       |
| Other liabilities                                                                                                                                     |   | 128,849     |        | 570,933     |       |
| **TOTAL LIABILITIES**                                                                                                                                 |   | 133,316,634 |        | 114,128,162 |       |
| Commitments and contingencies - Note # 4  and #12                                                                                                     |   | —      |        | —      |       |
| Stockholders’ equity                                                                                                                             |   |        |        |        |       |
| Preferred stock - 10,000,000 authorized,  none outstanding                                                                                            |   |        |        |        |       |
| Common stock no par value; 10,000,000  shares authorized; issued and outstanding:   638,300 in 2003 and 632,400 in 2002                          |   | 6,407,275   |        | 6,324,000   |       |
| Retained earnings                                                                                                                                     |   | 2,374,769   |        | 1,455,930   |       |
| Accumulated other comprehensive income -  net unrealized gains on available-for-sale securities, net of taxes of  $21,186 in 2003 and $33,928 in 2002 |   | 30,488      |        | 48,824      |       |
| **TOTAL STOCKHOLDERS’ EQUITY**                                                                                                                   |   | 8,812,532   |        | 7,828,754   |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                   |   | $           | 142,129,166 |        | $          | 121,956,916 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

38

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# **COASTBANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF INCOME**

 

**FORTHE YEARS ENDED DECEMBER 31, 2003 and 2002**

 
|                                                               |   | **2003**  |      | **2002**  |   |
|--------------------------------------------------------------------|--------|-----------|-----------|-----------|--------|
| **INTEREST INCOME**                                                |   |      |      |      |   |
| Interest and fees on loans                                         |   | $         | 7,135,831 |      | $      | 5,954,570 |   |
| Interest on investment securities                                  |   | 147,534   |      | 311,292   |   |
| Interest on federal funds sold                                     |   | 139,528   |      | 128,070   |   |
| Other interest income                                              |   | 20,135    |      | 12,094    |   |
| **TOTAL INTEREST INCOME**                                          |   | 7,443,028 |      | 6,406,026 |   |
| **INTEREST EXPENSE**                                               |   |      |      |      |   |
| Interest on money market and NOW accounts                          |   | 237,541   |      | 329,845   |   |
| Interest on savings deposits                                       |   | 56,036    |      | 54,531    |   |
| Interest on time deposits                                          |   | 1,107,419 |      | 1,113,113 |   |
| Interest on trust preferred securities                             |   | 263,568   |      | 77,979    |   |
| Interest on other borrowings                                       |   | 28,808    |      | 38,542    |   |
| **TOTAL INTEREST EXPENSE**                                         |   | 1,693,372 |      | 1,614,010 |   |
| **NET INTEREST INCOME**                                            |   | 5,749,656 |      | 4,792,016 |   |
| Provision for credit losses                                        |   | 204,345   |      | 145,412   |   |
| **NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES**          |   | 5,545,311 |      | 4,646,604 |   |
| **NONINTEREST INCOME**                                             |   |      |      |      |   |
| Service charges on deposits accounts and  other noninterest income |   | 297,381   |      | 230,719   |   |
| Gain on sale of loans and servicing fees                           |   | 497,968   |      | 518,603   |   |
| Mortgage packaging fees                                            |   | 251,056   |      | 23,750    |   |
| Gain on sale of securities                                         |   | 25,191    |      | 201,989   |   |
| **TOTAL NONINTEREST INCOME**                                       |   | 1,071,596 |      | 975,061   |   |
| **NONINTEREST EXPENSE**                                            |   |      |      |      |   |
| Salaries and benefits                                              |   | 2,795,592 |      | 2,318,075 |   |
| Net occupancy expenses                                             |   | 335,650   |      | 310,478   |   |
| Equipment and equipment expenses                                   |   | 252,964   |      | 187,697   |   |
| Customer related expenses                                          |   | 18,007    |      | 18,546    |   |
| Data processing                                                    |   | 361,562   |      | 357,233   |   |
| Director fees and expenses                                         |   | 96,032    |      | 89,222    |   |
| Insurance                                                          |   | 38,068    |      | 44,430    |   |
| Marketing and business promotion                                   |   | 380,150   |      | 351,871   |   |
| Other professional expenses                                        |   | 271,927   |      | 271,411   |   |
| Office expenses                                                    |   | 193,688   |      | 165,667   |   |
| Regulatory assessments                                             |   | 66,285    |      | 60,713    |   |
| Other expenses                                                     |   | 147,313   |      | 132,735   |   |
| **TOTAL NONINTEREST EXPENSE**                                      |   | 4,957,238 |      | 4,308,078 |   |
| **INCOME BEFORE INCOME TAXES**                                     |   | 1,659,669 |      | 1,313,587 |   |
| Income taxes                                                       |   | 677,500   |      | 542,520   |   |
| **NET INCOME**                                                     |   | $         | 982,169   |      | $      | 771,067 |   |
|                                                               |   |      |      |      |   |
| **Per Share Data**                                                 |   |      |      |      |   |
| Net income - basic                                                 |   | $         | 1.55      |      | $      | 1.22 |   |
| Net income - diluted                                               |   | $         | 1.46      |      | $      | 1.17 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

39

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**COASTBANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY**

 

**FORTHE YEARS ENDED DECEMBER 31, 2003 and 2002**

 
|                                                                                         |   | **Shares  Outstanding** |   | **Common  Stock** |      | **Comprehensive  Income** |    | **Retained  Earnings** |    | **Accumulated  Other  Comprehensive  Income** |   | **Total** |    |
|----------------------------------------------------------------------------------------------|--------|-------------------------|--------|-------------------|-----------|---------------------------|---------|------------------------|---------|-----------------------------------------------|--------|-----------|---------|
|                                                                                         |   |                    |   |              |      |                      |    |                   |    |                                          |   |      |    |
| **Balance, January 1, 2002**                                                                 |   | 632,400                 |   | $                 | 6,324,000 |                      |    |                   | $       | 732,293                                       |   | $         | 99,976  |   | $ | 7,156,269 |   |
|                                                                                         |   |                    |   |              |      |                      |    |                   |    |                                          |   |      |    |
| Cash dividends                                                                               |   |                    |   |              |      |                      |    | (47,430                | )       |                                          |   | (47,430   | )       |
| **Comprehensive income:**                                                                    |   |                    |   |              |      |                      |    |                   |    |                                          |   |      |    |
| Net income                                                                                   |   |                    |   |              |      | $                         | 771,067 |                   | 771,067 |                                          |   |      | 771,067 |   |
| Unrealized gains on available-for-sale  securities, net of taxes of $47,268                  |   |                    |   |              |      | 68,022                    |    |                   |    | 68,022                                        |   | 68,022    |    |
| Less reclassification adjustments for gains  included in net income, net of taxes of $82,815 |   |                    |   |              |      | (119,174                  | )       |                   |    | (119,174                                      | )      | (119,174  | )       |
| **Total comprehensive income**                                                               |   |                    |   |              |      | $                         | 719,915 |                   |    |                                          |   |      |    |   |
|                                                                                         |   |                    |   |              |      |                      |    |                   |    |                                          |   |      |    |
| **Balance, December 31, 2002**                                                               |   | 632,400                 |   | 6,324,000         |      |                      |    | 1,455,930              |    | 48,824                                        |   | 7,828,754 |    |
|                                                                                         |   |                    |   |              |      |                      |    |                   |    |                                          |   |      |    |
| Exercise of stock options                                                                    |   | 5,900                   |   | 83,275            |      |                      |    |                   |    |                                          |   | 83,275    |    |
| Cash dividends                                                                               |   |                    |   |              |      |                      |    | (63,330                | )       |                                          |   | (63,330   | )       |
| **Comprehensive income:**                                                                    |   |                    |   |              |      |                      |    |                   |    |                                          |   |      |    |
| Net income                                                                                   |   |                    |   |              |      | $                         | 982,169 |                   | 982,169 |                                          |   |      | 982,169 |   |
| Unrealized losses on available-for-sale  securities, net of taxes of $2,414                  |   |                    |   |              |      | (3,473                    | )       |                   |    | (3,473                                        | )      | (3,473    | )       |
| Less reclassification adjustments for gains  included in net income, net of taxes of $10,328 |   |                    |   |              |      | (14,863                   | )       |                   |    | (14,863                                       | )      | (14,863   | )       |
| **Total comprehensive income**                                                               |   |                    |   |              |      | $                         | 963,833 |                   |    |                                          |   |      |    |   |
|                                                                                         |   |                    |   |              |      |                      |    |                   |    |                                          |   |      |    |
| **Balance, December 31, 2003**                                                               |   | 638,300                 |   | $                 | 6,407,275 |                      |    |                   | $       | 2,374,769                                     |   | $         | 30,488  |   | $ | 8,812,532 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

40

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**COAST BANCORP AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

**FORTHE YEARS ENDED DECEMBER 31, 2003 and 2002**

 
|                                                                     |   | **2003**    |       | **2002**    |   |
|--------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|
| **OPERATING ACTIVITIES**                                                 |   |        |       |        |   |
| Net Income                                                               |   | $           | 982,169    |        | $      | 771,067 |   |
| Adjustments to reconcile net income to net  cash provided by operations: |   |        |       |        |   |
| Depreciation and amortization                                            |   | 349,981     |       | 206,884     |   |
| Provision for credit losses                                              |   | 204,345     |       | 145,412     |   |
| Realized gains in available-for-sale  securities                         |   | (25,191     | )          | (201,989    | )      |
| Deferred taxes                                                           |   | (96,693     | )          | (38,000     | )      |
| Gain on sale of loans                                                    |   | (433,718    | )          | (474,311    | )      |
| Net change in accrued interest, other  assets and other liabilities      |   | 28,560      |       | (145,567    | )      |
| **NET CASH PROVIDED BY OPERATING ACTIVITIES**                            |   | 1,009,453   |       | 263,496     |   |
| **INVESTING ACTIVITIES**                                                 |   |        |       |        |   |
| Net increase in loans                                                    |   | (22,924,791 | )          | (20,537,608 | )      |
| Proceeds from loans sold                                                 |   | 5,029,582   |       | 8,117,509   |   |
| Purchase of available-for-sale securities                                |   | (11,036,186 | )          | (2,012,400  | )      |
| Purchase of Federal Reserve Bank and  Federal Home Loan Bank stock       |   | (124,900    | )          | (97,250     | )      |
| Proceeds from sale of available-for-sale securities                      |   | 1,027,188   |       | 8,265,003   |   |
| Proceeds from maturities of  available-for-sale securities               |   | —      |       | 3,000,000   |   |
| Purchase of premises and equipment                                       |   | (1,169,903  | )          | (2,583,832  | )      |
| **NET CASH USED IN INVESTING ACTIVITIES**                                |   | (29,199,010 | )          | (5,848,578  | )      |
| **FINANCING ACTIVITIES**                                                 |   |        |       |        |   |
| Net increase in demand deposits and savings  accounts                    |   | 15,422,349  |       | 2,583,557   |   |
| Net increase in time deposits                                            |   | 4,764,586   |       | 8,726,173   |   |
| Proceeds from issuance of trust preferred  securities                    |   | —      |       | 5,000,000   |   |
| Principal payments on notes payable                                      |   | (556,379    | )          | (14,307     | )      |
| Payments for dividends                                                   |   | (63,330     | )          | (47,430     | )      |
| Proceeds from exercise of stock options                                  |   | 83,275      |       | —      |   |
| **NET CASH PROVIDED BY FINANCING ACTIVITIES**                            |   | 19,650,501  |       | 16,247,993  |   |
|                                                                     |   |        |       |        |   |
| **INCREASE  IN CASH AND CASH  EQUIVALENTS**                         |   | (8,539,056  | )          | 10,662,911  |   |
| Cash and cash equivalents at beginning of  period                        |   | 23,211,559  |       | 12,548,648  |   |
| Cash and cash equivalents at end of period                               |   | $           | 14,672,503 |        | $      | 23,211,559 |   |
|                                                                     |   |        |       |        |   |
| **Supplemental disclosure of cash flow  information**                    |   |        |       |        |   |
| Interest paid                                                            |   | $           | 1,696,917  |        | $      | 1,616,390 |   |
| Income taxes paid                                                        |   | $           | 687,164    |        | $      | 723,193 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

41

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**COAST BANCORP AND SUBSIDIARY**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

** **

**DECEMBER 31, 2003 and 2002**

 

**NOTE #1 - SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

***Principles of Consolidation***

 

The financial statements include the accounts of Coast Bancorp and itswholly owned subsidiary, Coast National Bank (“Bank”), collectively referred toherein as the “Company.”  Allsignificant intercompany transactions have been eliminated.

 

***Nature of Operations***

 

Coast Bancorp operates Coast National Bank.  The Bank has been organized as a single operating segment and operatesfour branches in San Luis Obispo, Arroyo Grande, Morro Bay, and Los Osos,California and two loan production offices in Santa Maria and Bakersfield,California.  The Bank’s primary sourceof revenue is providing loans to customers, who are predominantly small andmiddle-market businesses and individuals.

 

***Use of Estimates inthe Preparation of Financial Statements***

 

The preparation of financial statements in conformity with generallyaccepted accounting principles in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

***Presentation of Cash Flows***

 

For the purposes of reporting cash flows, cash and cash equivalentsincludes cash, noninterest-earning deposits and federal funds sold.  Generally, federal funds are sold for oneday periods.

 

***Cash and Due From Banks***

 

Banking regulations require that all banks maintain a percentage oftheir deposits as reserves in cash or on deposit with the federal reservebank.  The Bank complied with thereserve requirements as of December 31, 2003.

 

The Company maintains amounts due from banks which exceed federallyinsured limits.  The Company has notexperienced any losses in such accounts.

 

***Investment Securities***

 

Bonds, notes, and debentures for which the Company has the positiveintent and ability to hold to maturity are reported at cost, adjusted forpremiums and discounts that are recognized in interest income using theinterest method over the period to maturity.

 

Investments not classified as trading securities nor as held tomaturity securities are classified as available-for-sale securities andrecorded at fair value.  Unrealizedgains or losses on available-for-sale securities are excluded from net incomeand reported as an amount net of taxes as a separate component of othercomprehensive income included in stockholders’ equity.  Premiums or discounts on held-to-maturityand available-for-sale securities are amortized or accreted into income usingthe interest method.  Realized gains orlosses on sales of held-to-maturity or available-for-sale securities arerecorded using the specific identification method.

 

42

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***Loans***

 

Loans receivable that management has the intent and ability to hold forthe foreseeable future or until maturity or payoff are reported at theiroutstanding unpaid principal balances reduced by any charge-offs or specificvaluation accounts and net of any deferred fees or costs on originated loans,or unamortized premiums or discounts on purchased loans.

 

Loan origination fees and certain direct origination costs arecapitalized and recognized as an adjustment of the yield of the related loan.

 

Loans on which the accrual of interest has been discontinued aredesignated as nonaccrual loans.  Theaccrual of interest on loans is discontinued when principal or interest is pastdue 90 days based on contractual terms of the loan or when, in the opinion ofmanagement, there is reasonable doubt as to collectibility.  When loans are placed on nonaccrual status,all interest previously accrued but not collected is reversed against currentperiod interest income.  Income onnonaccrual loans is subsequently recognized only to the extent that cash isreceived and the loan’s principal balance is deemed collectible.  Interest accruals are resumed on such loansonly when they are brought current with respect to interest and principal andwhen, in the judgment of management, the loans are estimated to be fullycollectible as to all principal and interest.

 

The Bank considers a loan to be impaired when it is probable that theBank will be unable to collect all amounts due (principal and interest)according to the contractual terms of the loan agreement.  Measurement of impairment is based on theexpected future cash flows of an impaired loan which are to be discounted atthe loan’s effective interest rate, or measured by reference to an observablemarket value, if one exists, or the fair value of the collateral for acollateral-dependent loan.  The Bankselects the measurement method on a loan-by-loan basis except thatcollateral-dependent loans for which foreclosure is probable are measured atthe fair value of the collateral.  TheBank recognizes interest income on impaired loans based on its existing methodsof recognizing interest income on nonaccrual loans.

 

To calculate the gain (loss) on sale of loans, the Bank’s investment inthe loan is allocated among the retained portion of the loan, the servicingretained, the interest-only strip and the sold portion of the loan, based onthe relative fair market value of each portion.  The gain (loss) on the sold portion of the loan is recognized atthe time of sale based on the difference between the sale proceeds and theallocated investment.  As a result ofthe relative fair value allocation, the carrying value of the retained portionis discounted, with the discount accreted to interest income over the life ofthe loan.  That portion of the excessservicing fees that represent contractually specified servicing fees (contractualservicing) are reflected as a servicing asset which is amortized over anestimated life using a method approximating the level yield method; in theevent future prepayments exceed Management’s estimates and future expected cashflows are inadequate to cover the unamortized servicing asset, additionalamortization would be recognized.  Theportion of excess servicing fees in excess of the contractual servicing fees isreflected as interest-only (I/O) strips receivable, which are classified asinterest-only strips receivable available for sale and are carried at fairvalue.

 

43

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***Provision andAllowance for Credit Losses***

 

The allowance for credit losses is increased by charges to income anddecreased by charge-offs (net of recoveries). Management’s periodic evaluation of the adequacy of the allowance isbased on the Company’s past loan loss experience, known and inherent risks inthe portfolio, adverse situations that may affect the borrower’s ability torepay, the estimated value of any underlying collateral, and current economicconditions.

 

***Premises and Equipment***

 

Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciationand amortization.  Depreciation iscomputed using the straight-line method over the estimated useful lives, whichranges from three to ten years for furniture and fixtures and forty years forbuildings.  Leasehold improvements areamortized using the straight-line method over the estimated useful lives of theimprovements or the remaining lease term. Whichever is shorter.  Expenditures for betterments or majorrepairs are capitalized and those for ordinary repairs and maintenance arecharged to operations as incurred.

 

***Advertising Costs***

 

TheCompany expenses the costs of advertising in the period incurred.

 

***Income Taxes***

 

Deferred income taxes are computed using the asset and liabilitymethod, which recognizes a liability or asset representing the tax effects,based on current tax law, of future deductible or taxable amounts attributableto events that have been recognized in the consolidated financialstatements.  A valuation allowance isestablished to reduce the deferred tax asset to the level at which it is “morelikely than not” that the tax asset or benefits will be realized.  Realization of tax benefits of deductibletemporary differences and operating loss carryforwards depends on havingsufficient taxable income of an appropriate character within the carryforwardperiods.

 

***Disclosure About Fair Value of FinancialInstruments***

 

Statement of Financial Accounting Standard (“SFAS”) No. 107 specifiesthe disclosure of the estimated fair value of financial instruments.  The Company’s estimated fair value amountshave been determined by the Company using available market information andappropriate valuation methodologies.

 

However, considerable judgment is required to develop the estimates offair value.  Accordingly, the estimatesare not necessarily indicative of the amounts the Company could have realizedin a current market exchange.  The useof different market assumptions and/or estimation methodologies may have amaterial effect on the estimated fair value amounts.

 

Although management is not aware of any factors that wouldsignificantly affect the estimated fair value amounts, such amounts have notbeen comprehensively revalued for purposes of these financial statements sincethe balance sheet date and, therefore, current estimates of fair value maydiffer significantly from the amounts presented in the accompanying notes.

 

44

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***Comprehensive Income***

 

Beginning in 1998, the Company adopted SFAS No. 130, *“ReportingComprehensive Income,”* which requires the disclosure ofcomprehensive income and its components. Changes in unrealized gains (losses) on available-for-sale securitiesnet of income taxes is the only component of accumulated other comprehensiveincome for the Bank.

 

***FinancialInstruments***

 

In the ordinary course of business, the Company has entered intooff-balance sheet financial instruments consisting of commitments to extendcredit, commitments under credit card arrangements, commercial letters ofcredit, and standby letters of credit, see Note #12.  Such financial instruments are recorded in the consolidatedfinancial statements when they are funded or related fees are incurred orreceived.

 

***Earnings Per Shares(EPS)***

 

Basic EPS excludes dilution and is computed by dividing incomeavailable to common stockholders by the weighted-average number of commonshares outstanding for the period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock or resulted in the issuance of common stock that then sharedin the earnings of the entity.

 

***Current AccountingPronouncements***

 

InMay 2003, FASB issued SFAS No. 150, *“Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity.” *SFAS No. 150establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity.  SFAS No. 150 requires an issuer to classifya financial instrument that is within its scope as a liability.  Many of those instruments were previouslyclassified as equity.  SFAS No. 150 isgenerally effective for financial instruments entered into or modified afterMay 31, 2003, and otherwise effective at the beginning of the first interimperiod beginning after June 15, 2003; however, management does not believeadoption will have a material impact on the Bank’s financial statements.

 

InDecember 2003, FASB issued FASB Interpretation (FIN) No. 46, “*Consolidation of Variable Interest Entities, aninterpretations of ARB No.51.”*  This interpretation addresses the consolidation of variable interestentities as defined in the Interpretations. This Interpretation will require companies that have issued trustpreferred securities to deconsolidate the related entities.  The Company has deconsolidated its trustpreferred securities as of December 31, 2003, which did not have a materialimpact on the Company’s financial statements.

 

45

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***Stock-Based Compensation***

 

SFAS No. 123*, “Accounting for Stock-Based Compensation,”*encourages, but does not require, companies to record compensation cost forstock-based employee compensation plans at fair value.  The Company has chosen to continue toaccount for stock-based compensation using the intrinsic value methodprescribed in Accounting Principles Board (“APB”) Opinion No. 25, *“Accountingfor Stock Issued to Employees,”* and related Interpretations.  Accordingly, compensation cost for stockoptions is measured as the excess, if any, of the quoted market price of theCompany’s stock at the date of the grant over the amount an employee must payto acquire the stock.

 

Had compensation costs for the Company’s stock option plan beendetermined based on the fair value at the grant dates for awards under thisplan consistent with the method of SFAS No. 123, the Company’s net income andearnings per share would have been reduced for 2003 and 2002 to the pro formaamounts indicated below:

 
|                                                                                            |   | **2003** |    | **2002** |   |
|-------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Net income:                                                                                     |   |     |    |     |   |
| As reported                                                                                     |   | $        | 982,169 |     | $      | 771,067 |   |
| Stock-Based compensation using the  intrinsic value method                                      |   | —   |    | —   |   |
| Stock-Based compensation that would have  been reported using the fair value method of SFAS 123 |   | (50,560  | )       | (42,919  | )      |
| Pro Forma net income                                                                            |   | $        | 931,609 |     | $      | 728,148 |   |
|                                                                                            |   |     |    |     |   |
| Basic earnings per share:                                                                       |   |     |    |     |   |
| As reported                                                                                     |   | $        | 1.55    |     | $      | 1.22 |   |
| Pro forma                                                                                       |   | 1.47     |    | 1.15     |   |
|                                                                                            |   |     |    |     |   |
| Diluted earnings per share:                                                                     |   |     |    |     |   |
| As reported                                                                                     |   | $        | 1.46    |     | $      | 1.17 |   |
| Pro forma                                                                                       |   | 1.39     |    | 1.11     |   |

 

***Reclassification***

 

Certain reclassifications havebeen made in the 2002 consolidated financial statements to conform to thepresentation used in 2003.  Theseclassifications are of a normal recurring nature.

 

46

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**NOTE#2 - INVESTMENT SECURITIES**

 

Amortized cost and market values of securities are as follows:

 
|                           |   | **December  31, 2003** |       |
|--------------------------------|--------|------------------------|------------|
|                           |   | **Amortized  Cost**    |       | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
| Available-for-sale securities: |   |                   |       |   |   |   |   |   |   |
| U.S. Treasury obligations      |   | $                      | 1,987,107  |   | $ | 6,955 |   | $ | — |   | $ | 1,994,062 |   |
| U.S. Agency obligations        |   | 10,033,801             |       | 44,719 |   | — |   | 10,078,520 |   |
|                           |   | $                      | 12,020,908 |   | $ | 51,674 |   | $ | — |   | $ | 12,072,582 |   |

 

 
|                           |   | **December  31, 2002** |      |
|--------------------------------|--------|------------------------|-----------|
|                           |   | **Amortized  Cost**    |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
| Available-for-sale securities: |   |                   |      |   |   |   |   |   |   |
| U.S. Agency obligations        |   | $                      | 2,009,427 |   | $ | 82,752 |   | $ | — |   | $ | 2,092,179 |   |
|                                |        |                        |           |  |  |  |  |  |  |  |  |  |  |

 

Gross realized gains on sales of available-for-sale securities were$25,191 in 2003 and $201,989 in 2002

 

Securities with a carrying value of $1,032,394 and $1,051,544 at December31, 2003 and 2002, respectively, were pledged to secure public monies asrequired by law.

 

The Bank had no investments that have been in a continuousunrealized-loss position for more than twelve months as of December 31, 2003.

 

The amortized cost and fair values of investment securitiesavailable-for-sale at December 31, 2003, by expected maturities are shownbelow.  Expected maturities may differfrom contractual maturities because borrowers may have the right to call orprepay obligations with or without call or prepayment penalties.

 
|                            |   | **Securities  Available-for-Sale** |       |
|---------------------------------|--------|------------------------------------|------------|
|                            |   | **Amortized  Cost**                |       | **Fair Value** |   |
|                            |   |                               |       |   |   |
| Due in one year or less         |   | $                                  | —     |   | $ | — |   |
| Due from one year to five years |   | 12,020,908                         |       | 12,072,582 |   |
|                            |   | $                                  | 12,020,908 |   | $ | 12,072,582 |   |

 

47

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**NOTE #3 - LOANS**

 

The Bank’s loan portfolio consists primarily of loans to borrowerswithin San Luis Obispo, Santa Maria and Bakersfield, California and itssurrounding communities.  Although theBank seeks to avoid concentrations of loans to a single industry or based upona single class of collateral, real estate and real estate associated businessesare among the principal industries in the Bank’s market area and, as a result,the Bank’s loan and collateral portfolios are, to some degree, concentrated inthose industries.

 

The Bank also originates SBA and other governmental guaranteed loansfor sale to governmental agencies and institutional investors.  At December 31, 2003 and 2002 the Bank wasservicing approximately $12,804,000 and $5,944,000, respectively, in SBA andgovernmental guaranteed loans previously sold.

 

As described in Note #12, these consolidated financial statements donot reflect other various commitments to extend credit or letters of credit,which arise in the normal course of business.

 

A summary of the changes in the allowance for credit losses follows:

 
|                                 |   | **2003** |      | **2002** |   |
|--------------------------------------|--------|----------|-----------|----------|--------|
| Balance, beginning of year           |   | $        | 1,000,000 |     | $      | 850,000 |   |
| Provision for credit losses          |   | 204,345  |      | 145,412  |   |
| Loans charged off, net of recoveries |   | (95,628  | )         | 4,588    |   |
| Balance, end of year                 |   | $        | 1,108,717 |     | $      | 1,000,000 |   |

 

The following is a summary of the investment in impaired loans, therelated allowance for loan losses, income recognized thereon and informationpertaining to nonaccrual and past due loans as of December 31:

 
|                                                         |   | **2003** |   | **2002** |   |
|--------------------------------------------------------------|--------|----------|--------|----------|--------|
| Recorded Investment in Impaired Loans                        |   | $        | 31,991 |     | $      | — |   |
|                                                         |   |     |   |     |   |
| Related Allowance for Loan Losses                            |   | $        | 6,708  |     | $      | — |   |
|                                                         |   |     |   |     |   |
| Average Recorded Investment in Impaired  Loans               |   | $        | 33,750 |     | $      | — |   |
|                                                         |   |     |   |     |   |
| Interest Income Recognized for Cash  Payments                |   | $        | — |     | $      | — |   |
|                                                         |   |     |   |     |   |
| Total Nonaccrual Loans                                       |   | $        | 31,991 |     | $      | — |   |
|                                                         |   |     |   |     |   |
| Total Loans Past-Due Ninety Days or More  and Still Accruing |   | $        | — |     | $      | — |   |

 

48

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**NOTE #4 - PREMISESAND EQUIPMENT**

 

A summary of premises and equipment as of December 31, 2003 and 2002,follows:

 
|                                                   |   | **2003**   |      | **2002**  |   |
|--------------------------------------------------------|--------|------------|-----------|-----------|--------|
|                                                   |   |       |      |      |   |
| Land                                                   |   | $          | 2,736,721 |      | $      | 2,385,848 |   |
| Building                                               |   | 3,635,710  |      | 3,550,487 |   |
| Leasehold improvements                                 |   | 267,960    |      | 261,819   |   |
| Furniture, fixtures and equipment                      |   | 1,361,024  |      | 1,325,381 |   |
| Construction in progress                               |   | 280,383    |      | 40,255    |   |
|                                                   |   | 8,281,798  |      | 7,563,790 |   |
| Less:   Accumulated depreciation and amortization |   | (1,190,232 | )         | (879,424  | )      |
|                                                   |   | $          | 7,091,566 |      | $      | 6,684,366 |   |

 

TheBank has entered into leases for its branches and operating facilities, whichexpire at various dates through 2008. These leases include provisions forperiodic rent increases as well as payment by the lessee of certain operatingexpenses.  Rental expense relating tothese leases were approximately $83,000 in 2003 and $97,000 in 2002.

 

The approximate future minimum annual payments for these leases by yearare as follows:

 

| **Year** |   | **Amount** |    |
|----------|--------|------------|---------|
|     |   |       |    |
| 2004     |   | $          | 50,739  |   |
| 2005     |   | 40,380     |    |
| 2006     |   | 40,380     |    |
| 2007     |   | 30,065     |    |
| 2008     |   | 3,906      |    |
|     |   | $          | 165,470 |   |

 

The minimum rental paymentsshown above are given for the existing lease obligations and are not a forecastof future rental expense.

 

**NOTE #5 - DEPOSITS**

 

At December 31, 2003, all time deposits were scheduled to mature in2004, except for $1,197,355 that matures in one to five years.

 

49

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**NOTE #6 - NOTESPAYABLE AND OTHER BORROWING ARRANGEMENTS**

 

Notes payable consist of the following:

 
|                                                                                                                                                                                                         |   | **2003** |    | **2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| 4% noted payable to an individual, secured  by real property. Payable in monthly installments of $1,954 including  principal and interest, plus annual principal payments of $40,000, due  January 14, 2006. |   | $        | 164,387 |     | $      | 220,766 |   |
|                                                                                                                                                                                                         |   |     |    |     |   |
| 6% unsecured note payable to an individual  stockholder of the Company. Interest payable monthly, principal due November  1, 2003.                                                                           |   | —   |    | 500,000  |   |
|                                                                                                                                                                                                         |   | $        | 164,387 |     | $      | 720,766 |   |

 

The Bank may borrow up to $7,000,000overnight on an unsecured basis from three correspondent banks.  As of December 31, 2003, no amounts wereoutstanding under these arrangements.

 

**NOTE #7 – JUNIOR SUBORDINATED DEBT SECURITIES**

 

On September 26, 2002, the Company issued$5,155,000 of junior subordinated debt securities (the “debt securities”) toCoast Bancorp Statutory Trust I, a statutory trust created under the laws ofthe State of Delaware.  These debtsecurities are subordinated to effectively all borrowings of the Company andare due and payable on September 26, 2032. Interest is payable quarterly on these debt securities at 3-Month LIBORplus 3.4% for an effective rate of 4.57% as of December 31, 2003.  The debt securities can be redeemed for107.5% of the principal balance through September 26, 2007 and at parthereafter.  The debt securities canalso be redeemed at par if certain events occur that impact the tax treatmentor the capital treatment of the issuance.

 

The Company also purchased a 3% minorityinterest in Coast Bancorp Statutory Trust I. The balance of the equity of Coast Bancorp Statutory Trust I iscomprised of mandatorily redeemable preferred securities.  Under FASB Interpretation (FIN) No. 46, *“Consolidation of Variable Interest Entities, aninterpretation of ARB No. 51,”* the Company is not allowed toconsolidate Coast Bancorp Statutory Trust I into the Company financialstatements.  Prior to the issuance ofFIN No. 46, Bank Holding companies typically consolidated these entities.  The Federal Reserve Board had ruled thatcertain mandatorily redeemable preferred securities of a consolidated entity qualifiedas Tier 1 Capital.  The Federal ReserveBoard is evaluating the capital impact from FIN No. 46 but has not issued anyfinal ruling.  As of December 31, 2003,the Company has included the net junior subordinated debt in its Tier1 Capitalfor regulatory capital purposes.

 

50

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**NOTE #8 - INCOMETAXES**

 

The provisions for income taxes included in the consolidated statementsof income consist of the following:

 
|     |   | **2003** |    | **2002** |   |
|----------|--------|----------|---------|----------|--------|
| Current: |   |     |    |     |   |
| Federal  |   | $        | 575,800 |     | $      | 418,091 |   |
| State    |   | 176,700  |    | 162,429  |   |
|     |   | 752,500  |    | 580,520  |   |
| Deferred |   | (75,000  | )       | (38,000  | )      |
|     |   | $        | 677,500 |     | $      | 542,520 |   |

 

Deferred taxes are a result of differences between income taxaccounting and generally accepted accounting principles with respect to incomeand expense recognition.  The Company’sprincipal timing differences are from loan loss provision accounting, anddepreciation differences.

 

The following is a summary of the components of the net deferred taxasset accounts recognized in the accompanying statements of financial condition:

 
|                                                   |   | **2003** |    | **2002** |   |
|--------------------------------------------------------|--------|----------|---------|----------|--------|
| Deferred tax assets:                                   |   |     |    |     |   |
| Allowance for credit losses                            |   | $        | 373,000 |     | $      | 289,000 |   |
| Other assets/liabilities                               |   | 49,000   |    | 46,000   |   |
|                                                   |   | 422,000  |    | 335,000  |   |
| Deferred tax Liabilities:                              |   |     |    |     |   |
| Premises and equipment due to depreciation  difference |   | (27,000  | )       | (15,000  | )      |
| Market value adjustment on investment  securities      |   | (21,000  | )       | (34,000  | )      |
|                                                   |   | (48,000  | )       | (49,000  | )      |
| Net deferred tax assets                                |   | $        | 374,000 |     | $      | 286,000 |   |

 

A comparison of the federal statutory income tax rates to the Company’seffective income tax rates follow:

 
|                                        |   | **2003**   |    | **2002** |   |
|---------------------------------------------|--------|------------|---------|----------|--------|
|                                        |   | **Amount** |    | **Rate** |   | **Amount** |   | **Rate** |   |
|                                        |   |       |    |     |   |   |   |   |   |
| Statutory federal tax                       |   | $          | 564,000 |     | 34.0   | % | $ | 447,000 |   | 34.0 | % |
| State franchise tax, net of federal benefit |   | 117,000    |    | 7.0      | %      | 95,000 |   | 7.2 | % |
| Other items, net                            |   | (3,500     | )       | (0.2     | )%     | 520 |   | 0.1 | % |
| Actual tax expense                          |   | $          | 677,500 |     | 40.8   | % | $ | 542,520 |   | 41.3 | % |

 

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**NOTE #9 - EARNINGSPER SHARE (EPS)**

 

The following is a reconciliation of net income and shares outstandingto the net income and number of shares used to compute EPS:

 
|                                          |   | **2003**       |    | **2002**   |    |
|-----------------------------------------------|--------|----------------|---------|------------|---------|
|                                          |   | **Net Income** |    | **Shares** |    | **Net Income** |   | **Shares** |   |
|                                          |   |           |    |       |    |   |   |   |   |
| Used in basic EPS                             |   | $              | 982,169 |       | 633,356 |   | $ | 771,067 |   | 632,400 |   |
| Dilutive effect of outstanding stock  options |   |           |    | 38,289     |    |   |   | 27,946 |   |
| Used in dilutive EPS                          |   | $              | 982,169 |       | 671,645 |   | $ | 771,067 |   | 660,346 |   |

 

 

**NOTE #10 - STOCKOPTION PLAN**

 

At December 31, 2003, the Company had a fixed option plan under which187,500 shares of the Company’s common stock may be issued at not less than100% of the fair market value at the date the options are granted.  The Company applies APB Opinion No. 25 andrelated interpretations in accounting for its plan. Accordingly, nocompensation cost has been recognized for its fixed stock option plan.

 

The fair value of each option granted was estimated on the date ofgrant using the Black-Scholes option pricing model with the followingassumptions for 2003 and 2002, respectively; risk-free rate of 3% and 3.75%,dividend yields of 0.65% and 0.50%; volatility of 33% and 19%, and an expectedlife of six and five years.

 

A summary of the status of the Company’s fixed stock option plan as ofDecember 31, and changes during the years ending is presented below:

 
|                                                            |   | **2003**   |   | **2002**                               |   |
|-----------------------------------------------------------------|--------|------------|--------|----------------------------------------|--------|
|                                                            |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   |
|                                                            |   |       |   |                                   |   |   |   |   |   |
| Outstanding, beginning of year                                  |   | 145,900    |   | $                                      | 12.62  |   | 133,500 |   | $ | 12.40 |   |
| Granted                                                         |   | 9,500      |   | $                                      | 15.50  |   | 13,000 |   | $ | 14.99 |   |
| Exercised                                                       |   | (5,900     | )      | $                                      | 14.11  |   | — |   | $ | — |   |
| Cancelled                                                       |   | (2,000     | )      | $                                      | 13.00  |   | (600 | ) | $ | 14.75 |   |
| Outstanding, end of year                                        |   | 147,500    |   | $                                      | 12.74  |   | 145,900 |   | $ | 12.62 |   |
|                                                            |   |       |   |                                   |   |   |   |   |   |
| Options exercisable at year-end                                 |   | 112,167    |   | $                                      | 12.11  |   | 108,401 |   | $ | 12.00 |   |
| Weighted-average fair value of options  granted during the year |   |       |   | $                                      | 5.40   |   |   |   | $ | 3.52 |   |

 

52

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The following table summarizes information about fixed optionsoutstanding at December 31, 2003:

 
|                |   | **Options  Outstanding** |   | **Options  Exercisable**                            |   |
|---------------------|--------|--------------------------|--------|-----------------------------------------------------|--------|
| **Exercise  Price** |   | **Number  Outstanding**  |   | **Weighted-  Average  Remaining  Contractual Life** |   | **Weighted  Average  Exercise  Price** |   | **Number  Exercisable** |   | **Weighted  Average  Exercise  Price** |   |
|                |   |                     |   |                                                |   |   |   |   |   |   |   |
| $ 10.00             |   | 55,000                   |   | 3.45 Years                                          |   | $ | 10.00 |   | 55,000 |   | $ | 10.00 |   |
| $ 14.00 to $14.99   |   | 71,500                   |   | 4.65 Years                                          |   | $ | 14.12 |   | 54,867 |   | $ | 14.10 |   |
| $ 15.00 to $15.99   |   | 21,000                   |   | 6.22 Years                                          |   | $ | 15.23 |   | 2,300 |   | $ | 15.00 |   |
|                |   | 147,500                  |   | 4.42 Years                                          |   | $ | 12.74 |   | 112,167 |   | $ | 12.11 |   |

 

 

**NOTE #11 - RELATEDPARTY TRANSACTIONS**

 

In the ordinary course of business, the Bank has granted loans tocertain directors and the companies with which they are associated.  In the Bank’s opinion, all loans and loancommitments to such parties are made on substantially the same terms includinginterest rates and collateral, as those prevailing at the time for comparabletransactions with other persons.  Thebalance of these loans outstanding at December 31, 2003 and 2002, was asfollows:

 
|              |   | **2003** |      | **2002** |   |
|-------------------|--------|----------|-----------|----------|--------|
|              |   |     |      |     |   |
| Beginning balance |   | $        | 1,185,703 |     | $      | 1,991,169 |   |
| Additions         |   | 42,893   |      | 110,000  |   |
| Payments          |   | (177,445 | )         | (915,466 | )      |
| Ending balance    |   | $        | 1,051,151 |     | $      | 1,185,703 |   |

 

 

Also in the ordinary course of business, certainofficers, directors, shareholders, and employees of the Bank have deposits withthe Bank.  In the Bank’s opinion, alldeposit relationships with such parties are made on substantially the sameterms including interest rates and maturities, as those prevailing at the timeof comparable transactions with other persons. The balance of these deposits at December 31, 2003 was approximately$939,000.

 

53

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**NOTE #12 -COMMITMENTS**

 

In the normal course of business, the Bank enters into financialcommitments to meet the financing needs of its customers.  These financial commitments includecommitments to extend credit and standby letters of credit.  Those instruments involve to varyingdegrees, elements of credit and interest rate risk not recognized in thestatement of financial position.

 

The Bank’s exposure to loan loss in the event of nonperformance oncommitments to extend credit and standby letters of credit is represented bythe contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it doesfor loans reflected in the consolidated financial statements.

 

As of December 31, 2003 and 2002, the Bank had the followingoutstanding financial commitments whose contractual amount represents creditrisk:

 
|                         |   | **2003**  |       | **2002**  |   |
|------------------------------|--------|-----------|------------|-----------|--------|
|                         |   |      |       |      |   |
| Commitments to extend credit |   | $         | 36,708,000 |      | $      | 25,721,000 |   |
| Standby letters of credit    |   | 1,946,000 |       | 2,583,000 |   |
|                         |   | $         | 38,654,000 |      | $      | 28,304,000 |   |

 
|                                                                                                                                                                                                         |   | **2003** |    | **2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| 4% noted payable to an individual, secured  by real property. Payable in monthly installments of $1,954 including  principal and interest, plus annual principal payments of $40,000, due  January 14, 2006. |   | $        | 164,387 |     | $      | 220,766 |   |
|                                                                                                                                                                                                         |   |     |    |     |   |
| 6% unsecured note payable to an individual  stockholder of the Company. Interest payable monthly, principal due November  1, 2003.                                                                           |   | —   |    | 500,000  |   |
|                                                                                                                                                                                                         |   | $        | 164,387 |     | $      | 720,766 |   |

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Standby letters of credit areconditional commitments to guarantee the performance of a Bank customer to athird party.  Since many of thecommitments and standby letters of credit are expected to expire without beingdrawn upon, the total amounts do not necessarily represent future cashrequirements.  The Bank evaluates eachcustomer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained if deemed necessary by the Bankis based on management’s credit evaluation of the customer.

 

**NOTE #13 - REGULATORYMATTERS**

 

Coast Bancorp and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory - and possibly additional discretionary -actions by regulators that, if undertaken, could have a direct material effecton the Company’s consolidated financial statements.  Under capital adequacy guidelines and the regulatory frameworkfor prompt, corrective action, the Bank must meet specific capital guidelinesthat involve quantitative measures of the

 

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Bank’s assets, liabilities, and certain off-balance-sheet items ascalculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors.

 

Quantitative measures established by regulation to ensure capitaladequacy require the Bank to maintain minimum amounts and ratios (set forth inthe table below) of total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier 1 capital (as defined) toaverage assets (as defined).  Managementbelieves, as of December 31, 2003, that the Bank meets all capital adequacyrequirements to which it is subject.

 

55

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As of December 31, 2003, the most recent notification from the Officeof the Comptroller of the Currency (“OCC”) categorized the Bank aswell-capitalized under the regulatory framework for prompt corrective action(there are no conditions or events since that notification that managementbelieves have changed the Bank’s category). To be categorized as well-capitalized or adequately capitalized, theBank must maintain minimum ratios as set forth in the table below.  The following table also sets forth theBank’s actual capital amounts and ratios (dollar amounts in thousands):

 
|                                   |   |                |   |                               |   | **Amount of  Capital Required** |   |
|----------------------------------------|--------|---------------------|--------|------------------------------------|--------|---------------------------------|--------|
|                                   |   | **Actual  Capital** |   | **To Be  Adequately  Capitalized** |   | **To Be  Well-Capitalized**     |   |
|                                   |   | **Amount**          |   | **Ratio**                          |   | **Amount**                      |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| As of December 31, 2003                |   |                |   |                               |   |                            |   |   |   |   |   |   |   |
| Total capital to risk-weighted assets  |   | $                   | 14,269 |                               | 12.51  | %                               | $      | 9,122 |   | 8.0 | % | $ | 11,403 |   | 10.0 | % |
| Tier 1 capital to risk-weighted assets |   | $                   | 13,160 |                               | 11.54  | %                               | $      | 4,561 |   | 4.0 | % | $ | 6,842 |   | 6.0 | % |
| Tier 1 capital to  average assets |   | $                   | 13,160 |                               | 9.49   | %                               | $      | 5,545 |   | 4.0 | % | $ | 6,931 |   | 5.0 | % |
|                                   |   |                |   |                               |   |                            |   |   |   |   |   |   |   |
| As of December 31, 2002                |   |                |   |                               |   |                            |   |   |   |   |   |   |   |
| Total capital to risk-weighted assets  |   | $                   | 12,977 |                               | 13.33  | %                               | $      | 7,788 |   | 8.0 | % | $ | 9,735 |   | 10.0 | % |
| Tier 1 capital to risk-weighted assets |   | $                   | 11,977 |                               | 12.30  | %                               | $      | 3,894 |   | 4.0 | % | $ | 5,841 |   | 6.0 | % |
| Tier 1 capital to  average assets |   | $                   | 11,977 |                               | 10.18  | %                               | $      | 4,707 |   | 4.0 | % | $ | 5,884 |   | 5.0 | % |

 

The Company is subject tosimilar requirements administered by its primary regulator, the Federal ReserveBoard.  For capital adequacy purposes,the Company must maintain total capital to risk-weighted assets and Tier 1capital to risk-weighted assets of 8.0% and 4.0%, respectively.  Its total capital to risk-weighted assetsand Tier 1 capital to risk-weighted assets was 13.0% and 10.2%, respectively,at December 31, 2003 and 14.1% and 10.6%, respectively, at December 31, 2002.

 

The Bank is restricted to the amount of dividends which can bepaid.  Dividends declared by nationalbanks that exceed the net income (as defined) for the current year plusretained net income for the preceding two years must be approved by theOCC.  The Bank may not pay dividendsthat would result in its capital levels being reduced below the minimumrequirements shown above.

 

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**NOTE #14 - FAIR VALUEOF FINANCIAL INSTRUMENTS**

 

The fair value of a financial instrument is the amount at which theasset or obligation could be exchanged in a current transaction between willingparties, other than in a forced or liquidation sale.  Fair value estimates are made at a specific point in time basedon relevant market information and information about the financialinstrument.  These estimates do notreflect any premium or discount that could result from offering for sale at onetime the entire holdings of a particular financial instrument.  Because no market value exists for asignificant portion of the financial instruments, fair value estimates arebased on judgments regarding future expected loss experience, current economicconditions, risk characteristics of various financial instruments, and otherfactors.  These estimates are subjectivein nature, involve uncertainties and matters of judgment, and therefore cannotbe determined with precision.  Changesin assumptions could significantly affect the estimates.

 

Fair value estimates are based on financial instruments both on and offthe balance sheet without attempting to estimate the value of anticipatedfuture business and the value of assets and liabilities that are not consideredfinancial instruments.  Additionally,tax consequences related to the realization of the unrealized gains and lossescan have a potential effect on fair value estimates and have not beenconsidered in many of the estimates.

 

The following methods and assumptions were used to estimate the fairvalue of significant financial instruments:

 

***Financial Assets***

 

The carrying amounts of cash, short term investments, due fromcustomers on acceptances, and Bank acceptances outstanding are considered toapproximate fair value.  Short terminvestments include federal funds sold, securities purchased under agreementsto resell, and interest bearing deposits with Banks.  The fair values of investment securities, including available forsale, are generally based on quoted market prices.  The fair value of loans are estimated using a combination oftechniques, including discounting estimated future cash flows and quoted marketprices of similar instruments where available.

 

***Financial Liabilities***

 

The carrying amounts of deposit liabilities payable on demand,commercial paper, and other borrowed funds are considered to approximate fairvalue.  For fixed maturity deposits,fair value is estimated by discounting estimated future cash flows usingcurrently offered rates for deposits of similar remaining maturities.  The fair value of long term debt is based onrates currently available to the Bank for debt with similar terms and remainingmaturities.

 

***Off-Balance Sheet Financial Instruments***

 

The fair value of commitments to extend credit and standby letters of creditis estimated using the fees currently charged to enter into similaragreements.  The fair value of thesefinancial instruments are not deemed to be material.

 

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The estimated fair value of financial instruments at December 31, 2003and 2002 are summarized as follows (dollar amounts in thousands):

 
|                                   |   | **2003**             |   | **2002**       |   |
|----------------------------------------|--------|----------------------|--------|----------------|--------|
|                                   |   | **Carrying  Amount** |   | **Fair Value** |   | **Carrying  Amount** |   | **Fair Value** |   |
| Assets:                                |   |                 |   |           |   |   |   |   |   |
| Cash and cash equivalents              |   | $                    | 14,673 |           | $      | 14,673 |   | $ | 23,212 |   | $ | 23,212 |   |
| Investment securities                  |   | 12,073               |   | 12,073         |   | 2,092 |   | 2,092 |   |
| Loans, net                             |   | 106,353              |   | 107,152        |   | 88,415 |   | 89,439 |   |
| Accrued interest receivable            |   | 521                  |   | 521            |   | 414 |   | 414 |   |
| Federal Reserve and FHLB Bank stock    |   | 415                  |   | 415            |   | 287 |   | 287 |   |
|                                   |   |                 |   |           |   |   |   |   |   |
| Liabilities:                           |   |                 |   |           |   |   |   |   |   |
| Noninterest-bearing deposits           |   | 34,636               |   | 34,636         |   | 26,496 |   | 26,496 |   |
| Interest-bearing deposits              |   | 93,387               |   | 93,387         |   | 81,340 |   | 81,340 |   |
| Notes payable                          |   | 164                  |   | 164            |   | 721 |   | 721 |   |
| Trust preferred securities             |   | 5,000                |   | 5,000          |   | 5,000 |   | 5,000 |   |
| Accrued interest and other liabilities |   | 129                  |   | 129            |   | 571 |   | 571 |   |
|                                        |        |                      |        |                |        |  |  |  |  |  |  |  |  |

 

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**NOTE#15 - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY**

 

Coast Bancorp operates CoastNational Bank.  Coast Bancorp commencedoperations during 2001.  The earnings ofthe subsidiary are recognized on the equity method of accounting.  Condensed financial statements of the parentcompany only are presented below:

 

**CONDENSED BALANCE SHEET**

 
|                                           |   | **December  31,  2003** |       | **December  31,  2002** |   |
|------------------------------------------------|--------|-------------------------|------------|-------------------------|--------|
| **ASSETS:**                                    |   |                    |       |                    |   |
| Cash                                           |   | $                       | 347,639    |                    | $      | 1,046,803 |   |
| Investment in Coast Bancorp Statutory Trust  I |   | 155,000                 |       | 155,000                 |   |
| Investment in Coast National Bank              |   | 13,214,061              |       | 12,047,955              |   |
| Other assets                                   |   | 254,758                 |       | 238,120                 |   |
|                                           |   | $                       | 13,971,458 |                    | $      | 13,487,878 |   |
|                                           |   |                    |       |                    |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY:** |   |                    |       |                    |   |
| Other liabilities                              |   | $                       | 3,926      |                    | $      | 4,124 |   |
| Note payable                                   |   | —                  |       | 500,000                 |   |
| Trust preferred securities                     |   | 5,155,000               |       | 5,155,000               |   |
| Stockholders’ equity                      |   | 8,812,532               |       | 7,828,754               |   |
|                                           |   | $                       | 13,971,458 |                    | $      | 13,487,878 |   |

 

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**CONDENSED STATEMENT OF CASH FLOWS**

 
|                                                     |   | **Years  Ended**        |    |
|----------------------------------------------------------|--------|-------------------------|---------|
|                                                     |   | **December  31,  2003** |    | **December  31,  2002** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                |   |                    |    |   |   |
| Net income                                               |   | $                       | 982,169 |   | $ | 771,067 |   |
| Noncash items included in net income:                    |   |                    |    |   |   |
| Equity in income of Subsidiaries                         |   | (1,191,679              | )       | (910,276 | ) |
| Other                                                    |   | (16,836                 | )       | (233,996 | ) |
| **NET CASH USED IN OPERATING ACTIVITIES**                |   | (226,346                | )       | (373,205 | ) |
|                                                     |   |                    |    |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                |   |                    |    |   |   |
| Investment in Subsidiaries                               |   | —                  |    | (3,755,000 | ) |
| Dividends received from Subsidiaries                     |   | 7,237                   |    | 2,169 |   |
| **NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES**     |   | 7,237                   |    | (3,752,831 | ) |
|                                                     |   |                    |    |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                |   |                    |    |   |   |
| Principal payment on note payable                        |   | (500,000                | )       | — |   |
| Proceeds from trust preferred securities                 |   | —                  |    | 5,155,000 |   |
| Proceeds from exercise of stock options                  |   | 83,275                  |    | — |   |
| Dividends Paid                                           |   | (63,330                 | )       | (47,430 | ) |
| **NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES**     |   | (480,055                | )       | 5,107,570 |   |
|                                                     |   |                    |    |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS** |   | (699,164                | )       | 981,534 |   |
|                                                     |   |                    |    |   |   |
| **CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR**       |   | 1,046,803               |    | 65,269 |   |
|                                                     |   |                    |    |   |   |
| **CASH AND CASH EQUIVALENTS AT END OF YEAR**             |   | $                       | 347,639 |   | $ | 1,046,803 |   |

 

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**Item 8****.  Changes In and Disagreements withAccountants on Accounting and Financial Disclosure**

 

None

 

**Item 8A.Controls and Procedures**

 

**Quarterly Evaluation of the Company’s Disclosure Controls andInternal Controls.**

 

Asof December 31, 2003 and prior to the date of this Annual Report on Form10-KSB, the Company evaluated the effectiveness of the design and operation ofits “disclosure controls and procedures” (“Disclosure Controls”), and its“internal controls and procedures for financial reporting” (“Internal Controls”).This evaluation (the “Controls Evaluation”) was done under the supervision andwith the participation of management, including our Chairman and ChiefExecutive Officer (“CEO”) and Chief Financial Officer (“CFO”). Rules adopted bythe SEC require that in this section of the Annual Report we present theconclusions of the CEO and the CFO about the effectiveness of our DisclosureControls and Internal Controls based on and as of the date of the Controls

** **

**CEO and CFO Certifications.**

 

Appearingimmediately following the Signatures section of this Quarterly Report there aretwo separate forms of “Certifications” of the CEO and the CFO. The first formof Certification is required in accord with Section 302 of the Sarbanes-OxleyAct of 2002 (the “Section 302 Certification”). The section of the Annual Reportwhich you are currently reading is the information concerning the ControlsEvaluation referred to in the Section 302 Certifications and this informationshould be read in conjunction with the Section 302 Certifications for a morecomplete understanding of the topics presented.

** **

**Disclosure Controls and Internal Controls.**

 

DisclosureControls are procedures that are designed with the objective of ensuring thatinformation required to be disclosed in our reports filed under the ExchangeAct, such as this Annual Report, is recorded, processed, summarized andreported within the time periods specified in the Commission’s rules and forms.Disclosure Controls are also designed with the objective of ensuring that such informationis accumulated and communicated to our management, including the CEO and CFO,as appropriate to allow timely decisions regarding required disclosure.Internal Controls are procedures which are designed with the objective ofproviding reasonable assurance that (1) our transactions are properlyauthorized; (2) our assets are safeguarded against unauthorized or improperuse; and (3) our transactions are properly recorded and reported, all to permitthe preparation of our financial statements in conformity with generallyaccepted accounting principles.

** **

**Limitations on the Effectiveness of Controls.**

 

TheCompany’s management, including the CEO and CFO, does not expect that ourDisclosure Controls or our Internal Controls will prevent all error and allfraud. A control system, no matter how well conceived and operated, can provideonly reasonable, not absolute, assurance that the objectives of the controlsystem are met. Further, the design of a control system must reflect the factthat there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, within the Company have beendetected. These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerror or mistake. Additionally, controls can be circumvented by the individualacts of some persons, by collusion of two or more people, or by management

 

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override of the control. The design of anysystem of controls also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions;over time, control may become inadequate because of changes in conditions, orthe degree of compliance with the policies or procedures may deteriorate.Because of the inherent limitations in a cost-effective control system,misstatements due to error or fraud may occur and not be detected.

 

**Scope of the Controls Evaluation.**

 

TheCEO/CFO evaluation of our Disclosure Controls and our Internal Controlsincluded a review of the controls’ objectives and design, the controls’implementation by the Company and the effect of the controls on the informationgenerated for use in this Quarterly Report. In the course of the ControlsEvaluation, we sought to identify data errors, controls problems or acts offraud and to confirm that appropriate corrective action, including processimprovements, were being undertaken. This type of evaluation will be done on a quarterlybasis so that the conclusions concerning controls effectiveness can be reportedin our Quarterly Reports on Form 10-QSB and Annual Report on Form 10-KSB. OurInternal Controls are also evaluated on an ongoing basis by our Internal AuditDepartment, by other personnel in our organization and by our independentauditors in connection with their audit and review activities. The overallgoals of these various evaluation activities are to monitor our DisclosureControls and our Internal Controls and to make modifications as necessary; ourintent in this regard is that the Disclosure Controls and the Internal Controlswill be maintained as dynamic systems that change (including with improvementsand corrections) as conditions warrant.

 

Amongother matters, we sought in our evaluation to determine whether there were any“significant deficiencies” or “material weaknesses” in the Company’s InternalControls, or whether the Company had identified any acts of fraud involvingpersonnel who have a significant role in the Company’s Internal Controls. Thisinformation was important both for the Controls Evaluation generally andbecause items 5 and 6 in the Section 302 Certifications of the CEO and CFOrequire that the CEO and CFO disclose that information to our Board’s AuditCommittee and to our independent auditors and to report on related matters inthis section of the Annual Report. In the professional auditing literature,“significant deficiencies” are referred to as “reportable conditions”; theseare control issues that could have a significant adverse effect on the abilityto record, process, summarize and report financial data in the financialstatements. A “material weakness” is defined in the auditing literature as aparticularly serious reportable condition where the internal control does notreduce to a relatively low level the risk that misstatements caused by error orfraud may occur in amounts that would be material in relation to the financialstatements and not be detected within a timely period by employees in thenormal course of performing their assigned functions. We also sought to dealwith other controls matters in the Controls Evaluation, and in each case if aproblem was identified, we considered what revision, improvement and/orcorrection to make in accord with our on-going procedures.

 

Inaccord with Commission requirements, the CEO and CFO note that, since the dateof the Controls Evaluation to the date of this Annual Report, there have beenno significant changes in Internal Controls or in other factors that couldsignificantly affect Internal Controls, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

**Conclusions.**

 

Basedupon the Controls Evaluation, our CEO and CFO have concluded that, subject tothe limitations noted above, our Disclosure Controls are effective to ensurethat material information relating to the Company and its consolidatedsubsidiaries is made known to management, including the CEO and CFO,particularly during the period when our periodic reports are being prepared,and that our Internal Controls are effective to provide

 

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reasonable assurance that our financialstatements are fairly presented in conformity with generally acceptedaccounting principles.

 

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**INDEXTO EXHIBITS**

 

**PARTIII**

 

**Item 9****.  Directors, Executive Officers, Promoters andControl Persons: Compliance with Section 16(a) of the Exchange Act**

 

Boardof Directors:

 

**MarilynBritton**, age 64, graduated from Cal Poly San LuisObispo.  She was involved with the SanLuis Obispo County Farm Bureau for over 25 years, retiring as ExecutiveDirector in December 2002, a position she held for over 16 years.  Marilyn is a member and past director of theSan Luis Obispo Rotary, a member of San Luis Obispo County Farm Bureau, SanLuis Obispo County Farm Bureau Women, San Luis Obispo County Cattlewomen’sAssociation, San Luis Obispo County Cattlemen’s Association, Paso Robles Agri-BusinessTour Committee.  Mrs. Britton developedthe San Luis Obispo County Farm Bureau Agriculture Tour Program 24 years agoand has continued as its Tour Coordinator. She was also the Executive Director for the San Luis Obispo County GrainImprovement Association for 16 years. She serves on the Sheriff’s Parole Board, and she is past board memberfor the San Luis Obispo County Visitors Conference Bureau.

 

**DarioA. Domenghini**, age 66, is an original organizerand director of the Bank.  Mr.Domenghini is a life-long resident of San Luis Obispo County.  His family has been involved in agriculturein the County of San Luis Obispo since the early 1920’s.  Mr. Domenghini has been involved inagriculture, working in his family’s dairy and ranching operation since hischildhood.

 

Mr. Domenghini expanded the operation to include vegetablefarming.  He has since closed down thedairy operation, but continues to farm in partnership with his nephew.  Mr. Domenghini holds an ownership in thereal estate interest of Domenghini Brothers and is a 50% partner in DomenghiniFarms.  Mr. Domenghini was educated atCal Poly San Luis Obispo, majoring in Dairy Science.  Mr. Domenghini is active in local farming and ranchingactivities.

 

**JamesKaney**, age 57, is an original organizer anddirector of the Bank.  Mr. Kaney hasbeen a business owner/operator in San Luis Obispo since 1970 and he is acertified public accountant.  Hereceived his B.S. degree, cum laude, in Accounting/Finance with a minor inEconomics and his Masters of Business Administration Degree from CaliforniaPolytechnic State University, San Luis Obispo. He also teaches accounting and commercial bank management at CalPoly.  Mr. Kaney started Kaney Foods,Inc. in San Luis Obispo, a wholesaler to restaurants and institutions in thecounties of Monterey, Santa Barbara, Ventura, and San Luis Obispo.  Mr. Kaney was responsible for all phases ofthe company warehousing, distribution, sales and accounting.  The company was sold in 1987.  Mr. Kaney is partially disabled and isactively involved in his investments. Mr. Kaney is an organizer, founder and past director of Commerce Bank ofSan Luis Obispo N.A., which was sold in March 1996 to Valliwide Bank.  Mr. Kaney served for more than twelve yearson the Loan Committee and the Investment Committee of Commerce Bank.  Mr. Kaney is a past member of the KiwanisClub and a member and past director of the Rotary Club of San Luis Obispo.

 

**MichaelA. Lady**, age 52 is an original organizer anddirector of the Bank.  Mr. Lady has beena resident of Arroyo Grande for the past sixteen years and is the owner of LadyFamily Mortuary in Arroyo Grande and Nipomo. In addition to his involvement in the mortuary business, Mr. Lady is aninvestor, as well as the former Mayor of the City of Arroyo Grande.   Mr. Lady, through his development andgovernmental activities, is vitally aware of the future development plans forthe Arroyo Grande area, including plans for the possible annexation ofunincorporated lands bordering Arroyo Grande to provide the space for a majorincrease in commercial development in the community.

 

Mr. Lady is active in a large number of civic and fraternalorganizations.  He is the past presidentof the Arroyo

 

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Grande Chamber of Commerce andthe Arroyo Valley Kiwanis.  He is amember of the Elks Club, Moose Lodge, Shriner’s Club, the Freemasons, YMCA, andthe Fraternal Order of Eagles. He was named the 1991 Arroyo Grande Citizen ofthe Year, and he and his wife were named South County Couple of the Year alsoin 1991. Mr. Lady is a leader in the Arroyo Grande community, and hisinvolvement in the formation and management of the Bank has provided the Bankwith an impressive base of valuable business customers.

 

**GeneMintz**, age 64, is an original organizer anddirector of the Bank.  Mr. Mintz is abusiness and tax advisor for the Arroyo Grande area and owner of GSM BusinessServices, Inc., an Arroyo Grande business and tax advisory service.  A life-long resident of San Luis ObispoCounty, Mr. Mintz is involved in a number of professional, civic, andcharitable associations.  He is the pastpresident and director of the Kiwanis Club of greater Pismo Beach, and a 27year member of the Elks club of the Pismo Beach area.  Mr. Mintz is a general partner in, a Real Estate InvestmentPartnership. He is also the Secretary/Treasurer of Lanco Development Co., Inc.,a Real Estate Development Company.

 

Mr. Mintz is active in a number of professional organizations, servingas a past president of the Central Coast Chapter of the California Society ofEnrolled Agents.  His professionalactivities include his active accounting and tax advisory business, as well asinvolvement in a number of real estate development projects.  He is the Secretary-Treasurer of Burke andPace, a major supplier of building materials headquartered in ArroyoGrande.  Mr. Mintz is involved in theSouth County Performing Arts Foundation, as a Director and Vice President forthis cultural organization.

 

**RonOlson**, age 60, is a director of the Bank.  Mr. Olson is a Certified Public Accountantand is owner of Platino Management Services, Inc. which provides accounting andtax services, management consulting and property management services in ArroyoGrande and surrounding communities.

 

Mr. Olson has been a resident of Arroyo Grande for 30 years and isactive in local service and professional organizations.  Mr. Olson is a member of the Arroyo GrandeOptimists Club and of both the American Institute of CPA’s and the CaliforniaSociety of CPA’s.  Mr. Olson is aninvestor and director of a privately held chain of food supermarkets and a fastfood restaurant franchising company.

 

**JackW. Robasciotti**, age 76, is Vice Chairman of theboard and an original organizing director of the Bank.  Mr. Robasciotti was born in San Luis Obispoand has been active in banking since 1951. After an impressive 33 year career with Bank of America, Mr. Robasciotti“retired” to San Luis Obispo, where he worked for 11 years in variouspositions, including manager of the main office of Commerce Bank of San LuisObispo, N.A.

 

Mr. Robasciotti has been active in a number of civic, charitable andfraternal organizations in San Luis Obispo. His activities range from fundraising for the YMCA, to serving as adirector and a member of organizations that provide shelter for abused women(SAVE), and (ALPHA) that counsels pregnant women.   Mr. Robasciotti is a member of the San Luis Obispo HistoricalSociety, previously serving as First Vice President, a past member of HearstCastle Lighting Committee, and a committee member for a number of the San LuisObispo Old Mission operating groups.  Heis also active in the De Tolosa Rotary club.

 

**JackC. Wauchope**, age 68, is Chief Executive Officerand Chairman of the Board of Directors for both the Bank and the Bancorp.  Mr. Wauchope has been in the bankingindustry for more than 44 years.  Formore than half of that time, he has served as the President and Chief ExecutiveOfficer of independent banks.   Mr.Wauchope was the organizing President of Commerce Bank of San Luis Obispo.  During his ten-year term at Commerce Bank,the Bank earned consistently high CAMEL ratings and was named a PremierPerforming Bank for seven consecutive years. He is a graduate of Pacific Coast Banking School at the University ofWashington, Seattle, Washington.

 

Mr. Wauchope has served on the boards of numerous civic, charitable andtrade organizations which include the Foundation for the Performing ArtsCenter, Hotline of San Luis Obispo County, San Luis Obispo Economics

 

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Forecast Project, CommunityBankers of Southern California, Western Banking School, Rotary Club of San LuisObispo Daybreak and the Civic Ballet of San Luis Obispo.

 

**DanH. Wixom**, age 53, is an original organizer anddirector of the Bank.  Mr. Wixom is arancher and an owner/operator of Wixom Trucking, LLC.  Mr. Wixom formerly owned and operated Wixom Concrete, Inc., whichwas sold in 1997.  A graduate of CalPoly San Luis Obispo in Agriculture Management, Mr. Wixom is a fourthgeneration resident of San Luis Obispo County. He has been a member of Native Sons of the Golden West for twenty yearsand served as a president of the organization. Mr. Wixom served on the board of the Morro Bay CommunityFoundation.  The foundation helps withyouth activities on the Central Coast. He supports local educational institutions, volunteering time anddonating materials for the Morro Bay FFA and 4H groups and for youth sportsteams.

 

Mr. Wixom is a member of the California Cattlemen’s Association, theNational Cattlemen’s Association, and the San Luis Obispo County FarmBureau.  He has operated his owncalf/cow operation for more than 30 years. Currently he runs over 300 mother cows on over 4,000 acres, with anadditional 100 acres set aside for oat and hay production.  His trucking company is involved in thestatewide transportation of construction aggregates, bulk cement and livestock.

 

Executive Officers:

 

Jack C. Wauchope – Chief Executive Officer/President and Chairman ofthe Board – See “Directors”

 

Jack Robasciotti – Vice-Chairman of the Board, Business DevelopmentOfficer – See “Directors”

 

**JulieJoslin**, age 44, joined the Bank in 2000 as SeniorVice President and Compliance Officer.  She was raised and educated in Atascadero, California, where she beganher banking career with Atascadero Federal Credit Union in 1983.  She moved to Templeton National Bank in 1990where she remained until that bank was sold in 1995.  Joslin served as a Vice President and Controller while withTempleton National Bank.  Joslin is alsoa graduate of the California Banking School at the University of San Diego.

 

**BertaOlson**, age 64, was an original employee of theBank.  She currently serves as SeniorVice President, Controller and Operations Administrator.  She was raised and educated in SantaBarbara, California, where she began her banking career 45 years ago.  Berta is a graduate of the Graduate Schoolof Banking at the University of Wisconsin at Madison.  Over the years, Berta has volunteered for a number of civic andcharitable organizations.

 

**DavinaPalazzo**, age 35, is Executive Vice President andManager of the Bank’s Small Business Loan Center.  She was educated in Southern California, graduating from CaliforniaState University – Fullerton.  She hasbeen in banking for the past 16 years, concentrating primarily over the lastten years in government guaranteed lending programs such as the U.S. SmallBusiness Administration.  She is agraduate of the Pacific Coast Banking School at the University ofWashington.  She also serves on theBoard of Directors of the National Association of Government Guaranteed Lendersand Chairs their Small Bank Committee. She is presently serving on the Board of the Paso Robles Sunrise RotaryClub.  Ms. Palazzo was the recipient ofthe SBA’s Financial Service Advocate of the Year Award for 2002.

 

**LeahPauly**, age 41, is Executive Vice President andChief Credit Officer for the Bank.  Shewas raised and educated in Southern California but has lived in northern SanLuis Obispo county for the past 16 years. She has actively worked in progressively more responsible positions inbanking for the last 21 years and is presently attending Stonier BankingSchool.  Over the years, Pauly hasvolunteered for a number of civic and charitable organizations.  She currently serves on the Board ofDirectors of Life Span Services Network, Inc.

 

66

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**AlanTognazzini**, age 58, joined the Bank in 2001 as SeniorVice President, Los Osos Branch Manager and Chief Information Officer.  With more than 30 years banking experiencein the local market, Tognazzini previously served as Senior Executive VicePresident at First Bank of San Luis Obispo. Raised and educated locally, Tognazzini is a graduate of the CaliforniaBanking School at the University of San Diego. He has also served as an instructor for the American Institute ofBanking.  In addition to a long list ofservice to local non-profit organizations to his credit, he is currently aboard member and incoming president of the Exchange Club of San LuisObispo.  He is also a member of theAtascadero Elks Club and the American Legion of San Luis Obispo.

 

The executive officers were each elected by the Board ofDirectors.  There are no familyrelationships between directors and executive officers of the Bank.

 

No Director of the Bank holds a directorship in any other company witha class of securities registered pursuant to Section 12 of the SecuritiesExchange of 1934, as amended.

 

**Compliancewith Section 16(a) of the Securities Exchange Act**

 

Based solely on its review of Forms 3, 4, and 5, and amendmentsthereto, furnished to Bancorp during the 2003 fiscal year, no person who was adirector, officer, or beneficial owner of more than ten percent of the Bank’sCommon Stock failed to file on a timely basis reports required by Section 16(a)during the 2003 fiscal year.

 

**FinancialExpert** - The Board of Directors has determined, asrequired, that the Audit Committee contains three independent financialexperts.  They perform no services nordo they receive compensation from the bank other than normal directorfees.  The experts on the committee areJames Kaney, Gene Mintz and Ron Olson. Each of their qualifications is stated (See “Directors”) elsewhere inthis report.

 

**Codeof Ethics***-*This section of the Sarbanes Oxley Actnow requires small business filers to adopt and disclose whether the Bancorphas adopted a code of ethics that applies to the principal executive officer,principal financial officer, and principal accounting officer or controller, orany person performing similar functions. The Bancorp has complied with this requirement and a copy is attached asexhibit 14.

 

**Independenceof Accounting Firms -**Amendments to Regulation S-Xgoverns employment relationships between financial entities and accountingfirms.  Requirements include“independence” of the accounting firm, precluding the performance of any otheraudit functions such as bookkeeping, appraisal services, legal services and avariety of other functions.  Therequirements also preclude the Bancorp from having any interest, capitalbalances, nor influence over the accounting firm’s operations or policies. Thisamendment also requires approval, by the Audit Committee, of the accountingfirm prior to engagement and limits the number of years that the lead partneror concurring partner in the accounting firm may conduct audits withoutsacrificing their “independent” status. The Bancorp is in compliance with this regulation.

 

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**Item 10****.  Executive Compensation:**

 

The chart below contains information of Jack C. Wauchope, President/CEOand Davina Palazzo as the only executive officers whose salary and other compensationwas $100,000 or more.

 
| **Name and  Principal Position** |   | **Year** |   | **Salary ($)** |    | **Bonus ($)** |   | **Other  Annual  Compensation** |   | **Awards:  Securities  Underlying  Options (#)** |   | **All Other  Compensation** |   |
|----------------------------------|--------|----------|--------|----------------|---------|---------------|--------|---------------------------------|--------|--------------------------------------------------|--------|-----------------------------|--------|
|                             |   |     |   |           |    |          |   |                            |   |                                             |   |                        |   |
| **Jack C. Wauchope**             |   | 2003     |   | $              | 170,833 |          | $      | 25,000                          |   | $                                                | — |                        | $      | — |   | $ | 13,652 |   |
| President/CEO                    |   | 2002     |   | $              | 158,750 |          | $      | 7,800                           |   | $                                                | — |                        | $      | — |   | $ | 14,650 |   |
| Chairman of the Board            |   | 2001     |   | $              | 143,750 |          | $      | 6,000                           |   | $                                                | — |                        | $      | — |   | $ | 10,341 |   |
|                             |   |     |   |           |    |          |   |                            |   |                                             |   |                        |   |
| **Davina Palazzo**               |   | 2003     |   | $              | 108,750 |          | $      | 11,000                          |   | $                                                | — |                        | $      | — |   | $ | 377 |   |
| Senior Vice President            |   | 2002     |   | $              | 92,500  |          | $      | 6,000                           |   | $                                                | — |                        | $      | — |   | $ | 4,224 |   |
|                             |   | 2001     |   | $              | —  |          | $      | —                          |   | $                                                | — |                        | $      | — |   | $ | — |   |

 

 

Thevalue of perquisites and other personal benefits are disclosed in other annualcompensation if they exceed, in the aggregate, the lesser of $50,000 or 10% ofsalary and bonus.  No amounts arereported in this column for Mr. Wauchope or Mrs. Palazzo since the value ofperquisites and other personal benefits did not exceed the reporting threshold.

 

The Bank has employed Jack C. Wauchope as its Chief Executive Officerand entered into an employment agreement with him, which took effect in June2003.  The agreement provided for a termof five years at an annual base salary of $175,000.00 in year 1, $185,000.00 inyear 2 and 3, $200,000.00 in year 4 and 5, discretionary bonuses, and a Bankprovided automobile, country club membership, expense reimbursement,$400,000.00 of life insurance and standard and customary medical and dentalinsurance benefits.  Additionally, Mr.Wauchope will be entitled to severance benefits equal to one year’s base salaryor two years, each dependent upon the occurrence of one or more enumeratedevents.

 

The Bank has employed Davina Palazzo as itsExecutive Vice-President and Manager of the Small Business Lending Center andentered into an employment agreement with her, which took effect in June2003.  The agreement provides for a termof five years at an annual base salary of $115,000.00 in year 1, $125,000.00 inyear 2 and 3, $140,000.00 in year 4 and 5, discretionary bonuses, and anautomobile allowance of $400.00 per month, country club membership, andstandard and customary medical and dental insurance benefits.  Additionally, Ms. Palazzo will be entitledto severance benefits equal to one year’s base salary or two years, eachdependent upon the occurrence of one or more enumerated events.

 

The directors who are not full-time employees of the Bank are presentlyreceiving monthly directors’ fees.  Mr.Wauchope does not presently receive directors’ fees.

 

**EmployeesStock Option Plan**

 

In the course of the formation of Coast Bancorp as of May 31, 2001,Coast Bancorp adopted and assumed the Coast National Bank 1997 Stock OptionPlan, now known as the Coast Bancorp Employee Stock Option Plan (the

 

68

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“Employee Plan”).  The Employee Plan was adopted to strengthenthe Company and its subsidiaries by providing eligible full-time officers andemployees an added incentive to perform at a high level and to reward extraordinaryefforts to increase the earnings of Coast Bancorp and its subsidiaries.  The incentive will take the form of anopportunity for officers and employees of Coast Bancorp and its subsidiaries toacquire a proprietary interest in the success of Coast Bancorp by purchasingShares of Coast Bancorp common stock. 125,000 shares of Coast Bancorp common stock may be issued pursuant tothe exercise of Options granted under the Employee Plan, and in no event maythe total number of shares issuable upon exercise of all outstanding optionsand the total number of shares provided for under any other stock option plan,stock bonus or similar plan of Coast Bancorp exceed thirty percent (30%) of thethen-outstanding common stock of the Company. As of December 31, 2003, approximately twenty six officers and employeesof Coast Bancorp and its affiliates were eligible to hold options to purchaseunder the Employee Plan.  The EmployeePlan contemplates the grant of incentive stock options and nonstatutory stockoptions.

 

The Employee Plan is not qualified under Section 401(a) of the InternalRevenue Code of 1986, as amended (the “Code”) or subject to the provisions ofthe Employee Retirement Income Security Act of 1974, as amended.

 

**Exerciseand Grant of Options**

 

During 2003 no options were granted to President and Chief ExecutiveOfficer Jack C. Wauchope, or to Executive Vice President Davina Palazzo.

 

The following table shows exercises of stock options during fiscal year2003 by CEO President/Chairman of the Board Jack C. Wauchope, Executive VicePresident Davina Palazzo, and the value at December 31, 2003 of unexercisedoptions on an aggregated basis held by each such persons:

 

**Aggregated Option Exercises in Last FiscalYear and FY-End Option Values**

 
| **Name**         |   | **Shares  Acquired  On Exercise (#)** |   | **Value  Realized ($)** |   | **Number of  Securities  Underlying Unexercised  Options at FY-End (#)  Exercisable/Unexercisable** |   | **Value of  Unexercised  In-the-Money Options  at FY-End ($)  Exercisable/Unexercisable (1)** |   |
|------------------|--------|---------------------------------------|--------|-------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|--------|
|             |   |                                  |   |                    |   |                                                                                                |   |                                                                                          |   |
| Jack C. Wauchope |   | 0                                     |   | 0                       |   | 20,000 / 0                                                                                          |   | $270,000 / $-0-                                                                               |   |
|             |   |                                  |   |                    |   |                                                                                                |   |                                                                                          |   |
| Davina Palazzo   |   | 0                                     |   | 0                       |   | 4,500 /3,000                                                                                        |   | $42,750 / $28,500                                                                             |   |

 

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(1)           Based on a bid price of  $23.00 at February 17, 2004

 

**DirectorsStock Option Plan**

 

In the course of the formationof Coast Bancorp as of May 31, 2001, Coast Bancorp adopted and assumed theCoast National Bank 1998 Directors’ Stock Option Plan, now known as the CoastBancorp Directors Stock Option Plan (the “Director Plan”).  The Director Plan was adopted to offer thenon-employee directors of Coast Bancorp and its affiliates the opportunity toacquire a proprietary interest in the success of Coast Bancorp by purchasing

 

69

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shares of Coast Bancorp commonstock.  No new options were granted in2003.

 

The aggregate number of shares which may be issued pursuant to theexercise of Options granted under the Director Plan is 62,500 shares, and in noevent may the total number of shares issuable upon exercise of all outstandingoptions and the total number of shares provided for under any other stockoption plan, stock bonus or similar plan of Coast Bancorp exceed thirty percent(30%) of the then-outstanding common stock of the Company (the “Shares”).  As of March 15, 2004, approximately eight(8) directors of Coast Bancorp and its affiliates were eligible to hold optionsunder the Director Plan.  The DirectorPlan contemplates the grant of nonstatutory stock options only.

 

### **Item 11**.  Security Ownershipof Certain Beneficial Owners and Management

 

a.                                       There are no stockholderswith ownership of 5% of the Bank’s stock, except as set forth below.  Mr. Wauchope’s address is 500 Marsh Street,San Luis Obispo, CA  93401.

 

b.                                      

 
| **Name**                                                    |   | **Relationship  to Bank**           |   | **Number of  Shares** |   | **Notes** |   | **Percentage  Owned (1)** |   |
|-------------------------------------------------------------|--------|-------------------------------------|--------|-----------------------|--------|-----------|--------|---------------------------|--------|
|                                                        |   |                                |   |                  |   |      |   |                      |   |
| Jack C. Wauchope                                            |   | Chairman of  the Board & CEO    |   | 42,300                |   | (2)       |   | 6.43                      | %      |
| Marilyn Britton                                             |   | Corporate  Secretary & Director |   | 3,050                 |   | (7)       |   | 0.48                      | %      |
| Dario Domenghini                                            |   | Director                            |   | 11,400                |   | (3,5)     |   | 1.77                      | %      |
| James M. Kaney                                              |   | Director                            |   | 7,700                 |   | (5)       |   | 1.20                      | %      |
| Michael A. Lady                                             |   | Director                            |   | 6,000                 |   | (5)       |   | 0.93                      | %      |
| Gene D. Mintz                                               |   | Director                            |   | 25,140                |   | (5)       |   | 3.91                      | %      |
| Ron Olson                                                   |   | Director                            |   | 14,492                |   | (6)       |   | 2.26                      | %      |
| Jack W. Robasciotti                                         |   | Vice  Chairman & Director       |   | 7,000                 |   | (5)       |   | 1.09                      | %      |
| Dan H. Wixom                                                |   | Director                            |   | 16,800                |   | (4,5)     |   | 2.61                      | %      |
| Davina Palazzo                                              |   | EVP &  Executive Officer        |   | 4,500                 |   | (8)       |   | 0.70                      | %      |
| Alan Tognazzini                                             |   | SVP &  Executive Officer        |   | 2,000                 |   | (8)       |   | 0.31                      | %      |
| Leah Pauly                                                  |   | EVP &  Executive Officer        |   | 2,100                 |   | (8)       |   | 0.33                      | %      |
| Julie Joslin                                                |   | SVP &  Executive Officer        |   | 1,200                 |   | (8)       |   | 0.19                      | %      |
| Berta Olson                                                 |   | SVP &  Executive Officer        |   | 1,800                 |   | (10,8)    |   | 0.28                      | %      |
| Directors  & Executive Officers as a Group (14 persons) |   | 145,482                             |   | (9)                   |   | 21.01     | %      |

 

Notes Regarding Percentages Owned:

 

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(1)                                  Except asotherwise noted, may include shares held by such person’s spouse (except wherelegally separated) and minor children; shares held by any other relative ofsuch person who has the same home; shares held by a family trust as to whichperson is a beneficiary and trustee with sole voting and investment power (orshared power with a spouse); shares held in street name for the benefit of suchperson; or shares held in an Individual Retirement Account or pension plan asto which person is the sole beneficiary and has pass-through voting rights andinvestment power.

 

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(2)                                  Includes20,000 shares of incentive stock options that are presently exercisable.

 

(3)                                  Includes 300shares held by Domenghini Farms, a California General Partnership and 1,000shares held by Domenghini Brothers, A California General Partnership, overwhich Mr. Domenghini has shared voting and investment power.

 

(4)                                  Includes4,500 shares held by the Wixom Concrete, Inc. Profit Sharing Trust over whichMr. Wixom is trustee with sole voting and investment power.

 

(5)                                  Includes5,000 shares of director stock options that are presently exercisable.

 

(6)                                  Includes1,667 shares of director stock options that are presently exercisable.

 

(7)                                  Includes2,500 shares of director stock options that are presently exercisable.

 

(8)                                  Incentivestock options currently exercisable.

 

(9)                                  Includes42,400 shares of incentive stock options and 32,501 shares of director stockoptions which are presently exercisable.

 

(10)                            Includes1,400 shares held in the Olson Family Trust.

 

**Item 12****.  Certain Relationships and RelatedTransactions.**

 

Thereare no existing or proposed material interests or transactions between the Bankand/or any of its officers or directors outside the ordinary course of theBank’s business.

 

Itis anticipated that the directors and officers of the Bank, and the companies,with which they are associated, will have banking transactions with the Bank inthe ordinary course of business.  It isthe firm intention of the Board of Directors that any loans and commitments tolend included in such transactions will be made in accordance with allapplicable laws and regulations and on substantially the same terms, includinginterest rates and collateral, as those prevailing at the time for comparabletransactions with other persons of similar creditworthiness.

 

Itis also possible that one or more members of the Board of Directors may fromtime to time provide services and equipment to the Bank.  It is the firm policy of the Board that anysuch transactions between the Bank and any members of its Board, or any persondirectly or indirectly related to a director, be made in strict accordance withapplicable rules and regulations and on substantially the same terms as thoseavailable at the time for comparable transactions with disinterested persons.

 

**Item 13****.  Exhibits andReports on Form 8-K**

 

a)                                      Exhibits

 

Seeindex to exhibits at page 68 of this Annual Report on Form 10-KSB.

 

b)                                     A currentreport on Form 8-K was filed with the SEC on October 22, 2003 reporting underItem 5 a declaration of a cash dividend. A current report on Form 8-K was filed November 11, 2003 under Item 5reporting the resignation of the President.

 

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**Item 14****.  PrincipalAccountant Fees and Services**

 

Vavrinek, Trine, Day& Company LLP’s engagement by Coast Bancorp commenced on April 30, 2002.During the fiscal year ended December 31, 2003, Vavrinek, Trine & Day &Company, LLP provided professional services in connection with the review ofCoast Bancorp’s registration statement filed with the SEC in connection withthe company’s public offering, the review of Quarterly Reports on Form 10-QSBfor the quarters ended March 31, June 30, September 30, 2003, preparation forthe audit of financial statements of Coast Bancorp for the fiscal year ended December31, 2002, and consulted with Coast Bancorp’s management regarding year end taxplanning.  As part of the engagement,Vavrinek, Trine, Day & Company LLP also prepared quarterly tax estimatesand the federal and state income tax returns.

 

**Audit Fees**

 

The aggregate feesbilled by Vavrinek, Trine, Day & Company LLP for professional servicesrendered for the audit of the Company’s annual financial statements for fiscalyears 2002 and 2003 and the review of the financial statements included in theCompany’s Forms 10-QSB for the Quarters ended March 31, June 30, and September30, 2003 and for the preparation of tax estimates and federal and state incometax returns were $39,000.00 and $34,000.00, respectively.

 

**Audit Related Fees**

 

There were no feesbilled by Vavrinek, Trine, Day & Company, LLP for assurance and relatedservices provided to the Company that are reasonably related to the performanceof the audit or review of the Company’s financial statements that have not beenreported under “Audit Fees” for fiscal years 2002 and 2003.

 

**Tax Fees**

 

The aggregate feesbilled by Vavrinek, Trine, Day & Company, LLP for professional servicesrendered to the Company for tax compliance, tax advice, and tax planning forfiscal years 2002 and 2003 were $5,000.00 each year.

 

**Audit Committee’s Pre-ApprovalPolicies and Procedures**

 

The Audit Committee,acting on behalf of the Board of Directors of Coast Bancorp and Coast NationalBank has been charged with assisting the Board in fulfilling the fiduciaryresponsibility to the shareholders, depositors and investment communityrelating to the quality and integrity of the company’s accounting systems,accounting principles applied, financial reporting process, and overallinternal control structure.  In so doingthe Committee shall:

 

•                  Select andrecommend annually, to the Board of Directors, appointment of the Bancorp’sindependent public accountants.

 

•                  Reviewindependence, qualifications, the annual engagement letter, audit scope,accounting principles, related services and fees.

 

•                  Reviewmanagement’s plans for engaging the independent public accountants to performmanagement’s advisory services.

 

•                  Review theBancorp’s audited financial statements in relation to meeting the requirementsof an annual Director’s examination, related notes, the accountant’s opinion tobe rendered in connection therewith, and any unresolved disagreements withmanagement, if any.

 

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•                  Review theirreport on management’s assertions on in ternalcontrols and compliance with law and regulations.

 

•                  Reviewsignificant findings reported by bank regulators, management’s relatedresponses, and monitor corrective actions on major deficiencies noted.

 

•                  Reviewmanagement’s annual report on its responsibility for preparing financialstatements, establishing and maintaining internal control structure andprocedures for financial reporting, and for complying with certain laws andregulations.

 

•                  Performadditional functions as are necessary or prudent to fulfill the Committee’sduties and responsibilities.

 

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**CEO and CFO Certifications.**

 

Appearingimmediately following the Signatures section of this Quarterly Report there aretwo separate forms of “Certifications” of the CEO and the CFO. The first formof Certification is required in accord with Section 302 of the Sarbanes-OxleyAct of 2002 (the “Section 302 Certification”). The section of the Annual Reportwhich you are currently reading is the information concerning the ControlsEvaluation referred to in the Section 302 Certifications and this informationshould be read in conjunction with the Section 302 Certifications for a morecomplete understanding of the topics presented.

 

**Disclosure Controls and Internal Controls.**

 

DisclosureControls are procedures that are designed with the objective of ensuring thatinformation required to be disclosed in our reports filed under the ExchangeAct, such as this Annual Report, is recorded, processed, summarized and reportedwithin the time periods specified in the Commission’s rules and forms.Disclosure Controls are also designed with the objective of ensuring that suchinformation is accumulated and communicated to our management, including theCEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure. Internal Controls are procedures which are designed with theobjective of providing reasonable assurance that (1) our transactions areproperly authorized; (2) our assets are safeguarded against unauthorized orimproper use; and (3) our transactions are properly recorded and reported, allto permit the preparation of our financial statements in conformity withgenerally accepted accounting principles.

 

**Limitations on the Effectiveness of Controls.**

 

TheCompany’s management, including the CEO and CFO, does not expect that ourDisclosure Controls or our Internal Controls will prevent all error and allfraud. A control system, no matter how well conceived and operated, can provideonly reasonable, not absolute, assurance that the objectives of the controlsystem are met. Further, the design of a control system must reflect the factthat there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, within the Company have beendetected. These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerror or mistake. Additionally, controls can be circumvented by the individualacts of some persons, by collusion of two or more people, or by managementoverride of the control. The design of any system of controls also is based inpart upon certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions; over time, control may become inadequatebecause of changes in conditions, or the degree of compliance with the policiesor procedures may deteriorate. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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**INDEX TO EXHIBITS**

 
| **Exhibit  Number** |   | **Description  of Exhibit**                                                                                                                                                                                                |   | **Footnote**                     |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|
|                |   |                                                                                                                                                                                                                       |   |                             |
| 2.0                 |   | Plan  of Acquisition and Agreement of Merger dated March 1, 2001                                                                                                                                                           |   | (1)                              |
| 3.1                 |   | Articles  of Incorporation of Coast Bancorp                                                                                                                                                                                |   | (1)                              |
| 3.2                 |   | Bylaws  of Coast Bancorp                                                                                                                                                                                                   |   | (1)                              |
| 4.1                 |   | Certificate  Evidencing Floating Rate Capital Securities                                                                                                                                                                   |   | (3)                              |
| 4.2                 |   | Floating  Rate Junior Subordinated Deferrable Interest Debenture                                                                                                                                                           |   | (3)                              |
| 4.3                 |   | Certificate  Evidencing Floating Rate Common Securities                                                                                                                                                                    |   | (3)                              |
| 4.4                 |   | Guarantee  Agreement                                                                                                                                                                                                       |   | (3)                              |
| 4.5                 |   | Indenture  dated September 26, 2002, Coast Bancorp Issuer, State Street Bank and Trust  Company of Connecticut, N.A., as Trustee for Floating Rate Junior  Subordinated Deferrable Interest Debenture                      |   | (3)                              |
| 10.1                |   | Coast  Bancorp Stock Option Plan and specimen Non-Statutory and Incentive Stock  Option Agreements                                                                                                                         |   | (2) **                           |
| 10.2                |   | Coast  Bancorp Directors Stock Option Plan and specimen Non-Statutory Agreement                                                                                                                                            |   | (2) **                           |
| 10.3                |   | Employment  contract by and between Jack C. Wauchope and Coast National Bank                                                                                                                                               |   |      ** |
| 10.5                |   | Amended  and Restated Declaration of Trust by and Among State Street Bank and Trust  Company of Connecticut, N.A., as Institutional Trustee, Coast Bancorp as  Sponsor, and Administrators, dated as of September 26, 2002 |   | (3)                              |
| 11.0                |   | Statement  regarding computation of per share earnings.   Included in footnote 9 to the Registrant’s audited financial  statements included in this Annual Report.                                               |   | (3)                              |
| 14.0                |   | Code  of Ethics                                                                                                                                                                                                            |   |                             |
| 21.0                |   | Subsidiaries  of the Coast Bancorp – Coast National Bank   (100% owned)                                                                                                                                          |   |  *                          |
| 23.0                |   | Consent  of Independent Public Accountants                                                                                                                                                                                 |   |                             |
| 24.0                |   | Power  of Attorney                                                                                                                                                                                                         |   |  *                          |
| 31.1                |   | Certificate of Principal Executive Officer Pursuant to SEC Release  33-8238.                                                                                                                                               |   |                             |
| 31.2                |   | Certificate of Principal Financial Officer Pursuant to SEC Release  33-8238.                                                                                                                                               |   |                             |
| 32.1                |   | Certification  of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350                                                                                                                                           |   |                             |
| 32.2                |   | Certification  of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350                                                                                                                                           |   |                             |

 

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| *   |   | Not  Applicable                                                                                                                                                                                                            |   |   |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| **  |   | Employment  contracts and compensation plans                                                                                                                                                                               |   |   |
| (1) |   | Filed  as Exhibits 2, 3.1, and 10.4, respectively, to Registrant’s Annual Report on  Form 10-KSB for the Fiscal Year ended December 31, 2001 filed with the SEC  and incorporated herein by reference.                |   |   |
| (2) |   | Filed  as Exhibits 99.1 and 99.2, respectively, to Registrant’s Registration  Statement on Form S-8 No. 333-84518 filed with the SEC and incorporated  herein by reference.                                           |   |   |
| (3) |   | Filed  as Exhibits 4.1, 4.2, 4.3,4.4,4.5, and 10.5, respectively, to Registrant’s  Annual Report on Form 10-KSB for the Fiscal Year ended December 31, 2002  filed with the SEC and incorporated herein by reference. |   |   |

 

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**SIGNATURES**

 

Inaccordance with Section 13 or 15(d) of the Securities Exchange Act, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereto duly authorized.

 
| COAST  NATIONAL BANK |
|----------------------|
|                 |
|                 |
| By:                  | /s/  Jack C. Wauchope |   |
|                 |   Jack C.  Wauchope |
|                 |   Chief  Executive Officer |
|                 |   Chairman  of the Board |

 

Inaccordance with the Securities Exchange Act, this report has been signed by thefollowing persons on behalf of the registrant and in the capacities on thedates indicated:

 
| **Signature**            |   | **Title** |   | **Date**       |
|--------------------------|--------|-----------|--------|----------------|
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  Marilyn Britton     |   | Director  |   | March 25, 2004 |
| Marilyn  Britton         |   |      |   |           |
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  Dario Domenghini    |   | Director  |   | March 25, 2004 |
| Dario  Domenghini        |   |      |   |           |
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  James M. Kaney      |   | Director  |   | March 25, 2004 |
| James  M. Kaney          |   |      |   |           |
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  Michael A. Lady     |   | Director  |   | March 25, 2004 |
| Michael  A. Lady         |   |      |   |           |
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  Gene D. Mintz       |   | Director  |   | March 25, 2004 |
| Gene  D. Mintz           |   |      |   |           |
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  Ron Olson           |   | Director  |   | March 25, 2004 |
| Ron  Olson               |   |      |   |           |
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  Jack W. Robasciotti |   | Director  |   | March 25, 2004 |
| Jack  W. Robasciotti     |   |      |   |           |
|                     |   |      |   |           |
|                     |   |      |   |           |
| /s/  Dan H. Wixom        |   | Director  |   | March 25, 2004 |
| Dan  H. Wixom            |   |      |   |           |

 

76

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