<PAGE>   1
                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB

(Mark One)

[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934

        For the Fiscal Year Ended December 31, 1997

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

        For the transition period from ___________________ to _________________

                         Commission File Number: 0-12231

                             BAY COMMERCIAL SERVICES
                 (Name of small business issuer in its charter)

           California                                 77-2760444
-------------------------------                   ----------------
(State or other jurisdiction of                   (I.R.S. Employer
 incorporation or organization)                   Identification No.)



1495 East 14th Street. San Leandro. California               94577
----------------------------------------                   ----------
(Address of principal executive offices)                   (Zip code)

Issuer's telephone number     (510) 357-2265
                          ----------------------

Securities registered under Section 12(b) of the Exchange Act:  NONE
                                                              ---------

Securities registered under Section 12(g) of the Exchange Act:

                         Common Stock, No Par Value
                         --------------------------
                             (Title of Class)

   Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
YES [X] NO [ ]

   Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]

   State issuer's revenues for its most recent fiscal year:   $ 9,730,000.
                                                           ----------------

   State the aggregate market value of the voting stock held by nonaffiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of March 1, 1998: $13,723,098
                                                       ---------------

   State the number of shares of Common Stock outstanding as of March 11, 1998:
  1,080,720
--------------


<TABLE>
<CAPTION>
Documents Incorporated by Reference:                        Part of Form 10-KSB
------------------------------------                        -------------------
<S>                                                         <C>
1997 Annual Report to Shareholders for fiscal year          Part II, Items 5, 6 and 7
ended December 31, 1997.

Proxy Statement for 1998 Annual Meeting of                  Part III, Items 9, 10, 11 and 12
Shareholders to be filed pursuant to Regulation 14A.
</TABLE>


    Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]


<PAGE>   2
                                TABLE OF CONTENTS


<TABLE>
<S>                                                                                <C>
ITEM 1 - DESCRIPTION OF BUSINESS ................................................   1

ITEM 2 - DESCRIPTION OF PROPERTY ................................................  29

ITEM 3 - LEGAL PROCEEDINGS ......................................................  30

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ....................  30

ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ...............  30

ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION...............  30

ITEM 7 - FINANCIAL STATEMENTS ...................................................  31

ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
         ACCOUNTING AND FINANCIAL DISCLOSURE ....................................  31

ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
          SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE ...............  31

ITEM 10 - EXECUTIVE COMPENSATION ................................................  31

ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ........  32

ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ........................  32

ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K ......................................  32
</TABLE>


<PAGE>   3
                                     PART I


ITEM 1 DESCRIPTION OF BUSINESS

GENERAL

        Bay Commercial Services (the "Company") is a California corporation and
a bank holding company registered under the Bank Holding Company Act of 1956, as
amended. The Company was incorporated on June 7, 1981. Bay Bank of Commerce (the
"Bank"), was incorporated as a California banking corporation on August 11, 1980
and became a wholly-owned subsidiary of the Company through a reorganization in
1983.

        Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-KSB including, but not limited to, those described in "ITEM 6-
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION," are forward-looking
statements that are subject to risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Such risks and uncertainties include, among others, (1) significant
increases in competitive pressure in the banking industry; (2) changes in the
interest rate environment reduce margins; (3) general economic conditions,
either nationally or regionally, are less favorable than expected, resulting in,
among other things, a deterioration in credit quality; (4) changes in the
regulatory environment; (5) changes in business conditions and inflation; and
(6) changes in securities markets. Therefore, the information set forth in such
forward-looking statements should be carefully considered when evaluating the
business prospects of the Company and the Bank.

        At present, the Company's principal business is conducted through the
Bank. At December 31, 1997, the Company had total consolidated assets of
$116,369,000. The Bank accounted for $116,245,000, or virtually all, of the
total assets of the Company. The Company's primary source of income, other than
its equity in the undistributed earnings of the Bank, is the receipt of
dividends and rent from the Bank. The Bank is a full service commercial bank
serving the cities of San Leandro and Hayward, in Alameda County, and the city
of San Ramon, in Contra Costa County, and the surrounding areas in California.
The Company itself does not engage in any business activities other than the
ownership of the Bank, nor does it own any other subsidiaries. The Company
regularly reviews options to expand the operations of the Bank and may seek
opportunities for acquiring or forming other banks and non-banking subsidiaries.

        The Company is regulated by the Federal Reserve Board (the "FRB") and,
pursuant to that authority, is examined periodically by the Federal Reserve Bank
of San Francisco.

BAY BANK OF COMMERCE - GENERAL BANKING SERVICES

        At December 31, 1997, the Bank had total assets of $116,245,000, total
loans of $74,129,000 (including loans held for sale) and total deposits of
$101,174,000. The Bank provides a wide range of commercial banking services to
individuals, professionals, and small and medium-sized businesses through its
principal office in San Leandro, California and its branch offices in Hayward
and San Ramon, California. In order to attract these types of customers, the
Bank offers personalized services and banking convenience. The services provided
include checking, interest checking, savings and interest-bearing demand, money
market and other time deposit accounts; commercial, real estate and consumer
loans; travelers' checks; safe deposit boxes, collection services, night
depository facilities and wire and telephone transfers. The Bank is a member of
the Federal Deposit Insurance Corporation (the "FDIC") and the deposits of each
depositor are insured up to $100,000. The Bank is not a member of the Federal
Reserve System. Professional firms and individuals and businesses form the core
of the Bank's customer and deposit base.

        The Bank's Small Business Administration ("SBA") loan department has
been a component of the Bank's operations since 1985. Total SBA loan fundings in
1997 were $985,000. SBA-guaranteed loans of $1,076,000 were sold in 1997. With a
decline in SBA loan volume in recent years precipitated by increased competition
from other bank and non-bank financial entities, the Bank's SBA Division was
downsized during 1994 to better reflect the


<PAGE>   4
lower level of activity. The Bank is still active in marketing SBA loans and
continues as a Preferred (PLP) Lender with the Small Business Administration.

EXISTING LOCATIONS

        The Bank's headquarters are located at 1495 East 14th Street, San
Leandro, California and the Bank operates two branch offices located at 1030 La
Playa Drive, Hayward, California and at 2821 Crow Canyon Road, San Ramon,
California. The Bank also has an extension office located at 1500 Washington
Avenue, San Leandro, California, which houses its SBA and construction
divisions. The Bank currently has no branch applications pending or any plans to
open additional branch offices.

DEPOSITS

        Most of the Bank's deposits are obtained from individuals, professionals
and small and medium-sized businesses. As of December 31, 1997, the Bank had a
total of 4,002 accounts representing 1,702 noninterest-bearing demand deposit
(checking) accounts with an average balance of approximately $17,000 each; 1,484
savings, interest-bearing demand, and money market accounts with an average
balance of approximately $20,000 each; and 816 time accounts with an average
balance of approximately $53,000 each.

LENDING ACTIVITIES

        The Bank concentrates its lending activities in the areas of commercial
real estate mortgage loans, commercial loans to businesses and individuals and
real estate construction loans. At December 31, 1997, commercial real estate
mortgage loans accounted for 55%, commercial loans accounted for 25%, real
estate construction loans accounted for 10%, real estate equity loans accounted
for 4%, consumer installment and other loans accounted for 4% and SBA loans held
for sale accounted for 2% of the Bank's loan portfolio. See "Selected
Statistical Information -- Loan Portfolio" herein for information concerning the
composition of the Bank's loan portfolio, maturities and sensitivity to changes
in interest rates in the loan portfolio and non-performing assets. The interest
rates charged by the Bank vary with the degree of risk and the size and maturity
of the loans involved and are generally affected by competition, governmental
regulation and current market interest rates.

        Except as described in the discussion which accompanies TABLE F, SUMMARY
OF NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS, the Bank's loan portfolio is not
concentrated in any one category and includes loans to individuals, partnerships
and corporations for diverse purposes.

        At December 31, 1997, the Bank had total loans outstanding of
$74,129,000, net of deferred loan fees. Inherent in the lending function is the
fact that loan losses will be experienced and that the risk of loss will vary
with the type of loan being made and the creditworthiness of the borrower over
the term of the loan. To reflect currently perceived risks of loss associated
with its loan portfolio, adjustments are made to the Bank's allowance for loan
losses. At December 31, 1997, the Bank's allowance for loan losses was
$1,000,000 or 1.3% of total loans. See "Selected Statistical Information --
Summary of Loan Loss Experience" herein for a discussion of Management's policy
for establishing and maintaining the allowance for loan losses.

CORRESPONDENT BANKS

        The Bank has correspondent relationships with Union Bank of California
and Bank of America, N.T.&S.A. These relationships are a result of the Bank's
efforts to obtain a wide range of services for the Bank and its customers,
including arranging loan participations, investment services, sale of federal
funds, and obtaining lines for


                                       2


<PAGE>   5
letters of credit. As a net seller of federal funds (overnight interbank loans),
the Bank also maintains such correspondent relationships to minimize the risk of
undue concentration of its resources with a few institutions. The Bank does not
currently serve, nor does it have plans to serve, as a correspondent to other
banks.

EMPLOYEES

        At December 31, 1997, the Company employed forty-five (45) full-time
employees and twelve (12) part-time employees.

SELECTED STATISTICAL INFORMATION

        The following tables present certain consolidated statistical
information concerning the business of the Company and the Bank. This
information should be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's 1997 Annual Report to
Shareholders (the "Annual Report"), which have been incorporated herein by
reference.

        DISTRIBUTION OF ASSETS, LIABILITIES AND
        STOCKHOLDERS' EQUITY; INTEREST RATES AND
        INTEREST DIFFERENTIAL

        TABLE A sets forth the Company's consolidated average balance sheets for
the years ended December 31, 1997 and 1996 and an analysis of interest rates and
the interest rate differential.

        TABLE B sets forth the changes in interest income and interest expense
in 1997 and 1996 resulting from changes in volume and changes in rates.

        SECURITIES PORTFOLIO

        The book value of securities held to maturity and securities available
for sale at December 31, 1997 and 1996, and maturities and weighted average
yield of securities at December 31, 1997 are set forth in TABLE C.

        LOAN PORTFOLIO

        The composition of the loan portfolio at December 31, 1997 and 1996 is
summarized in TABLE D.

        Maturities and sensitivity to changes in interest rates in the loan
portfolio, excluding real estate mortgage loans, installment loans and lease
financing, at December 31, 1997 are summarized in TABLE E.

        TABLE F shows the composition of nonaccrual, past due and restructured
loans at December 31, 1997 and 1996. Set forth in the text accompanying TABLE F
is a discussion of the Company's policy for placing loans on nonaccrual status.

        SUMMARY OF LOAN LOSS EXPERIENCE

        TABLE G sets forth an analysis of loan loss experience as of and for the
years ended December 31, 1997 and 1996.

        Set forth in the text accompanying TABLE G is a description of the
factors which influenced Management's judgment in determining the amount of the
additions to the allowance charged to operating expense in each fiscal year, a
table showing the allocation of the allowance for loans losses, as well as a
discussion of Management's policy for establishing and maintaining the allowance
for loan losses.


                                       3


<PAGE>   6
        DEPOSITS

        TABLE H sets forth the average amount of and the average rate paid on
major deposit categories for the years ended December 31, 1997 and 1996.

        TABLE I sets forth the maturity of time certificates of deposit of
$100,000 or more and other time deposits of $100,000 or more at December 31,
1997.

        RETURN ON EQUITY AND ASSETS

        TABLE J sets forth certain financial ratios for the years ended December
31, 1997 and 1996.


                                       4


<PAGE>   7
                                     TABLE A

          DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
                    INTEREST RATES AND INTEREST DIFFERENTIAL

        The following table sets forth consolidated average assets, liabilities
and shareholders' equity; interest income earned and interest expense paid; and
the average yields earned or rates paid thereon for the years ended December 31,
1997 and 1996. The average balances are averages of daily balances.


<TABLE>
<CAPTION>
                                                            1997                               1996
                                              ----------------------------------   ------------------------------
                                                           Interest      Average              Interest   Average
                                               Average      Income/      Yield/    Average    Income/     Yield/
(dollars in thousands)                        Balances      Expense       Rate     Balances   Expense      Rate
                                              ---------    ---------    --------   ---------  ---------  --------
<S>                                           <C>          <C>              <C>    <C>        <C>            <C>
ASSETS

Securities (amortized cost):

   Taxable                                    $  18,396    $   1,131        6.15%  $  15,257  $     947      6.21%

   Tax-exempt(l)                                  3,874          297        7.67       3,165        244      7.65
                                              ---------    ---------    --------   ---------  ---------  --------


          Total securities                       22,270        1,428        6.41      18,422      1,191      6.45

Federal funds sold and securities
  purchased under repurchase agreements           5,338          288        5.40       4,870        250      5.13

Loans(2)(3)                                      69,824        7,137       10.22      62,818      6,463     10.29
                                              ---------    ---------    --------   ---------  ---------  --------


     Total interest-earning assets(l)            97,432        8,853        9.09      86,110      7,904      9.18


Less allowance for loan losses                     (977)                                (970)

Nonaccrual loans                                    393                                  190

Cash and due from banks                           6,963                                6,377

Premises and equipment                            2,205                                2,070

Other assets                                      1,702                                1,300
                                              ---------                             --------

TOTAL ASSETS                                  $ 107,088                             $ 95,077
                                              =========                            =========

Average earning loans/average
  earning assets                                  71.66%                               72.95%
                                              =========                            =========
</TABLE>


                                       5


<PAGE>   8

          DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
                INTEREST RATES AND INTEREST DIFFERENTIAL (CONT.)


<TABLE>
<CAPTION>
                                                            1997                                    1996
                                             ---------------------------------        --------------------------------
                                                           Interest     Average                    Interest     Average
                                              Average       Income/      Yield/       Average       Income/      Yield/
(dollars in thousands)                       Balances       Expense       Rate        Balances      Expense       Rate
                                             --------       -------       ----        -------       -------       ----
<S>                                          <C>           <C>          <C>           <C>          <C>          <C>
LIABILITIES AND SHAREHOLDERS'
    EQUITY

Deposits:

Savings and interest-bearing demand          $ 25,893       $   708       2.73%       $25,050       $   651       2.60%

Time                                           30,626         1,588       5.19         27,239         1,407       5.17

Certificates of deposit, $100 and over          9,974           564       5.65          5,198           293       5.64

Other borrowed funds                            1,894            96       5.07          2,209           106       4.80
                                             --------       -------       ----        -------       -------       ----

     Total interest-bearing liabilities        68,387         2,956       4.32         59,696         2,457       4.12

Demand deposits                                27,744                                  25,124

Other liabilities                               1,006                                   1,028

Shareholders' equity                            9,951                                   9,229
                                             --------                                 -------

TOTAL LIABILITIES AND
    SHAREHOLDERS' EQUITY                     $107,088                                 $95,077
                                             ========                                 =======

Interest income and average yield
    on earning assets(1)                                      8,853       9.09                        7,904       9.18

Interest expense and average
    interest cost related to earning assets                   2,956       3.03                        2,457       2.85
                                                            -------       ----                      -------       ----


Net interest income and
    margin(1)(4)                                             $5,897       6.06%                      $5,447       6.33%
                                                            =======       ====                      =======       ====
</TABLE>


(1)     Interest on tax-exempt securities, total interest income and net
        interest income include the effect of taxable equivalent adjustments
        using the expected federal corporate income tax rate of 34% in 1997 and
        1996 in adjusting interest on tax-exempt investment securities to a
        fully taxable basis. The amount of the taxable equivalent adjustment was
        $94,000 and $76,000 in 1997 and 1996, respectively.

(2)     Loan interest income includes loan fees of $334,000 in 1997 and $319,000
        in 1996.

(3)     Average loans do not include nonaccrual loans.

(4)     Net interest margin is computed by dividing net interest income by total
        average interest-earning assets.


                                       6


<PAGE>   9

                                     TABLE B

                            RATE AND VOLUME ANALYSIS

        The following table sets forth, for the periods indicated, a summary of
the changes in interest earned and interest paid resulting from changes in asset
and liability volumes and changes in rates. The change in interest due to both
rate and volume has been allocated to changes due to volume and rate in
proportion to the relationship of absolute dollar amounts of change in each.


<TABLE>
<CAPTION>
                                                                        (Dollars in thousands)
                                                                       Period Ended December 31,
                                            ----------------------------------------------------------------------------------
                                                   1997 Compared to 1996                        1996 Compared to 1995
                                                  Increase (decrease) in:                       Increase (decrease) in:
                                            -------------------------------------        -------------------------------------
                                             Volume         Rate           Total         Volume          Rate           Total
                                            -------        -------        -------        -------        -------        -------
<S>                                         <C>            <C>            <C>            <C>            <C>            <C>
Changes in interest income:
  Securities (amortized cost):

    Taxable                                 $   193        $    (9)       $   184        $  (315)       $    45        $  (270)

    Tax-exempt(l)                                52              1             53             77              9             86
                                            -------        -------        -------        -------        -------        -------

      Total securities                          245             (8)           237           (238)            54           (184)

  Federal funds sold and securities
    purchased under repurchase                   25             13             38            (85)           (33)          (118)
      agreements

  Loans                                         717            (43)           674          1,064           (365)           699
                                            -------        -------        -------        -------        -------        -------

    Total(l)                                    987            (38)           949            741           (344)           397
                                            -------        -------        -------        -------        -------        -------

Changes in interest expense:

Total interest-bearing liabilities:

  Savings and interest-bearing demand            22             35             57            (64)            (1)           (65)

  Time                                          176              5            181            221            (54)           167

  Certificates of deposit, $100 and             270              1            271              1             (2)            (1)
    over

  Other borrowed funds                          (16)             6            (10)            43              3             46
                                            -------        -------        -------        -------        -------        -------

    Total                                       452             47            499            201            (54)           147
                                            -------        -------        -------        -------        -------        -------

Changes in net interest income(l)           $   535        $   (85)       $   450        $   540        $  (290)       $   250
                                            =======        =======        =======        =======        =======        =======
</TABLE>


(1)     Taxable equivalent basis. See Note 1 to TABLE A.


                                       7


<PAGE>   10
                                     TABLE C

                              SECURITIES PORTFOLIO

        The following tables set forth the amortized cost of securities held to
maturity and the fair value of securities available for sale at December 31,
1997 and 1996 and the amortized cost, maturities, and weighted average yield of
securities at December 31, 1997.


<TABLE>
<CAPTION>
                                                             Estimated
                                                             Fair Value
                                                           At December 31,
                                                       ---------------------
                                                          (In Thousands)
SECURITIES AVAILABLE FOR SALE                            1997          1996
                                                       -------       -------
<S>                                                    <C>           <C>
U. S. Treasury and agency securities                   $ 4,002       $ 8,974

Corporate securities                                    14,401            --

Mortgage-backed securities                               6,248           365
                                                       -------       -------
                                                       $24,651       $ 9,339
                                                       =======       =======
</TABLE>


<TABLE>
<CAPTION>
                                                           Amortized Cost
                                                          At December 31,
                                                       ---------------------
                                                           (In thousands)
SECURITIES HELD TO MATURITY                              1997          1996
                                                       -------       -------
<S>                                                    <C>           <C>
U. S. Treasury and agency securities                   $ 3,197       $ 3,198

Obligations of states and political subdivisions         4,661         3,434

Mortgage-backed securities                                  71            72
                                                       -------       -------
                                                       $ 7,929       $ 6,704
                                                       =======       =======
</TABLE>










                                       8
<PAGE>   11
                                     TABLE C

                        SECURITIES PORTFOLIO (CONTINUED)


<TABLE>
<CAPTION>
                                                                    Maturing
                                ---------------------------------------------------------------------------------
                                                        After One            After Five
                                   In One Year           Through              Through                After
                                     Or Less            Five Years           Ten Years             Ten Years              Total
                                -------  ---------   -------  ---------   -------  ---------   -------  ---------   -------  -----
                                  Cost     Yield       Cost     Yield      Cost      Yield      Cost      Yield       Cost   Yield
                                -------  ---------   -------  ---------   -------  ---------   -------  ---------   -------  -----
<S>                             <C>      <C>         <C>      <C>         <C>      <C>         <C>      <C>         <C>      <C>
AVAILABLE FOR SALE:
U.S. Treasury and
  agency securities             $    --        --%   $ 2,000       5.50%  $ 2,000       7.23%  $    --        --%   $ 4,000   6.37%

Corporate securities             14,401       6.13        --         --        --         --        --         --    14,401   6.13

Mortgage-backed securities           --         --     1,969       6.19     3,347       6.22       946       6.19     6,262   6.21
                                -------  ---------   -------  ---------   -------  ---------   -------  ---------   -------  -----
Total amortized cost            $14,401       6.13%  $ 3,969       5.84%  $ 5,347       6.60%  $   946       6.19%  $24,663   6.19%
                                =======  =========   =======  =========   =======  =========   =======  =========   =======  =====
Estimated fair value            $14,401              $ 3,960              $ 5,351              $   939              $24,651
                                =======              =======              =======              =======              =======


HELD TO MATURITY:
U.S. Treasury and
  agency securities             $ 2,200       5.82%  $    --        --%   $   997       6.69%  $    --        --%   $ 3,197   6.09%

Obligations of states and
  political subdivisions (1)        107       7.97     1,074       8.26     2,072       7.08     1,408       7.34     4,661   7.39

Mortgage-backed securities           --         --        --         --        --         --        71       9.00        71   9.00
                                -------  ---------   -------  ---------   -------  ---------   -------  ---------   -------  -----

Total amortized cost            $ 2,307       5.92%  $ 1,074       8.26%  $ 3,069       6.96%  $ 1,479       7.36%  $ 7,929   7.07%
                                =======  =========   =======  =========   =======  =========   =======  =========   =======  =====
Estimated fair value            $ 2,309              $ 1,109              $ 3,126              $ 1,513              $ 8,057
                                =======              =======              =======              =======              =======
</TABLE>


(1) Interest on tax-exempt securities, total interest income and net interest
income include the effect of taxable equivalent adjustments using the expected
federal corporate income tax rate of 34% in 1997 in adjusting interest on
tax-exempt securities to a fully taxable basis.










                                       9

<PAGE>   12
                                     TABLE C

                        SECURITIES PORTFOLIO (CONTINUED)

        At December 31, 1997, securities from the following issuers each totaled
over ten percent (10%) of shareholders' equity of the Company:


<TABLE>
<CAPTION>
                                                         (In Thousands)
                                                      --------------------
                                                    Amortized        Fair
                                                       Cost         Value
                                                      ------        ------
<S>                                                   <C>           <C>
Federal Home Loan Mortgage                            $3,063        $3,066
  Corporation
Federal National Mortgage Association                  1,753         1,749
Federal Home Loan Bank                                 1,200         1,202
</TABLE>




                                     TABLE D

                                 LOAN PORTFOLIO

  The composition of the loan portfolio at December 31, 1997 and 1996 is
summarized in the table below.


<TABLE>
<CAPTION>
                                                      1997               1996
                                                    --------           --------
                                                          (In Thousands)
<S>                                                 <C>                <C>
Commercial                                          $ 18,980           $ 15,568
Real estate:
    Construction                                       7,436              6,813
    Mortgage                                          41,181             41,930
    Equity                                             2,718              2,178
Held for sale                                          1,501              2,923
Installment                                            1,895              1,602
Other                                                    947                903
                                                    --------           --------
                                                      74,658             71,917
Deferred loan fees                                      (529)              (555)
                                                    --------           --------
                                                    $ 74,129           $ 71,362
                                                    ========           ========
</TABLE>










                                       10

<PAGE>   13
                                     TABLE E

          LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES

        The following table presents information concerning loan maturities and
sensitivity to changes in interest rates in the loan portfolio, as well as loans
that have fixed or variable interest rates at December 31, 1997.


<TABLE>
<CAPTION>
                                                              (In Thousands)
                                              ----------------------------------------------
                                                One       After One      After
Maturity Distribution of                       Year       Through        Five
Selected Loans:                               Or Less    Five Years      Years       Total
                                              -------      -------      -------      -------
<S>                                           <C>        <C>            <C>          <C>
    Commercial                                $ 8,967      $ 5,477      $ 5,257      $19,701
    Real estate-construction                    7,436           --           --        7,436
    Real estate - mortgage                      6,131       11,855       23,975       41,961

    Equity                                         --           --        2,718        2,718
    Installment                                    48        1,701          146        1,895

    Other                                         657          290           --          947
                                              -------      -------      -------      -------
                                              $23,239      $19,323      $32,096      $74,658
                                              =======      =======      =======      =======


Sensitivity to Changes in Interest
  Rates:
    Loans with fixed interest rates           $ 2,186      $ 8,015      $11,427      $21,628
    Loans with variable interest
     rates                                     53,030           --           --       53,030
                                              -------      -------      -------      -------
                                              $55,216      $ 8,015      $11,427      $74,658
                                              =======      =======      =======      =======
</TABLE>


                                     TABLE F

             SUMMARY OF NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS

        A summary of nonaccrual, past due and restructured loans at December 31,
1997 and 1996 is set forth below:


<TABLE>
<CAPTION>
                                                                 December 31,
                                                                (In thousands)
                                                               1997         1996
                                                               ----         ----
<S>                                                            <C>          <C>
Nonaccrual                                                     $440         $208
Accruing loans past due 90 days or                               --          227
  more
Restructured loans                                              471           --
                                                               ----         ----
                                                               $991         $435
                                                               ====         ====
</TABLE>


        The Company's consolidated financial statements are prepared on the
accrual basis of accounting, including the recognition of interest income on the
loan portfolio. Interest income from nonaccrual loans is not accrued on the
books, but rather is recorded only when and if received and the principal is
deemed to be collectible.


                                       11


<PAGE>   14
      Loans are placed on a nonaccrual basis and any accrued but unpaid interest
is reversed and charged against income when the payment of interest or principal
is ninety days or more past due, except when the loan is well secured and in the
process of collection. Nonaccrual loans constituted approximately 0.6 % and 0.3%
of total gross loans at December 31, 1997 and 1996, respectively. Loans in the
nonaccrual category are treated as nonaccrual loans even though the Bank may
ultimately recover all or a portion of the interest due. The classification of a
loan as a nonaccrual loan is not necessarily indicative of a potential
charge-off. The Senior Loan Officer, on at least a quarterly basis, assesses the
loan portfolio to determine which loans should be added to or removed from the
quarterly Watch list. The Bank's internal Loan Review Examiner grades all new
commercial loans and all credits where the total liability equals or exceeds the
reporting limit. If either the Senior Loan Officer or the Loan Review Examiner
detects a serious deficiency, the loan is placed on the next quarterly Watch
list.

      Once a loan is on the Watch List, the Loan Officers are required to
complete a "Report of Collection Activity" and to make at least monthly status
reports. While the loan is on the Watch list, the Senior Loan Officer oversees
and coordinates the Loan Officer's efforts to either rehabilitate the loan or
effect collection in an expeditious manner.

      Restructured loans reflect situations in which, due to the inability of
the borrower to comply with the original terms of the loan, the terms have been
modified, usually with the accrual of interest at a reduced rate. As of December
31, 1997, the Bank had $471,000 in restructured loans.

      Interest income on nonaccrual loans that would have been recognized for
the year ended December 31, 1997, if the loans had been current in accordance
with their original terms totaled $39,498. The Company recognized $12,602 in
interest income on these loans for the year ended December 31, 1997.

      There are no loans, which were current at December 31, 1997, where known
information about possible credit problems of borrowers causes Management of the
Company to have serious doubt as to the ability of such borrowers to comply with
the present loan repayment terms.

      Outstanding loans to contractors engaged in construction and land
development constituted $7,436,000, or 10% of total loans, at December 31, 1997.
The loans are a cross-section of types, from commercial to real estate
construction and are not all secured by real estate. The borrowers as a group,
however, are engaged in business activities which could be affected by changing
conditions in the real estate market. There were no other categories of loans
representing a concentration of 10% or more of total loans at December 31, 1997,
except as set forth in TABLE D above.


                                       12


<PAGE>   15
                                     TABLE G

                         SUMMARY OF LOAN LOSS EXPERIENCE

        The following table summarizes loan loss experience as of and for the
years ended December 31, 1997 and 1996.


<TABLE>
<CAPTION>
                                                          1997          1996
                                                        --------      --------
                                                        (Dollars in thousands)
<S>                                                     <C>           <C>
Allowance for loan losses:
Balance at beginning of year:                           $    971      $    982
Charge-offs:
  Commercial                                                   5            25
  Real estate - mortgage                                      --            --
  Installment                                                 --             8
  Other                                                       26             2
                                                        --------      --------
    Total loans charged off                                   31            35
                                                        --------      --------
Recoveries:
Commercial                                                     6            19
  Real estate - mortgage                                      --             3
  Other                                                        2             2
                                                        --------      --------
    Total recoveries                                           8            24
                                                        --------      --------
Net charge-offs                                              (23)          (11)
Provision for loan losses                                     52            --
                                                        --------      --------
Balance at end of year                                  $  1,000      $    971
                                                        ========      ========
Loans outstanding at December 31                        $ 74,129      $ 71,362
                                                        ========      ========
Average loans outstanding during period                 $ 70,217      $ 63,008
                                                        ========      ========
Allowance for loan losses as a percentage
  of outstanding loan balance                                1.3%          1.4%
                                                        ========      ========
Net charge-offs to average loans outstanding                  --            --
                                                        ========      ========
</TABLE>


        In evaluating the allowance for loan losses, the Company considers such
factors as: historical loan loss experience; Management's review of outstanding
credits; the current and projected size and composition of the loan portfolio;
expectations of future economic conditions and their impact on particular
industries and specific borrowers; evaluation of the underlying collateral for
secured loans; and periodic evaluations made by Bank regulatory authorities.

        Although the Bank does not specifically allocate its allowance for loan
losses on the basis of type of loan, using these criteria the allocation of the
allowance for loan losses would be as set forth below:


                                       13


<PAGE>   16
                     ALLOWANCE FOR LOAN LOSSES BY LOAN TYPE


<TABLE>
<CAPTION>
                                               1997                          1996
                                       ---------------------          ---------------------
                                                    Percent of                    Percent of
                                                      Loans                         Loans
                                                     in Each                       in Each
                                                     Category                      Category
(Dollars in thousands)                 Amount      to Total Loans     Amount     to Total Loans
                                       ------         ------          ------         ------
<S>                                    <C>         <C>                <C>        <C>
Commercial                             $  431             25%         $  242             22%

Real estate - mortgage                    201             55             241             59

Equity                                     14              4              11              3

Held for sale                               2              2               4              4

Installment                                23              3              22              2

Other                                      33              1              29              1

Unallocated                               242            N/A             385            N/A
                                       ------         ------          ------         ------
                                       $1,000            N/A          $  971            N/A
</TABLE>


        The Company provides for potential loan losses by a charge to operating
income based upon the current composition of the loan portfolio, past loan loss
experience, current and projected economic conditions, an evaluation of the risk
elements in the loan portfolio and other factors that, in Management's judgment,
deserve recognition in estimating loan losses. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for loan losses. Such agencies may require the Company
to make additions to the allowance based on their evaluations of information
available to them at the time of their examination. Management will charge off
loans to the allowance when it determines that there has been a permanent
impairment of the related carrying values.


                                       14


<PAGE>   17
                                    TABLE H

                                    DEPOSITS

        The following table sets forth the average amount of and the average
rate paid on certain deposit categories which were in excess of 10% of average
total deposits for the years ended December 31, 1997 and 1996.


<TABLE>
<CAPTION>
(Dollars in thousands)                                    1997                  1996
                                                   ----------------       ----------------
                                                   Balance     Rate       Balance     Rate
                                                   -------     ----       -------     ----
<S>                                                <C>        <C>         <C>        <C>
Noninterest-bearing demand deposits                $27,744      N/A       $25,124      N/A
Savings and interest-bearing demand                 25,893    2.73%        25,050    2.60%
Time                                                40,600    5.30%        32,437    5.25%
                                                    ------                 ------
                                                   $94,237                $82,611
                                                   =======                =======

</TABLE>


                                     TABLE I

                                  TIME DEPOSITS

        The following table sets forth the maturity of time certificates of
deposit of $100,000 or more and other time deposits of $100,000 or more at
December 31, 1997.


<TABLE>
<CAPTION>
(Dollars in thousands)                        Time Certificates of      Other Time
                                                    Deposit of          Deposits of
                                                   $100 or More         $100 or More
                                                      -------              -------
<S>                                           <C>                       <C>
          Three months or less                         $7,355              $11,585
          Over 3 through 6 months                       2,153
          Over 6 through 12 months                      1,701
          Over 12 months                                1,625
                                                      -------              -------
                                                      $12,834              $11,585
                                                      =======              =======
</TABLE>


                                     TABLE J

                           RETURN ON EQUITY AND ASSETS

        The following table sets forth certain financial ratios for the years
ended December 31, 1997 and 1996.


<TABLE>
<CAPTION>
(Dollars in thousands)                                 1997         1996
                                                       ----         ----
<S>                                              <C>          <C>
Net income                                           $1,062       $1,083
Net income to average assets                           1.0%         1.1%
Net income to average shareholders' equity            10.7%        11.8%
Dividends declared per share to diluted net
   income per share                              0.36 to 1    0.34 to 1
Average shareholders' equity to average                9.3%         9.7%
   assets
</TABLE>


                                       15


<PAGE>   18
COMPETITION

        In California and in the Bank's primary service area, major banks
dominate the commercial banking industry. Among the advantages these banks have
over the Bank are their ability to finance wide-ranging advertising campaigns
and to allocate their investment assets, including loans, to regions of higher
yield and demand. By virtue of their larger amounts of capital, such
institutions have substantially greater lending limits than the Bank and perform
certain functions, including trust services and international banking, which are
not presently offered directly by the Bank but are offered indirectly by the
Bank through correspondent institutions. The Bank also competes for loans and
deposits with savings and loan associations, finance companies, money market
funds, brokerage houses, credit unions, and other nonfinancial institutions.

        The Bank's primary service area consists principally of the cities of
Oakland, San Leandro, Hayward and San Ramon and the unincorporated areas of
Castro Valley and San Lorenzo which at June 30, 1997, contained ninety-six (96)
competing banking offices, which includes the Bank and twenty-two (22) branch
offices of other independent banks. At June 30, 1997, the Bank's primary service
area also contained sixty-three (63) offices of savings and loan associations.

        From time to time, legislation is proposed or enacted which has the
effect of increasing the cost of doing business, limiting permissible activities
or affecting the competitive balance between banks and other financial
institutions. It is impossible to predict the competitive impact these and other
changes in legislation will have on commercial banking in general or on the
business of the Bank in particular. See "SUPERVISION AND REGULATION - Recent and
Proposed Legislation".

SUPERVISION AND REGULATION

THE COMPANY

        The Company, as a bank holding company, is subject to regulation under
the Bank Holding Company Act of 1956, as amended (the "BHC Act") and is
registered with and subject to the supervision of the Board of Governors of the
Federal Reserve System ("Federal Reserve"). It is the policy of the Federal
Reserve that each bank holding company serve as a source of financial and
managerial strength to its subsidiary banks. The Federal Reserve has the
authority to examine the Company and the Bank.

        The BHC Act requires the Company to obtain the prior approval of the
Federal Reserve before acquisition of all or substantially all of the assets of
any bank or ownership or control of the voting shares of any bank if, after
giving effect to such acquisition, the Company would own or control, directly or
indirectly, more than 5% of the voting shares of such bank. However, amendments
to the BHC Act effected by the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 ("Riegle-Neal"), which is discussed further below, expand
the circumstances under which a bank holding company may acquire control of or
all or substantially all of the assets of a bank located outside the State of
California.

        The Company may not engage in any business other than managing or
controlling banks or furnishing services to its subsidiaries, with the exception
of certain activities which, in the opinion of the Federal Reserve, are so
closely related to banking or to managing or controlling banks as to be
incidental to banking. The Company is also generally prohibited from acquiring
direct or indirect ownership or control of more than 5% of the voting shares of
any company unless that company is engaged in such activities and unless the
Federal Reserve approves the acquisition.

        The Company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit, sale or lease of
property or provision of services. For example, with certain


                                       16


<PAGE>   19
exceptions, the Bank may not condition an extension of credit on a customer
obtaining other services provided by it, the Company or any other subsidiary, or
on a promise by the customer not to obtain other services from a competitor. In
addition, federal law imposes certain restrictions on transactions between the
Bank and its affiliates. As affiliates, the Bank and the Company are subject,
with certain exceptions, to the provisions of federal law imposing limitations
on and requiring collateral for loans by the Bank to any affiliate.

THE BANK

        As a California state-licensed bank, the Bank is subject to regulation,
supervision and periodic examination by the California Department of Financial
Institutions ("DFI") and the Federal Deposit Insurance Corporation ("FDIC"). The
Bank is not a member of the Federal Reserve System, but is nevertheless subject
to certain regulations of the Federal Reserve. The Bank's deposits are insured
by the FDIC to the maximum amount permitted by law, which is currently $100,000
per depositor in most cases.

        The regulations of these state and federal bank regulatory agencies
govern most aspects of the Bank's business and operations, including but not
limited to, the scope of its business, its investments, its reserves against
deposits, the nature and amount of any collateral for loans, the timing of
availability of deposited funds, the issuance of securities, the payment of
dividends, bank expansion and bank activities, including real estate development
and insurance activities, and the maximum rates of interest allowed on certain
deposits. The Bank is also subject to the requirements and restrictions of
various consumer laws and regulations.

        The following description of statutory and regulatory provisions and
proposals is not intended to be a complete description of these provisions and
is qualified in its entirety by reference to the particular statutory or
regulatory provisions discussed.

CHANGE IN CONTROL

        The BHC Act and the Change in Bank Control Act of 1978, as amended (the
"Change in Control Act"), together with regulations of the Federal Reserve,
require that, depending on the particular circumstances, either Federal Reserve
approval must be obtained or notice must be furnished to the Federal Reserve and
not disapproved prior to any person or company acquiring "control" of a bank
holding company, such as the Company, subject to exemptions for certain
transactions. Control is conclusively presumed to exist if an individual or
company acquires 25% or more of any class of voting securities of the bank
holding company. Control is rebuttably presumed to exist if a person acquires
10% or more but less than 25% of any class of voting securities and either the
company has securities registered under Section 12 of the Exchange Act, or no
other person will own a greater percentage of that class of voting securities
immediately after the transaction. The Financial Code also contains approval
requirements for the acquisition of 10% or more of the securities of a person or
entity which controls a California licensed bank.


CAPITAL ADEQUACY REQUIREMENTS

        The Company is subject to the Federal Reserve's capital guidelines for
bank holding companies and the Bank is subject to the FDIC's regulations
governing capital adequacy for nonmember banks. Additional capital requirements
may be imposed on banks based on market risk.

        THE FEDERAL RESERVE AND FDIC

        The Federal Reserve has established risk-based and leverage capital
guidelines for bank holding companies which are similar to the FDIC's capital
adequacy regulations for nonmember banks. The Federal Reserve guidelines apply
on a consolidated basis to bank holding companies with consolidated assets of
$150 million or more.

        The Federal Reserve capital guidelines for bank holding companies and
the FDIC's regulations for nonmember banks set total capital requirements and
define capital in terms of "core capital elements," or Tier 1


                                       17


<PAGE>   20
capital(1) and "supplemental capital elements," or Tier 2 capital(2). At least
fifty percent (50%) of the qualifying total capital base must consist of Tier 1
capital. The maximum amount of Tier 2 capital that may be recognized for
risk-based capital purposes is limited to one-hundred percent (100%) of Tier 1
capital, net of goodwill.

        Both bank holding companies and nonmember banks are required to maintain
a minimum ratio of qualifying total capital to risk-weighted assets of eight
percent (8%), at least one-half of which must be in the form of Tier 1 capital.
Risk-based capital ratios are calculated with reference to risk-weighted assets,
including both on and off-balance sheet exposures, which are multiplied by
certain risk weights assigned by the Federal Reserve and the FDIC to those
assets.

        The Federal Reserve and the FDIC have established a minimum leverage
ratio of three percent (3%) Tier 1 capital to total assets for bank holding
companies and nonmember banks that have received the highest composite
regulatory rating and are not anticipating or experiencing any significant
growth. All other institutions are required to maintain a leverage ratio of at
least 100 to 200 basis points above the 3% minimum for a minimum of four percent
(4%) or five percent (5%).








--------------
(1) Tier 1 capital is generally defined as the sum of the core capital elements
less goodwill and certain intangibles. The following items are defined as core
capital elements: (i) common stockholders' equity; (ii) qualifying noncumulative
perpetual preferred stock and related surplus; and (iii) minority interests in
the equity accounts of consolidated subsidiaries.

(2) Supplementary capital elements include: (i) allowance for loan and lease
losses (which cannot exceed 1.25% of an institution's risk-weighted assets);
(ii) perpetual preferred stock and related surplus not qualifying as core
capital; (iii) hybrid capital instruments, perpetual debt and mandatory
convertible debt securities; and (iv) term subordinated debt and
intermediate-term preferred stock and related surplus.


                                       18


<PAGE>   21
        Set forth below are the Company's and the Bank's risk based and leverage
capital ratios as of December 31, 1997:




<TABLE>
<CAPTION>
                                                                          RISK BASED CAPITAL RATIO
                                                                          (Dollars in thousands)

                                                                Company                          Bank
                                                       -------------------------       -----------------------
                                                        Amount           Ratio          Amount          Ratio
                                                       --------        --------        --------        -------
<S>                                                    <C>             <C>             <C>             <C>
Tier 1 capital                                         $ 10,069           10.7%        $ 10,214          10.9%
Tier 1 capital regulatory minimum requirement             3,763            4.0            3,758           4.0
                                                       --------        --------        --------        -------
Capital held in excess of regulatory minimum           $  6,306            6.7%        $  6,456           6.9%
                                                       ========        ========        ========        =======


Total capital                                          $ 11,069           11.8%        $ 11,214          11.9%
Total capital regulatory minimum requirement              7,526            8.0            7,516           8.0
                                                       --------        --------        --------        -------
Capital held in excess of regulatory minimum           $  3,543            3.8%        $  3,698           3.9%
                                                       ========        ========        ========        =======
Risk weighted assets                                           $ 94,071                        $ 93,947
                                                       ========================        =======================
</TABLE>


<TABLE>
<CAPTION>
                                                                                     LEVERAGE RATIO
                                                                                (Dollars in thousands)
                                                                Company                           Bank
                                                       -------------------------       -------------------------
                                                          Amount          Ratio          Amount           Ratio
                                                       ---------         -------       ---------         -------
<S>                                                    <C>               <C>           <C>               <C>
Tier 1 capital to average total assets                 $ 10,069            8.7%        $ 10,214             8.8%

Range of regulatory minimum leverage                      3,476-           3.0-           3,472-            3.0-
  requirement                                             5,793            5.0            5,787             5.0
                                                       ---------         -------       ---------         -------
Range of regulatory excess                                4,276-           3.7-           4,427-            3.8-
                                                       $  6,593            5.7%        $  6,742             5.8%
                                                       =========         =======       =========         =======
Average total assets for fourth quarter*                        $ 115,855                       $ 115,730
                                                       =========================       =========================
</TABLE>


(*Average total assets do not include unrealized gains/losses on securities
available for sale.)

        The risk-based capital ratio discussed above focuses principally on
broad categories of credit risk, and may not take into account many other
factors that can affect a bank's financial condition. These factors include
overall interest rate risk exposure; liquidity, funding and market risks; the
quality and level of earnings; concentrations of credit risk; certain risks
arising from nontraditional activities; the quality of loans and investments;
the effectiveness of loan and investment policies; and management's overall
ability to monitor and control financial and operating risks, including the risk
presented by concentrations of credit and nontraditional activities. The FDIC
has addressed many of these areas in related rule-making proposals and under
FDICIA (as defined below), some of which are discussed herein. In addition to
evaluating capital ratios, an overall assessment of capital adequacy must take
account of each of these other factors including, in particular, the level and
severity of problem and adversely classified assets. For this reason, the final
supervisory judgment on a bank's capital adequacy may differ significantly from
the conclusions that might be drawn solely from the absolute level of the bank's
risk-based capital ratio. In light of the foregoing, the FDIC has stated that
banks generally are expected to operate above the


                                       19


<PAGE>   22
minimum risk-based capital ratio. Banks contemplating significant expansion
plans, as well as those institutions with high or inordinate levels of risk,
should hold capital commensurate with the level and nature of the risks to which
they are exposed.

        Recently adopted regulations by the federal banking agencies have
revised the risk-based capital standards to take adequate account of
concentrations of credit and the risks of non-traditional activities.
Concentrations of credit refers to situations where a lender has a relatively
large proportion of loans involving one borrower, industry, location, collateral
or loan type. Non-traditional activities are considered those that have not
customarily been part of the banking business but that start to be conducted as
a result of developments in, for example, technology or financial markets. The
regulations require institutions with high or inordinate levels of risk to
operate with higher minimum capital standards. The federal banking agencies also
are authorized to review an institution's management of concentrations of credit
risk for adequacy and consistency with safety and soundness standards regarding
internal controls, credit underwriting or other operational and managerial
areas. In addition, the agencies have promulgated guidelines for institutions to
develop and implement programs for interest rate risk management, monitoring and
oversight.

        Further, the banking agencies recently have adopted modifications to the
risk-based capital regulations to include standards for interest rate risk
exposures. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital arising from movements in interest rates. While
interest rate risk is inherent in a bank's role as financial intermediary, it
introduces volatility to bank earnings and to the economic value of the bank.
The banking agencies have addressed this problem by implementing changes to the
capital standards to include a bank's exposure to declines in the economic value
of its capital due to changes in interest rates as a factor that the banking
agencies will consider in evaluating an institution's capital adequacy. Bank
examiners will consider a bank's historical financial performance and its
earnings exposure to interest rate movements as well as qualitative factors such
as the adequacy of a bank's internal interest rate risk management.

        Finally, institutions with significant trading activities must measure
and hold capital for exposure to general market risk arising from fluctuations
in interest rates, equity prices, foreign exchange rates and commodity prices
and exposure to specific risk associated with debt and equity positions in the
trading portfolio. General market risk refers to changes in the market value of
on-balance-sheet assets and off-balance-sheet items resulting from broad market
movements. Specific market risk refers to changes in the market value of
individual positions due to factors other than broad market movements and
includes such risks as the credit risk of an instrument's issuer. The additional
capital requirements apply effective January 1, 1998 to institutions with
trading assets and liabilities equal to 10% or more of total assets or trading
activity of $1 billion or more. The federal banking agencies may apply the
market risk regulations on a case by case basis to institutions not meeting the
eligibility criteria if necessary for safety and soundness reasons.

        In connection with the recent regulatory attention to market risk and
interest rate risk, the federal banking agencies will evaluate an institution in
its periodic examination on the degree to which changes in interest rates,
foreign exchange rates, commodity prices or equity prices can affect a financial
institution's earnings or capital. In addition, the agencies will focus in the
examination on an institution's ability to monitor and manage its market risk,
and will provide management with a clearer and more focused indication of
supervisory concerns in this area.

        In certain circumstances, the FDIC or the Federal Reserve may determine
that the capital ratios for an FDIC-insured bank or a bank holding company must
be maintained at levels which are higher than the minimum levels required by the
guidelines or the regulations. A bank or bank holding company which does not
achieve and maintain the required capital levels may be issued a capital
directive by the FDIC or the Federal Reserve to ensure the maintenance of
required capital levels.


                                       20


<PAGE>   23
PAYMENT OF DIVIDENDS

        The shareholders of the Company are entitled to receive dividends when
and as declared by its Board of Directors, out of funds legally available,
subject to the dividends preference, if any, on preferred shares that may be
outstanding and also subject to the restrictions of the California Corporations
Code. At December 31, 1997, the Company had no outstanding shares of preferred
stock.

        The principal source of cash revenue to the Company has been dividends
received from the Bank. The Bank's ability to make dividend payments to the
Company is subject to state and federal regulatory restrictions.

        Dividends payable by the Bank to the Company are restricted under
California law to the lesser of the Bank's retained earnings, or the Bank's net
income for the latest three fiscal years, less dividends previously declared
during that period, or, with the approval of the DFI, to the greater of the
retained earnings of the Bank, the net income of the Bank for its last fiscal
year or the net income of the Bank for its current fiscal year.

        The FDIC has broad authority to prohibit a bank from engaging in banking
practices which it considers to be unsafe or unsound. It is possible, depending
upon the financial condition of the bank in question and other factors, that the
FDIC may assert that the payment of dividends or other payments by the bank is
considered an unsafe or unsound banking practice and therefore, implement
corrective action to address such a practice.

        In addition to the regulations concerning minimum uniform capital
adequacy requirements discussed above, the FDIC has established guidelines
regarding the maintenance of an adequate allowance for loan and lease losses.
Therefore, the future payment of cash dividends by the Bank to the Company will
generally depend, in addition to regulatory constraints, upon the Bank's
earnings during any fiscal period, the assessment of the respective Boards of
Directors of the capital requirements of such institutions and other factors,
including the maintenance of an adequate allowance for loan and lease losses.

IMPACT OF FEDERAL AND CALIFORNIA TAX LAWS

        The following are the more significant federal and California income tax
provisions affecting commercial banks.

               CORPORATE TAX RATES

        The federal corporate tax rate is 34% for up to $10 million of taxable
income, and 35% for taxable income over $10 million. The 1% differential is
phased out between $15 million and approximately $18.3 million so that
corporations with over approximately $18.3 million of taxable income are taxed
at a flat rate of 35%.

               CORPORATE ALTERNATIVE MINIMUM TAX

        Generally, a corporation will be subject to an alternative minimum tax
("AMT") to the extent the tentative minimum tax exceeds the corporation's
regular tax liability. The tentative minimum tax is equal to (a) 20% of the
excess of a corporation's "alternative minimum taxable income" ("AMTI") over an
exemption amount, less (b) the alternative minimum foreign tax credit. AMTI is
defined as taxable income computed with special adjustments and increased by the
amount of tax preference items for a tax year. An important adjustment is made
for "adjusted current earnings," which generally measures the difference between
corporate earnings and profits (as adjusted) and taxable income. Finally, a
corporation's net operating loss computed for AMT purposes (if any) only can be
utilized to offset up to 90% of AMTI, with the result that a corporation with
current year taxable income will pay some tax.

               BAD DEBT DEDUCTION

        A bank with average adjusted bases of all assets exceeding $500 million
(a "large bank") must compute its bad debt deduction using the specific
charge-off method. Under that method, a deduction is taken at the time the


                                       21


<PAGE>   24
debt becomes partially or wholly worthless. A bank not meeting the definition of
a large bank may use either the specific charge-off method or the "experience"
reserve method, under which the addition to bad debt reserve is based on the
bank's actual loss experience for the current year and five preceding years. The
U.S. Treasury has promulgated regulations which permit a bank to elect to
establish a conclusive presumption that a debt is worthless, based on applying a
single set of standards for both regulatory and tax accounting purposes.

               INTEREST INCURRED FOR TAX-EXEMPT OBLIGATIONS

        Generally, taxpayers are not allowed to deduct interest on indebtedness
incurred to purchase or carry tax-exempt obligations. This rule applies to a
bank, to the extent of its interest expense that is allocable to tax-exempt
obligations acquired after August 7, 1986. The Taxpayer Relief Act of 1997 (the
"1997 Act") made a technical change which expands the interest potentially
disallowed. A special exception applies, however, to a "qualified tax-exempt
obligation," which includes any tax-exempt obligation that (a) is not a private
activity bond and (b) is issued after August 7, 1986 by an issuer that
reasonably anticipates it will issue not more than $10 million of tax-exempt
obligations (other than certain private activity bonds) during the calendar
year. Interest expense on qualified tax-exempt obligations is deductible,
although it is subject to a 20% disallowance under special rules applicable to
financial institutions.

               NET OPERATING LOSSES

        The 1997 Act changed the tax treatment of net operating losses (an
"NOL"). Effective for tax years beginning after August 5, 1997, a bank generally
is permitted to carry a NOL back to the prior two tax years and forward to the
succeeding twenty tax years. For tax years beginning on or before August 5,
1997, the NOL may be carried back three years and forward fifteen years.
However, if the NOL of a commercial bank is attributable to a bad debt deduction
taken under the specific charge-off method after December 31, 1986, and before
January 1, 1994, such portion of the NOL may be carried back ten years and
carried forward five years. A commercial bank's bad debt loss is treated as a
separate NOL to be taken into account after the remaining portion of the NOL for
the year.

               AMORTIZATION OF INTANGIBLE ASSETS INCLUDING BANK DEPOSIT BASE

        Certain intangible property acquired by a taxpayer must be amortized
over a 15-year period. For this purpose, acquired assets required to be
amortized include goodwill and the deposit base or any similar asset acquired by
a financial institution (such as checking and savings accounts, escrow accounts
and similar items). The 15-year amortization rule generally applies to property
acquired after August 10, 1993.

               MARK-TO-MARKET RULES

        The Revenue Reconciliation Act of 1993 introduced certain
"mark-to-market" tax accounting rules for "dealers in securities." Under these
rules, certain "securities" held at the close of a taxable year must be marked
to fair market value, and the unrealized gain or loss inherent in the security
must be recognized in that year for federal income tax purposes. Under the
definition of a "dealer," a bank or financial institution that regularly
purchases or sells loans may be subject to the new rules. The rules generally
are effective for tax years ending on or after December 31, 1993.

        Certain securities are excepted from the mark-to-market rules provided
the taxpayer timely complies with specified identification rules. The principal
exceptions affecting banks are for (1) any security held for investment and (2)
any note, bond, or other evidence of indebtedness acquired or originated in the
ordinary course of business and which is not held for sale. If a taxpayer timely
and properly identifies loans and securities as being excepted from the
mark-to-market rules, these loans and securities will not be subject to these
rules. Generally, a financial institution may make the identification of an
excepted debt obligation in accordance with normal accounting practices, but no
later than 30 days after acquisition.


                                       22


<PAGE>   25
               CALIFORNIA TAX LAWS

        A commercial bank is subject to the California franchise tax at a
special bank tax rate based on the general corporate (non financial) rate plus
2%. For calendar income year 1997, the bank tax rate is 10.84% (which reflects a
decrease in the general corporate tax rate to 8.84%). The applicable tax rate is
higher than that applied to general corporations because it includes an amount
"in lieu" of many other state and local taxes and license fees payable by such
corporations but generally not payable by banks and financial corporations.

        California has adopted substantially the federal AMT, subject to certain
modifications. Generally, a bank is subject to California AMT in an amount equal
to the sum of (a) 7% of AMTI (computed for California purposes) over an
exemption amount and (b) the excess of the bank tax rate over the general
corporation tax rate applied against net income for the taxable year, unless the
bank's regular tax liability is greater. The 7% rate is lowered to 6.65% for any
income year beginning after 1996.

        California permits a bank to compute its deduction for bad debt losses
under either the specific charge-off method or according to the amount of a
reasonable addition to a bad debt reserve.

        California has incorporated the federal NOL provisions, subject to
significant modifications for most corporations. First, NOLs arising in income
years beginning before 1987 are disregarded. Second, no carryback is permitted,
and for most corporations NOLs may be carried forward only five years. Third, in
most cases, only 50% of the NOL for any income year may be carried forward.
Fourth, NOL carryover deductions are suspended for income years beginning in
calendar years 1991 and 1992, although the carryover period is extended by one
year for losses sustained in income years beginning in 1991 and by two years for
losses sustained in income years beginning before 1991. Finally, the special
federal NOL rules regarding bad debt losses of commercial banks do not apply for
California purposes.

        Finally, in 1994, California enacted legislation conforming to the
federal tax treatment of amortization of intangibles and goodwill, with certain
modifications. No deduction is allowed under this provision for any income year
beginning prior to 1994.

        The various tax laws discussed herein contain other changes that could
have a significant impact on the banking industry. The effect of these changes
is uncertain and varied, and it is unclear to what extent any of these changes
may influence the Bank's operations or the banking industry generally.

        In addition, there are several tax bills currently pending before
Congress which could have a significant impact on the banking industry. It is
uncertain whether these bills will be enacted and what impact these bills will
have on the Bank.

IMPACT OF MONETARY POLICIES

        The earnings and growth of the Bank and the Company are subject to the
influence of domestic and foreign economic conditions, including inflation,
recession and unemployment. The earnings of the Bank and, therefore, the
Company, are affected not only by general economic conditions but also by the
monetary and fiscal policies of the United States and federal agencies,
particularly the Federal Reserve. The Federal Reserve can and does implement
national monetary policy, such as seeking to curb inflation and combat
recession, by its open market operations in United States Government securities
and by its control of the discount rates applicable to borrowings by banks from
the Federal Reserve System. The actions of the Federal Reserve in these areas
influence the growth of bank loans, investments and deposits and affect the
interest rates charged on loans and paid on deposits. As demonstrated recently
by the Federal Reserve's actions regarding interest rates, its policies have had
a significant effect on the operating results of commercial banks and are
expected to continue to do so in the future. The nature and timing of any future
changes in monetary policies are not predictable.


                                       23


<PAGE>   26
RECENT AND PROPOSED LEGISLATION

        Federal and state laws applicable to financial institutions have
undergone significant changes in recent years. The most significant recent
federal legislative enactments are the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 ("Riegle-Neal") and the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA").

        RIEGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994

        In September 1994, President Clinton signed Riegle-Neal, which amends
the BHC Act and the Federal Deposit Insurance Act ("FDIA") to provide for
interstate banking, branching and mergers. Subject to the provisions of certain
state laws and other requirements, Riegle-Neal allows a bank holding company
that is adequately capitalized and adequately managed to acquire a bank located
in a state other than the holding company's home state regardless of whether or
not the acquisition is expressly authorized by state law. Similarly, beginning
on June 1, 1997, the federal banking agencies were permitted to approve
interstate merger transactions, subject to applicable restrictions and state
laws. Further, a state may elect to allow out of state banks to open de novo
branches in that state. However, recently adopted regulations of the federal
banking agencies prohibit interstate branching primarily for the purpose of
deposit production and provide guidelines to ensure that banks operating
interstate branches are reasonably helping to meet the credit needs of the
communities served by the branches.

        Riegle-Neal includes several other provisions which may have an impact
on the Company's and the Bank's business. The provisions include, among other
things, a mandate for review of regulations to equalize competitive
opportunities between U.S. and foreign banks, evaluation on a bank-wide,
state-wide and, if applicable, metropolitan area basis of the Community
Reinvestment Act compliance of banks with interstate branches, and, in the event
the FDIC is appointed as conservator or receiver of a financial institution, the
revival of otherwise expired causes of action for fraud and intentional
misconduct resulting in unjust enrichment or substantial loss to an institution.

        California has adopted the Caldera, Weggeland, and Killea California
Interstate Banking and Branching Act of 1995 ("IBBA"), which became effective on
October 2, 1995. The IBBA addresses the supervision of state chartered banks
which operate across state lines, and covers such areas as branching,
applications for new facilities and mergers, consolidations and conversions,
among other things. The IBBA allows a California state bank to have agency
relationships with affiliated and unaffiliated insured depository institutions
and allows a bank subsidiary of a bank holding company to act as an agent to
receive deposits, renew time deposits, service loans and receive payments for a
depository institution affiliate. In addition, pursuant to the IBBA, California
"opted in early" to the Riegle-Neal provisions regarding interstate branching,
allowing a state bank chartered in a state other than California to acquire by
merger or purchase, at any time after effectiveness of the IBBA, a California
bank or industrial loan company which is at least five (5) years old and thereby
establish one or more California branch offices. However, the IBBA prohibits a
state bank chartered in a state other than California from entering California
by purchasing a California branch office of a California bank or industrial loan
company without purchasing the entire entity or establishing a de novo
California branch office.

        The changes effected by Riegle-Neal and the IBBA may increase the
competitive environment in which the Company and the Bank operate in the event
that out of state financial institutions directly or indirectly enter the Bank's
market area. It is expected that Riegle-Neal will accelerate the consolidation
of the banking industry as a number of the largest bank holding companies expand
into different parts of the country that were previously restricted. However, at
this time, it is not possible to predict what specific impact, if any,
Riegle-Neal and the IBBA will have on the Company and the Bank, the competitive
environment in which the Bank operates, or the impact on the Company or the Bank
of any regulations adopted or proposed under Riegle-Neal and the IBBA.


                                       24


<PAGE>   27
        FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 ("FDICIA")

               General

        FDICIA primarily addresses the safety and soundness of the deposit
insurance funds, supervision of and accounting by insured depository
institutions and prompt corrective action by the federal bank regulatory
agencies with respect to troubled institutions. FDICIA gives the FDIC, in its
capacity as federal insurer of deposits, broad authority to promulgate
regulations to assure the viability of the deposit insurance funds, including
regulations concerning safety and soundness standards. FDICIA also places
restrictions on the activities of state-chartered institutions and on
institutions failing to meet minimum capital standards and provides enhanced
enforcement authority for the federal banking agencies. FDICIA also strengthened
Federal Reserve Act regulations regarding insider transactions.

               Prompt Corrective Action

        FDICIA amended the FDIA to establish a format for closer monitoring of
insured depository institutions and to enable prompt corrective action by
regulators when an institution begins to experience difficulty. The general
thrust of these provisions is to impose greater scrutiny and more restrictions
on institutions as they descend the capitalization ladder.

        FDICIA establishes five capital categories for insured depository
institutions: (a) Well Capitalized;(3) (b) Adequately Capitalized;(4) (c)
Undercapitalized;(5) (d) Significantly Undercapitalized;(6) and (e) Critically
Undercapitalized.(7) All insured institutions (e.g., the Bank) are barred from
making capital distributions or paying management fees to a controlling person
(e.g., the Company) if to do so would cause the institution to fall into any of
the three undercapitalized categories.

        An institution which is undercapitalized, significantly undercapitalized
or critically undercapitalized becomes subject to mandatory supervisory actions,
including: (1) restrictions on payment of capital distributions, such as
dividends; (2) restrictions on payment of management fees to any person having
control of the institution; (3) close monitoring by the FDIC of the condition of
the institution, compliance with capital restoration plans, restrictions, and
requirements imposed under Section 38 of the FDIA, and periodic review of the
institution's efforts to restore its capital and comply with restrictions; (4)
submission to the FDIC of a capital restoration plan; (5) requirement that any
company which controls an undercapitalized institution must guarantee, in an
amount equal to the lesser of 5% of the institution's total assets or the amount
needed to bring the institution into full capital compliance, that the
institution will comply with the capital restoration plan until the institution
has been adequately capitalized, on the average, for four consecutive quarters;
(6) restrictions on the institution's asset growth; and (7)


----------------
(3) Well Capitalized means a financial institution with a total risk-based ratio
of 10% or more, a Tier 1 risk-based ratio of 6% or more and a leverage ratio of
5% or more, so long as the institution is not subject to any written agreement
or order issued by the FDIC.

(4) Adequately Capitalized means a total risk-based ratio of 8% or more, a Tier
1 risk-based ratio of 4% or more and a leverage ratio of 4% or more (3% or more
if the institution has received the highest composite rating in its most recent
report of examination) and does not meet the definition of a Well Capitalized
institution.

(5) Undercapitalized means a total risk-based capital ratio of less than 8%, a
Tier 1 risk-based capital ratio of less than 4% or a leverage ratio of less
than 4%.

(6) Significantly Undercapitalized means a financial institution with a total
risk-based ratio of less than 6%, a Tier 1 risk-based ratio of less than 3% or a
leverage ratio of less than 3%.

(7) Critically Undercapitalized means a financial institution with a ratio of
tangible equity to total assets that is equal to or less than 2%.


                                       25


<PAGE>   28
limitations on the institution's ability to make any acquisition, open any new
branch offices or engage in any new line of business.

        Significantly undercapitalized and undercapitalized institutions that
fail to submit and implement adequate capital restoration plans are subject to
the mandatory provisions set forth above and, in addition, to increasingly
stringent operating restrictions, including an immediate requirement to raise
capital.

        Finally, a critically undercapitalized institution must be placed in
conservatorship or receivership within 90 days of becoming critically
undercapitalized, unless the FDIC determines that other action would better
achieve the purposes of the FDIA. Critically undercapitalized institutions which
are not placed in conservatorship or receivership may be subject to additional
stringent operating restrictions.

               Safety and Soundness; Other Provisions of FDICIA

        FDICIA required the federal banking agencies to adopt regulations or
guidelines with respect to safety and soundness standards. The agencies have
adopted uniform guidelines which are used, primarily in connection with
examinations, to identify and address problems at insured depository
institutions before capital becomes impaired. The federal bank regulatory
agencies have adopted asset quality and earnings standards as part of the safety
and soundness guidelines. The asset quality standards require a depository
institution to establish and maintain a system appropriate to the institution's
size and operations to identify and prevent deterioration in problem assets.
With respect to earnings, the institution should adopt and maintain a system to
evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves.

        The federal banking agencies recently published a "Policy Statement on
the Internal Audit Function and its Outsourcing," which provides guidance on the
elements of an effective internal audit function, including director and senior
management responsibilities, the structure of the internal audit department and
procedures for resolving internal control weaknesses. The Policy Statement also
provides guidance on how outsourcing arrangements may affect an examiner's
internal control assessment, as well as the independence of an external auditor
who is also providing internal audit services to an institution.

        In response to the increasing number of financial institutions using the
Internet, the FDIC recently issued a paper identifying many of the risks to an
institution's information system security associated with Internet use, together
with several security and risk control measures. The paper is designed to
complement the FDIC's safety and soundness examination procedures for electronic
banking activities. The Bank is investigating internet banking options, however,
there are no plans at this time to offer such a service.

        FDICIA restricts the acceptance of brokered deposits by insured
depository institutions that are not well capitalized. It also places
restrictions on the interest rate payable on brokered deposits and the
solicitation of such deposits by such institutions. An undercapitalized
institution will not be allowed to solicit brokered deposits by offering rates
of interest that are significantly higher than the prevailing rates of interest
on insured deposits in the particular institution's normal market areas or in
the market area in which such deposits would otherwise be accepted. In addition
to these restrictions on acceptance of brokered deposits, FDICIA provides that
no pass-through deposit insurance will be provided to employee benefit plan
deposits accepted by an institution which is ineligible to accept brokered
deposits under applicable law and regulations.

        Pursuant to FDICIA, the FDIC has established a risk-based assessment
system for depository institutions. This risk-based system is used to calculate
a depository institution's semiannual deposit insurance assessment based on the
probability that the deposit insurance fund will incur a loss with respect to
the institution. To arrive at a risk-based assessment for each depository
institution, the FDIC has constructed a matrix of nine risk categories based on
capital ratios and relevant supervisory information. Each institution is
assigned to one of three capital categories: "well capitalized," "adequately
capitalized" or "undercapitalized." Each institution also is assigned to one of
three supervisory groups based on levels of risk. Risk assessment premiums are
based on an institution's assignment within the matrix and for 1997 ranged from
$0.00 to $0.27 per $100 of deposits. The FDIC has stated that the foregoing risk
assessment premiums will be in effect indefinitely.


                                       26


<PAGE>   29
        FDICIA also places restrictions on insured state bank activities and
equity investments, interbank liabilities and extensions of credit to insiders
and transactions with affiliates.


        OTHER RECENT LEGISLATION

        On September 23, 1994, President Clinton signed into law the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "Regulatory
Improvement Act"). The Regulatory Improvement Act provides regulatory relief for
both large and small banks by, among other things, reducing the burden of
regulatory examinations, streamlining bank holding company procedures and
establishing a formal regulatory appeals process. The Regulatory Improvement Act
also addresses a variety of other topics, including, but not limited to,
mortgage loan settlement procedures, call reports, insider lending, money
laundering, currency transaction reports, management interlocks, foreign
accounts, mortgage servicing and credit card receivables. Although the
Regulatory Improvement Act should reduce the regulatory burden currently imposed
on banks, it is not possible to ascertain the precise effect its various
provisions will have on the Company or the Bank.

YEAR 2000 COMPLIANCE

        The Federal Financial Institutions Examination Council ("FFIEC")
released interagency statements in May and December, 1997 addressing critical
issues for Year 2000 readiness. Year 2000 issues exist because most computer
programs use only two digits to identify a year in the date field (e.g., "98"
for "1998"). Bank information processing systems must be made Year 2000
compliant well in advance of December 31, 1999. In addition, banks face risks
from vendors whose programs are not Year 2000 compliant and must begin testing
of programming changes no later than December 31, 1998. The computer programs of
banks' corporate customers also may pose Year 2000 risks. Failure to address
Year 2000 issues could affect a borrower's creditworthiness. Accordingly, the
FFIEC guidelines require senior management to provide the board of directors
with quarterly or more frequent reports on efforts to reach Year 2000 goals both
internally and by the institution's major vendors. Each institution must
implement its own internal testing or verification processes for vendor products
and services to insure that its different computer systems function properly
together and should develop processes to periodically assess large corporate
borrower Year 2000 efforts. Finally, institutions should develop contingency
plans for all vendors that service "mission-critical" applications should the
vendor not complete its conversion efforts on time.

        The Company presently believes that with modifications to the Bank's
existing software and/or, if required, upgrading to new software, the Year 2000
problem will not pose significant operational problems for the Company's
computer systems as so modified and/or upgraded. However, if such modifications
and conversions are not completed on a timely basis, the Year 2000 problem could
have a material impact on the operations of the Bank.

        During 1997, the Company performed a comprehensive review of its
information systems and, in connection with that review, has initiated formal
communications with all of its significant vendors and service providers to
determine the extent to which the Company is vulnerable to those third parties'
failure to remediate their own Year 2000 issues. There can be no guarantee that
the systems of the other companies on which the Company's systems rely will be
timely remediated. Therefore, it is possible that the Company could be
negatively affected to the extent that other entities not affiliated with the
Company are unsuccessful in addressing these issues. The Company is developing
contingency plans wherever possible to limit those potential negative impacts.

        The Company plans to utilize both internal and external resources to
attempt to identify, correct or replace, and test systems for Year 2000
compliance. The Company anticipates that all corrective action and testing of
the key systems will be completed by December 31, 1998.

        Other significant Year 2000 risks to the Bank include the adequacy of
steps taken by the Bank's borrowers to address the potential impact of the Year
2000 problem on their own businesses. The Bank intends to require information
from its borrowers as part of its credit underwriting process to determine
whether they will take appropriate remedial action in time to avoid Year 2000
problems. However, no assurance can be given that these


                                       27


<PAGE>   30
actions will be taken on a timely basis, and no assurance can be given that the
Bank's existing borrowers will not suffer Year 2000 problems, either of which
could have the effect of increasing the Bank's problem loans and credit losses
in future years.

        For 1997, the Company did not incur a material increase in expense
related to the Year 2000 problem and, during 1998, Year 2000 related expenses
are projected not to exceed $25,000. However, no assurance can be given that the
Company may not be required to expend additional amounts in connection with the
Year 2000 problem in the future.

CONSUMER PROTECTION LAWS AND REGULATIONS

        The bank regulatory agencies are focusing greater attention on
compliance with consumer protection laws and their implementing regulations.
Examination and enforcement have become more intense in nature, and insured
institutions have been advised to monitor carefully compliance with such laws
and regulations. The Bank is subject to many federal consumer protection
statutes and regulations, some of which are discussed below.

        The Community Reinvestment Act ("CRA") is intended to encourage insured
depository institutions, while operating safely and soundly, to help meet the
credit needs of their communities. The CRA specifically directs the federal
regulatory agencies, in examining insured depository institutions, to assess a
bank's record of helping meet the credit needs of its entire community,
including low- and moderate-income neighborhoods, consistent with safe and sound
banking practices. The CRA further requires the agencies to take a financial
institution's record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, mergers or
acquisitions, or holding company formations. The agencies use the CRA assessment
factors in order to provide a rating to the financial institution. The ratings
range from a high of "outstanding" to a low of "substantial noncompliance." The
Bank was examined for CRA compliance by its primary regulator within the past 12
months and received a "Satisfactory" CRA Assessment Rating. New evaluation
criteria in the examination process for small institutions (total assets of $250
million or less) were implemented on January 1, 1996, while new criteria for
large institutions (assets of $250 million or more and, for multiple-bank
holding companies, total bank and thrift assets in excess of $1 billion) were
implemented beginning July 1, 1997.

        The Equal Credit Opportunity Act ("ECOA") generally prohibits
discrimination in any credit transaction, whether for consumer or business
purposes, on the basis of race, color, religion, national origin, sex, marital
status, age (except in limited circumstances), receipt of income from public
assistance programs, or good faith exercise of any rights under the Consumer
Credit Protection Act. The Truth in Lending Act ("TILA") is designed to ensure
that credit terms are disclosed in a meaningful way so that consumers may
compare credit terms more readily and knowledgeably. As a result of the TILA,
all creditors must use the same credit terminology to express rates and
payments, including the annual percentage rate, the finance charge, the amount
financed, the total of payments and the payment schedule, among other things.

        The Fair Housing Act ("FH Act") regulates many practices, including
making it unlawful for any lender to discriminate in its housing-related lending
activities against any person because of race, color, religion, national origin,
sex, handicap, or familial status. A number of lending practices have been found
by the courts to be, or may be considered, illegal under the FH Act, including
some that are not specifically mentioned in the FH Act itself. The Home Mortgage
Disclosure Act ("HMDA") grew out of public concern over credit shortages in
certain urban neighborhoods and provides public information that will help show
whether financial institutions are serving the housing credit needs of the
neighborhoods and communities in which they are located. The HMDA also includes
a "fair lending" aspect that requires the collection and disclosure of data
about applicant and borrower characteristics as a way of identifying possible
discriminatory lending patterns and enforcing anti-discrimination statutes.

        Finally, the Real Estate Settlement Procedures Act ("RESPA") requires
lenders to provide borrowers with disclosures regarding the nature and cost of
real estate settlements. Also, RESPA prohibits certain abusive practices, such
as kickbacks, and places limitations on the amount of escrow accounts.

        Penalties under the above laws may include fines, reimbursements and
other penalties. Due to heightened


                                       28


<PAGE>   31
regulatory concern related to compliance with the CRA, TILA, FH Act, ECOA, HMDA
and RESPA generally, the Bank may incur additional compliance costs or be
required to expend additional funds for investments in its local community.


OTHER

        Other legislation which has been or may be proposed to the United States
Congress and the California Legislature and regulations which may be proposed by
the Federal Reserve, the FDIC and the DFI may affect the business of the Company
or the Bank. It cannot be predicted whether any pending or proposed legislation
or regulations will be adopted or the effect such legislation or regulations may
have upon the business of the Company or the Bank.


ITEM 2 -       DESCRIPTION OF PROPERTY

        The Company and the Bank have their principal offices in a modern
facility located at 1495 East 14th Street, San Leandro, California 94577, which
serves as the Bank's headquarters office. The headquarters office consists of
11,000 square feet of interior space and includes eight (8) teller stations, a
night depository and an automated teller machine.

        The Bank entered into a lease for the premises which commenced on April
1, 1981, extends for a term of twenty-five years and provided for rental
payments of $4,000 per month for the first ten years of the lease term. On the
tenth anniversary (April 1, 1991), the monthly rental payment obligation of the
Bank was raised to $10,310. As of the fifteenth anniversary (April 1, 1996) and
for the five year period ending March 31, 2001, the monthly rental payment
obligation of the Bank will remain at $10,310. Each fifth anniversary
thereafter, the monthly rental amount is to be adjusted as negotiated by the
Bank and the lessor or, if the parties are unable to agree on such adjustment,
by arbitration. The lease also grants to the Bank a right of first refusal in
the event of a proposed sale of the leased premises.

        The Bank entered into an 18-year lease which commenced on October 1,
1987, pursuant to which the Bank acquired an additional 3,000 square feet of
office space at 1475 East 14th Street adjacent to its original headquarters
office. The lease provided for monthly rental payments of $1,800 for the first
three years, and $2,200, $2,680, and $3,270, respectively, for each subsequent
five-year period. The area accommodates the accounting department, computer
operations, storage facilities and certain operations functions.

        The Bank has invested approximately $2,782,000 through December 31, 1997
in leasehold improvements and furniture, fixtures and equipment in its
headquarters office, which includes 1495 and 1475 East 14th Street, San Leandro.

        The Bank's SBA and construction divisions are located in the Bank's
extension office at 1500 Washington Avenue, San Leandro, California 94577. The
premises consists of a one-story wood frame structure which has a floor area of
2,072 square feet. There is a parking lot adjacent to the building. The property
was purchased by the Company at a cost of $196,512 in 1985, and the premises are
leased from the Company by the Bank for the SBA and construction divisions at a
monthly rental of $2,000. The Bank invested approximately $254,000 in leasehold
improvements and furniture, fixtures and equipment in its extension office
through December 31, 1997.

        The Bank's Hayward branch office is located in a modern facility at 1030
La Playa Drive, Hayward, California. The Hayward branch office consists of 4,285
square feet of interior space and includes four (4) teller stations, a night
depository and an automated teller machine.


                                       29


<PAGE>   32
     The Bank purchased the Hayward branch premises in February, 1993 at a total
cost of $700,000. The Bank invested approximately $693,000 in improvements and
furniture, fixtures and equipment in its Hayward branch office through December
31, 1997.

        The Bank's San Ramon branch office is located in a modern facility at
2821 Crow Canyon Road, San Ramon, California. The San Ramon branch office
consists of approximately 5,526 square feet of space and includes five teller
stations, a night depository and an automated teller machine. The Bank invested
approximately $345,000 in leasehold improvements and furniture, fixtures and
equipment in its San Ramon office through December 31, 1997.

        The Bank entered into a lease for the San Ramon branch office premises
which commenced on November 1, 1996, extends for a term of sixty months and
provides for rental payments of $7,500 per month for the first twelve months of
the lease term, increasing to $8,000 per month for the next twelve months of the
lease term. On each subsequent anniversary of the lease commencement date, the
rental payments will be adjusted to reflect changes in the Consumer Price Index,
subject to a cap on each such adjustment of five percent. The lease also grants
to the Bank options to extend the lease term for three additional five year
periods with the rental payments for such extension periods to be determined by
mutual agreement of the Bank and the lessor or by appraisal.


ITEM 3 -       LEGAL PROCEEDINGS

        Neither the Company nor the Bank is a party to, nor is any of their
property the subject of, any material pending legal proceedings other than
ordinary routine litigation incidental to their respective businesses nor are
any such proceedings known to be contemplated by governmental authorities.


ITEM 4 -       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year covered by this report.


                                     PART II

ITEM 5 -       MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        For information concerning the Company's Common Stock and related
shareholder matters, see "Stock Prices and Dividend Information" on the inside
back cover of the Annual Report, which is incorporated herein by reference and
"SUPERVISION AND REGULATION" under the heading "ITEM 1 - BUSINESS" above.

        As of March 11, 1998, there were 418 holders of record of the Company's
Common Stock.


ITEM 6 -       MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

        For Management's Discussion and Analysis, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations" at Pages 18
through 22 of the Annual Report, which are incorporated herein by reference.

        CERTAIN MATTERS DISCUSSED OR INCORPORATED BY REFERENCE IN THIS ANNUAL
REPORT ON FORM 10-KSB ARE FORWARD-LOOKING STATEMENTS THAT ARE SUBJECT TO RISKS
AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DESCRIBED IN MANAGEMENT'S DISCUSSION AND
ANALYSIS OR PLAN OF OPERATION. THEREFORE, THE INFORMATION SET FORTH THEREIN
SHOULD BE CAREFULLY CONSIDERED WHEN EVALUATING THE BUSINESS PROSPECTS OF THE
COMPANY AND THE BANK.


                                       30

<PAGE>   33
ITEM 7 -       FINANCIAL STATEMENTS

        For consolidated financial statements of the Company, see consolidated
balance sheets at December 31, 1997 and 1996, and consolidated income
statements, consolidated statements of cash flows and consolidated statements of
changes in shareholders' equity for the years ended December 31, 1997, 1996 and
1995, and notes to consolidated financial statements for the years ended
December 31, 1997, 1996 and 1995 and the "Independent Auditors' Report" thereon
at Pages 2 through 16 of the Annual Report, which are incorporated herein by
reference.


ITEM 8 -       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
               ACCOUNTING AND FINANCIAL DISCLOSURE

        None.

                                    PART III


ITEM 9 -       DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
               SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

        For information concerning directors and executive officers of the
Company, see "ELECTION OF DIRECTORS OF THE COMPANY" in the definitive Proxy
Statement for the Company's 1998 Annual Meeting of Shareholders to be filed
pursuant to Regulation 14A (the "Proxy Statement"), which is incorporated herein
by reference.



SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

        Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission.
Officers, directors and greater than ten-percent shareholders are required by
SEC regulation to furnish the Company with copies of all Section 16(a) forms
they file. To the best knowledge of the Company, there are no greater than
ten-percent holders of the Company's Common Stock other than Richard M. Kahler,
President and Chief Executive Officer of the Company and the Company's Employee
Stock Ownership Plan.

        Based solely on its review of the copies of such forms received by it,
or written representations from certain reporting persons that no Forms 5 were
required for those persons, the Company believes that, for fiscal year 1997, the
officers and directors of the Company complied with all applicable filing
requirements, except that executive officer Randall D. Greenfield failed to file
on a timely basis a Report of Changes in Beneficial Ownership on Form 4 to
report one transaction in securities, which was subsequently reported during
1997.


ITEM 10 -      EXECUTIVE COMPENSATION

        For information concerning executive compensation, see "EXECUTIVE
COMPENSATION" in the Proxy Statement, which is incorporated herein by reference.


                                       31


<PAGE>   34
ITEM 11 -      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        For information concerning security ownership of certain beneficial
owners and Management, see "PRINCIPAL SHAREHOLDERS" and "ELECTION OF DIRECTORS
OF THE COMPANY" in the Proxy Statement, which is incorporated herein by
reference.


ITEM 12 -      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        For information concerning certain relationships and related
transactions, see "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" and
"INDEBTEDNESS OF MANAGEMENT" in the Proxy Statement, which is incorporated
herein by reference.

ITEM 13 -              EXHIBITS AND REPORTS ON FORM 8-K


<TABLE>
<CAPTION>
(a)     FINANCIAL STATEMENTS                                             REFERENCE PAGE
                                                                            1997 Annual
                                                                              Report
<S>                                                                      <C>
1. Consolidated Financial Statements:
   Balance Sheets at December 31, 1997 and 1996                                2

   Income Statements for the years ended December 31, 1997,
       1996 and 1995                                                           3

   Statements of Cash Flows for the years ended December 31,
       1997, 1996 and 1995                                                     4

   Statements of Changes in Shareholders' Equity for the years ended
       December 31, 1997, 1996 and 1995                                        5

   Notes to Consolidated Financial Statements for the years ended
       December 31, 1997, 1996 and 1995                                        6-15

   Independent Auditors' Report                                               16
</TABLE>


2.      FINANCIAL STATEMENT SCHEDULES:

        In accordance with Regulation S-X, the financial statement schedules
have been omitted because (a) they are not applicable to or required of the
Company or (b) the information required is included in the consolidated
financial statements or notes thereto.

EXHIBITS

        See Index to Exhibits at pages 35 and 36 of this Form 10-KSB.

(b)     REPORTS ON FORM 8-K

        No reports on Form 8-K were filed by the Company during the quarter
ended December 31, 1997.

      For the purposes of complying with the amendments to the rules governing
Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the
undersigned registrant hereby undertakes as follows, which undertaking shall be
incorporated by reference into registrant's Registration Statements on Form S-8
No. 2-97378, 33-24302 and 33-75330.


                                       32


<PAGE>   35
        Insofar as indemnification for liabilities arising under the Securities
Act of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.


                                       33


<PAGE>   36
                                   SIGNATURES

        In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

Date: March 25, 1998               BAY COMMERCIAL SERVICES


                                   By:    /s/Richard M. Kahler
                                      -------------------------------
                                          Richard M. Kahler,
                                          President and Chief Executive Officer

        In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.


<TABLE>
<S>                                                      <C>
/ s/Richard M. Kahler                                    DATE:  March 25, 1998
----------------------
Richard M. Kahler,
President and Chief Executive Officer
(Principal Executive Officer) and Director

Randall D. Greenfield*                                   DATE:  March 25, 1998
----------------------
Randall D. Greenfield,
Chief Financial Officer (Principal Financial
Officer and Principal Accounting Officer) and
Secretary

Joshua Fong, O.D.*                                       DATE:  March 25, 1998
----------------------
Joshua Fong, O.D.,
Chairman of the Board of Directors and Director

William R. Henson*                                       DATE:  March 25, 1998
------------------
William R. Henson, Director

Dimitri V. Koroslev*                                     DATE:  March 25, 1998
--------------------
Dimitri V. Koroslev, Director

William E. Peluso*                                       DATE:  March 25, 1998
------------------
William E. Peluso, Director

Oswald A. Rugaard*                                       DATE:  March 25, 1998
------------------
Oswald A. Rugaard, Director

*By /s/Richard M. Kahler                                 DATE:  March 25, 1998
   ----------------------
(Richard M. Kahler, as Attorney-in-Fact)
</TABLE>


                                       34


<PAGE>   37
                                INDEX TO EXHIBITS


<TABLE>
<CAPTION>
EXHIBIT
NUMBER                              EXHIBIT
------                              -------
<S>     <C>
2       Not applicable.

3.1     Articles of Incorporation of Company, as amended to date.(1)

3.2     Bylaws of Company, as amended to date.(1)

4       Not applicable.

9       Not applicable.

10.1    Lease dated September 28, 1980 between Bay Bank of Commerce and John J.
        Montero and Margaret Montero.(2)

10.2    Employee Stock Ownership Plan of Bay Bank of Commerce, as amended and
        restated as of January 1, 1987.(3)

10.3    Bay Commercial Services 1982 Amended and Restated Stock Option Plan. (4)

10.4    Form of Stock Option Agreements, Amended Stock Option Agreements
        and Supplemental Letter under Bay Commercial Services 1982
        Amended and Restated Stock Option Plan.(5)

10.5    Lease, dated October 1, 1987 for Bay Bank of Commerce premises at 1475
        East 14th Street, San Leandro, California.(5)

10.6    Bay Commercial Services Directors' Stock Option Plan and Form of
        Directors Stock Option Agreement.(6)

10.7    Letter dated December 5, 1990 modifying rental obligation under Lease
        dated September 28, 1980 between Bay Bank of Commerce and John J.
        Montero and Margaret Montero.(7)

10.8    Lease dated November 1, 1990 by and between Metro Properties and Bay
        Bank of Commerce for premises located at 286 Juana Avenue, San Leandro,
        California.(7)

10.9    Bay Commercial Services Adoption Agreement of Nonstandardized
        Section 401(k) Profit Sharing Plan and Bank of California Defined Contribution
        Master Plan and Trust Agreement.(8)

10.10   Bay Commercial Services 1994 Stock Option Plan and Form of Stock Option
        Agreements.(9)
</TABLE>




                                       35
<PAGE>   38
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                              EXHIBIT
------                              -------
<S>     <C>
10.11   Lease dated July 31, 1996 by and between Oak Creek Plaza Associates and
        Bay Bank of Commerce for premises located at 2821 Crow Canyon Road, San
        Ramon, California.(11)

11      Not applicable.

13      Bay Commercial Services 1997 Annual Report to Shareholders (parts not
        incorporated by reference are furnished for informational purposes only
        and are not filed herewith).

16      Not applicable.

18      Not applicable.

21      Subsidiaries of the Company.(10)

22      Not applicable.

23      Independent Auditors' Consent.

24      Power of Attorney.

27.1    Financial Data Schedule year ended 12-31-1997.

27.2    Restated Financial Data Schedule year ended 12-31-1996.

27.3    Restated Financial Data Schedule year ended 12-31-1995.

27.4    Restated Financial Data Schedule quarter ended 09-30-1997.

27.5    Restated Financial Data Schedule quarter ended 06-30-1997.

27.6    Restated Financial Data Schedule quarter ended 03-31-1997.

27.7    Restated Financial Data Schedule quarter ended 09-30-1996.

27.8    Restated Financial Data Schedule quarter ended 06-30-1996.

27.9    Restated Financial Data Schedule quarter ended 03-31-1996.

28      Not applicable.
</TABLE>



(1)     Filed as Exhibits 3.2 and 3.4, respectively, to the Company's Annual
        Report on Form 10-K for the fiscal year ended December 31, 1993, which
        are incorporated herein by this reference.

(2)     Filed as Exhibit 10.4 to the Company's Registration Statement on Form
        S-14 (Registration No. 2-79801), which is incorporated herein by this
        reference.

(3)     Filed as Exhibit 10.2 to the Company's Annual Report on Form 10-KSB for
        the fiscal year ended December 31, 1995, which is incorporated herein by
        this reference.

(4)     Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for
        the Quarter Ended September 30, 1987, which is incorporated herein by
        this reference.

(5)     Filed as Exhibits 10.10 and 10.12, respectively, to the Company's Annual
        Report on Form 10-K for the fiscal year ended December 31, 1987, which
        are incorporated herein by this reference.

(6)     Filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for
        the fiscal year ended December 31, 1988, which is incorporated herein by
        this reference.

(7)     Filed as Exhibits 10. 10 and 10.11, respectively, to the Company's
        Annual Report on Form 10-K for the fiscal year ended December 31, 1990,
        which are incorporated herein by this reference.




                                       36

<PAGE>   39
(8)     Filed as Exhibit 10.13 to the Company's Annual Report on Form 10-K for
        the fiscal year ended December 31, 1991, which is incorporated herein by
        this reference.

(9)     Filed as Exhibit 10.14 to the Company's Annual Report on Form 10-K for
        the fiscal year ended December 31, 1994, which is incorporated herein by
        this reference.

(10)    Filed as Exhibit 3 to the Company's Current Report on Form 8-K filed
        with the Commission on June 14, 1983, which is incorporated herein by
        this reference.

(11)    Filed as Exhibit 10.12 to the Company's Annual Report on Form 10-KSB for
        the fiscal year ended December 31, 1996, which is incorporated herein by
        this reference.


                  EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS

1.      Bay Commercial Services Employee Stock Ownership Plan, as amended and
        restated as of January 1, 1987 - Form 10-KSB for fiscal year ended
        December 31, 1995, Exhibit 10.2.

2.      Bay Commercial Services 1982 Amended and Restated Stock Option Plan -
        Form 10-Q for the Quarter Ended September 30, 1987, Exhibit 10.1.

3.      Form of Stock Option Agreements, Amended Stock Option Agreements and
        Supplemental Letter under Bay Commercial Services 1982 Amended and
        Restated Stock Option Plan - Form 10-K for fiscal year ended December
        31, 1987, Exhibit 10.10.

4.      Bay Commercial Services Directors' Stock Option Plan and Form of
        Directors' Stock Option Agreement Form 10-K for fiscal year ended
        December 31, 1988, Exhibit 10.10.

5.      Bay Commercial Services 1994 Stock Option Plan and Form of Stock Option
        Agreements- Form 10-K for fiscal year ended December 31, 1994, Exhibit
        10.14.


                                       37