**FORM 10-KSB**

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**(Mark One)**

**x:**                          ANNUALREPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe fiscal year ended December 31, 2004**

**o**                                 TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe transition periodfrom           to           **

**CommissionFile No. 333-105991**

| EPIC BANCORP                                                                        |
|-------------------------------------------------------------------------------------|
| (Exact name of small business issuer as specified in  its charter)                  |
| **California**                                                                      | **68-0175592** |
| (State or  jurisdiction of incorporation)                                           | (I.R.S. Employer  Identification No.) |
| **851 IRWIN STREET, SAN RAFAEL, CA 94901**                                          |
| (Address of  principal office)                                                      |
| Issuer’s  telephone number:** (415) 526-6400**                            |
| **Epic Bancorp**                                                                    |
| (Former name,  former address and formal fiscal year, if changed since last report) |

 

Securitiesregistered under Section 12(b) of the Act:  **None**

Securitiesregistered under Section 12(g) of the Act:  **Common Stock, no par value**

Check whether the issuer (1) filedall reports required to be filed by Section 13 or 15 (d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.   Yes x  No o

Check if there is nodisclosure of delinquent filers in response to Item 405 of Regulation S-B isnot contained in this form, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB orany amendment to this Form 10-KSB.   x

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes o  No x

Registrant’s revenues offiscal year ended December 31, 2004 were $14,819,542.

The aggregate market valueof the voting stock held by non-affiliates computed by reference to the averagebid and asked prices of such stock, as of February 28, 2005: $49,672,028.

Number of registrant’sshares of Common Stock outstanding as of February 28, 2005 was 3,671,165.

The following documentsare incorporated by reference in Part III of this Form 10-KSB:Items 9 through 12 and Item 14 of Registrant’s definitive Proxy Statement for its 2005 Annual Meeting of Shareholders

Transitional SmallBusiness Disclosure Format (Check one)   Yes: o   No: x

 

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| **PART I**                                                                                                                        | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| Item 1—Description of Business                                                                                               |       | 4          |
| Item 2—Description of Property                                                                                               |       | 41         |
| Item 3—Legal Proceedings                                                                                                     |       | 41         |
| Item 4—Submission of Matters  to a Vote of Security Holders                                                                  |       | 41         |
| **PART II**                                                                                                                       | ** ** | ** ** |
| Item 5—Market for Common  Equity and Related Stockholder Matters                                                             |       | 42         |
| Item 6—Management’s  Discussion and Analysis                                                                            |       | 44         |
| Item 7—Financial Statements                                                                                                  |       | 69         |
| Item 8—Changes In and  Disagreements with Accountants on Accounting and Financial Disclosure                                 |       | 100        |
| Item 8A—Controls and Procedures                                                                                              |       | 100        |
| Item 8B—Other Information                                                                                                    |       | 100        |
| **PART III**                                                                                                                      | ** ** | ** ** |
| Item 9—Directors, Executive  Officers, Promoters and Control Person; Compliance with Section 16(a) of  the Exchange Act |       | 101        |
| Item 10—Executive Compensation                                                                                               |       | 101        |
| Item 11—Security Ownership  of Certain Beneficial Owners and Management                                                      |       | 101        |
| Item 12—Certain  Relationships and Related Transactions                                                                      |       | 101        |
| Item 13—Exhibits                                                                                                             |       | 101        |
| Item  14. Principal Accountant Fees and Services.                                                                                 |       | 101        |

 

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**FORWARD-LOOKING STATEMENTS**

*In addition to thehistorical information, this Annual Report on Form 10-KSB (“AnnualReport”), contains certain forward-looking information within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended, and are subject to the “SafeHarbor” created by those Sections. Certain statements contained in the AnnualReport, including, without limitation, statements containing the words “believes”,”anticipates”, “intends”, “expects”, and words of similar impact constitute such“forward-looking statements” The reader of this Annual Report should understandthat all such forward-looking statements are subject to various uncertaintiesand risks that could affect their outcome. Epic Bancorp’s actual results coulddiffer materially from those suggested by such forward-looking statements.Factors that could cause or contribute to such differences include, but are notlimited to, (i) variances in the actual versus projected growth in assets,return on assets, loan losses, expenses, rates charged on loans and earned onsecurities investments, rates paid on deposits, and fee and other noninterestincome earned; (ii) competitive pressures among depository and other financialinstitutions may increase significantly and have an effect on pricing,spending, third-party relationships and revenues; (iii) enactment ofadverse government regulation; (iv) adverse conditions and volatility,including as a result of recent economic uncertainty created by the war in Iraqand the United States’ war on terrorism, in the stock market, the public debtmarket and other capital markets and the impact of such conditions on EpicBancorp and Tamalpais Bank; (v) continued changes in the interest rateenvironment may reduce interest margins and adversely impact net interestincome; (vi) as well as other factors. This entire Annual Report should beread to put such forward-looking statements in context and to gain a morecomplete understanding of the uncertainties and risks involved in the businessof Epic Bancorp and Tamalpais Bank.*

*Moreover, whereverphrases such as or similar to “In Management’s opinion”, or “Managementconsiders” are used, such statements are as of and based upon the knowledge ofManagement, at the time made and are subject to change by the passage of timeand/or subsequent events, and accordingly such statements are subject to thesame risks and uncertainties noted above with respect to forward-lookingstatements.*

*The Companydisclaims any obligation to update any such factors or to publicly announce theresults of any revisions to any of the forward-looking statements containedherein to reflect future events or developments.*

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**PART I**

***Item 1—Description of Business***

**DESCRIPTION OF BUSINESS**

**General**

Epic Bancorp (the “Company”) was incorporated in theState of California on December 20, 1988 for the primary purpose oforganizing, as a wholly owned industrial banking company subsidiary, TamalpaisBank (the “Bank”). The Company’s name was changed from San Rafael Bancorp toEpic Bancorp at the 2004 Annual Meeting of Shareholders. Tamalpais Bank wasknown as San Rafael Thrift and Loan until December 1998. As of December 31,2004 the consolidated company was comprised of two entities, the parentcompany, Epic Bancorp, and its wholly-owned consolidated subsidiary, TamalpaisBank. On August 9, 2004, the Company’s common stock was listed on theNASDAQ SmallCap Stock Market and is publicly traded under the symbol “EPIK.” Asof December 31, 2004 Tamalpais Bank represented substantially all of theoperational activities of Epic Bancorp, and accordingly, the discussion andanalysis of Tamalpais Bank and Epic Bancorp are substantially the same. In January 2005,a new wholly owned subsidiary, Epic Wealth Management, Inc. was created tooffer registered investment advisory services. Because Epic Bancorp is the soleshareholder of Tamalpais Bank, the Board of Directors of Epic Bancorp electsthe Board of Directors of Tamalpais Bank. The Company had approximately 713shareholders that own approximately 3,671,165 shares of the Company’s commonstock as of February 28, 2005.

At December 31, 2004, the Company had $425.6million in total assets, $325.7 million in net loans receivable, and $274.6million in total deposits. At December 31, 2003, the Company had $302.0million in total assets, $246.4 million in net loans receivable, and $211.6million in total deposits. The Bank is subject to regulation by the CaliforniaState Department of Financial Institutions (“DFI”) and the Federal DepositInsurance Corporation (“FDIC”). The principal executive offices of the Companyand the Bank are located at 851 Irwin Street, San Rafael, California, 94901,telephone number (415)526-6400, facsimile number (415)485-3742. TheCompany may also be contacted via electronic mail at: *info@epicbancorp.com.*

The Company makes available free of charge on itswebsite at *www.epicbancorp.com* its annual report onForm 10-KSB, quarterly reports on Form 10-QSB, currentreports on Form 8-K and all amendments thereto, and reports ofinsider transactions on Forms 3, 4, and 5 as soon as reasonably practicableafter the Company files such reports with, or furnishes them to, the Securitiesand Exchange Commission (“SEC”). Investors are encouraged to access thesereports and the other information about the Company’s business on its website.

Epic Bancorp focuses on serving high-net-worthconsumers and small businesses in its market area. The Company conductsbusiness from its five full service branches, its network of six ATMs, and fromits administrative headquarters. In addition, the Company supports its customersthrough internet banking, 24 hour telephone banking, courier service,mail, and access through the STAR, PLUS, and VISA ATM networks. The Company’sretail branch network is expanding rapidly, with two new branches opened in2004 and one additional branch scheduled to open in 2005.

In 2003 and 2004 investment advisory and financialplanning services were offered in the Bank’s branches through its affiliate,Kit Cole Investment Advisory Services. Please see “CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS” for additional information regarding business activitiesby Kit Cole Investment Advisory Services. In January 2005 the Companycreated a new subsidiary, Epic Wealth Management, to offer registeredinvestment advisory services to its clients.

Through its network of the Tamalpais banking officesand its investment advisor, Epic Wealth Management, the Company offersclient-centered personalized services to enable its customers to reach theirlifetime personal and financial goals. In addition to investment advice andfinancial planning ,the 

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Company offers through itsBank, a wide complement of lending and deposit products to help facilitateclients’ planning including:

Lending productsand services:

·       Mortgagesfor multifamily real estate;

·       Commercialand industrial real estate loans;

·       Commercialloans to businesses, including SBA loans, revolving lines of credit and termloans.

·       Consumerloans, including home equity lines of credit and secured and unsecured lines ofcredit;

·       Landand construction lending for single family residences, apartment buildings, andcommercial real estate; and

·       Abroad array of residential mortgage products, both fixed, and adjustable rate;

Deposit productsand services:

·       TheBank provides an extensive selection of deposit instruments. These include:multiple checking products for both personal and business accounts;

·       Tieredmoney market accounts offering a variety of access methods;

·       Taxqualified deposits accounts (e.g., IRAs);

·       Abroad array of certificates of deposit products; and

·       Depositrelated services such as electronic funds transfers, issuing ATM cards, andonline banking and bill payment.

The Company’s revenues arecurrently primarily derived from interest on its loans, interest and dividendson its investment securities, and fee income associated with the provision ofvarious customer services. Interest paid on deposits and borrowings constitutesthe Company’s largest type of expense. The Company’s primary sources of fundsare deposits, various sources of wholesale borrowing including FHLB advancesand brokered certificates of deposit, and proceeds from the sale of loans andinvestment securities. The Company’s most significant operating expendituresare its staffing expenses and the costs associated with maintaining its branchnetwork.

**Company Strategy**

The Company is headquartered in Marin County, CA. MarinCounty, with a population of 247,707, has the highest household income in thestate and the fourth highest per capita income out of the 3,111 countiesnationwide, according to data from the US Census Bureau and the HUD. Marincounty has $7.1 billion in total deposits as of June 30, 2004 according todata from the FDIC.

During the past several years, the Company has adopteda business strategy of developing a community-based private banking approach asa means of increasing market share in Marin County and increasing shareholdervalue.

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The Company’sprivate banking strategy incorporates a relationship-based approach to customerservice and marketing, with an understanding of the balance sheet and incomestatement profile of clients to even more effectively present loan, depositproducts and investment management to its constituency. Directors and employeesof the Company maintain a high level of community involvement and visibilitywithin the community’s high net worth and not-for-profit sector. This strategy,executed primarily through its expanding retail branch presence, incorporates:

·       Buildingrelationships through wealth management services in the high net worthcommunity of Marin County;

·       Offeringconsultation and planning services, delivered in a personalized,non-intimidating way;

·       Targetingthe market of high net worth households with liquid assets of $1 to $10million;

·       Providingfee-based investment advisory, asset management, and financial planningservices;

·       Tailoringloan and deposit products to high net worth individuals such as commercial andmultifamily mortgages, personal loans and lines of credit, and cash managementservices;

·       Increasingfee income to a greater portion of total revenue than historically generated;and

·       Utilizingnew technologies to better meet the financial needs of individuals, families,professionals, and businesses.

The Company hasachieved favorable financial performance and has made progress in achieving itsstrategic goals over the past several years. The following are among theaccomplishments that the Company achieved in financial performance andexecuting its strategic plan in 2004:

·       TheCompany has successfully emphasized checking and money market accounts in itsmarketing, new product development, and advertising as a means of cementing itsrelationship with its customers, decreasing its relative cost of funds, andbolstering non-interest income. Checking and money market accounts represented52.4% of total deposits as of December 31, 2004, up from 50.2% as of December 31,2003 and 48.8% as of December 31, 2001.

·       TheCompany’s loan portfolio continues to emphasize income producing multifamilyand commercial real estate as management serves the high net worth investor. Multifamilyand commercial real estate loans comprised 83.5% of the loan portfolio as of December 31,2004 and 84.8% of the portfolio as of December 31, 2003.

·       Netincome for the Company increased 23.3% over the prior year, to $3,448,000 andearnings per share increased 8.0% to $0.94 on a fully diluted basis. The returnon average shareholders equity was 17.19%, compared to a return of 22.24% in2003.

·       TheCompany’s earning asset base increased significantly, as net loans receivableincreased 32.2% and deposits increased 29.8%. Shareholders’ equity increased67.0% to $13.9 million, with $6.4 million coming from the Company’s publicoffering. The stock offering increased the number of shares outstanding by 16%.

·       Therapid growth was accomplished while maintaining minimal levels of non-performingassets. Loans 90 days or more past due represented 0.12% of net loansoutstanding as of December 31, 2004, and 0.00% of net loans outstanding asof December 31, 2003.

·       TheBank launched its fourth branch in San Anselmo and its fifth branch in north SanRafael, CA, and announced the planned opening of its sixth branch located inCorte Madera, CA in 2005, thus substantially increasing its market presence inMarin County.

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·       TheBank launched a Small Business Administration lending program in January 2004and began offering SBA 504 and 7A loans through retail and wholesale sources Theprogram is expected to result in more robust interest and non-interest incomeand increased market presence. Total SBA 504 and 7A loan originations were$11.6 million, and SBA 7A sales generated a net gain of $343,000.

·       TheCompany completed its $26 million stock offering. The stock offering resultedin a net capital infusion of $6.4 million into the Company, with the balancegoing to selling shareholders. The additional capital has enabled the Companyand the Bank to grow its earning asset base and expand its Marin County branchnetwork.

·       TheBank received an outstanding Community Reinvestment Act rating due to acombination of deploying a large amount of its assets in loans, strongoriginations of multifamily and small business loans in its market area, anexcellent distribution of loans in low and moderate income census tracts,robust lending to businesses with revenues under $1 million per year, and itsdiligent focus on community development investments, services, and lending.

·       TheCompany successfully listed its common stock on the NASDAQ Small Cap Market,providing increased liquidity for its shareholders. The Company’s stock istraded under the symbol “EPIK.”

The Company enhanced itsoffering to its small business customers by establishing a new SBA department,which also increases the Company’s total revenue generated from fees andservice charges.

In order to execute thestrategy of rapidly expanding the Company’s retail and private bankingoperations, several new business development officers, private bankers, andbranch managers were hired in 2004. These new employees also enhanced theCompany’s capacity to better serve its consumer base.

The Marin County depositmarket is $7.1 billion per information obtained from the FDIC as of June 30,2004. Based on this information, on the Bank’s growth path over the last twoyears, the anticipated branch to be opened in 2005, future potential branchlocations, and the demographics of Marin County, the Company believes that,over time, it can obtain significant market share in Marin County.

The Bank has a five yearstrategic plan to grow to $1.0 billion in total assets, consisting of $900million in loans, $925 million in deposits, $75 million in stockholders equity,and $100 million in short term investments. However, no assurance can be giventhat the branches will achieve their goals as the Company cannot guaranteelevels of deposit activity or the performance or achievement of its individualbranches.

Management believes thatthe likelihood of success of its new branches is increased by placing newbranches in proximity to existing branches of other financial institutions withlarge deposit bases. Therefore, the Bank’s branching strategy focused onopening branches in those geographies in Marin County that had at least onebranch with $100 million in deposits.

The Company has identifiedat least 9 areas that satisfy this criteria. The Bank opened one new branch in2002 (Mill Valley), one new branch in 2003 (Greenbrae), two new branches in 2004(San Anselmo and Northgate—North San Rafael), and expects to open one newbranch in 2005 (Corte Madera). The Company intends to open at least 3 morebranches in Marin County in the near future.

Whetheror not the Company can achieve these financial goals depends on risks anduncertainties that could be beyond the Company’s control. Risks anduncertainties which could affect the ability to grow deposits include, amongothers:

·       competitivepressures in the Bank’s marketing area;

·       changesin the interest rate environment;

·       generaleconomic conditions, nationally, regionally and in the Bank’s operating marketareas; and

·       changesin business conditions and inflation, and

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·       lossof key management.

On June 10, 2003, the Company filed aRegistration Statement with the Securities and Exchange Commission(Registration Statement No. 333-105991) with respect to a publicoffering of the Company’s common stock for an aggregate consideration ofbetween $9,681,113 and $26,000,000. The registration statement was declaredeffective on October 20, 2003, and the Company commenced an offering of744,701 to 2,000,000 shares of its common stock at a price of $13.00 per share.This offering was completed in the first quarter of 2004. Of the 2,000,000shares offered, 510,599 shares were sold by Epic Bancorp, and 1,444,290 shareswere sold by Community Bankshares, L.P., a limited partnership, of which Kit M.Cole, the Chairman/CEO of Epic Bancorp is the CEO of the general partner, ColeFinancial Ventures, Inc. Community Bankshares elected to retain 45,111 ofits shares, which were subsequently distributed to its investors. Net proceedsof the offering to Epic Bancorp totaled $6,369,000. The proceeds from the saleof new shares sold in the offering were utilized by Epic Bancorp and TamalpaisBank to support their growth and for working capital. In the second quarter of2004 the Company applied to list its common stock on the NASDAQ Small CapMarket. The common stock began trading on the NASDAQ Small Cap Market under thesymbol “EPIK” on August 9, 2004.

In June 2002, theCompany completed a private placement of trust preferred securities in theamount of $10 million. The $10.3 million in junior subordinated debentures havea floating rate of interest, which is reset quarterly, equal to 3-monthLIBOR plus 3.65%. The floating rate, however, may not exceed 12.0% for thefirst five years. The Company is reflecting the junior subordinated debenturesas unconsolidated financing debt on its consolidated balance sheet. The rate asof December 31, 2004 was 5.72%.

**Market Area and Competition**

*Market Area.  *The Bank is acommunity oriented financial institution which originates multifamily,commercial real estate, business, consumer, construction, and residential loanswithin its market area. The Bank’s deposit gathering efforts are focusedprimarily in the Marin County communities surrounding its full service branches.The Bank’s retail lending market is also focused on Marin County, howeverwholesale lending efforts for loans originated through mortgage brokers isconcentrated in Alameda, Contra Costa, San Francisco, San Mateo, Santa Claraand Sonoma Counties as well as Marin County.

There has been continued consumer demand for housingin the Company’s primary market area over the last several years, and in 2004there was an evident economic recovery after economic slowdown in certainsegments of the San Francisco Bay Area from 2000 through 2002. The bear marketin stocks that began in early 2000 and accelerated after the September 11,2001 terrorist attacks led to the demise of many internet companies and tosubstantial layoffs in many technology companies in the Company’s market area. Beginningin late 2000 and continuing into early 2003, the Company noted significantslowing in the local economy, likely due in part to the decline of manytechnology companies during this time and the significant reduction in thestock market, most notably in the technology heavy NASDAQ stock market index. TheCompany believes that the local economy was in recovery in the latter half of2003 and throughout 2004 as evidenced by declining unemployment rates andcontinued strong housing demand. However, the Company is cognizant of thepossible vulnerability of the recovery and has noted that much of the improvedeconomic performance was due to increases in corporate efficiencies rather thanthrough increases in revenue.

Management has also noted that much of the ongoingrecovery has been enabled by the historically low interest rate environment. Increasesin consumer and mortgage debt incurred at very low interest rates has contributedto strong consumer spending. Consumer demand for goods and services maydecline, causing an overall economic slowdown, in the event of a rapidlyincreasing interest rate environment. During 2003 the problems of inflationremained relatively controlled, due primarily to continuous management of themoney supply by the Federal Reserve, which substantially reduced interest rates

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throughout the last halfof 2000 through the first half of 2003 and maintained the Federal Funds rate at1.00% until June 2004.

In efforts to combat future inflation, the FederalReserve began to increase the Federal Funds rate at a measured pace in 2004. FromJune through December 2004 the Federal Reserve increased the FederalFunds rate from 1.00% to 2.25% in five separate rate increases.

The Company cannotcontrol or accurately predict changes in market rates of interest. Thefollowing are some factors that may affect market interest rates, all of whichare beyond the Company’s control:

·       inflation;

·       slowor stagnant economic growth or recession;

·       unemployment;

·       moneysupply and the monetary policies of the FRB;

·       internationaldisorders; and

·       instabilityin domestic and foreign financial markets.

The Company is vulnerable to a sharp increase ininterest rates in the short-run because its interest-earning assets generallyhave longer re-pricing terms than its interest-bearing liabilities. Under suchcircumstances, material and prolonged increases in interest rates willnegatively affect the Company’s market value of equity. In addition, loanvolume and yields are affected by market interest rates on loans, and risinginterest rates generally are associated with a lower volume of loanoriginations. In addition, an increase in the general level of interest ratesmay adversely affect the ability of certain borrowers to pay the interest onand principal of their obligations. Accordingly, changes in levels of marketinterest rates could materially and adversely affect the Company’s net interestspread, asset quality, loan origination volume, securities portfolio, andoverall profitability. Although the Company attempts to manage its interestrate risk, the Company cannot be certain that it can minimize its interest raterisk.

*Competition.  *TheBanking and financial services business in California generally, and in theBank’s market area specifically, is highly competitive. The increasinglycompetitive environment is a result of many factors including, but not limitedto:

·       Significantconsolidation among financial institutions which has occurred over the pastseveral years, resulting in a number of substantially larger competitors withgreater resources than the Company;

·       Increasingintegration among commercial banks, insurance companies, securities brokers,and investment banks;

·       Continuedgrowth and increased market share of non-bank financial service providers thatoften specialize in a single product line such as credit cards or residentialmortgages;

·       Riseof the Internet, causing the Bank to compete more frequently with remoteentities soliciting customers in its primary market area via web basedadvertising and product delivery; and

·       Introductionof new technologies which may bypass the traditional banking system for fundssettlement.

The Company competes for loans, deposits, fee basedproducts, and customers for financial services with commercial banks, savingsand loans, credit unions, industrial banks, mortgage bankers, securities andbrokerage companies, insurance firms, finance companies, mutual funds, andother non-bank financial service providers. Many of these competitors are muchlarger than the Bank in total assets, market reach, 

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and capitalization; andenjoy greater access to capital markets and can offer a broader array ofproducts and services than the Bank currently offers.

In order to competewith other financial service providers, the Company relies upon:

·       Localcommunity involvement;

·       Personalservice and the resulting personal relationships of its staff and customers;

·       Referralsfrom directors, employees, and satisfied customers;

·       Developmentand sale of specialized products and services tailored to meet its customers’needs; and

·       Local,flexible, and fast decision making.

In addition, managementconsiders its approach of placing highly skilled personal bankers andinvestment advisors representatives in separate, prominent areas in itsbranches with close contact to clients to be a competitive advantage inattracting and retaining customers within its primary market area.

**Lending Activities**

*General.*

The Company originates a wide variety of loanproducts. Loans originated by the Company are subject to federal and state lawand regulations. Interest rates charged by the Company on loans are affected bythe demand for such loans and the supply of money available for lendingpurposes and the rates offered by competitors. These factors are, in turn,affected by, among other things, economic conditions, monetary policies of thefederal government, including the Federal Reserve Board, and legislative taxpolicies. The Company targets certain lending toward low to moderate incomeborrowers as part of its commitment to serve its local communities.

At December 31, 2004, the Company’s net loanportfolio totaled $325.7 million. This represented the highest total in theCompany’s history. The vast majority of this portfolio was associated with realestate of various types. In 2004, originations, including funding commitmentsfor construction loans and lines of credit, totaled $155.9 million, up from$152.9 million in 2003. Activity in 2004 was supported by an active real estatemarket, ongoing historically low levels of interest rates, continued strongwholesale loan originations, and increased retail loan originations. The mix ofloans originated in 2004 reflected the Company’s business strategy of becominga broader based, community focused financial services firm with a balance sheetdiversified away from relatively lower yielding residential mortgages. As of December 31,2004 was comprised of 4% in residential 1-4 unit loans, 39% inmultifamily loans, 45% in commercial real estate loans, 6% in land andconstruction loans, 5% in commercial loans, and 1% in consumer loans. TheCompany realized particular progress in bolstering its production of relativelyhigher yielding commercial real estate loans, taking advantage of favorablereal estate markets in many of the communities served by the Company.

Net loans as a percentage of total assets decreasedfrom 81.6% at December 31, 2003 to 76.6% at December 31, 2004. TheCompany instituted a wholesale transaction to leverage the capital madeavailable by the capital offering completed in 2004. In this transaction,assets were initially deployed into an investment portfolio in 2004 with the intentto replace investment portfolio with loans as the investments prepay or aresold. This strategy was successfully executed in 2004 as the investmentportfolio decreased by $33.2 million from April through December 2004while the loan portfolio increased by $48.6 million during the same period oftime.

The strategy to increase the loan portfolio largelythrough funds provided by principal pay downs and sales in the investmentportfolio allowed the loan portfolio to increase substantially in 2004. Allocatinga 

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substantial percentage ofits total assets to loans is fundamental to the Company’s strategies ofeffectively supporting the financing needs of its local communities, increasingits net interest margin, and effectively leveraging the Company’s capitalposition.

The Company accepts loan applications generatedthrough brokers for most of its product line. Broker referred loans areunderwritten in the same manner as direct originations. The Company encouragesits employees to refer and solicit loan business as an integral part offunctioning as a community bank. Employees receive various types of awards orcommissions based upon the volume and nature of business booked.

The Company requires titleand hazard insurance for all real estate loans.

*MultifamilyLending.*

The Company offers hybrid and adjustable ratepermanent multifamily (five or more units) real estate loans secured by realestate located primarily in the in San Francisco Bay Area. Multifamily housingvaluations have generally increased in California during the past severalyears, however in the last year the Company has noted a trend of decreasingmarket rents.

Permanent loans on multifamily properties typicallyhave maturities of up to 15 years. Factors considered by the Company inreaching a lending decision on such properties include the net operating incomeof the mortgaged premises before debt service and depreciation, the debtservice ratio (the ratio of net earnings to debt service), the ratio of theloan amount to appraised value, and the financial profile of any borrowers. Pursuantto the Company’s underwriting policies, multifamily adjustable rate mortgageloans are generally originated in amounts up to 80% of the appraised value ofthe underlying properties. The Company can require a debt service ratio of atleast 1.00:1 to 1.15:1, indicating that the property produces sufficient cashflow to cover its operating costs, including the cost to service debt. However,the Company will on occasion originate loans that have a debt service ratio ofless than 1.00:1 depending on the borrower’s experience, sources of income,credit profile, and net worth. Properties securing loans are appraised by anindependent appraiser. Title insurance is required on all loans. Whenevaluating the qualifications of the borrower for a multifamily loan, theCompany considers the financial resources and income level of the borrower, theborrower’s experience in owning or managing similar property, and the Company’slending experience with the borrower.

Because payments on loans secured by multifamilyproperties are often dependent on successful operation or management of theproperties, repayment of these loans may be subject to adverse conditions inthe real estate market or the economy. The Company seeks to minimize theserisks through its underwriting policies, which require such loans to bequalified at origination in adherence with the Company’s underwritingguidelines. The Company also attempts to limit its risk exposure by requiringannual operating statements on the properties and by acquiring personalguarantees from the borrowers.

At December 31, 2004,the Company’s portfolio of multifamily residential loans totaled $126.1million, or 38.3% of net loans receivable. This compares to $97.9 million, or39.3% of net loans receivable, at December 31, 2003. The Company acquiredmultifamily residential loans from direct originations, broker referrals, andretail sources during 2004. It is expected that all of these sources will beutilized in 2005. As of December 31, 2004 one $393,000 multifamily loanswas on non-accrual status. No multifamily loans were on non-accrual as of December 31,2003.

*Commercial &Industrial Real Estate Lending*

The Company originates permanent loans secured bycommercial and industrial real estate located primarily in the San FranciscoBay Area. The Company’s underwriting procedures provide that commercial andindustrial real estate loans may generally be made in amounts up to 75% of theappraised 

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value of the property. Permanentloans are typically made with amortization terms of 30 years with a 15 yearballoon payment at maturity. Some of these loans are adjustable rate mortgagesrepricing based principally on the 6 Month Constant Maturity Treasury (CMT) andthe London Inter-Bank Offered Rate (LIBOR), and some are hybrid (fixed for twoto seven years, then adjustable). The Company’s underwriting standards andcredit review procedures on commercial and industrial real estate loans aresimilar to those applicable to multifamily loans. The Company considers theproperty’s net operating income, the loan to value ratio, the presence ofguarantees, and the borrower’s expertise, credit history, and financial status.

The Company’s commercial and industrial real estateloans are typically secured by properties such as retail stores, retail stripcenters, office buildings, warehouse, and light manufacturing facilities. TheCompany also extends loans secured by mixed use property, which typicallypresent commercial (often retail) space in one part of the building (oftenstreet level) and residential units in other parts of the building.

Because payments on loans secured by commercial realestate properties are often dependent on successful operation or management ofthe properties, repayment of these loans may be significantly subject toadverse conditions in the properties’ management or real estate markets ingeneral or particular to a subject property. The Company seeks to mitigatethese risks through its underwriting standards and credit review policy, whichrequires annual operating statements for each collateral property. The Companyalso participates larger commercial and industrial real estate loans with otherfinancial institutions as a means of diversifying its credit risk and remainingbelow the Bank’s regulatory limit on loans to one borrower.

Commercial and industrial real estate loans canpresent various environmental risks, as such properties are sometimes locatedon sites or in areas where various types of pollution may have historicallyoccurred. The Company attempts to mitigate this risk through environmentalsurveys, reports, and, in some cases, testing; in addition to using a limitedlist of pre-approved appraisers. Commercial and industrial real estate can alsobe affected by changing government regulation.

At December 31, 2004,the Company’s permanent commercial and industrial real estate loan portfoliototaled $147.4 million, or 44.8% of net loans. This compares to $112.2 million,or 45.0% of net loans as of December 31, 2003. As of December 31,2004 and December 31, 2003 no commercial real estate loans were onnon-accrual status.

*Small BusinessAdministration (SBA) Lending.*

In 2004, the Bank began its SBA lending division toexpand on its commercial and business banking product lines. SBA loans aregenerally made pursuant to a federal government program designed to assistsmall businesses in obtaining financing. The federal government guarantees SBAloans as an incentive for financial institutions to make loans to smallbusinesses. In 2004, the Bank funded $11.6 million of SBA loans. The Bank sellsthe guaranteed portion of the SBA loan which is approximately 75% to 85% of theoriginated balance at a premium sale price between 108% and 110% and servicingmargins of between 1.00% and 1.62%. In 2004, the Bank sold $3.1 million of SBAloans, resulting in gain on sale and broker fee income of $343,000.

All of the SBA loansoriginated in 2004 were secured by commercial real estate and are included inthe balances of commercial real estate loans. The SBA loan portfolio as of December 31,2004 totaled $5.3 million. As of December 31, 2004 no SBA loans were onnon-accrual status.

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*ConstructionLending.*

The Company originates construction loans for theacquisition and development of 1-4 unit residential, multifamily, andcommercial property. Collateral has been historically concentrated inresidential properties, both owner occupied and speculative.

Construction financing is generally considered toinvolve a higher degree of risk than long-term financing on improved, occupiedreal estate. The Company’s risk of loss on construction loans depends largelyupon the accuracy of the initial estimate of the property’s value based on thecompletion of construction or development and the estimated cost (includinginterest) of construction. If the estimate of construction costs proves to beinaccurate, the Company may have to advance funds beyond the amount originallycommitted to permit completion of the development and to protect its securityposition. The Company may also be confronted, at or prior to maturity of theloan, with a project with insufficient value to ensure full repayment. TheCompany’s underwriting, monitoring, and disbursement practices with respect toconstruction financing are intended to ensure that sufficient funds areavailable to complete construction projects. The Company attempts to limit itsrisk through its underwriting procedures, by using only approved, qualifiedappraisers, and by dealing with qualified builders / borrowers. The Companyalso participates in larger construction loans with other financialinstitutions as a means of diversifying its credit risk and remaining below theBank’s regulatory limit on loans to one borrower.

The Company’s construction loans typically haveadjustable rates and terms of 12 to 18 months. The Company originates one tofour family owner occupied construction loans in amounts up to 80% of theappraised value of the property, and multifamily and commercial real estateconstruction loans in amounts up to 75% of the appraised value of the property.Loan proceeds are disbursed in increments as construction progresses and asinspections warrant.

At December 31, 2004, the Company had grossconstruction and land development loans totaling $12.7 million, on whichthere were undisbursed loan funds of $3.6 million. At December 31, 2003,the Company had gross construction and land development loans totaling $20.1million, on which there were undisbursed loan funds of $6.4 million. Thebalance of disbursed construction loans as a percentage of net loans declinedfrom 4.8% at December 31, 2003 to 2.9% at December 31, 2004. As of December 31,2004 and December 31, 2003, no construction loans were on non-accrualstatus.

In general, the Company’s strategy is to increase theconstruction loan portfolio and to have construction loans represent a greaterportion of total assets. The Company has targeted increased constructionlending because of the interest rate sensitivity of the loans, the Company’shistoric expertise and experience in this type of lending, the yields availablefrom this type of lending, and, in the case of owner residential constructionloans, the strong customer bond developed in financing the building of someone’shome. Construction loan borrowers are typically candidates for the Company’sprivate banking services.

Because construction loansare generally more complex than typical residential, multifamily, or commercialmortgages, they present a greater degree of credit risk. The Company attemptsto control this credit risk through its underwriting and funds disbursementprocesses. In addition, it is the Company’s strategy to, over time, build aseries of strong relationships with local developers / builders / contractorsabout whom the Company has detailed financial knowledge and from whom itreceives a steady stream of repeat business.

*Land Lending*

The Company offers loans secured by land, generallythroughout the San Francisco Bay Area. The types of land generally consideredby the Company are suitable for residential, multifamily, or commercialdevelopment or are demarcated residential lots. The types of land generallyconsidered by the Company 

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are suitable forresidential, multifamily, or commercial development or are demarcatedresidential lots. The Company’s underwriting procedures provide that land loansmay generally be made in amounts up to 65% of the appraised value of theproperty

Because land and lots are generally less readilymarketable than residential, multifamily, and commercial real estate, lendingon land presents additional risks not present in other real estate loans. Themarket value of land and lots can be more susceptible to changes in interestrates, economic conditions, or local real estate markets than the market valuefor homes. Zoning changes by various government authorities may also affect thevalue and marketability of certain types of land. To mitigate these risks, theCompany generally restricts total land loans to 100% of its tier 1 capital.

At December 31, 2004,the Company’s land loan portfolio totaled $9.1 million, or 2.8% of net loans. Thiscompares to $8.0 million, or 3.2% of net loans as of December 31, 2003. Asof December 31, 2004 and December 31, 2003, no land loans were onnon-accrual status.

*Residential One ToFour Unit Mortgage Lending.*

The Company originates adjustable rate and hybrid(fixed for a period, and then adjustable) mortgage loans secured by one to fourfamily residential properties. Loans that meet stricter secondary marketunderwriting guidelines are sold through conduits on the secondary market. TheCompany is able to retain, at significantly higher yields, residentialmortgages that do not meet these secondary market parameters on its books. TheCompany has a demonstrated expertise in financing properties that other lendersare less inclined to originate. Examples of the types of residential mortgageloans that the Company originates include loans where the borrowing entity is atrust or limited liability corporation, short term swing loans, and loans onvacation property. The Company originates one to four family residentialmortgage loans in amounts up to 80% of the lower of the appraised value or theselling price of the property securing the loan.

At December 31, 2004, the Company’s portfolio ofone to four family residential loans totaled $13.9 million, or 4.2% of netloans receivable. This compares to $11.4 million, or 4.6% of net loansreceivable, at December 31, 2003. As of December 31, 2004  and December 31, 2003 no one to fourunit residential loan were on non-accrual status.

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*Business Lending.*

The Company offers business loans that are eitheruncollateralized or collateralized by business assets or commercial orresidential real estate. The collateral typically consists of common stock orother securities. Business lending is generally considered to involve a higherdegree of risk than the financing of real estate, primarily because thecollateral may be difficult to obtain or liquidate following an uncureddefault. Business loans typically offer relatively higher yields, short maturities,and variable interest rates. The availability of this type of loan enablesexisting and potential business depositors to establish a more completefinancial relationship with the Bank. The Company attempts to reduce the riskof loss associated with business lending by closely monitoring the financialcondition and performance of its customers.

As part of its business strategy, and in order tofacilitate the growth of its business lending portfolio, the Company plans in2005 on having business loans managed by an assigned account manager. TheCompany believes this approach provides for better credit monitoring andfacilitates the Company’s seeking expanded business relationships with growingfirms. The Company’s business strategy envisions business loans representing agreater percentage of total assets in the future.

At December 31, 2004,the Company had disbursed business loans and lines totaling $17.7 million, or5.43% of net loans. This compares to totaling $3.8 million, or 1.5% of grossloans as of December 31, 2003. As of December 31, 2004 and December 31,2003, no business loans were non-performing.

*Consumer Lending.*

The Company offers consumer loans that are eitheruncollateralized or collateralized by personal assets or commercial or personalreal estate. Collateral typically consists of common stock, other securities,or deposits. Consumer lending is generally considered to involve a higherdegree of risk than the financing of real estate, primarily because securityinterests in the collateral are more difficult to perfect and the collateralmay be difficult to obtain or liquidate following an uncured default. Consumerloans typically offer relatively higher yields, short maturities, and variableinterest rates. The availability of consumer loans enables existing andpotential personal banking clients to establish a more complete financialrelationship with the Bank. The Company attempts to reduce the risk of lossassociated with consumer lending through prudent underwriting and periodic financialreview of its borrowers.

At December 31, 2004,the Company had disbursed consumer loans and lines totaling $3.9 million, or1.2% of net loans. This compares to $2.3 million, or 0.9% of net loans as of December 31,2003. As of December 31, 2004 no consumer loans were non-performing.

*Originations,Purchases, and Sales of Loans.*

The Company’s mortgage lending activities areconducted primarily through its branch offices and through its list of approvedwholesale loan brokers who deliver completed loan applications to the Company. Inaddition, the Company has developed correspondent relationships with a numberof financial institutions to facilitate the origination of real estate loans ona participation basis. Loans presented to the Company for purchase orparticipation are generally underwritten substantially in accordance with theCompany’s established lending standards, which consider the financial conditionof the borrower, the location of the underlying property, and the appraisedvalue of the property, among other factors.

On an ongoing basis, depending on its current asset /liability strategy, the Company sells or participates residential, multifamily,and commercial loans to other financial institutions in the secondary market.Loan sales are dependent on the level of loan originations and the relativecustomer demand for mortgage loans, which is affected by the current andexpected future level of interest rates. Loan sales and participations are anintegral part of the Company’s business strategy, as such sales andparticipations are 

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used to manage the Company’scapital, liquidity and earnings. The level and timing of any future loan saleswill depend upon market opportunities and prevailing interest rates.

In 2004 loan originations totaled $155.9 million. Ofthis amount, $98.0 million, or 63%, were originated through wholesale sourcesand $57.9 million, or 37%, were originated through retail sources. No loanswere purchased in 2004. Loans and participations sold in 2004 totaled $5.1million and consisted of $2.0 million in multifamily loans and $3.1 million ingovernment guaranteed SBA loans. The Company expects to utilize both loanpurchases and sales in 2005.

Because both the volume ofsales and the amount of gain recognized on loan sales is subject to marketconditions, there are risks inherent in relying on loan sales as a source ofincome and balance sheet management. In general, it is more difficult to sellloans, and the gain on sale of loans is lower, when interest rates rise. TheBank is exposed to risks to its capital, liquidity, and earnings if loan salesfail to materialize or if the gain on sale of loans is lower than specified inthe Company’s business strategy. To mitigate these risks, the Company generallysells adjustable rate mortgages whose prices are less susceptible to changes ininterest rates.

*Loan Servicing.*

The Company services itsown loans as well as loans owned by others. Loan servicing includes collectingand remitting loan payments, accounting for principal and interest, contactingdelinquent borrowers, and supervising foreclosures and property dispositions inthe event of unremedied defaults. Loan servicing income includes servicing feesfrom investors and certain charges collected from borrowers, such as latepayment fees. At December 31, 2004 and 2003, the Company was servicing$21.7 million and $32.8 million of loans for others, respectively. The Company’sstrategic plan does not contain a significant expansion in its loan servicingfor others, with the exception of government guaranteed SBA loans, asmanagement believes that it is more advantageous to retain the underlying loanassets on its balance sheet to generate ongoing net interest income rather thanselling or participating the loans and receiving a one time gain on sale.

**Credit Quality**

*General.*

As of December 31,2004 the Company had one $393,000 non-performing multifamily loan. The loansubsequently paid off in January 2005 with full collection of principaland interest. Management believes that non-performing loans will generally bewell secured and or reserved, real estate acquired through foreclosure will beproperly valued, and inherent losses are provided for in the allowance for loanlosses. However, there can be no assurance that future deterioration in localor national economic conditions, collateral values, borrowers’ financialstatus, or other factors will not result in future credit losses and associatedcharges against operations. Concerning real estate acquired via foreclosure, noassurance can be provided regarding when these properties will be sold or whatthe terms of sale will be when they are sold. It is the Company’s generalpolicy to obtain appraisals at the time of foreclosure and to obtain updatedappraisals periodically for foreclosed properties that remain unsold.

*Non-accrual,Delinquent, and Restructured Loans.*

Management generally places loans on non-accrualstatus when they become 90 days past due, unless they are well secured and inthe process of collection. Management also places loans on non-accrual statuswhen they are less than 90 days delinquent when there is concern about thecollection of the debt in accordance with the terms of the loan agreement. Whena loan is placed on non-accrual status, any interest previously accrued but notcollected is reversed from income. Loans are charged off when managementdetermines that collection has become unlikely. Restructured loans are thosewhere the Company has 

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granted a concession onthe interest paid or the original repayment terms due to financial difficultiesof the borrower or because of issues with the collateral securing the loan. Asof December 31, 2004 there was one non-accrual and no restructured loans.

All payments on non-accrual loans are recognized on acash basis until the loan is returned to current status and the quality of theloan has improved to warrant further accruals. Once non-accrual loans arebrought current and have exhibited improved performance, the previouslyreserved delinquent interest is reversed and the loan is returned to accrualstatus.

Interest income foregoneon non-accrual loans outstanding at year-end totaled $14,000 and $0 for theyears ended December 31, 2004 and 2003, respectively. At December 31,2004, the Company had no commitments to extend additional funds to loans onnon-accrual status.

*Delinquent LoanProcedures*

Specific delinquencyprocedures vary depending on the loan type and period of delinquency. However,the Company’s policies generally provide that loans be reviewed monthly fordelinquencies, and that if a borrower fails to make a required payment whendue, the Company institutes internal collection procedures. For mortgage loans,written late charge notices are mailed no later than the 15th day ofdelinquency. At 25 days past due, the borrower is contacted by telephone andthe Company makes a verbal request for payment. At 30 days past due, theCompany begins tracking the loan as a delinquency, and at 45 days past due anotice of intent to foreclose is mailed. When contact is made with the borrowerprior to foreclosure, the Company generally attempts to obtain full payment ordevelop a repayment schedule with the borrower to avoid foreclosure.

*Non-performingAssets*

Non-performing loans include non-accrual loans, loans90 or more days past due and still accruing interest, and restructured loans. Non-performingassets include all non-performing loans, real estate acquired throughforeclosure, and repossessed consumer assets.

Real estate acquiredthrough foreclosure is recorded at the lower of the recorded investment in theloan or the fair value of the related asset on the date of foreclosure, lessestimated costs to sell. Fair value is defined as the amount in cash orcash-equivalent value of other consideration that a real estate asset wouldyield in a current sale between a willing buyer and a willing seller. Developmentand improvement costs relating to the property are capitalized to the extentthey are deemed to be recoverable upon disposal. The carrying value of acquiredproperty is regularly evaluated and, if appropriate, an allowance isestablished to reduce the carrying value to fair value less estimated costs tosell. The Company typically obtains appraisals on real estate acquired throughforeclosure at the time of foreclosure. The Company generally conductsinspections on foreclosed properties and properties deemed in-substanceforeclosures on a quarterly basis.

**Criticized And Classified Assets**

To measure the quality ofassets, the Company has established internal asset classification guidelines aspart of its credit monitoring system for identifying and reporting current andpotential problem assets. Under these guidelines, both asset specific andgeneral portfolio valuation allowances are established. The Company currentlyclassifies problem and potential problem assets into one of four categories,presented below in order of increasing severity.

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*Special MentionAssets.*

Special Mention loans, orOther Assets Especially Mentioned (sometimes referred to as “watch list” loans)possess weaknesses, but do not currently expose the Company to sufficient riskto warrant categorization as a classified asset or assignment of a specificvaluation allowance. Weaknesses that might categorize a loan as Special Mentioninclude, but are not limited to, past delinquencies or a general decline inbusiness, real estate, or economic conditions applicable to the loan.

*Classified Assets.*

*Substandard.*

Substandard loans have oneor more defined weakness and are characterized by the distinct possibility thatthe Company will sustain some loss if the deficiencies are not corrected.

*Doubtful.*

Doubtful loans have theweaknesses of substandard loans, with the additional characteristic that theweaknesses make collection or liquidation in full on the basis of currently existingfacts, conditions, and values questionable; and there is a high possibility ofloss of some portion of the principal balance.

*Loss.*

Loss loans are considered uncollectible and theircontinuance as an asset is not warranted.

Assets classified as substandard or doubtful requirethe establishment of general valuation allowances in amounts considered bymanagement to be adequate under generally accepted accounting principles. Theseamounts represent loss allowances which have been established to recognize theinherent risk associated with lending activities, but which, unlike specificallowances, have not been allocated to particular problem assets. Judgmentsregarding the adequacy of general valuation allowances are based on continualevaluation of the nature, volume and quality of the loan portfolio, otherassets, and current economic conditions that may affect the recoverability ofrecorded amounts. Assets classified as a loss require either a specificvaluation allowance equal to 100% of the amount classified or a charge-off ofsuch amount.

As of December 31,2004, the Company had six special mention loans totaling $1,618,000 and fourloans totaling $1,751,000 classified as substandard. The Company’s largestsubstandard asset is $537,000 land loan in Northern California.

**Allowance For Loan Losses.**

The allowance for loan losses is established through aprovision for loan losses based on management’s evaluation of the risksinherent in the Company’s loan portfolio. The allowance for loan losses isincreased by provisions charged against earnings and reduced by net loancharge-offs. Loans are charged-off when they are deemed to be uncollectible;recoveries are generally recorded only when cash payments are received.

The allowance for loan losses is maintained at anamount management considers adequate to cover estimated losses in loansreceivable which are deemed probable and estimable. The allowance is based upona number of factors, including, but not limited to, asset classifications, thesize and mix of the loan portfolio, economic trends and conditions, industryexperience and trends, industry and geographic concentrations, estimatedcollateral values, management’s assessment of the credit risk inherent in theportfolio, historical loan loss experience, changes in non-performing and pastdue loans, and the Company’s underwriting policies.

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General valuationallowances represent loss allowances that have been established to recognizeinherent risk associated with lending activities, but which, unlike specificallowances, have not been allocated to particular problem assets. In additionto the requirements of Generally Accepted Accounting Principles in the UnitedStates of America, or “GAAP”, related to loss contingencies, a state charteredindustrial banking company’s determination as to the classification of itsassets and the amount of its valuation allowances is subject to review by theFDIC and DFI. The FDIC, in conjunction with other federal banking agencies,provides guidance for financial institutions on both the responsibilities ofmanagement for the assessment and establishment of adequate allowances andguidance for banking agency examiners to use in determining the adequacy ofgeneral valuation allowances. It is required that all institutions:

·       Haveeffective systems and controls to identify, monitor, and address asset qualityproblems

·       Analyzeall significant factors that affect the collectibility of the loan portfolio ina reasonable manner

·       Establishacceptable allowance evaluation processes that meet the objectives of thefederal regulatory agencies.

Various regulatory agencies, in particular the DFI andthe FDIC, as an integral part of their examination process, periodically reviewthe Company’s allowance for loan losses. These agencies may require the Companyto make additional provisions for loan losses, based on their judgments of theinformation available at the time of the examination. Although managementbelieves that the allowance for loan losses is adequate to provide forestimated inherent losses in the loan portfolio, future provisions chargedagainst operations will be subject to continuing evaluations of the inherentrisk in the loan portfolio. In addition, if the national or local economydeclines or asset quality deteriorates, additional provisions could be required.Such additional provisions could negatively and materially impact the Company’sfinancial condition and results of operations.

The Company continuallymonitors the adequacy of its Allowance for Loan Losses and may increase theallowance in the future. The growth in the nominal size of the loan portfoliohas led management to increase the amount of the allowance in recent years. Asof December 31, 2004 the allowance for loan losses was $3.6 million, or1.09% of net loans receivable. As of December 31, 2003 the allowance forloan losses was $2.7 million, or 1.09% of net loans receivable. Althoughmanagement believes the Company’s loan loss allowance is adequate to absorbprobable losses in its loan portfolio, management cannot predict these lossesor whether the allowance will be adequate or that regulators will not requirethe Company to increase this allowance.

**Loan Concentrations**

The Company’s loanportfolio at December 31, 2004 presented significant geographicconcentration. 94% of the Company’s loans outstanding at December 31, 2004were secured by real estate located in the seven counties which constitute theCompany’ s primary lending area:

·       SanFrancisco County, 27% of loan portfolio

·       MarinCounty, 21% of loan portfolio

·       AlamedaCounty, 18% of loan portfolio

·       ContraCosta County, 9% of loan portfolio

·       SantaClara County, 8% of loan portfolio

·       SonomaCounty, 6% of loan portfolio

·       SanMateo County, 5% of loan portfolio

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This concentration provides certain benefits. Forexample, the Company has become well known in its market areas and thereforeattracts more business. In addition, management develops a more comprehensiveknowledge of real estate values and business trends in markets where lending isregularly conducted. However, this concentration also presents certain risks. Anatural disaster such as an earthquake centered in the San Francisco Bay Areawould affect the Company more significantly than firms with loansgeographically dispersed over a wider area. Another concentration risk is thata downturn in the economy or real estate values in the San Francisco Bay Areawould disproportionately unfavorably affect the Company versus a State-wide ornational lender. The geographic concentration of the Company’s loans is animportant factor that management considers in determining appropriate levels ofgeneral loan loss reserves.

The Company isevaluating the following trends and factors which in management’s opinion mayincrease the inherent loss in the loan portfolio:

·       Ageneral reduction in national economic growth and increases in the unemploymentrate may affect local real estate values.

·       Theincreasing interest rate environment that is expected in 2005 may slow economicgrowth and may affect local real estate values.

·       Thepotential affect of lower stock prices on consumer spending, liquidity, andinvestment, with a particular concern regarding effects on the demand andpricing for real estate in the Bank’s primary market areas.

·       Fallingprices is residential or Commercial real estate.

To the extent that the Company is successful in itsstrategic plan and therefore continues to expand its loan portfolio and toincrease the proportion of non-residential loans in the portfolio, Managementanticipates increasing, in future periods, the allowance for loan losses in amanner consistent with the Company’s loan loss allowance methodology. Experienceacross the financial services industry indicates that commercial business andincome property loans present greater risks than residential real estate loans,and therefore should be accompanied by suitably higher levels of reserves. Thesignificant geographic concentration in the loan portfolio may also necessitatesuitably higher levels of reserves.

Please refer to Note 3 tothe Consolidated Financial Statements and the Management’s Discussion andAnalysis for additional information concerning loans.

**Investment Activities**

*Cash Equivalents.*

The Company doesnot include certain short term, highly liquid investments as investment securities,instead classifying these as cash equivalents. These include:

·       Federalfunds sold.

·       Securitiespurchased under agreements to resell

·       Commercialpaper

·       Moneymarket mutual fund investments

·       Bankers’acceptances

·       Certificatesof deposit in federally insured financial institutions

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*LiquidityMaintenance.*

State chartered industrialbanking companies have the authority to invest in various types of liquidassets, as defined in applicable regulations, including United States Treasuryobligations, securities of or guaranteed by various federal agencies,certificates of deposit of insured banks and savings institutions, bankers’acceptances, repurchase agreements, and federal funds. Management believes thatmaintaining an adequate level of liquidity at all times is fundamental toeffective guidance of a financial institution. Management believes that theCompany at all times in 2004 maintained a level of available liquidityconsidered to be adequate to meet foreseeable operational needs.

*Investment Policies.*

In addition toliquid assets, subject to various restrictions, state chartered industrialbanking companies may also invest in various other types of securities,including investment-grade corporate debt securities, mortgage-backedsecurities, asset-backed securities, collateralized mortgage obligations notguaranteed by a federal agency, and mutual funds whose assets conform to theinvestments that a state chartered industrial banking company is otherwiseauthorized to make directly. The Company maintains separate internal investmentpolicies for the Bank. These policies are established by the board of directorswith the key objectives of:

·       Providingand maintaining liquidity

·       Generatinga favorable total return on a risk-adjusted basis

·       Managingthe overall interest rate risk profile

·       Maintainingcompliance with various associated regulations

·       Controllingcredit risk exposure

Specifically, the Company’spolicies generally limit investments to publicly traded securities that areinvestment grade. These policies prohibit the Company’s maintenance of atrading portfolio as defined under SFAS No. 115.

*Accounting AndReporting.*

Investment securities classified as available for saleare recorded at fair value, while investment securities classified as held tomaturity are recorded at cost. Unrealized gains or losses on available for salesecurities, net of the deferred tax effect, are reported as a component ofother comprehensive income and are included in shareholders’ equity.

At December 31,2004 the Company’s investment portfolio was composed of adjustable rate andballoon pass through mortgage backed securities. In 2004 the Company increasedits investment portfolio in pursuing the following objectives:

·       Generatinga steady stream of cash flows to provide liquidity in support of the expandingloan portfolio

·       Increasingthe interest rate sensitivity of the portfolio in conjunction with the Company’sasset / liability management program

·       Deployingthe capital that was obtained through the Company’s capital offering through ashort term leverage transaction to increase return on equity and to allowassets to be re-deployed from investments into loans.

Please refer to Note 2 tothe Consolidated Financial Statements and the Management Discussion and Analysisfor additional information concerning investment securities.

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**Sources of Funds**

*General.*

The Company’s primarysources of funds are customer deposits, principal, interest, and dividendpayments on loans and securities, FHLB advances and other borrowings, and, to alesser extent, proceeds from sales of loans and investment securities. Whilematurities and scheduled amortization of loans and securities are predictablesources of funds, deposit flows and loan and securities prepayments are greatlyinfluenced by general interest rates, economic conditions, and competition.

*Retail Deposits.*

The Company offers a variety of deposit accounts witha range of interest rates and terms. The Company’s deposits consist of noninterest and NOW checking accounts, savings accounts, money market accounts,and certificates of deposit. The flow of deposits is influenced significantlyby general economic conditions, changes in money market rates, prevailinginterest rates, and competition. The Company’s deposits are obtainedpredominantly from Marin County, California where its branches are located. TheCompany relies primarily on customer service and relationships with customersto attract and retain these deposits; however, market interest rates and ratesoffered by competing financial institutions significantly affect the Company’sability to attract and retain deposits. The Bank will also accept brokereddeposits and non-brokered wholesale deposits from time to time. Managementcontinually monitors the Company’s certificate accounts and historically theCompany has retained a large portion of such accounts upon maturity. Many ofthe customers who invest in certificate accounts are candidates for the Company’sprivate banking services.

The Company’s strategic plan incorporates increasingthe percentage of deposits represented by transaction accounts. Managementbelieves that transaction accounts present the opportunity to strengthencustomer relationships, build franchise value, generate fee income, and lowerthe Company’s relative cost of funds. In addition, an expansion in transactionaccounts supports the Company’s asset / liability management program, astransaction accounts are generally less interest rate sensitive than mostalternative sources of funding.

In recent years, the Company has introduced a seriesof money market accounts specifically designed for certain target markets. Forexample, in 2004 the Company continued to offer a highly tiered money marketaccount specifically designed to attract higher average balance depositors whomight otherwise pursue money market mutual funds. As a result, money market andsavings deposit balances have increased in recent years, from $75.8 million at December 31,2002 to $87.1 million at December 31, 2003, to $123.0 million at December 31,2004. The Company has had notable success in obtaining new money market andsavings account funds in 2004 as it has been able to offer attractive rateswhile still maintaining a moderate cost of funds.

In 2004, the Bank established a relationship withReserve Funds, an institutional money manager that offers a money marketsavings based sweep product to community banks. Under this program, endinvestors use the Reserve Funds as a conduit to invest money market savingsdeposits in a consortium of community banks. The end investors receive a rateof interest that is generally higher than alternative money market funds, thecommunity banks receive large money market savings balances, and the ReserveFunds receives a fee by acting as the conduit. The Bank began acceptingdeposits from this program in November 2004. By December 2004deposits reached $11.5 million, and by February 28, 2005 deposits reached$16.6 million. The Bank pays an interest rate equivalent to the Federal Fundsrate plus 40 basis points. As of December 31, 2004 the rate was 2.50%.

The Company’s other area of focus in depositacquisition in recent years has been checking accounts, coincident with theCompany’s business strategy of becoming more of a community based financialservices 

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organization, meeting theprimary financial needs of both consumers and small businesses. Total checkingbalances expanded from $10.1 million at December 31, 2002 to $19.1 millionat December 31, 2003 and to $20.8 million at December 31, 2004.

The increase in checking account balances during 2004was supported by increased account balances maintained by local businesses withwhich the Company established comprehensive relationships, through suchservices as lines of credit, courier service, real estate financing, anddedicated account relationship officers. The Company plans to augment itsbusiness checking product line further in 2005 with an enhancement to itsinternet banking services for businesses. The Company also plans to augment itsline of consumer checking products in 2005 through the opening of a new branchand the expansion of its retail sales force.

During 2004, the Company’s certificate of depositportfolio increased by $25.4 million. During the past several years, theCompany has focused its deposit related sales efforts on transaction accountsas a means of increasing net interest margins, bolstering fee income, andbuilding more comprehensive customer relationships. Nonetheless, the Companyhas seen an increase in certificates of deposit, partially in response todeclines in the stock market. The Company encounters significant pricecompetition for certificates of deposit from one local thrift in particular,and from new or Internet banks seeking to build their customer bases throughaggressive pricing without regard to short term profitability.

The Company’s weighted average cost of deposits at December 31,2004 was 2.10%, 1 basis point below the 11th District Cost of Funds Index for December 2004of 2.11%. While COFI contains funding components other than deposits, theCompany uses a comparison to COFI as a benchmark of its success in managing itscost of deposits. The Company seeks to manage its cost of deposits both viapricing for individual products and through the deposit portfolio product mix. TheCompany’s weighted average cost of deposits decreased initially in 2004 butbegan to rise later in the year in response to the series of interest rateincreases instituted by the Federal Reserve. The Company maintained no depositsin foreign banking offices at December 31, 2004.

Please refer to Note 6 tothe Consolidated Financial Statements and the Management Discussion andAnalysis for additional information concerning deposits.

*Borrowings andWholesale Certificates of Deposit*

From time to time, the Company obtains borrowed fundsthrough FHLB advances, brokered deposits, and wholesale deposits not obtainedthrough brokers. The Company also has access to federal funds purchased andsecurities sold under agreements to repurchase as alternatives to retaildeposit funds. The Company will continue to utilize these sources in the futureas part of its operating strategy. Borrowings are also utilized to acquirecertain other assets as deemed appropriate by management and to better utilizethe capital resources of the Bank and the Company. Borrowings are also used asa tool in the Company’s interest rate risk management process.

FHLB advances are collateralized by the Bank’s pledgedmortgage loans and investment securities and investments in the capital stockof the FHLB. See “SUPERVISION AND REGULATION—Federal Home Loan Bank System.”  FHLB advances are made pursuant to severaldifferent credit programs with varying interest rate, amortization, andmaturity terms. The maximum amount that the FHLB will advance to memberinstitutions, including the Bank, fluctuates from time to time in accordancewith the policies of the FHLB. During 2003 and 2004 the Bank used FHLB advancesto manage interest rate risk, to provide needed liquidity, and to supplementdeposit gathering activity. As of December 31, 2004 FHLB borrowingstotaled $115.8 million and there was $54.2 million in additional availableborrowing capacity.

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The Bank has the ability to obtain wholesalecertificates of deposit through approved deposit brokers. These brokereddeposits are obtained for rates and terms that are generally comparable to whatthe Company can obtain through its retail marketing efforts. The Bank also hasthe ability to obtain wholesale deposits directly from investing institutionswithout the use of a deposit broker. The Bank will continue to obtain brokeredand non-brokered wholesale CD’s as appropriate in the execution of its long termstrategic plan.

The Bank maintains federal funds lines of credit withtwo correspondent banks. From time to time, the Bank may borrow federal fundsfrom its correspondent banks as a source of short term liquidity.

Please refer to Note 8 tothe Consolidated Financial Statements and the Management Discussion andAnalysis for additional information regarding FHLB advances.

*Junior SubordinatedDebentures*

On June 27, 2002, the Company completed itsoffering of junior subordinated debentures in the amount of $10.3 million. Thesecurities were issued by a special purpose business trust formed by theCompany and were sold to a pooled investment vehicle sponsored by Bear StearnsL.P. and Salomon Smith Barney Inc. in a private transaction. The securitieswere sold pursuant to an applicable exemption from registration under theSecurities Act and have not been registered under the Act. Bear Stearnsassisted the Company in the placement of the trust preferred securities. Thesecurities may not be offered or sold in the United States absent registrationor an applicable exemption from registration requirements.

The $10.3 million in junior subordinated debentureshave a floating rate of interest, which is reset quarterly, equal to 3-monthLIBOR plus 3.65%. The floating rate, however, may not exceed 12.0% for thefirst five years. As of December 31, 2004 the floating rate was 5.72%.

Please refer to Note 7 tothe Consolidated Financial Statements and the Management Discussion andAnalysis for additional information regarding the junior subordinateddebentures.

**Investment Advisory Services**

In 2003 and 2004 pursuant to a referral agreementinvestment advisory services and financial planning services were offered inthe Bank’s branches through its affiliate, Kit Cole Investment AdvisoryServices, “KCIAS”. Kit M. Cole, the Chairman/CEO of Epic Bancorp is the CEO ofKCIAS and its principal shareholder. The agreement provided that Epic Bancorp’ssubsidiary, Tamalpais Bank, referred potential investment advisory clients toKCIAS. While not required to do so by agreement, KCIAS referred loan businessto the Bank. The agreement between KCIAS and Epic Bancorp’s subsidiary,Tamalpais Bank, wherein Tamalpais Bank referred potential investment advisoryclients to KCIAS ended as of December 31, 2004.

Management believes that these services are importantto the Company’s continued efforts on building its private banking and high networth client base. Therefore, Epic Bancorp formed a new wholly owned subsidiaryin the first quarter of 2005, Epic Wealth Management “EWM”. EWM was initiallycapitalized by a $100,000 capital infusion by Epic Bancorp. Additional capitalinfusions to EWM from Epic Bancorp totaled $125,000 in February and$179,000 in March 2005. Kit M. Cole is acting as the interim CEO of EpicWealth Management.

An agreement between EWM and Tamalpais Bank forTamalpais Bank to refer investment advisory clients to Epic Wealth Managementwas entered into in January 2005.

EWM is in negotiationswith KCIAS to potentially acquire some of the relationships with the formerclients of KCIAS. The terms and amount of any potential payment to KCIAS for theacquisition of former KCIAS clients has not yet been determined and therefore,is unknown at this time. In the first quarter of 

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2005KCIAS and EMW entered into an interim arrangement covering certain revenue andexpense sharing.

**SUPERVISION AND REGULATION**

**General**

Industrialbanking companies are extensively regulated under both federal and state law.This regulation is intended primarily for the protection of depositors and theBank Insurance Fund and not for the benefit of shareholders. The following informationdescribes certain aspects of that regulation applicable to the Company and theBank, and does not purport to be complete. The following discussion isqualified in its entirety by reference to all particular statutory orregulatory provisions.

**Regulation of The Company**

**General.**

The Company is not under direct oversight by the FDICor the DFI. However, as a part of their examinations of the Bank, the FDIC andDFI may review the operating records of the holding company as they reviewaffiliated party transactions and to determine any obligation that the Bankwill have to cover the holding company’s operating expenses or fundingcommitments. The Company is not a bank holding company and accordingly is notregulated by the Board of Governors of the Federal Reserve System.

Directors, officers and principal shareholders of theCompany have had and will continue to have banking transactions with the Bankin the ordinary course of business. Any loans and commitments to lend includedin such transactions are made in accordance with applicable law, onsubstantially the same terms, including interest rates and collateral, as thoseprevailing at the time for comparable transactions with other persons ofsimilar creditworthiness, and on terms not involving more than the normal risksof collection or presenting other unfavorable features.

The Company’s securitiesare registered with the SEC under the Securities Exchange Act of 1934, asamended (the “Exchange Act”). As such, the Company is subject to theinformation, proxy solicitation, insider trading and other requirements andrestrictions of the Exchange Act (See Item 1. Business; Supervision andRegulation; Sarbanes-Oxley Act of 2002.)

**Restrictions on Acquisitions.**

Federal law generallyprovides that no “person,” acting directly or indirectly or through or inconcert with one or more other persons, may acquire “control,” as that term isdefined in FDIC regulations, of a federally insured institution without givingat least 60 days written notice to the FDIC and providing the FDIC anopportunity to disapprove the proposed acquisition. In addition, no company mayacquire control of such an institution in California without prior DFIapproval.

**Regulation of The Bank**

The Bank, as a California chartered industrial bank,is subject to primary supervision, periodic examination, and regulation by theDFI and the FDIC. If, as a result of an examination of the Bank, the FDICshould determine that the financial condition, capital resources, assetquality, earnings prospects, management, liquidity, or other aspects of theBank’s operations are unsatisfactory or that the Bank or its management isviolating or has violated any law or regulation, various remedies are availableto the FDIC. Such remedies include the power to enjoin “unsafe or unsound”practices, to require affirmative action to correct any conditions resultingfrom any violation or practice, to issue an administrative order that can bejudicially enforced, to direct an increase in capital, to restrict the growthof the Bank, to assess civil monetary penalties, to remove officers anddirectors and ultimately to terminate the Bank’s deposit 

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insurance, which for aCalifornia chartered bank would result in a revocation of the Bank’s charter.The DFI has many of the same remedial powers.

Various requirements andrestrictions under the laws of the State of California and the United Statesaffect the operations of the Bank. State and federal statues and regulationsrelate to many aspects of the Bank’s operations, including reserves againstdeposits, ownership of deposit accounts, interest rates payable on deposits,loans, investments, mergers and acquisitions, borrowings, dividends, locationsof banking centers and capital requirements. Furthermore, the Bank is requiredto maintain certain levels of capital (See Item 7. Management Discussion andAnalysis of Financial Condition and Results of Operations; Capital Resources.)

**Dividendsand Other Transfer of Funds**

Dividends from the Bank constitute the principalsource of funds to the Company. The Company is a legal entity separate anddistinct from the Bank. The Company’s ability to pay cash dividends is limitedby California law. Under California law, shareholders of the Company mayreceive dividends when and as declared by the Board of Directors out of fundslegally available for such purpose. With certain exceptions, a Californiacorporation may not pay a dividend to its shareholders unless (i) itsretained earnings equal at least the amount of the proposed dividend, or (ii) aftergiving effect to the dividend, the corporation’s assets would equal at least1.25 times its liabilities and, for corporations with classified balancesheets, the current assets of the corporation would be at least equal to itscurrent liabilities or, if the average of the earnings of the corporationbefore taxes on income and before interest expense for the two preceding fiscalyears was less than the average of the interest expense of the corporation forthose fiscal years, at least equal to 1.25 times its current liabilities.

The FDIC and the DFI have authority to prohibit theBank from engaging in activities that, in their opinion, constitute unsafe orunsound practices in conducting its business. It is possible, depending uponthe financial condition of the bank in question and other factors, that theFDIC and the DFI could assert that the payment of dividends or other paymentsmight, under some circumstances, be an unsafe or unsound practice. Furthermore,the FDIC has established guidelines with respect to the maintenance ofappropriate levels of capital by banks under its jurisdiction. Compliance withthe standards set forth in such guidelines and the restrictions that are or maybe imposed under the prompt corrective action provisions of federal law couldlimit the amount of dividends which the Bank may pay. An insured depositoryinstitution is prohibited from paying management fees to any controllingpersons or, with certain limited exceptions, making capital distributions ifafter such transaction the institution would be undercapitalized. The DFI mayimpose similar limitations on the Bank (See Item. 1 Business; Supervision andRegulation; Prompt Corrective Action.)

The Bank is subject to certain restrictions imposed byfederal law on any extensions of credit to, or the issuance of a guarantee orletter of credit on behalf of, the Company or other affiliates, the purchaseof, or investments in, stock or other securities thereof, the taking of suchsecurities as collateral for loans, and the purchase of assets of the Companyor other affiliates. Such restrictions prevent the Company and other affiliatesfrom borrowing from the Bank unless the loans are secured by marketableobligations of designated amounts. Furthermore, such secured loans and investmentsby the Bank to or in the Company or to or in any other affiliates are limited,individually, to 10% of the Bank’s capital and surplus (as defined by federalregulations), and such secured loans and investments are limited, in theaggregate, to 20% of the Bank’s capital and surplus (as defined by federalregulations). California law also imposes certain restriction with respect totransactions involving the Company and other controlling persons of the Bank.Additional restrictions on transaction with affiliates may be imposed on theBank under the prompt corrective action provisions of federal law (See Item. 1Business; Supervision and Regulation; Prompt Corrective Action.)

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The FDIC has established risk-based minimum capitalguidelines with respect to the maintenance of appropriate levels of capital byUnited States banking organizations. These guidelines are intended to provide ameasure of capital that reflects the degree of risk associated with a bankingorganization’s operations for both transactions reported on the balance sheetas assets and transactions, such as letters of credit and recoursearrangements, which are recorded as off balance sheet items. Under theseguidelines, nominal dollar amounts of assets and credit equivalent amounts ofoff balance sheet items are multiplied by one of several risk adjustmentpercentages, which range from 0% for assets with low credit risk, such ascertain U.S. Treasury securities, to 100% for assets with relatively highcredit risk, such as commercial loans.

The federal bankingagencies require a minimum ratio of qualifying total capital to risk-adjustedassets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of4%. In addition to the risked-based guidelines, federal banking regulatorsrequire banking organizations to maintain a minimum amount of Tier 1 capital toaverage assets, referred to as the leverage ratio. For a banking organizationrated in the highest of the five categories used by regulators to rate bankingorganizations, the minimum leverage ratio must be 3%. In addition to theseuniform risk-based capital guidelines and leverage ratios that apply across theindustry, the regulators have the discretion to set individual minimum capitalrequirements for specific institutions at rates significantly above minimumguidelines and ratios. As of December 31, 2004 the Bank was “WellCapitalized” with a total capital to risk-adjusted assets of 11.0%, a Tier 1capital to risk adjusted assets ratio of 10.0%, and a leverage ratio of 8.1%.

**Prompt Corrective Action**

The Federal Deposit Insurance Corporation ImprovementAct of 1991 (“FDICIA”), among other things, identifies five capital categoriesfor insured depository institutions (well capitalized, adequately capitalized,undercapitalized, significantly undercapitalized and criticallyundercapitalized) and requires the respective federal regulatory agencies toimplement systems for “prompt corrective action” for insured depositoryinstitutions that do not meet minimum capital requirements within such categories.FDICIA imposes progressively more restrictive constraints on operations,management and capital distributions, depending on the category in which aninstitution is classified. Failure to meet the capital guidelines could alsosubject a banking institution to capital raising requirements. An “undercapitalized”institution must develop a capital restoration plan. At December 31, 2004,the Bank exceeded all of the required ratios for classification as “wellcapitalized.”

An institution that, based upon its capital levels, isclassified as well capitalized, adequately capitalized, or undercapitalized,may be treated as though it were in the next lower capital category if theappropriate federal banking agency, after notice and opportunity for hearing, determinesthat an unsafe or unsound condition or practice warrants such treatment. Ateach successive lower capital category, an insured depository institution issubject to more restrictions.

Banking agencies have also adopted regulations whichmandate that regulators take into consideration (i) concentrations ofcredit risk; (ii) interest rate risk (when the interest rate sensitivityof an institution’s assets does not match the sensitivity of its liabilities orits off-balance-sheet position); and (iii) risks from non-traditionalactivities, as well as an institution’s ability to manage those risks, whendetermining the adequacy of an institution’s capital. This evaluation will bemade as a part of the institution’s regular safety and soundness examination.In addition, the banking agencies have amended their regulatory capitalguidelines to incorporate a measure for market risk. In accordance with theamended guidelines, the Company and any company with significant tradingactivities must incorporate a measure for market risk in its regulatory capitalcalculations.

In addition to measurestaken under the prompt corrective action provisions, industrial bankingorganizations may be subject to potential enforcement actions by thesupervising agencies for unsafe or 

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unsoundpractices in conducting their businesses for violations of law, rule,regulation or any condition imposed in writing by the agency or any writtenagreement with the agency. Enforcement actions vary commensurate with theseverity of the violation.

**Safety and Soundness Standards**

The federal bankingagencies have adopted guidelines designed to assist the federal bankingagencies in identifying and addressing potential safety and soundness concernsbefore capital becomes impaired. The guidelines set forth operational andmanagerial standards relating to: (i) internal controls, informationsystems and internal audit systems; (ii) loan documentation; (iii) creditunderwriting; (iv) asset growth; (v) earnings; and (vi) compensation,fees and benefits. In addition, the federal banking agencies have also adoptedsafety and soundness guidelines with respect to asset quality and earningsstandards. These guidelines provide six standards for establishing andmaintaining a system to identify problem assets and prevent those assets fromdeteriorating. Under these standards, any insured depository institutionshould: (i) conduct periodic asset quality reviews to identify problemassets; (ii) estimate the inherent losses in problem assets and establishreserves that are sufficient to absorb estimated losses; (iii) compareproblem asset totals to capital; (iv) take appropriate corrective actionto resolve problem assets; (v) consider the size and potential risks ofmaterial asset concentrations; and (vi) provide periodic asset qualityreports with adequate information for management and the board of directors toassess the level of asset risk. These guidelines also set forth standards forevaluating and monitoring earnings and for ensuring that earnings are sufficientfor the maintenance of adequate capital and reserves.

**Premiums for Deposit Insurance**

The Company’s deposit accounts are insured by the BankInsurance Fund (“BIF”), as administered by the FDIC, up to the maximumpermitted by law. Insurance of deposits may be terminated by the FDIC upon afinding that the institution has engaged in unsafe or unsound practices, is inan unsafe or unsound condition to continue operation, or has violated anyapplicable law, regulation, rule, order, or condition imposed by the FDIC orthe institution’s primary regulator.

The FDIC charges an annual assessment for theinsurance of deposits, which as of December 31, 2004, ranged from 0 to 27basis points per $100 of insured deposits, based on the risk a particularinstitution poses to its deposit insurance fund. The risk classification isbased on an institution’s capital group and supervisory subgroup assignment. Aninstitution’s risk category is based upon whether the institution is wellcapitalized, adequately capitalized, or less than adequately capitalized. Eachinsured depository institution is also assigned to one of the following “supervisorysubgroups”: Subgroup A, B or C. Subgroup A institutions are financially soundinstitutions with few minor weaknesses; Subgroup B institutions areinstitutions that demonstrate weaknesses which, if not corrected, could resultin significant deterioration; and Subgroup C institutions are institutions forwhich there is a substantial probability that the FDIC will suffer a loss inconnection with the institution unless effective action is taken to correct theareas of weakness. Insured institutions are not allowed to disclose their riskassessment classification and no assurance can be given as to what the futurelevel of premiums will be.

The FDIC is authorized toterminate a depository institution’s deposit insurance upon a finding by theFDIC that the institution’s financial condition is unsafe or unsound or thatthe institution has engaged in unsafe or unsound practices or has violated anyapplicable rule, regulation, order or condition enacted or imposed by theinstitution’s regulatory agency.

**The Community Reinvestment Act (“CRA”)**

The Bank is subject to certain fair lendingrequirements and reporting obligations involving lending, investing and otherCRA activities. CRA requires the Company to identify the communities served bythe 

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Company’s offices and toidentify the types of credit and investments the Company is prepared to extendwithin such communities including low and moderate income neighborhoods. Italso requires the Company’s regulators to assess the Company’s performance inmeeting the credit needs of its community and to take such assessment intoconsideration in reviewing application for mergers, acquisitions, relocation ofexisting branches, opening of new branches and other transactions. A bank maybe subject to substantial penalties and corrective measures for a violation ofcertain fair lending laws. The federal banking agencies may take compliancewith such laws and CRA in consideration when regulating and supervising otherbanking activities.

A bank’s compliance withits CRA obligations is determined based on a performance-based evaluationsystem which bases CRA ratings on an institution’s lending, service andinvestment performance. An unsatisfactory rating may be the basis for denying amerger application. The Bank’s latest CRA examination was completed by theFDIC. The Bank received an overall rating of outstanding in complying with itsCRA obligations.

**Transactions with Related Parties**

The Bank’sauthority to engage in transactions with related parties or “affiliates” ( e.g., any company that controls, is controlled by or is under common control withan institution, including the Company and any non-financial institutionsubsidiaries) is limited by Sections 23A and 23B of the Federal Reserve Act.Section 23A limits the aggregate amount of covered transactions asfollows:

·       Toan amount equal to 10% of the Bank’s capital and surplus, in the case ofcovered transactions with any one affiliate; and

·       Toan amount equal to 20% of the Bank’s capital and surplus, in the case ofcovered transactions with all affiliates.

In addition, aninstitution and its subsidiaries may engage in covered transactions and otherspecified transactions only on terms and under circumstances that aresubstantially the same, or at least as favorable to the Bank or its subsidiary,as those prevailing at the time for comparable transactions with nonaffiliatedcompanies. A “covered transaction” includes:

·       Aloan or extension of credit to an affiliate;

·       Apurchase of investment securities issued by an affiliate;

·       Apurchase of assets from an affiliate, with some exceptions;

·       Theacceptance of securities issued by an affiliate as collateral for a loan orextension of credit to any party; and

·       Theissuance of a guarantee, acceptance, or letter of credit on behalf of anaffiliate.

The Bank’s authority toextend credit to executive officers, directors, and 10% shareholders, as wellas entities such persons control, is governed by the Federal Reserve Act andFederal Reserve Regulation O through application of the FDI Act. Among otherthings, such loans are required to be made on terms substantially the same asthose offered to unaffiliated individuals and do not involve more than thenormal risk of repayment. Specific legislation created an exception for loansmade pursuant to a benefit or compensation program that is widely available toall employees of the institution and does not give preference to insiders overother employees. Regulation O also places individual and aggregate limits onthe amount of loans the Bank may make to insiders based, in part, on the Bank’scapital position and requires certain Board approval procedures to be followed.For information concerning loans to executive officers and directors of theCompany, please refer to Note 19 to the Consolidated Financial Statements.

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**Recent and Proposed Legislation**

From time to time,legislation is enacted which has the effect of increasing the cost of doingbusiness, limiting or expanding permissible activities or affecting thecompetitive balance between banks and other financial institutions. Proposalsto change the laws and regulations governing the operations and taxation ofbanks and other financial institutions are frequently made in Congress, in theCalifornia legislature and by various bank regulatory agencies.

*Financial ServicesModernization Legislation*

In November 1999, the Gramm-Leach-Bliley Act of1999 (the “GLB Act”) was enacted. The GLB Act repeals provisions of theGlass-Steagall Act which restricted the affiliation of Federal Reserve memberbanks with firms “engaged principally” in specified securities activities, andwhich restricted officer, director or employee interlocks between a member bankand any company or person “primarily engaged” in specified securitiesactivities.

In addition, the GLB Act contains provisions thatexpressly preempt any state law restricting the establishment of financialaffiliations, primarily related to insurance. The general effect of the law isto establish a comprehensive framework to permit affiliations among commercialbanks, insurance companies, securities firms and other financial serviceproviders by revising and expanding the BHCA framework to permit a holdingcompany to engage in a full range of financial activities through a new entityknown as a “financial holding company.” “Financial activities” is broadlydefined to include not only banking, insurance and securities activities, butalso merchant banking and additional activities that the FRB, in consultationwith the Secretary of the Treasury, determines to be financial in nature,incidental to such financial activities or complementary activities that do notpose a substantial risk to the safety and soundness of depository institutionsor the financial system generally.

The GLB Act provides that no company may acquirecontrol of an insured savings association unless that company engages, andcontinues to engage, only in the financial activities permissible for afinancial holding company, unless the company is grandfathered as a unitarysavings and loan holding company. The GLB Act grandfathers any company that wasa unitary savings and loan holding company on May 4, 1999 or became aunitary savings and loan holding company pursuant to an application pending onthat date.

The GLB Act also permits national banks to engage inexpanded activities through the formation of financial subsidiaries. A nationalbank may have a subsidiary engaged in any activity authorized for nationalbanks directly or any financial activity, except for insurance underwriting,insurance investments, real estate investment or development, or merchantbanking, which may only be conducted through a subsidiary of a financialholding company. Financial activities include all activities permitted undernew sections of the BHCA or permitted by regulation.

To the extent that the GLBAct permits banks, securities firms and insurance companies to affiliate, thefinancial services industry may experience further consolidation. The GLB Actis intended to grant to community banks powers as a matter of right that largerinstitutions have accumulated on an ad hoc basis and which unitary savings andloan holding companies already possess. Nevertheless, the GLB Act may have theresult of increasing the amount of competition that the Company faces fromlarger institutions and other types of companies offering financial products,many of which may have substantially more financial resources than the Companyhas.

*USA PATRIOT Act of2001*

In the wake of thetragic events of September 11th, on October 26, 2001, the Presidentsigned the Uniting and Strengthening America by Providing Appropriate ToolsRequired to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. The USAPATRIOT Act also made significant changes to the 

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BankSecrecy Act. Under the USA PATRIOT Act, financial institutions are subject toprohibitions against specified financial transactions and account relationshipsas well as enhanced due diligence and of identifying customers whenestablishing new relationships and standards in their dealings with foreignfinancial institutions and foreign customers. For example, the enhanced duediligence policies, procedures, and controls generally require financialinstitutions to take reasonable steps:

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

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

·       Toascertain for any foreign bank, the shares of which are not publicly traded,the identity of the owners of the foreign bank, and the nature and extent ofthe ownership interest of each such owner; and

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

Under the USAPATRIOT Act, financial institutions are to establish anti-money launderingprograms to enhance their Bank Secrecy Act program. The USA PATRIOT Act setsforth minimum standards for these programs, including:

·       Thedevelopment of internal policies, procedures, and controls;

·       Thedesignation of a compliance officer;

·       Anongoing employee training program; and

·       Anindependent audit function to test the programs.

Management believes thatthe Bank is currently in compliance with the Act.

*Sarbanes-Oxley Actof 2002*

On July 30, 2002, the Sarbanes-Oxley Act of 2002(“SOX”), was signed into law to address corporate and accounting fraud. SOXestablishes a new accounting oversight board that will enforce auditingstandards and restricts the scope of services that accounting firms may provideto their public company audit clients. Among other things, SOX also (i) requireschief executive officers and chief financial officers to certify to theaccuracy of periodic reports filed with the SEC; (ii) imposes newdisclosure requirements regarding internal controls, off balance-sheettransactions, and pro forma (non-GAAP) disclosures; (iii) accelerates thetime frame for reporting of insider transactions and periodic disclosures bypublic companies; and (iv) requires companies to disclose whether or notthey have adopted a code of ethics for senior financial officers and whetherthe audit committee includes at least one “audit committee financial expert.”

Under SOX, the SEC is required to regularly andsystematically review corporate filings, based on certain enumerated factors.To deter wrongdoing, SOX: (i) subjects bonuses issued to top executives todisgorgement if a restatement of a company’s financial statements was due tocorporate misconduct; (ii) prohibits an officer or director frommisleading or coercing an auditor; (iii) prohibits insider trades duringpension fund “blackout periods”; (iv) imposes new criminal penalties forfraud and other wrongful acts; and (v) extends the period during whichcertain securities fraud lawsuits can be brought against a company or itsofficers. As a public reporting company, the Company is subject to therequirements of SOX and related rules and regulations issued by the SECand Nasdaq. It is anticipated that the Company 

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will incur additionalexpense as a result of the Act, but we do not expect that such compliance willhave a material impact on our business.

The Company has adopted acode of ethics (“Code of Ethics”) that applies to its executive officers. Acopy of the Code of Ethics is filed as an exhibit hereto.

*CaliforniaFinancial Information Privacy Act/Fair Credit Reporting Act*

In 1970, the federal Fair Credit Reporting Act (the “FCRA”)was enacted to insure the confidentiality, accuracy, relevancy and properutilization of consumer credit report information. Under the framework of theFCRA, the United States has developed a highly advanced and efficient creditreporting system. The information contained in that broad system is used byfinancial institutions, retailers and other creditors of every size in making awide variety of decisions regarding financial transactions. Employers and lawenforcement agencies have also made wide use of the information collected andmaintained in databases made possible by the FCRA. The FCRA affirmativelypreempts state law in a number of areas, including the ability of entitiesaffiliated by common ownership to share and exchange information freely, andthe requirements on credit bureaus to reinvestigate the contents of reports inresponse to consumer complaints, among others.

The California Financial Information Privacy Act,which was enacted in 2003, requires a financial institution to provide specificinformation to a consumer related to the sharing of that consumer’s nonpublicpersonal information. The Act  wouldallow a consumer to direct the financial institution not to share his or hernonpublic personal information with affiliated or nonaffiliated companies withwhich a financial institution has contracted to provide financial products andservices, and would require that permission from each such consumer be acquiredby a financial institution prior to sharing such information. These provisionsare much more restrictive than the privacy provisions of the Financial ServicesModernization Act, and would require the Bank to adopt new policies, proceduresand disclosure documentation if implemented as enacted. The cost of complyingwith this legislation is not predictable at this time.

Congress enacted the FACTAct, (“Fair and Accurate Credit Transaction Act”) of 2003, which will have theeffect of avoiding the sunset preemption provision of the Fair Credit ReportingAct (FCRA) that were due to expire on December 31, 2003. The Presidentsigned the FACT Act into law on December 4, 2003. In general, the FACT Actamends the FCRA and, in addition, provides that, when the implementingregulations have been issued and become effective, the FACT Act will preemptelements of the California Financial Information Privacy Act.  The FACT Act requires the Board of Governorsand the Federal Trade Commission to issue final regulations within nine monthsof the effectiveness of the FACT Act, and that those regulations must becomeeffective within six months of issuance. The provisions of the regulations thatwill implement the FACT Act, and the timing of their effect on the Bank, cannotbe determined at this time.

*Check 21 Act*

On December 22, 2003, the Board of Governorsapproved a proposed rule to amend Regulation CC and its commentary toimplement the Check Clearing for the 21st Century Act (“Check 21 Act”). TheCheck 21 Act was enacted on October 28, 2003 and becomes effective on October 28,2004.

To facilitate check truncation and electronic checkexchange, the Check 21 Act authorizes a new negotiable instrument called a “substitutecheck” and provides that a properly prepared substitute check is the legalequivalent of the original check for all purposes. A substitute check is apaper reproduction of the original check that can be processed just like theoriginal check. The Check 21 Act does not require any bank to create substitutechecks or to accept checks electronically. The Board’s proposed amendments: 1)set forth the requirements of the Check 21 Act that apply to banks; 2) providea model disclosure and 

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model notices relating tosubstitute checks; and 3) set forth bank endorsement and identificationrequirements for substitute checks. The proposed amendments also clarify someexisting provisions of the rule and commentary.

The Bank beganimaging  its customers’ checks in 2003and anticipates that the Check 21 Act will have limited impact on the Bank. TheAct provides for “paperless” clearing of transit items which may provide somecost savings in transportation costs.

*Predatory Lending*

The term “predatorylending,” much like the terms “safety and soundness” and “unfair and deceptivepractices,” is far-reaching and covers a potentially broad range of behavior.As such, it does not lend itself to a concise or a comprehensive definition.But typically predatory lending involves at least one, and perhaps all three,of the following elements:

·       makingunaffordable loans based on the assets of the borrower rather than on theborrower’s ability to repay an obligation, or asset-based lending;

·       inducinga borrower to refinance a loan repeatedly in order to charge high points andfees each time the loan is refinanced, or loan flipping; and

·       engagingin fraud or deception to conceal the true nature of the loan obligation from anunsuspecting or unsophisticated borrower.

Federal ReserveBoard regulations aimed at curbing such lending significantly widened the poolof high-cost home-secured loans covered by the Home Ownership and EquityProtection Act of 1994, a federal law that requires extra disclosures andconsumer protections to borrowers. The following triggers coverage under theHome Ownership and Equity Protection Act of 1994:

·       interestrates for first lien mortgage loans in excess of 8 percentage points abovecomparable Treasury securities,

·       subordinate-lienloans of 10 percentage points above Treasury securities, and

·       feessuch as optional insurance and similar debt protection costs paid in connectionwith the credit transaction, when combined with points and fees if deemedexcessive.

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In addition, theregulation bars loan flipping by the same lender or loan servicer within ayear. Lenders also will be presumed to have violated the law—which says loansshouldn’t be made to people unable to repay them—unless they document that theborrower has the ability to repay. Lenders that violate the rules facecancellation of loans and penalties equal to the finance charges paid. TheCompany does not expect these rules and potential state action in thisarea to have a material impact on our financial condition or results ofoperation.

**Impact of Monetary Policies**

The earnings and growth ofthe Bank are subject to the influence of domestic and foreign economicconditions, including inflation, recession and unemployment. The earnings ofthe Bank are affected not only by general economic conditions but also by themonetary and fiscal policies of the United States and federal agencies,particularly the Federal Reserve. The Federal Reserve can and does implementnational monetary policy, such as seeking to curb inflation and combatrecession, by its open market operations in United States Government securitiesand by its control of the discount rates applicable to borrowings by banks fromthe Federal Reserve System. The actions of the Federal Reserve in these areasinfluence the growth of bank loans, investments and deposits and affect theinterest rates charged on loans and paid on deposits. As demonstrated over thepast several years by the Federal Reserve’s actions regarding interest rates,its policies have had a significant effect on the operating results ofcommercial banks and are expected to continue to do so in the future. Thenature and timing of any future changes in monetary policies are notpredictable.

**ConsumerProtection Laws and Regulations**

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

The Equal Credit Opportunity Act (“ECOA”) generallyprohibits discrimination in any credit transaction, whether for consumer orbusiness purposes, on the basis of race, color, religion, national origin, sex,marital status, age (except in limited circumstances), receipt of income frompublic assistance programs, or good faith exercise of any rights under theConsumer Credit Protection Act.

The Truth in Lending Act (“TILA”) is designed toensure that credit terms are disclosed in a meaningful way so that consumersmay compare credit terms more readily and knowledgeably. As a result of theTILA, all creditors must use the same credit terminology to express rates andpayments, including the annual percentage rate, the finance charge, the amountfinanced, the total of payments and the payment schedule, among other things.

The Fair Housing Act (“FH Act”) regulates manypractices, including making it unlawful for any lender to discriminate in itshousing-related lending activities against any person because of race, color,religion, national origin, sex, handicap or familial status. A number of lendingpractices have been found by the courts to be, or may be considered, illegalunder the FH Act, including some that are not specifically mentioned in the FHAct itself.

The Home Mortgage Disclosure Act (“HMDA”) grew out ofpublic concern over credit shortages in certain urban neighborhoods andprovides public information that will help show whether financial institutionsare serving the housing credit needs of the neighborhoods and communities inwhich they are located. The HMDA also includes a “fair lending” aspect thatrequires the collection and disclosure of data about applicant and borrowercharacteristics as a way of identifying possible discriminatory lendingpatterns and enforcing anti-discrimination statutes.

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Finally, the Real Estate Settlement Procedures Act (“RESPA”)requires lenders to provide borrowers with disclosures regarding the nature andcost of real estate settlements. Also, RESPA prohibits certain abusivepractices, such as kickbacks, and places limitations on the amount of escrowaccounts. Penalties under the above laws may include fines, reimbursements andother penalties.

Due to heightenedregulatory concern related to compliance with the TILA, FH Act, ECOA, HMDA andRESPA generally, the Bank may incur additional compliance costs or be requiredto expend additional funds for investments in its local community.

**Loans to One Borrower Limitation**

Pursuant to the California Financial Code, a statechartered industrial banking company’s total unsecured loans or extensions ofcredit to a single or related group of borrowers may not exceed 15% of the sumof the Bank’s shareholders’ equity, allowance for loan losses, and capital notes and debentures. The totalof secured and unsecured loans or extensions of credit to a single or relatedgroup of borrowers may not exceed 25% of the sum of the Bank’s shareholders’equity,  allowance for loan losses, andcapital notes and debentures.

At December 31, 2004,the Bank’s limit on loans to one borrower was $5.5 million for unsecured loansand $9.2 million total unsecured and secured loans. At December 31, 2004,the Bank’s largest aggregate outstanding balance of loans to one borrowertotaled approximately $6.0 million. This consists of one $3.1 million loansecured as an abundance of caution by real estate, three loans totaling $2.8million secured by multifamily and commercial real estate, and a $1 millionline of credit with a disbursed balance of $1,000 secured as an abundance ofcaution by real estate.

**Federal Home Loan Bank System**

The Bank is amember of the FHLB system. Among other benefits, each FHLB serves as a reserveor central bank for its members within its assigned region. Each FHLB isfinanced primarily from the sale of consolidated obligations of the FHLBsystem. Each FHLB makes available loans or advances to its members incompliance with the policies and procedures established by the board ofdirectors of the individual FHLB. As an FHLB member, the Bank is required toown capital stock in an FHLB in an amount equal to the greater of:

·       1%of its aggregate outstanding principal amount of its residential mortgageloans, home purchase contracts and similar obligations at the beginning of eachcalendar year; or

·       4.7%of its FHLB advances or borrowings.

The Bank’s requiredinvestment in FHLB stock, based on December 31, 2004 financial data, was$5.4 million. At December 31, 2004, the Bank had $6.9 million of FHLBstock.

**Other**

Other legislation whichhas been or may be proposed to the United States Congress and the CaliforniaLegislature and regulations which may be proposed by the FDIC and the DFI mayaffect the business of the Company and the Bank. It cannot be predicted whetherany pending or proposed legislation or regulations will be adopted or theeffect such legislation or regulations may have upon the business of theCompany and the Bank.

**Regulationof Non-banking Affiliates—Epic Wealth Management**

Epic Wealth Management, which was created in January 2005to offer registered investment advisory services, is registered with the SECand is a member of the NASD. Epic Wealth Management is subject to 

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various regulations andrestrictions imposed by those entities, as well as by various stateauthorities. Such regulations cover a broad range of subject matters. Rules andregulations for registered investment advisors cover such issues as: capitalrequirements; sales and trading practices; use of client funds and securities;the conduct of directors, officers, and employees; record-keeping andrecording; supervisory procedures to prevent improper trading on materialnon-public information; qualification and licensing of sales personnel; andlimitations on the extension of credit in securities transactions.

The SEC’s risk assessment rules also apply toEpic Wealth Management as a registered investment advisor. These rules requireregistered investment advisory to maintain and preserve records and certaininformation, describe risk management policies and procedures, and report onthe financial condition of affiliates whose financial and securities activitiesare reasonably likely to have a material impact on the financial andoperational condition of the investment advisor.

In addition to federal registration, state securitiescommissions require the registration of certain investment advisors.

Violations of federal,state and NASD rules or regulations may result in the revocation ofinvestment advisor licenses, imposition of censures or fines, the issuance ofcease and desist orders, and the suspension or expulsion of officers andemployees from the securities business firm.

**Other Information**

Neither the Company nor the Bank holds materialpatents, trademarks, licenses, franchises or concessions. No expenditures havebeen made by the Company, during the last two fiscal years, on materialresearch activities relating to the development of services or the improvementof existing services.

Based upon present business activities, compliancewith federal, state and local provisions regulating discharge of materials intothe environment will have no material effects upon the capital expenditures,earnings and competitive position of the Company or the Bank.

The Company’s business isnot seasonal. The Company intends to continue with the same basic industrialbanking activities that have characterized the Company’s operations since itsinception. The Company anticipates continued profitable growth whilemaintaining sound credit and management policies.

**Employees**

As of December 31, 2004, the Company directlyemployed one full time employee. As of December 31, 2003, the Companydirectly employed one part time employee.

As of December 31,2004, the Bank employed forty eight (48) full-time employees, including threeexecutive officers. As of December 31, 2003, the Bank employed thirtyseven (37) full-time employees, including three executive officers.

***Factors That May Affect Future Results ofOperations***

**TheCompany’s inability to execute its business strategy could adversely affect itsfinancial performance.**

The Company’s financialperformance and profitability depends, in large part, on its ability tofavorably execute its business strategy in converting to a private bankingfocused financial services firm. This evolution entails risks in, among otherareas, technology implementation, market segmentation, brand identification,banking operations, and capital and human resource investments. Accordingly,there can be no assurance that the Company will be successful in its businessstrategy.

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**TheCompany’s new business segments could adversely affect its financialperformance.**

The Company has opened twonew branches in 2004, began a new SBA lending division in 2004, created a newsubsidiary offering registered investment advisory services in January 2005,and expects to open an additional branch in 2005. These new business segmentsinvolve up front investments in personnel, facilities, and technology. Earningscould suffer if these new business segments do not produce the planned level ofrevenue. In addition, establishing these new operations has consumed asignificant amount of management’s time, and business activities in other areasof the company could suffer as a result.

**Thereis strong competition in the Company’s market area and the Company may beunable to increase its market share.**

The Company facessubstantial competition for deposits and loans throughout its market area, andexpects to face substantial competition for its other contemplated products andservices. Competition for deposits comes primarily from five other financialinstitutions that control 69% of the market share in Marin County. Theseinstitutions include three national banks, one regional bank, and one communitybank, and all of these competitors have greater resources than does the Company.Competition for loans comes from other commercial banks, savings institutions,mortgage banking firms, credit unions, and other financial intermediaries, aswell out of state financial intermediaries which have opened low-end productionoffices or which solicit deposits in the Company’s market areas. Many of thefinancial intermediaries operating in the Company’s market area offer certainservices, such as trust, investment and international banking services, whichwe do not offer directly. Additionally, banks and other financial institutionswith larger capitalization and financial intermediaries have larger lendinglimits and as a result are able to serve the credit and investment needs oflarger customers.

**TheCompany’s multi-family residential and commercial real estate loans held forinvestment are relatively unseasoned, and defaults on such loans couldadversely affect its financial condition and results of operations.**

At December 31, 2004,the Company’s multi-family residential loans amounted to $126.1 million, or 38%of its total loans net of unearned income, and the average size of itsmulti-family residential loans was $624,000 as of that date. At December 31,2004, The Company’s commercial real estate loans amounted to $147.4 million, or45% of its total loans, net of unearned income, and the average size of itscommercial real estate loans was $505,000 as of that date. The Company’smulti-family residential and commercial real estate loan portfolios consistprimarily of loans originated after December 31, 2002, and are,consequently, unseasoned. The payment on these loans is typically dependent onthe successful operation of the property, which is affected by the supply anddemand for multi-family residential units and commercial property within therelevant market. If the market for multi-family units and commercial propertyexperiences a decline in demand, multi-family and commercial borrowers maysuffer losses on their projects and be unable to repay their loans. Defaults onthese loans could negatively affect The Company’s financial condition, resultsof operations and prospects.

**TheCompany relies, in part, on external financing to fund its operations and theunavailability of such funds in the future could adversely affect its growthstrategy and prospects.**

The Company relies oncustomer deposits and on advances from the Federal Home Loan Bank of SanFrancisco, or FHLB, to fund its operations. The Company has historicallyutilized certificates of deposit obtained out of its market area. As of December 31,2004, the Company had $116 million in FHLB borrowings, $32 million of brokeredcertificates of deposit, and $17 million of non-brokered wholesale certificatesof deposit. While the Company has reduced its reliance on wholesale funding inthe last half of 2004 and has been successful in promoting its money marketdeposit product, brokered and non-brokered 

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wholesaledeposits nevertheless constituted 18% of total deposits as of December 31,2004. Although management has historically been able to replace such depositson maturity if desired, no assurance can be given that the Company would beable to replace such funds at any given point in time, were its financialcondition or market conditions to change.

**TheCompany’s investment portfolio includes securities which are sensitive tointerest rates and variations in interest rates may adversely affect itsprofitability.**

At December 31, 2004,the Company’s securities portfolio totaled $62.9 million, of which $22.0million was classified as available-for-sale, and $40.9 million was classifiedas held to maturity, and was comprised of mortgage-backed securities which areinsured or guaranteed by government-sponsored enterprises. These securitiesamounted to 15% of total assets and are sensitive to interest ratefluctuations. The unrealized gains or losses in the Company’savailable-for-sale portfolio are reported as a separate component ofshareholders’ equity until realized upon sale. As a result, future interestrate fluctuations may affect shareholders’ equity, causing materialfluctuations from quarter to quarter. Failure to hold these securities untilmaturity or until market conditions are favorable for a sale could adverselyaffect the Company’s financial condition, profitability and prospects.

**TheCompany may have difficulty managing its growth, which may divert resources andlimit its ability to successfully expand its operations.**

The Company has grownsubstantially from $109.0 million in total assets and $99.4 million in totaldeposits at December 31, 2000 to $425.6 million in total assets and $274.6million in total deposits at December 31, 2004. The Company has expandedthe number of full service branches from one as of December 31, 2001 tofive as of December 31, 2004 and one additional branch is currently underconstruction. The Company expects to continue to experience significant growthin the amount of its assets, the level of its deposits, the number of itsclients and the scale of its operations. The Company’s future profitabilitywill depend in part on its continued ability to grow and the Company can give noassurance that it will be able to sustain its historical growth rate or even beable to grow at all.

**Deteriorationof local economic conditions could hurt the Company’s profitability.**

The Company’s operationsare located in Northern California and its lending activities are concentratedin San Francisco, Marin, Alameda, Contra Costa, Santa Clara, Sonoma, and SanMateo Counties. Deposit generation is generally limited to Marin County. Althoughthe Company has diversified its loan portfolio into other California counties,the vast majority of its credits remain concentrated in the seven primarycounties. As a result of this geographic concentration, the Company’s resultsdepend largely upon economic and real estate market conditions in these areas. Adeterioration in economic or real estate market conditions in the Company’sprimary market area could have a material adverse affect on the quality of itsloan portfolio, the demand for its products and services, and its financialcondition and results of operations. In addition, because the Company does notrequire earthquake insurance in conjunction with its real estate lending, anearthquake with an epicenter in or near the Company’s primary market areascould also significantly adversely affect its financial condition and resultsof operations. See “DESCRIPTION OF BUSINESS—Lending Activities.”

**Deteriorationof real estate markets could hurt the Company’s performance.**

At December31, 2004,approximately 94% of the Company’s loans were secured by real estate. TheCompany’s ability to continue to originate real estate secured loans may beimpaired by adverse changes in local and regional economic conditions in thereal estate market, increasing interest rates, or by acts of nature, includingearthquakes and flooding. Due to the concentration of real estate collateral,these events could have a material adverse affect on the value of thecollateral, resulting in losses to the Company. For 

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informationabout the Company’s real estate loans, see “DESCRIPTION OF BUSINESS-LendingActivities,” and “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS–Allowance and Provision for Loan Losses.”

**Loanand lease losses could hurt the Company’s operating results.**

A significant source ofrisk arises from the possibility that losses could be sustained becauseborrowers, guarantors, and related parties may fail to perform in accordancewith the terms of their loans. The Company adopted underwriting and creditmonitoring procedures and credit policies, including the establishment andreview of the allowance for loan losses, that management believes areappropriate to control this risk by assessing the likelihood ofnon-performance, tracking loan performance, and diversifying the creditportfolio. These policies and procedures may not, however, prevent unexpectedlosses that could have a material adverse effect on the Company’s financialcondition or results of operations. Unexpected losses may arise from a widevariety of specific or systemic factors, many of which are beyond the Company’sability to predict, influence, or control.

**Interestrates and general economic conditions could hurt the Company’s results ofoperations and share price.**

The Company’s operatingincome and net income depends to a great extent on “rate differentials,” i.e.,the difference between the income received from loans, securities and otherearning assets, and the interest expense paid on deposits and other liabilities.These rates are highly sensitive to many factors beyond its control, includinggeneral economic conditions, both domestic and foreign, and the monetary andfiscal policies of various governmental and regulatory authorities, and inparticular, the Board of Governors of the Federal Reserve System. The Companyis financially exposed to parallel shifts in general market interest rates,changes in the relative pricing of the term structure of general marketinterest rates, and relative credit spreads. As a result, significantfluctuations in interest rates may result in an adverse effect on the Company’sfinancial condition and results of operations. See “SUPERVISION AND REGULATION—Effectof Monetary Policies” and “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS-Liquidity and Liability Management.”

**TheCompany relies heavily on technology and computer systems and computer failurecould result in loss of business and adversely affect its earnings.**

Advances and changes intechnology could significantly affect the Company’s business and operations. TheCompany anticipates converting to a new data processing provider in 2005 andfaces significant expenditures and commitments of management’s time for thisconversion. The Company may face many challenges including the increased demandfor providing computer access to its accounts and the systems to performbanking transactions electronically. The Company’s ability to compete dependson its ability to continue to adapt technology on a timely and cost-effectivebasis to meet these demands. In addition, The Company’s business and operationsare susceptible to negative affects from computer system failures,communication and energy disruption, and unethical individuals with thetechnological ability to cause disruptions or failures of the Company’s dataprocessing systems.

**TheCompany’s business strategy relies upon its Chief Executive Officer and otherkey employees.**

The Company is, and forthe foreseeable future will be, dependent upon the services of Kit M. Cole, whoserves as Chairman and Chief Executive Officer of the Company and Chairman ofthe Bank, Mark Garwood, who serves as President and Chief Executive Officer ofthe Bank, Michael Moulton, who serves Chief Financial Officer of the Companyand the Bank, and on the services of other senior officers retained 

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by theCompany. The loss of the services of Ms. Cole, Mr. Garwood, Mr. Moultonor other key employees could have a material adverse effect on The Company’soperations. See “MANAGEMENT.”

**TheCompany’s ability to service its debt, pay dividends, and otherwise pay itsobligations as they come due is substantially dependent on capitaldistributions from the Bank, and these distributions are subject to regulatorylimits and other restrictions.**

A substantial source ofthe Company’s funds from which it services its debt and pays its obligationsand dividends is the receipt of dividends from the Bank. The availability ofdividends from the Bank is limited by various statutes and regulations. It ispossible, depending upon the financial condition of the Bank, and otherfactors, that the applicable regulatory authorities could assert that paymentof dividends or other payments, including payments to the Company, is an unsafeor unsound practice. In the event the Bank is unable to pay dividends to the Company,the Company may not be able to service its debt, pay its obligations or paydividends on its outstanding common stock. The inability to receive dividendsfrom the Bank would adversely affect the Company’s business, financialcondition, results of operations and prospects.

**TheCompany is subject to extensive regulation which could adversely affect itsbusiness.**

The Company’s operationsare subject to extensive regulation by federal, state and local governmentalauthorities and are subject to various laws and judicial and administrativedecisions imposing requirements and restrictions on part or all of itsoperations. The Company believes that it is in substantial compliance in allmaterial respects with applicable federal, state and local laws, rules andregulations. Because the Company’s business is highly regulated, the laws, rules andregulations applicable to it are subject to regular modification and change.There are currently proposed various laws, rules and regulations that, ifadopted, would impact the Company’s operations. If these or any other laws, rules orregulations are adopted in the future, they could make compliance much moredifficult or expensive, restrict the Company’s ability to originate or sellloans, further limit or restrict the amount of commissions, interest or othercharges earned on loans originated or sold by the Company or otherwisematerially and adversely affect its business, financial condition, prospects orprofitability.

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***Item 2—Description of Property***

The following table setsforth information relating to each of Epic Bancorp’s offices as of December 31,2004:
|                                                 | ** ** | **Leased** | ** ** | **  Original Date  ** | ** ** | **Date of** | ** ** |
|-------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|------------------|------------|
| ** **                                      | ** ** | **Or**     | ** ** | **Leased or**                             | ** ** | **Lease**        | ** ** |
| ** **                                      | ** ** | **Owned**  | ** ** | **Acquired**                                   | ** ** | **Expiration**   | ** ** |
| **Administrative Offices:**                     |       |       |       |                                           |       |             |       |   |   |
| 4380 Redwood Hyw.  Suite A-1                    |       | Leased     |       |                                           | 2/27/2002  |             |       | 3/31/2005 |   |
| San Rafael,  California 94903                   |       |       |       |                                           |       |             |       |   |   |
| **Full Service Branch Offices Currently Open:** |       |       |       |                                           |       |             |       |   |   |
| 851 Irwin St.  Suite 100                        |       | Leased     |       |                                           | 8/18/1998  |             |       | 8/31/2008 |   |
| San Rafael,  California 94901                   |       |       |       |                                           |       |             |       |   |   |
| 453-455 Miller Ave.                             |       | Leased     |       |                                           | 5/1/2002   |             |       | 4/31/2012 |   |
| MillValley, California 94941                    |       |       |       |                                           |       |             |       |   |   |
| 575 Sir Francis Drake Blvd.                     |       | Leased     |       |                                           | 7/23/2002  |             |       | 7/31/2012 |   |
| Greenbrae,  California 94904                    |       |       |       |                                           |       |             |       |   |   |
| 100 Sir Francis Drake Blvd.                     |       | Leased     |       |                                           | 11/15/2002 |             |       | 11/15/2017 |   |
| San Anselmo, California  94960                  |       |       |       |                                           |       |             |       |   |   |
| 630 Las Gallinas Ave                            |       | Leased     |       |                                           | 12/17/2003 |             |       | 12/17/2013 |   |
| San Rafael,  California 94903                   |       |       |       |                                           |       |             |       |   |   |
| **Stand Alone ATM Machine**                     |       |       |       |                                           |       |             |       |   |   |
| 735 College Ave.                                |       | Leased     |       |                                           | 5/29/2003  |             |       | 5/29/2006 |   |
| Kentfield,  California 94904                    |       |       |       |                                           |       |             |       |   |   |
| **Full Service Branch Offices Not Yet Open:**   |       |       |       |                                           |       |             |       |   |   |
| 71 Casa Buena Dr                                |       | Leased     |       |                                           | 12/29/2003 |             |       | 12/29/2013 |   |
| Corte Madera, California  94925                 |       |       |       |                                           |       |             |       |   |   |

 

Management believes thatits existing facilities are adequate for its present needs and that the Company’sinsurance coverage on its properties is adequate.

***Item 3—LegalProceedings***

Epic Bancorp is not adefendant in any material pending legal proceedings and no such proceedings areknown to be contemplated. No director, officer, affiliate, more than 5%shareholder of Epic Bancorp or any associate of these persons is a partyadverse to Epic Bancorp or has a material interest adverse to Epic Bancorp inany material legal proceeding.

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

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

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**PART II**

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

On June 10, 2003, the Company filed aRegistration Statement with the Securities and Exchange Commission(Registration Statement No. 333-105991) with respect to a public offeringof the Company’s common stock at $13.00 per share. Of the 2,000,000 sharesoffered, 510,599 shares were sold by Epic Bancorp and 1,444,290 shares weresold by Community Bankshares, L.P., a limited partnership, of which Kit M.Cole, the Chairman/CEO of the Company is the CEO of the general partner, ColeFinancial Ventures, Inc. Community Bankshares elected to retain 45,111 ofits shares, which were subsequently distributed to its investors. The offeringraised $6.4 million in additional capital, net of fees and expenses, for theCompany.

On August 9, 2004, the Company’s Common Stock waslisted on the Nasdaq SmallCap Market under the symbol “EPIK”. Prior to thatdate the Company’s stock was not listed on a stock exchange.

Thefollowing table sets forth those trades since January 1, 2003 through August 8,2004 of which we have knowledge, including the quarter in which the tradesoccurred and the range of sales price per share:
| ** **     | ** ** | **Sales Price of  Common Stock** | ** ** |
|----------------|------------|-------------------------------------------------|------------|
| ** **     | ** ** | **High**                                        | ** ** | **Low** | ** ** |
| 2004           |       |                                            |       |   |   |
| First Quarter  |       | $                                               | 13.00      |   | $ | 13.00 |   |
| Second Quarter |       | —                                          |       | — |   |
| Third Quarter  |       | —                                          |       | — |   |
| 2003           |       |                                            |       |   |   |
| First Quarter  |       | $                                               | 10.00      |   | $ | 8.33 |   |
| Second Quarter |       | 10.00                                           |       | 10.00 |   |
| Third Quarter  |       | —                                          |       | — |   |
| Fourth Quarter |       | 13.00                                           |       | 13.00 |   |

 

Thefollowing table sets forth the low and high closing prices for the period from August9, 2004 through December 31, 2004.
| **Period**                       | ** ** | ** ** | ** ** | **Closing Prices** | ** ** |
|----------------------------------|------------|------------|------------|-------------------------|------------|
| ** **                       | ** ** | **Low**    | ** ** | **High**                | ** ** |
| August 10 to  September 30, 2004 |       | $          | 12.25      |                    | $          | 15.40 |   |
| Fourth Quarter 2004              |       | 14.35      |       | 16.70                   |       |
|                                  |            |            |            |                         |            |  |  |  |  |

 

**Holders**

As of February 28,2005, there were approximately 713 holders of the Company’s Common Stock. Thereare no other classes of equity outstanding.

**Dividends**

The Company initiated a cash dividend program in 2004.The Company paid four $0.025 per share cash dividends in 2004. In addition, theCompany declared a $0.03 per share cash dividend in the first quarter of 2005. Priorto 2004, Epic Bancorp has paid only one cash dividend of $0.05 per share, whichwas payable in April, 2001. The Company’s primary source of income is dividendsfrom the Bank, and the Bank is subject to certain regulatory restrictions whichmay limit its ability to pay dividends to the Company (See Item 1. Business;Supervision and Regulation; Dividends and Other Transfer of Funds.)

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Thefollowing chart provides information as of December 31, 2004 concerningthe Bank’s Stock Option Plans, the Bank’s only equity compensation plans: 
| ** **                                                       | ** ** | **Number of  securities to be  issued upon exercise  of outstanding  options, warrants,  and rights** | ** ** | **Weighted-  average exercise  price of  outstanding  options, warrants  and rights** | ** ** | **Number of securities  remaining available for  future issuance under   equity compensation plans  (excluding securities  reflecting in column(a)** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **(a)**                                                                                                                                       | ** ** | **(b)**                                                                                                   | ** ** | **(c)**                                                                                                                                                                                                          | ** ** |
| Plan Category                                                    |       |                                                                                                                                          |       |                                                                                                      |       |                                                                                                                                                                                                             |       |   |   |   |   |   |   |
| Equity  compensation plans approved by security holders:         |       |                                                                                                                                          |       |                                                                                                      |       |                                                                                                                                                                                                             |       |   |   |   |   |   |   |
| 1997 Incentive Stock Option Plan                                 |       |                                                                                                                                          | 329,227    |                                                                                                      |       |                                                                                                                                                                                                             | 10.45      |   |   |   | 85,378 |   |   |
| 2003 Non-Employee Directors’ Stock Option Plan              |       |                                                                                                                                          | 66,000     |                                                                                                      |       |                                                                                                                                                                                                             | 12.18      |   |   |   | — |   |   |
| Equity compensation plans not approved by security  holders |       |                                                                                                                                          | —     |                                                                                                      |       |                                                                                                                                                                                                             | N/A        |   |   |   | — |   |   |
| Total                                                            |       |                                                                                                                                          | 395,227    |                                                                                                      |       |                                                                                                                                                                                                             | 10.74      |   |   |   | 85,378 |   |   |

 

 

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***Item 6***—Management’sDiscussion and Analysis 

**Overview**

The Company is a California corporation formerly knownas San Rafael Bancorp. The Company’s principal asset is the common stock of theBank, a California-chartered industrial bank, headquartered in San Rafael,California. In January 2005 the Company created a new subsidiary, EpicWealth Management, offering registered investment advisory services primarilyin the Bank’s Marin County marketplace. The Company is dedicated torelationship banking and the success of its customers. The Company caters tothe needs of high net worth individuals and small-to-mid-size commercialbusinesses and to property owner/investors. The Company attracts deposits fromthe Marin County community by offering convenience, a friendly differentiatedbranch environment, competitive interest rate products and providingvalue-added consumer services. The Company also strives to add value for itsshareholders by optimizing its net interest margin and expanding the volume ofits earning assets. In the past four years, the Company has grownsignificantly; however, its business is subject to various risks which arediscussed in “Business; Factors That May Affect Future Results ofOperations” in Item 1 hereof.

Based on historical results and current economicforecasts, management anticipates that the Company will continue to grow in2005. However, due to risk factors that are beyond the control of the Company,actual results could differ from management’s estimates.

Management’s discussion andanalysis of financial condition and results of operations is intended toprovide a better understanding of the significant changes in trends relating tothe Company’s financial condition, results of operations, liquidity andinterest rate sensitivity. The following discussion and analysis should be readin conjunction with the Consolidated Financial Statements of the Company.

**Critical Accounting Policies**

Our accounting policiesare integral to understanding the results reported. Our most complex accountingpolicies require management’s judgment to ascertain the valuation of assets,liabilities, commitments and contingencies. We have established detailedpolicies and control procedures that are intended to ensure valuation methodsare well controlled and applied consistently from period to period. Inaddition, the policies and procedures are intended to ensure that the processfor changing methodologies occurs in an appropriate manner. The following is abrief description of our current accounting policies involving significantmanagement valuation judgments.

*Allowance for LoanLosses.*

The allowance for loan losses represents management’sbest estimate of losses inherent in the existing loan portfolio. The allowancefor loan losses is increased by the provision for loan losses charged toexpense and reduced by loans charged-off, net of recoveries.

We evaluate our allowance for loan loss on a monthlybasis. We believe that the allowance for loan loss is a “critical accountingestimate” because it is based upon management’s assessment of various factorsaffecting the collectibility of the loans, including current and projectedeconomic conditions, past credit experience, delinquency status, the value ofthe underlying collateral, if any, and a continuing review of the portfolio ofloans and commitments.

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We determine theappropriate level of the allowance for loan losses, primarily on an analysis ofthe various components of the loan portfolio, including all significant creditson an individual basis. We segment the loan portfolios into as many componentsas practical. Each component would normally have similar characteristics, suchas risk classification, past due status, type of loan, industry or collateral. Weanalyze the following components of the portfolio and provide for them in theallowance for loan losses:

·       Allsignificant credits on an individual basis that are classified doubtful.

·       Allother significant credits reviewed individually. If no allocation can bedetermined for such credits on an individual basis, they shall be provided fora part of an appropriate pool.

·       Allother loans that are not included by our credit grading system in thepopulation of loans reviewed individually, but are delinquent or are classifiedor designated special mention (e.g. pools of smaller delinquent, specialmention and classified commercial and industrial, Real Estate Loans).

·       Homogenousloans that have not been reviewed individually, or are not delinquent,classified, or designated as special mention (e.g. pools of real estatemortgages).

·       Allother loans that have not been considered or provided for elsewhere (e.g. poolsof commercial and industrial loans that have not been reviewed, classified, ordesignated special mention, standby letters of credit, and other off-balancesheet commitments to lend).

No assurance can be giventhat further economic difficulties or other circumstances which would adverselyaffect our borrowers and their ability to repay outstanding loans will notoccur, which would be reflected in increased losses in our loan portfolio andwhich losses could possibly exceed the amount then reserved for loan losses.

*Available for SaleSecurities.*

SFAS 115 requires thatAvailable for Sale securities be carried at fair value. We believe this is a “criticalaccounting estimate” in that the fair value of a security is based on quotedmarket prices or if quoted market prices are not available, fair values areextrapolated from the quoted prices of similar instruments. Adjustments to theavailable for sale securities fair value impact the consolidated financialstatements by increasing or decreasing assets and stockholders’ equity.

*Deferred TaxAssets.*

Deferred income taxesreflect the estimated future tax effects of temporary differences between thereported amount of assets and liabilities for financial reporting purposes andsuch amounts as measured by tax laws and regulations. We use an estimate offuture earnings to support our position that the benefit of our deferred taxassets will be realized. If future income should prove non-existent or lessthan the amount of the deferred tax assets within the tax years to which theymay be applied, the asset may not be realized and our net income will bereduced.

**General**

The consolidated Company is comprised of two entitiesas of December 31, 2004, the parent company, Epic Bancorp, formerly SanRafael Bancorp, (the “Company”) and its wholly owned subsidiary, Tamalpais Bank(the “Bank”). San Rafael Capital Trust I (the “Trust”) is a wholly ownedunconsolidated subsidiary that was formed during 2002 for the purpose ofenabling the Company to issue junior subordinated debentures trust preferredsecurities and accordingly, the investment activities related to the issuance,investment and debt service payments associated with the $10.3 million of trustpreferred securities are so 

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reflected. The Bankrepresents substantially all of the operational activities of the Company, andaccordingly, the discussion and analysis of the Bank and Company aresubstantially the same.

At the 2004 Annual Meeting of Shareholders of SanRafael Bancorp, held on June 21, 2004, the shareholders of San RafaelBancorp voted to approve an amendment to San Rafael Bancorp’s Articles ofIncorporation changing San Rafael Bancorp’s name to Epic Bancorp. The Board ofDirectors of the Company recommended the name change to reflect a broader reachthan is associated with a single geographic area.

In January 2005, Epic Bancorp established EpicWealth Management, a new subsidiary offering registered investment advisoryservices to the Bank’s clients and to the general Marin County marketplace. EpicWealth Management was initially capitalized by a $100,000 capital infusion byEpic Bancorp. Additional capital infusions to Epic Wealth Management from EpicBancorp totaled $125,000 in February 2005 and $179,000 in March 2005,for a total capital infusion of $404,000 through March 24, 2005. BecauseEpic Wealth was not in operation during 2004, the accompanying financialstatements and financial data does not include the results of Epic WealthManagement.

For the year ended December 31, 2004 we reported,on a consolidated basis, net income of $3,448,000 as compared to $2,798,000 for2003. Basic earnings per share were $0.97 for 2004 as compared to $0.89 for2003. Diluted earnings per share were $0.94 for 2004 as compared to $0.87 for2003

The increase in netincome and basic and fully diluted earnings per share in 2004 over the prioryear period was primarily the result of several factors:

·       In2004 net interest income increased by $2,853,000 (26%) over 2003, primarily asa result of a 32% increase in the amount of average earning assets.

·       In2004 noninterest income increased by $254,000 (45%) over 2003, primarily as aresult of a $336,000 increase in the gain on sale of loans associated with thesale of the government guaranteed portion of Small Business Administrationloans during 2004.

Partially offsetting these items, which had a positiveimpact on net income, was an increase in noninterest expense. Noninterestexpense in 2004 increased $2,378,000 (37%) over 2003 primarily to due toincreased staff and facilities, and costs associated with the capital offeringcompleted in the first quarter of 2004 and listing the Company’s stock on theNASDAQ Small Cap Market. Income tax expense decreased by $12,000 due to theadoption of certain federal tax deductions.

As of December 31, 2004, consolidated totalassets were $425,610,000 as compared to $301,961,000 at December 31, 2003,which represents an increase of approximately 41%. Net loans increased$79,232,000 from $246,418,000 at December 31, 2003 to $325,651,000 at December 31,2004 which represents an increase of approximately 32%. Total investmentsecurities increased by $43,984,000 from $18,907,000 at December 31, 2003to $62,891,000 at December 31, 2004 which represents an increase ofapproximately 233%. Total deposits increased $62,994,000 from $211,626,000 at December 31,2003 to $274,620,000 at December 31, 2004 which represents an increase ofapproximately 30%. Stockholders’ equity increased $9,301,000 from $13,874,000as of December 31, 2003 to $23,175,000 as of December 31, 2004 whichrepresents an increase of approximately 67%.

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Thefollowing table presents summary financial information at or for the periodsindicated:
| ** **                                          | ** ** | **At or For the Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                                                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)**                                         | ** ** |
| **Financial Condition Data:**                       |       |                                                                         |       |   |   |   |   |
| Total assets                                        |       | $                                                                            | 425,610    |   | $ | 301,961 |   | $ | 268,133 |   |
| Available for  sale securities                      |       | 22,040                                                                       |       | — |   | 37,657 |   |
| Held to maturity  securities                        |       | 40,851                                                                       |       | 18,907 |   | 35,628 |   |
| Federal Home Loan  Bank restricted stock            |       | 6,934                                                                        |       | 3,609 |   | 4,333 |   |
| Pacific Coast  Bankers’ Bank restricted stock  |       | 50                                                                           |       | 50 |   | 50 |   |
| Loans receivable, net of allowance for loan losses  |       | 325,651                                                                      |       | 246,418 |   | 174,947 |   |
| Deposits                                            |       | 274,620                                                                      |       | 211,626 |   | 175,904 |   |
| Federal Home Loan  Bank advances                    |       | 115,781                                                                      |       | 65,101 |   | 69,869 |   |
| Junior  Subordinated Debentures                     |       | 10,310                                                                       |       | 10,310 |   | 10,310 |   |
| Other borrowings                                    |       | —                                                                       |       | — |   | — |   |
| Total  stockholders’ equity                    |       | 23,175                                                                       |       | 13,874 |   | 11,014 |   |
| **Statement of Operations Data:**                   |       |                                                                         |       |   |   |   |   |
| Interest income                                     |       | $                                                                            | 21,602     |   | $ | 17,451 |   | $ | 13,187 |   |
| Interest expense                                    |       | 7,602                                                                        |       | 6,303 |   | 5,410 |   |
| Net interest  income                                |       | 14,000                                                                       |       | 11,148 |   | 7,777 |   |
| Provision for  loan losses                          |       | 874                                                                          |       | 784 |   | 597 |   |
| Net interest income after provision for loan losses |       | 13,126                                                                       |       | 10,364 |   | 7,180 |   |
| Noninterest  income                                 |       | 814                                                                          |       | 560 |   | 1,028 |   |
| Noninterest  expenses(4)                            |       | 8,783                                                                        |       | 6,405 |   | 4,798 |   |
| Income (loss)  before income tax expense (benefit)  |       | 5,157                                                                        |       | 4,519 |   | 3,410 |   |
| Income tax  expense (benefit)                       |       | 1,709                                                                        |       | 1,721 |   | 1,340 |   |
| Net income (loss)                                   |       | $                                                                            | 3,448      |   | $ | 2,798 |   | $ | 2,070 |   |
| **Per  Share Data:**                                |       |                                                                         |       |   |   |   |   |
| Earnings (loss)  per share—Basic               |       | $                                                                            | 0.97       |   | $ | 0.89 |   | $ | 0.66 |   |
| Earnings (loss)  per share—Diluted             |       | 0.94                                                                         |       | 0.87 |   | 0.65 |   |
| Common shares  outstanding at end of period         |       | 3,665,702                                                                    |       | 3,136,957 |   | 3,128,739 |   |
| Book value per  share                               |       | $                                                                            | 6.32       |   | $ | 4.42 |   | $ | 3.52 |   |
| **Performance  Ratios and Other Data:**             |       |                                                                         |       |   |   |   |   |
| Return on average  assets                           |       | 0.90                                                                         | %          | 0.97 | % | 1.03 | % |
| Return on average  stockholders equity              |       | 17.2                                                                         | %          | 22.2 | % | 20.5 | % |
| Efficiency ratio                                    |       | 59.3                                                                         | %          | 54.7 | % | 54.5 | % |
| **Tamalpais  Bank Capital Ratios:**                 |       |                                                                         |       |   |   |   |   |
| Tier 1 risk based  capital                          |       | 10.0                                                                         | %          | 9.1 | % | 11.0 | % |
| Total risk based  capital                           |       | 11.0                                                                         | %          | 10.2 | % | 12.1 | % |
| Tier 1 leverage capital                             |       | 8.1                                                                          | %          | 7.5 | % | 7.5 | % |

 

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**Distribution ofAssets, Liabilities and Stockholders’ Equity**

The following tablepresents the average amounts outstanding for the major categories of our assetsand liabilities, the amount of interest income and expense, the averageinterest rates earned or paid and the net yield on average interest-earningassets for the periods indicated:

**EPIC BANCORP ANDSUBSIDIARIESAverage Balance Sheets (Unaudited)**
| ** **                                                  | ** ** | **For the Year Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2004**                                                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                  | ** ** | ** **                                                   | ** ** | **Interest** | ** ** | **Yields** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Yields** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Yields** | ** ** |
| ** **                                                  | ** ** | **Average**                                                  | ** ** | **Income/** | ** ** | **Earned/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Earned/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Earned/** | ** ** |
| ** **                                                  | ** ** | **Balance**                                                  | ** ** | **Expense** | ** ** | **Paid** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Paid** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Paid** | ** ** |
| ** **                                                  | ** ** | **(dollars in thousands)**                         | ** ** |
| Assets                                                      |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment  securities—taxable(1)                      |       | $                                                            | 64,113     |   | $ | 2,068 |   |   | 3.23 | % |   | $ | 55,516 |   | $ | 1,567 |   |   | 2.82 | % |   | $ | 26,007 |   | $ | 820 |   |   | 3.15 | % |   |
| Other investments                                           |       | 6,728                                                        |       | 256 |   |   | 3.80 | % |   | 6,684 |   | 178 |   |   | 2.66 | % |   | 4,594 |   | 139 |   |   | 3.03 | % |   |
| Interest bearing  deposits in other financial  institutions |       | 3,485                                                        |       | 78 |   |   | 2.24 | % |   | 4,500 |   | 166 |   |   | 3.68 | % |   | 10,428 |   | 360 |   |   | 3.45 | % |   |
| Federal funds sold                                          |       | 7,114                                                        |       | 95 |   |   | 1.34 | % |   | 2,156 |   | 22 |   |   | 1.04 | % |   | 7,088 |   | 113 |   |   | 1.59 | % |   |
| Loans(2)                                                    |       | 291,999                                                      |       | 19,106 |   |   | 6.54 | % |   | 215,041 |   | 15,518 |   |   | 7.22 | % |   | 146,956 |   | 11,755 |   |   | 8.00 | % |   |
| Total Interest  Earning Assets                              |       | 373,439                                                      |       | 21,603 |   |   | 5.78 | % |   | 283,897 |   | 17,450 |   |   | 6.15 | % |   | 195,073 |   | 13,187 |   |   | 6.76 | % |   |
| Allowance for loan  losses                                  |       | (3,158                                                       | )          |   |   |   |   |   |   | (2,324 | ) |   |   |   |   |   |   | (1,592 | ) |   |   |   |   |   |   |
| Cash and due from  banks                                    |       | 4,894                                                        |       |   |   |   |   |   |   | 2,671 |   |   |   |   |   |   |   | 3,503 |   |   |   |   |   |   |   |
| Net premises,  furniture and equipment                      |       | 2,300                                                        |       |   |   |   |   |   |   | 1,489 |   |   |   |   |   |   |   | 1,607 |   |   |   |   |   |   |   |
| Other assets                                                |       | 4,438                                                        |       |   |   |   |   |   |   | 3,211 |   |   |   |   |   |   |   | 2,048 |   |   |   |   |   |   |   |
| Total Assets                                                |       | $                                                            | 381,913    |   |   |   |   |   |   |   | $ | 288,944 |   |   |   |   |   |   |   | $ | 200,639 |   |   |   |   |   |   |   |
| Liabilities and  Shareholders’ Equity                  |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  checking                                  |       | $                                                            | 6,368      |   | 42 |   |   | 0.66 | % |   | $ | 5,833 |   | 48 |   |   | 0.82 | % |   | $ | 4,300 |   | 44 |   |   | 1.02 | % |   |
| Savings  deposits(3)                                        |       | 93,671                                                       |       | 1,463 |   |   | 1.56 | % |   | 79,579 |   | 1,241 |   |   | 1.56 | % |   | 60,667 |   | 1,357 |   |   | 2.24 | % |   |
| Time deposits                                               |       | 123,492                                                      |       | 2,916 |   |   | 2.36 | % |   | 105,742 |   | 2,943 |   |   | 2.78 | % |   | 76,496 |   | 2,672 |   |   | 3.49 | % |   |
| Other borrowings                                            |       | 110,571                                                      |       | 2,635 |   |   | 2.38 | % |   | 65,403 |   | 1,553 |   |   | 2.37 | % |   | 38,395 |   | 1,050 |   |   | 2.73 | % |   |
| Junior  Subordinated Debentures                             |       | 10,310                                                       |       | 546 |   |   | 5.30 | % |   | 10,310 |   | 518 |   |   | 5.02 | % |   | 5,385 |   | 287 |   |   | 5.33 | % |   |
| Total Interest  Bearing Liabilities                         |       | 344,412                                                      |       | 7,602 |   |   | 2.21 | % |   | 266,867 |   | 6,303 |   |   | 2.36 | % |   | 185,243 |   | 5,410 |   |   | 2.92 | % |   |
| Noninterest  deposits                                       |       | 11,680                                                       |       |   |   |   |   |   |   | 6,937 |   |   |   |   |   |   |   | 3,985 |   |   |   |   |   |   |   |
| Other liabilities                                           |       | 5,765                                                        |       |   |   |   |   |   |   | 2,560 |   |   |   |   |   |   |   | 1,335 |   |   |   |   |   |   |   |
| Total Liabilities                                           |       | 361,857                                                      |       |   |   |   |   |   |   | 276,364 |   |   |   |   |   |   |   | 190,563 |   |   |   |   |   |   |   |
| Shareholders’  Equity                                  |       | 20,056                                                       |       |   |   |   |   |   |   | 12,580 |   |   |   |   |   |   |   | 10,076 |   |   |   |   |   |   |   |
| Total Liabilities  and Shareholders’ Equity            |       | $                                                            | 381,913    |   |   |   |   |   |   |   | $ | 288,944 |   |   |   |   |   |   |   | $ | 200,639 |   |   |   |   |   |   |   |
| Net interest  income                                        |       |                                                         |       | $ | 14,001 |   |   |   |   |   |   |   | $ | 11,148 |   |   |   |   |   |   |   | $ | 7,777 |   |   |   |   |   |
| Net interest  spread(4)                                     |       |                                                         |       |   |   |   | 3.57 | % |   |   |   |   |   |   | 3.79 | % |   |   |   |   |   |   | 3.84 | % |   |
| Net interest  margin(5)                                     |       |                                                         |       |   |   |   | 3.75 | % |   |   |   |   |   |   | 3.93 | % |   |   |   |   |   |   | 3.99 | % |   |

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(1)             The yields for securities were computed using theaverage amortized cost and therefore do not give effect for changes in fairvalue.

(2)             Loans, net of unearned income, includenon-accrual loans but do not reflect average reserves for possible loan losses.

(3)             Savings deposits include Money Marketaccounts.

(4)             Net interest spread is the interestdifferential between total interest earning assets and total interest-bearingliabilities.

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(5)             Net interest margin is the net yield onaverage interest earning assets.

**Net Interest Income and Net Yield**

Our earnings dependlargely upon the difference between the interest income we receive from ourloan portfolio, investment securities, and other earning assets and theinterest paid on our liabilities, including interest paid on deposits and anyborrowings and/or debentures. This difference is net interest income. Netinterest income, when expressed as a percentage of average totalinterest-earning assets, is referred to as the net yield on interest-earningassets. Our net interest income is affected by the change in the level and themix of interest-earning assets and interest-bearing liabilities, referred to asvolume changes. Our net yield on interest-earning assets is also affected bychanges in the yields earned on assets and rates paid on liabilities, referredto as rate changes. Interest rates charged on our loans are affectedprincipally by the demand for such loans, the supply of money available forlending purposes and competitive factors. These factors are in turn affected bygeneral economic conditions and other events beyond our control, including themonetary policies of the Federal Reserve.

For the year end ended December 31, 2004, netinterest income was $14,001,000 versus $11,148,000 for the year ended December 31,2003 an increase of 26%. Average interest-earning assets were $381,913,000 forthe year ending December 31, 2004 versus $288,944,000 for the year ended December 31,2003, an increase of $92,969,000 or 32%. Average loans increased to$291,999,000 in 2004 versus $215,041,000 in 2003, an increase of $76,958,000 or36%. Average investment securities increased to $64,113,000 in 2004 versus$55,516,000 in 2003, an increase of 15%. Average interest-bearing liabilitieswere $361,857,000 for the year ending December 31, 2004 versus$276,364,000 for the year ended December 31, 2003, an increase of$85,493,000 or 31%. Average interest bearing deposits increased to $223,531,000in 2004 versus $191,154,000 in 2003, an increase of $32,377,000 or 17%. Averageother borrowings were $110,571,000 for the year ending December 31, 2004versus $65,403,000 for the year ended December 31, 2003, an increase of$45,168,000 or 69%.

The yield on interest-earning assets was 5.78% and theaverage cost of interest-bearing liabilities was 2.21% for the year ended December 31,2004. This resulted in the net yield (margin) on interest-earning assets of3.75%. The yield on interest-earning assets was 6.15% and the average cost ofinterest-bearing liabilities was 2.36% for the year ended December 31,2003. This resulted in the net yield (margin) on interest-earning assets of3.93% in 2003.

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Thefollowing table sets forth changes in interest income and interest expense foreach major category of average interest-earning assets and interest-bearingliabilities, and the amount of change attributable to volume and rate changesfor the years indicated. Changes not solely attributable to volume or rate havebeen allocated to volume and rate changes in proportion to the relationship ofthe absolute dollar amounts of the changes in each.
| ** **                                  | ** ** | **Year ended December 31, 2004**                               | ** ** | **Year ended December 31, 2003**                             | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Compared to Year ended December 31, 2003**         | ** ** | **Compared to Year ended December 31, 2002**       | ** ** |
| ** **                                  | ** ** | **      Volume      ** | ** ** | **      Rate      ** | ** ** | **      Total      ** | ** ** | **      Volume      ** | ** ** | **      Rate      ** | ** ** | **      Total      ** | ** ** |
| ** **                                  | ** ** | **(Dollars in Thousands)**                                               | ** ** |
| Increase/(decrease) in  Interest Income     |       |                                                                               |       |                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment securities                       |       |                                                                               | $          | 261                                                                              |       |   |   | $ | 240 |   |   |   | $ | 501 |   |   |   | $ | 841 |   |   |   | $ | (94 | ) |   |   | $ | 747 |   |   |
| Other investments                           |       |                                                                               | 1          |                                                                             |       |   | 77 |   |   |   | 78 |   |   |   | 57 |   |   |   | (18 | ) |   |   | 39 |   |   |
| Interest-bearing deposits                   |       |                                                                               | (32        | )                                                                                |       |   | (56 | ) |   |   | (88 | ) |   |   | (217 | ) |   |   | 23 |   |   |   | (194 | ) |   |
| Federal Funds Sold                          |       |                                                                               | 64         |                                                                             |       |   | 9 |   |   |   | 73 |   |   |   | (60 | ) |   |   | (31 | ) |   |   | (91 | ) |   |
| Loans                                       |       |                                                                               | 5,143      |                                                                             |       |   | (1,554 | ) |   |   | 3,589 |   |   |   | 5,006 |   |   |   | (1,243 | ) |   |   | 3,763 |   |   |
|                                        |       |                                                                               | 5,437      |                                                                             |       |   | (1,284 | ) |   |   | 4,153 |   |   |   | 5,627 |   |   |   | (1,363 | ) |   |   | 4,264 |   |   |
|                                        |       |                                                                               |       |                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Increase/(decrease) in Interest  Expense    |       |                                                                               |       |                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing checking                   |       |                                                                               | 4          |                                                                             |       |   | (10 | ) |   |   | (6 | ) |   |   | 14 |   |   |   | (10 | ) |   |   | 4 |   |   |
| Savings deposits                            |       |                                                                               | 220        |                                                                             |       |   | 2 |   |   |   | 222 |   |   |   | 358 |   |   |   | (474 | ) |   |   | (116 | ) |   |
| Time Deposits                               |       |                                                                               | 455        |                                                                             |       |   | (482 | ) |   |   | (27 | ) |   |   | 886 |   |   |   | (615 | ) |   |   | 271 |   |   |
| FHLB and other borrowings              |       |                                                                               | 1,077      |                                                                             |       |   | 6 |   |   |   | 1,083 |   |   |   | 658 |   |   |   | (154 | ) |   |   | 504 |   |   |
| Trust Preferred Securities                  |       |                                                                               | 0          |                                                                             |       |   | 28 |   |   |   | 28 |   |   |   | 248 |   |   |   | (17 | ) |   |   | 231 |   |   |
|                                        |       |                                                                               | 1,756      |                                                                             |       |   | (456 | ) |   |   | 1,300 |   |   |   | 2,164 |   |   |   | (1,270 | ) |   |   | 894 |   |   |
| Increase/(decrease) in Net  Interest Income |       |                                                                               | $          | 3,681                                                                            |       |   |   | $ | (828 | ) |   |   | $ | 2,853 |   |   |   | $ | 3,463 |   |   |   | $ | (93 | ) |   |   | $ | 3,370 |   |   |

 

**NoninterestIncome**

In 2004 non-interest income was $814,000, representingan increase of $254,000 or 45% from the 2003 amount of $560,000. The increasewas primarily attributed to a $3.1 million sale of the government guaranteedportion of six Small Business Administration (SBA) loans that generated a netgain of $343,000. There were no SBA loan sales in 2003. Partially offsettingthis gain was a $42,000 loss on sale of securities, as compared to a $218,000gain on sale of securities in 2003.

The Company began an SBAdepartment in the beginning of 2004 as a means to increase noninterest andinterest income. The Company anticipates that it will sell substantially all ofthe government guaranteed portion of SBA loans that it originates in 2005 as ameans of producing income to offset the personnel costs associated with the SBAdepartment. However, due to the length of time necessary to process, approve,and fund SBA loans and due to uncertain future volumes, the Company makes noassurance that it will be able to fund and sell a significant volume of SBAloans in 2005.

**NoninterestExpense**

Noninterest expense in 2004 increased $2,378,000 or37% to $8,783,000 from the 2003 amount of $6,404,000. The increases in allconsolidated expense classifications are attributable to our growth. The majorcontributing items to this increase were salaries and benefits increasing$1,366,000 or 37%, occupancy expenses increasing $412,000 or 70%, professionalservices increasing $171,000 or 62%, and 

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other administrativeexpense increasing $355,000 or 32%. The increases were due to the opening oftwo new full-service branches earlier in 2004, increases in the number of staffand the level of salaries and benefits packages, a general increase in thevolume of business at each of the offices, and costs associated with listingthe Company’s stock on the NASDAQ Small Cap market.

In 2004 we hired additional staff for our new SmallBusiness Administration lending program and for two new retail branches. Inaddition, we incurred additional occupancy and equipment expenses for our newbranches and for additional back office space. Although these expenses areessential in increasing our market share, many of these expenses have beenincurred before the revenue associated with the new operations has beenrecorded, and there is a risk that new operations will not produce the plannedlevel of revenue.

In 2004 the Company incurred substantial costsassociated with the capital offering completed during the first quarter of 2004and costs associated with listing the Company’s stock on the NASDAQ Small Capmarket. The $171,000 increase in professional services was primarily attributableto legal and accounting services associated with these efforts. Although thesecosts are not expected to recur, substantial new professional services expensesassociated with the implementation of Sarbanes Oxley legislation are expectedover the next several years.

Thefollowing table sets forth information regarding our noninterest expenses forthe periods shown.
| ** **                  | ** ** | ** **                            | ** ** | ** **     | ** ** | **Increase/**  | ** ** | **Increase/** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                  | ** ** | **For the Year Ended** | ** ** | **(decrease)** | ** ** | **(decrease)** | ** ** |
| ** **                  | ** ** | **2004**                              | ** ** | **2003**       | ** ** | **amount**     | ** ** | **percent**   | ** ** |
| ** **                  | ** ** | **(Dollars in thousands)**  | ** ** |
| Salaries and  benefits      |       | $                                     | 5,052      |           | $          | 3,687          |       |          | $          | 1,365 |   |   |   | 37.0 | % |   |
| Occupancy                   |       | 999                                   |       | 588            |       |           | 411        |          |       |   | 69.9 | % |   |
| Advertising                 |       | 297                                   |       | 331            |       |           | (34        | )             |       |   | -10.3 | % |   |
| Professional                |       | 446                                   |       | 275            |       |           | 171        |          |       |   | 62.2 | % |   |
| Data processing             |       | 248                                   |       | 185            |       |           | 63         |          |       |   | 34.1 | % |   |
| Equipment and  depreciation |       | 276                                   |       | 230            |       |           | 46         |          |       |   | 20.0 | % |   |
| Other  administrative       |       | 1,465                                 |       | 1,109          |       |           | 356        |          |       |   | 32.1 | % |   |
| Total                       |       | $                                     | 8,783      |           | $          | 6,405          |       |          | $          | 2,378 |   |   |   | 37.1 | % |   |

 

**IncomeTaxes**

Income tax expense in 2004 amounted to $1,709,000,which was a decrease of $12,000 or 1% under the $1,721,000 incurred for 2003.In 2004 the Company recorded a recovery of $82,000 due to the collection of a$309,000 refund from the State of California for amended prior period taxreturns to take advantage of the California Enterprise Zone net interest incomededuction. In 2004 the Company recognized a Federal tax write-off of $587,479for unamortized deferred costs on all loans originated from January 22,2002 through December 31, 2004. At the Company’s marginal Federal tax rateof 34%, the tax recovery from this deduction was $199,743. Also in 2004, theCompany recognized a Federal tax write-off of $181,891 for prepaid assets as ofDecember 31, 2004 that are scheduled to fully amortize in the next twelvemonths. At the Company’s marginal Federal tax rate is 34%, the tax recoveryfrom this deduction was be $61,843.

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**Loans**

Thefollowing table sets forth components of total net loans outstanding in eachcategory at the dates indicated:
| ** **                                              | ** ** | **At December 31,**        | ** ** |
|---------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                              | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                              | ** ** | **(Dollars in thousands)** | ** ** |
| One-to-four  family residential                         |       | $                                    | 13,878     |   | $ | 11,403 |   | $ | 14,294 |   | $ | 6,988 |   | $ | 4,087 |   |
| Multifamily  residential                                |       | 126,099                              |       | 97,941 |   | 65,488 |   | 39,025 |   | 34,361 |   |
| Commercial real  estate                                 |       | 147,357                              |       | 112,217 |   | 71,076 |   | 54,862 |   | 38,269 |   |
| Land                                                    |       | 9,150                                |       | 8,039 |   | 8,572 |   | 8,112 |   | 8,723 |   |
| Construction real  estate                               |       | 9,157                                |       | 12,071 |   | 10,651 |   | 9,113 |   | 2,638 |   |
| Consumer loans                                          |       | 3,925                                |       | 2,318 |   | 2,309 |   | 1,420 |   | 192 |   |
| Commercial, non  real estate                            |       | 17,746                               |       | 3,780 |   | 3,657 |   | 3,796 |   | 4,603 |   |
| **Total  gross loans**                                  |       | 327,312                              |       | 247,769 |   | 176,047 |   | 123,316 |   | 92,873 |   |
| Net deferred loan  costs                                |       | 1,939                                |       | 1,375 |   | 842 |   | 389 |   | 288 |   |
| **Total  loans receivable, net of deferred loan costs** |       | 329,251                              |       | 249,144 |   | 176,889 |   | 123,705 |   | 93,161 |   |
| Allowance for  loan losses                              |       | (3,600                               | )          | (2,726 | ) | (1,942 | ) | (1,345 | ) | (1,022 | ) |
| **Loans receivable, net**                               |       | $                                    | 325,651    |   | $ | 246,418 |   | $ | 174,947 |   | $ | 122,360 |   | $ | 92,139 |   |

 

Real estate construction loans are primarily interimloans to finance the construction of commercial and single family residentialproperty. These loans are typically short-term. Other real estate loans consistprimarily of loans made based on the borrower’s cash flow and which are securedby deeds of trust on commercial and residential property to provide anothersource of repayment in the event of default. Maturities on real estate loansother than construction loans are generally restricted to fifteen years (on anamortization of thirty years with a balloon payment due in fifteen years). Anyloans extended for greater than five years generally have re-pricing provisionsthat adjust the interest rate to market rates at times prior to maturity.

Commercial and industrial loans are made for thepurpose of providing working capital, financing the purchase of equipment, orfor other business purposes. Such loans include loans with maturities rangingfrom one to five years.

Consumer loans are made for the purpose of financingvarious types of consumer goods and other personal purposes. Consumer loansgenerally provide for the monthly payment of principal and interest.

Outstanding loan commitments at December 31, 2004and December 31, 2003 primarily consisted of undisbursed constructionloans and commitments to originate commercial real estate and multifamily loans.Based upon past experience, the outstanding loan commitments and standbyletters of credit are expected to grow throughout the year as loan demandcontinues to increase, subject to economic conditions. We do not have anyconcentrations in our loan portfolio by industry or group of industries, exceptthat as of December 31, 2004 and December 31, 2003, approximately93.4% and 97.5%, respectively, of our loans were secured by real estate. TheCompany has pursued a strategy emphasizing multifamily and commercial realestate loans over the last several years and seeks real estate collateral whenpossible.

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Thefollowing table sets forth the maturity distribution of our loans outstandingas of December 31, 2004 and December 31, 2003. At that date, we hadno loans with maturity greater than thirty years.
| ** **                      | ** ** | **At December 31, 2004** | ** ** |
|---------------------------------|------------|-----------------------------------------|------------|
| ** **                      | ** ** | **Maturing  Within  One Year**     | ** ** | **Maturing  One to   Five Years ** | ** ** | **Maturing  After  Five Years** | ** ** | **Total** | ** ** |
| ** **                      | ** ** | **(Dollars in Thousands)**    | ** ** |
| One-to-four  family residential |       | $                                       | 719        |   |   | $ | 342 |   |   | $ | 12,817 |   | $ | 13,878 |   |
| Multifamily  residential        |       | —                                  |       |   | 3,765 |   |   | 122,334 |   | 126,099 |   |
| Commercial real  estate         |       | 1,270                                   |       |   | 4,562 |   |   | 141,525 |   | 147,357 |   |
| Land                            |       | 2,890                                   |       |   | 5,467 |   |   | 793 |   | 9,150 |   |
| Construction real  estate       |       | 8,939                                   |       |   | 218 |   |   | — |   | 9,157 |   |
| Consumer loans                  |       | 2,558                                   |       |   | 1,367 |   |   | — |   | 3,925 |   |
| Commercial, non  real estate    |       | 11,850                                  |       |   | 1,262 |   |   | 4,634 |   | 17,746 |   |
| Total                           |       | $                                       | 28,226     |   |   | $ | 16,983 |   |   | $ | 282,103 |   | $ | 327,312 |   |

 
| ** **                      | ** ** | **At December 31, 2003** | ** ** |
|---------------------------------|------------|-----------------------------------------|------------|
| ** **                      | ** ** | **Maturing  Within  One Year**     | ** ** | **Maturing  One to   Five Years ** | ** ** | **Maturing  After  Five Years** | ** ** | **Total** | ** ** |
| ** **                      | ** ** | **(Dollars in Thousands)**    | ** ** |
| One-to-four  family residential |       | $                                       | 2,159      |   |   | $ | 674 |   |   | $ | 8,570 |   | $ | 11,403 |   |
| Multifamily  residential        |       | 1,011                                   |       |   | 130 |   |   | 96,800 |   | 97,941 |   |
| Commercial real  estate         |       | 5,053                                   |       |   | 4,506 |   |   | 102,658 |   | 112,217 |   |
| Land                            |       | 1,092                                   |       |   | 6,947 |   |   | — |   | 8,039 |   |
| Construction real  estate       |       | 8,255                                   |       |   | 3,816 |   |   | — |   | 12,071 |   |
| Consumer loans                  |       | 2,299                                   |       |   | 19 |   |   | — |   | 2,318 |   |
| Commercial, non  real estate    |       | 2,641                                   |       |   | — |   |   | 1,139 |   | 3,780 |   |
| Total                           |       | $                                       | 22,510     |   |   | $ | 16,092 |   |   | $ | 209,167 |   | $ | 247,769 |   |

 

As of December 31, 2004, our entire loanportfolio was comprised of floating and adjustable interest rate loans.

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Thefollowing table presents the repricing frequency of the Company’s gross loansas of December 31, 2004 and December 31, 2003, segregating those withfixed versus floating and adjustable interest rates. Adjustable rates generallyfluctuate with changes in the various pricing indices, primarily the six-monthconstant maturity treasury index, the six month LIBOR, and the Prime Rate.
| ** **                     | ** ** | **At December 31, 2004** | ** ** |
|--------------------------------|------------|-----------------------------------------|------------|
| ** **                     | ** ** | **Repricing  Within  One Year**    | ** ** | **Repricing  One to   Five Years ** | ** ** | **Repricing  After  Five Years** | ** ** | **Total** | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)**              | ** ** |
| Adjustable rate  loans         |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| One-to-four family residential |       | $                                       | 10,779     |   |   | $ | 3,099 |   |   |   | $ | — |   |   | $ | 13,878 |   |
| Multifamily residential        |       | 92,697                                  |       |   | 32,585 |   |   |   | 817 |   |   | 126,099 |   |
| Commercial real estate         |       | 101,086                                 |       |   | 43,630 |   |   |   | 2,641 |   |   | 147,357 |   |
| Land                           |       | 8,201                                   |       |   | 949 |   |   |   | — |   |   | 9,150 |   |
| Construction real estate       |       | 9,157                                   |       |   | — |   |   |   | — |   |   | 9,157 |   |
| Consumer loans                 |       | 3,925                                   |       |   | — |   |   |   | — |   |   | 3,925 |   |
| Commercial, non real estate    |       | 17,746                                  |       |   | — |   |   |   | — |   |   | 17,746 |   |
| Total                          |       | $                                       | 243,591    |   |   | $ | 80,263 |   |   |   | $ | 3,458 |   |   | $ | 327,312 |   |
| Fixed rate loans               |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Commercial real estate         |       | $                                       | —     |   |   | $ | — |   |   |   | $ | — |   |   | $ | — |   |
| Total                          |       | $                                       | —     |   |   | $ | — |   |   |   | $ | — |   |   | $ | — |   |
| Total Loans                    |       | $                                       | 243,591    |   |   | $ | 80,263 |   |   |   | $ | 3,458 |   |   | $ | 327,312 |   |

 
| ** **                     | ** ** | **At December 31, 2003** | ** ** |
|--------------------------------|------------|-----------------------------------------|------------|
| ** **                     | ** ** | **Repricing  Within  One Year**    | ** ** | **Repricing  One to   Five Years ** | ** ** | **Repricing  After  Five Years** | ** ** | **Total** | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)**              | ** ** |
| Adjustable rate  loans         |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| One-to-four family residential |       | $                                       | 9,872      |   |   | $ | 1,531 |   |   |   | $ | — |   |   | $ | 11,403 |   |
| Multifamily residential        |       | 64,343                                  |       |   | 32,868 |   |   |   | 730 |   |   | 97,941 |   |
| Commercial real estate         |       | 68,341                                  |       |   | 41,248 |   |   |   | 1,038 |   |   | 110,627 |   |
| Land                           |       | 7,084                                   |       |   | 955 |   |   |   | — |   |   | 8,039 |   |
| Construction real estate       |       | 12,071                                  |       |   | — |   |   |   | — |   |   | 12,071 |   |
| Consumer loans                 |       | 2,318                                   |       |   | — |   |   |   | — |   |   | 2,318 |   |
| Commercial, non real estate    |       | 3,780                                   |       |   | — |   |   |   | — |   |   | 3,780 |   |
| Total                          |       | $                                       | 167,809    |   |   | $ | 76,602 |   |   |   | $ | 1,768 |   |   | $ | 246,179 |   |
| Fixed rate loans               |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Commercial real estate         |       | $                                       | —     |   |   | $ | 1,590 |   |   |   | $ | — |   |   | $ | 1,590 |   |
| Total                          |       | $                                       | —     |   |   | $ | 1,590 |   |   |   | $ | — |   |   | $ | 1,590 |   |
| Total Loans                    |       | $                                       | 167,809    |   |   | $ | 78,192 |   |   |   | $ | 1,768 |   |   | $ | 247,769 |   |

 

Of the of adjustable rateloans, 74.4% reprice within one year, 10.7% reprice within one to two years,5.2% reprice within two to three years, 5.8% reprice within three to fouryears, 3.0% reprice within four to five years, and 0.8% reprice within five toseven years.

**Nonperforming Assets**

Prior to classifying a loan as nonperforming, wereview each loan to determine the nature of the problem and the need toclassify. Further, all nonperforming loans are reviewed on a monthly basis todiscern if there were changes to the value of the collateral and the ability ofthe borrower to repay. Interest on performing loans is accrued and taken intoincome daily. Loans over 90 days past due are deemed 

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“nonperforming” and areplaced on a non-accrual status, unless the loan is well collateralized and inthe process of collection. Interest received on non-accrual loans is creditedto income only upon receipt and in certain circumstances may be applied toprincipal until the loan has been repaid in full, at which time the interestreceived is credited to income.

When appropriate or necessary to protect ourinterests, real estate taken as collateral on a loan may be taken by us throughforeclosure or a deed in lieu of foreclosure. Real property acquired in thismanner is known as other real estate owned, or OREO. OREO would be carried onour books as an asset, at the lesser of our recorded investment or the fairvalue less estimated costs to sell. OREO represents an additional category of “nonperformingassets.” For the period commencing January 1, 1998 through December 31,2004, we have not had any OREO.

Thefollowing table provides information with respect to the components of ournonperforming assets at the dates indicated.
| ** **                                                 | ** ** | **Balances as of December 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                 | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                 | ** ** | **(Dollars in Thousands)**                | ** ** |
| Non-accrual loans                                          |       |                                                |       |   |   |   |   |   |   |   |   |
| One-to-four family residential                             |       | $                                                   | —     |   | $ | — |   | $ | 248 |   | $ | — |   | $ | — |   |
| Multifamily residential                                    |       | 393                                                 |       | — |   | — |   | 196 |   | — |   |
| Commercial real estate                                     |       | —                                              |       | — |   | 463 |   |   |   | — |   |
|                                                       |       | $                                                   | 393        |   | $ | — |   | $ | 711 |   | $ | 196 |   | $ | — |   |
| Restructured  Loans                                        |       | —                                              |       | — |   | — |   | — |   | — |   |
| Nonperforming  assets as a percent of total loans          |       | 0.12                                                | %          | 0.00 | % | 0.40 | % | 0.16 | % | 0.00 | % |
| Nonperforming assets as a percent of total assets          |       | 0.09                                                | %          | 0.00 | % | 0.27 | % | 0.14 | % | 0.00 | % |
| Allowance for  Loan Losses                                 |       | $                                                   | 3,600      |   | $ | 2,726 |   | $ | 1,942 |   | $ | 1,345 |   | $ | 1,022 |   |
| Allowance for Loan  Losses/loans outstanding at period end |       | 1.09                                                | %          | 1.09 | % | 1.10 | % | 1.09 | % | 1.10 | % |

 

As of December 31, 2004, we had one multifamilyloan classified as non-accrual. This loan paid off in January 2005 withfull collection of principal and interest. As of December 31, 2003 we hadno loans classified as non-accrual.

Thefollowing table provides information with respect to delinquent but stillaccruing loans at the dates indicated.
| ** **                                     | ** ** | **Balances as of December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)**                | ** ** |
| Loans delinquent  60-89 days and accruing      |       |                                                |       |   |   |   |   |   |   |   |   |
| Commercial real estate                         |       | $                                                   | —     |   | $ | — |   | $ | 84 |   | $ | — |   | $ | — |   |
| Consumer loans                                 |       | —                                              |       | — |   | 200 |   |   |   | — |   |
| Commercial, non real estate                    |       | 62                                                  |       | — |   | — |   |   |   | — |   |
|                                           |       | $                                                   | 62         |   | $ | — |   | $ | 284 |   | $ | — |   | $ | — |   |
| Loans delinquent  90 days or more and accruing |       |                                                |       |   |   |   |   |   |   |   |   |
| Commercial real estate                         |       | $                                                   | —     |   | $ | — |   | $ | 22 |   | $ | — |   | $ | — |   |
| Land and Construction                          |       | —                                              |       | 121 |   | — |   | — |   | 145 |   |
|                                           |       | $                                                   | —     |   | $ | 121 |   | $ | 22 |   | $ | — |   | $ | 145 |   |

 

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These loans are in variousstages of collection; however, no assurance can be given that we will besuccessful in collecting all of these loans or that we have adequate loan lossreserves established for these loans.

**Criticized and Classified Assets**

Thefollowing table presents the Company’s criticized and classified assets as ofthe dates indicated:
| ** **                                            | ** ** | **As of December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                            | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Criticized Assets**                                 |       |                                  |       |   |   |   |   |
| One-to-four  family residential                       |       | $                                     | —     |   | $ | — |   | $ | 499 |   |
| Multifamily  residential                              |       | 513                                   |       | 275 |   | 400 |   |
| Commercial real  estate                               |       | 446                                   |       | 183 |   | 400 |   |
| Land                                                  |       | —                                |       | 1,059 |   | 498 |   |
| Construction real  estate                             |       | —                                |       | — |   | 1,036 |   |
| Consumer, non  real estate                            |       | 177                                   |       | 120 |   | — |   |
| Commercial, non  real estate                          |       | 482                                   |       | 427 |   | 500 |   |
| **Special  mention**                                  |       | $                                     | 1,618      |   | $ | 2,064 |   | $ | 3,333 |   |
| **Classified  Assets**                                |       |                                  |       |   |   |   |   |
| One-to-four  family residential                       |       | $                                     | —     |   | $ | — |   | $ | 248 |   |
| Multifamily  residential                              |       | 393                                   |       | 395 |   | — |   |
| Commercial real  estate                               |       | 563                                   |       | — |   | 463 |   |
| Land                                                  |       | 795                                   |       | 261 |   | 263 |   |
| Substandard loans                                     |       | $                                     | 1,751      |   | $ | 656 |   | $ | 974 |   |
| **Total  classified assets**                          |       | $                                     | 1,751      |   | $ | 656 |   | $ | 974 |   |
| Classified assets to total assets                     |       | 0.04                                  | %          | 0.02 | % | 0.04 | % |
| Classified assets  to stockholders’ equity       |       | 0.76                                  | %          | 0.47 | % | 0.88 | % |
| Allowance for loan losses  to total classified assets |       | 206                                   | %          | 416 | % | 199 | % |

 

As of December 31, 2004 we have identified fourloans totaling $1,751,000 and representing 0.53% of net loans that have ahigher than normal risk of loss and have been classified as substandard. Oneloan is a $393,000 multifamily loan on non-accrual status as of December 31,2004 that is located in the Bank’s primary market area and that paid off in January 2005.One loan is a performing $563,000 commercial real estate loan located in theBank’s primary market area, and the remaining two loans are a performing$258,000 land loan and a performing $537,000 land loan located in the Bank’sprimary market area.

With the exception of these loans, management is notaware of any loans as of December 31, 2004 where the known credit problemsof the borrower would cause it to have serious doubts as to the ability of suchborrowers to comply with their present loan repayment terms. Management cannotpredict the extent to which the current economic environment may persist orworsen or the full impact such environment may have on the Company’s loanportfolio. Furthermore, management cannot predict the results of any subsequentexaminations of the Company’s loan portfolio by the banking regulatoryagencies. Accordingly, there can be no assurance that other loans will beclassified as discussed above.

In addition, approximately $1,618,000 in loans,representing 0.50% of net loans, have been placed on our internal “watch list”for special attention and loss potential and are closely monitored. These loanshave been categorized as Special Mention. As of December 31, 2004,approximately $513,000 were multifamily loans, $446,000 were commercial realestate loans, $177,000 were consumer loans, and $482,000 were commercial loans.These loans are in various stages of collection; however, no assurance can 

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be given that we will besuccessful in collecting all of these loans or that we have adequate loan lossreserves established for these loans.

Please refer to Note 3 tothe Consolidated Financial Statements and the Business section of this AnnualReport for additional information concerning loans.

**Allowanceand Provisions for Loan Losses**

We maintain an allowance for loan losses to providefor potential losses in the loan portfolio. Additions to the allowance are madeby charges to operating expenses in the form of a provision for loan losses. Allloans that are judged to be uncollectible are charged against the allowancewhile any recoveries are credited to the allowance. We have instituted loanpolicies, designed primarily for internal use, to adequately evaluate andassess the analysis of risk factors associated with our loan portfolio and toenable us to assess such risk factors prior to granting new loans and to assessthe sufficiency of the allowance. We conduct a critical evaluation of the loanportfolio monthly. This evaluation includes an assessment of the followingfactors: the results of our internal loan review, any external loan review andany regulatory examination, loan loss experience, estimated potential lossexposure on each credit, concentrations of credit, value of collateral, anyknown impairment in the borrower’s ability to repay and present economicconditions.

Each month we also review the allowance and makeadditional transfers to the allowance as needed. For the year 2004, theprovision for loan losses was $874,000 as compared to $784,000 for the year2003. This represents an increase of $90,000 or 11% from 2003 to 2004. For year2004 and 2003 there were no charge-offs of loans nor were there any recoverieson previously charged-off loans.

At December 31, 2004 and December 31, 2003,the allowance for loan losses was 1.09% of loans outstanding. At December 31,2004 the ratio of the allowance for loan and lease losses to nonperformingloans was 916%. There were no non performing loans at December 31, 2003. Althoughwe deemed these levels adequate, no assurance can be given that furthereconomic difficulties or other circumstances which would adversely affect ourborrowers and their ability to repay outstanding loans will not occur whichwould be reflected in increased losses in our loan portfolio, which lossescould possibly exceed the amount then reserved for loan losses.

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Thefollowing table summarizes our loan loss experience, transactions in theallowance for loan losses and certain pertinent ratios for the periodsindicated:
| ** **                                                                                                   | ** ** | **For the year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2004**                                                     | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                                                   | ** ** | **(Dollars In Thousands)**                         | ** ** |
| **Loans  Outstanding, Period End**                                                                           |       | 329,251                                                      |       | $ | 249,144 |   | $ | 176,889 |   | $ | 123,705 |   | $ | 93,146 |   |
| Average Amount of  Loans Outstanding                                                                         |       | 291,999                                                      |       | 215,041 |   | 146,956 |   | 113,050 |   | 94,659 |   |
| Period end  non-performing loans outstanding                                                                 |       | 393                                                          |       | — |   | 711 |   | 196 |   | — |   |
| **Loans Loss Reserve Balance, Beginning of Period**                                                          |       | $                                                            | 2,726      |   | $ | 1,942 |   | $ | 1,345 |   | $ | 1,022 |   | $ | 979 |   |
| Charge-offs                                                                                                  |       | —                                                       |       | — |   | — |   | — |   | — |   |
| Recoveries                                                                                                   |       | —                                                       |       | — |   | — |   | — |   | — |   |
| Additions/(Reductions) charged to operations                                                                 |       | 874                                                          |       | 784 |   | 597 |   | 323 |   | 43 |   |
| **Allowance  for Loan and Lease Loss, End of Period**                                                        |       | $                                                            | 3,600      |   | $ | 2,726 |   | $ | 1,942 |   | $ | 1,345 |   | $ | 1,022 |   |
| **Ratio  of Net Charge-offs/(Recoveries) During the Period to Average Loans  Outstanding During the Period** |       | 0.00                                                         | %          | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| **Ratio of Allowance for Loan  Losses to Loans at Period End**                                               |       | 1.09                                                         | %          | 1.09 | % | 1.10 | % | 1.09 | % | 1.10 | % |

 

**Investments**

In order to maintain areserve of readily saleable assets to meet our liquidity and loan requirements,we purchase mortgage-backed securities and other investments. Sales of “FederalFunds,” short-term loans to other banks, are regularly utilized. Placement offunds in certificates of deposit with other financial institutions may be madeas alternative investments pending utilization of funds for loans or otherpurposes. Securities may be pledged to meet security requirements imposed as acondition to secure Federal Home Loan Bank advances, the receipt of public funddeposits and for other purposes. As of December 31, 2004 and December 31,2003, the carrying values of securities pledged were $62,891,000 and$18,907,000, respectively, representing our entire investment securitiesportfolio. Our policy is to stagger the maturities and to utilize the cash flowof our investments to meet our overall liquidity requirements.

As of December 31, 2004 and December 31,2003, our investment portfolio consisted entirely of mortgage-backed securities.We also owned $6,933,500 and $3,609,000 in Federal Home Loan Bank stock and$50,000 of Pacific Coast Banker’s Bank stock as of December 31, 2004 and December 31,2003, respectively. We also had interest-bearing time deposits in other financialinstitutions amounting to $999,646 and $12,844,000 as of December 31, 2004and December 31, 2003, respectively.

At December 31, 2004, $40,851,000 of oursecurities was classified as held-to-maturity and $22,040,000 of our securitieswere classified as available-for-sale. At December 31, 2003, $18,907,000of our securities was classified as held-to-maturity and we had no availablefor sale securities. The Federal Home Loan Bank stock and the Pacific CoastBanker’s Bank stock are not classified since they have no stated maturities. Available-for-salesecurities are bonds, notes, debentures, and certain equity securities that arenot classified as trading securities or as held-to-maturity securities. Unrealizedholding gains and losses, net of tax, on available-for-sale securities arereported as a net amount in a separate component of capital until realized. Gainsand losses on the sale of available-for-sale securities are determined usingthe specific identification method. Premiums and discounts are recognized ininterest income using the interest method over the period to maturity. Held-to-maturitysecurities consist of bonds, notes and debentures for 

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which we have the positiveintent and the ability to hold to maturity and are reported at cost, adjustedfor premiums and discounts that are recognized in interest income using theinterest method over the period to maturity.

Thefollowing tables summarize the amounts and distribution of our investmentsecurities, held as of the dates indicated, and the weighted average yields:
| ** **                                      | ** ** | **As of December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                      | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                      | ** ** | ** Amortized   Cost**       | ** ** | **Fair  Value** | ** ** | ** Amortized   Cost** | ** ** | **Fair  Value** | ** ** | ** Amortized   Cost** | ** ** | **Fair  Value** | ** ** |
| ** **                                      | ** ** | **(Dollars in Thousands)**  | ** ** |
| Available for  sale  Mortgage backed securities |       |                                  | $          | 22,422 |   |   | $ | 22,040 |   |   | $ | — |   |   | $ | — |   |   | $ | 37,730 |   |   | $ | 37,657 |   |
| Held to maturity  Mortgage backed securities    |       |                                  | $          | 40,851 |   |   | $ | 40,327 |   |   | $ | 18,907 |   |   | $ | 19,006 |   |   | $ | 35,628 |   |   | $ | 35,547 |   |

 
| ** **                                      | ** ** | **As of December 31,  2004**                             | ** ** | **As of December 31,  2003** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **     Balance     ** | ** ** | **  Yield  **           | ** ** | **     Balance     ** | ** ** | **  Yield  ** | ** ** |
| ** **                                      | ** ** | **(Dollars in Thousands)**                                    | ** ** | **(Dollars in Thousands)**        | ** ** |
| Available for  sale  Mortgage backed securities |       |                                                                    | $          | 22,422                                      |       |   |   | 3.29 | % |   |   | $ | — |   |   |   | — | % |   |
| Held to maturity  Mortgage backed securities    |       |                                                                    | $          | 40,851                                      |       |   |   | 3.48 | % |   |   | $ | 18,907 |   |   |   | 2.84 | % |   |

 

**Deposits**

Deposits are our primary source of funds. Our depositsare obtained from a cross-section of the communities we serve. As of December 31,2004, we had a deposit mix of 44% money market and savings deposits, 22% intime deposits less than $100,000, 26% in time deposits greater than $100,000,5% in noninterest-bearing deposits, and 3% in interest-bearing checkingdeposits. At December 31, 2003, we had a deposit mix of 41% money marketand savings deposits, 36% in time deposits less than $100,000, 13% in timedeposits greater than $100,000, 5% in interest-bearing checking deposits, and4% in noninterest-bearing deposits. Included in our deposit totals were$32.0 million (12% of deposits) and $25.7 million (11% of deposits) of brokereddeposits and $17.8 million (7% of deposits) and $25.8 million (12% of deposits)in non-brokered wholesale certificates of deposits as of December 31, 2004and December 31, 2003, respectively.

We have obtained wholesale deposits through one of twodeposit brokers and through non-brokered wholesale sources. These deposits,some of which were certificates of deposit of $100,000 or more, were obtainedfor generally longer terms than we can acquire through our retail sources as ameans to control interest rate risk. However, based on the amount of wholesalefunds maturing in each month, we may not be able to replace all wholesaledeposits with retail deposits upon maturity. To the extent that we need torenew maturing wholesale deposits at then current interest rates, we incur therisk of paying higher interest rates for these potentially volatile sources offunds.

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In an effort to expand our market share, we arecontinuing a business plan to develop our retail presence in Marin Countythrough an expanding network of full service branches. We operated threebranches during the first quarter of 2004, and we opened two new branches inthe second quarter of 2004.

Total deposits outstanding were affected by theCompany’s common stock offering that closed in the first quarter of 2004. As ofDecember 31, 2003 the Bank had a deposit of $3,548,000 in the common stockescrow account that was used to accumulate funds raised in the offering untilshares were issued.

In 2004 the Bank established a relationship withReserve Funds, an institutional money manager that offers a money marketsavings based sweep product to community banks. Under this program, endinvestors use the Reserve Funds as a conduit to invest money market savingsdeposits in a consortium of community banks. The end investors receive a rateof interest that is generally higher than alternative money market funds, thecommunity banks receive large money market savings balances, and the ReserveFunds receives a fee by acting as the conduit. The Bank began acceptingdeposits from this program in November 2004. By December 2004deposits reached $11.5 million, and by February 28, 2005 deposits reached$16.6 million. The Bank pays an interest rate equivalent to the Federal Fundsrate plus 40 basis points. As of December 31, 2004 the rate was 2.50%.

Thefollowing table summarizes the distribution of deposits and the period endingrates paid for the periods indicated:
| ** **                                        | ** ** | **December 31, 2004**      | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **Balance**                          | ** ** | **Weighted  Average  Rate**     | ** ** | **Balance**                     | ** ** | **Weighted  Average  Rate** | ** ** | **Balance** | ** ** | **Weighted  Average  Rate** | ** ** |
| ** **                                        | ** ** | **(Dollars in Thousands)** | ** ** |
| Noninterest-bearing  deposits                     |       | $                                    | 13,030     |                            |       | 0.00                            | %          |   | $ | 9,528 |   |   | 0.00 | % |   | $ | 4,391 |   |   | 0.00 | % |   |
| Interest-bearing  checking deposits          |       | 7,773                                |       |                            | 0.67       | %                               |       | 9,589 |   |   | 0.86 | % |   | 5,728 |   |   | 0.93 | % |   |
| Money Market and  savings deposit            |       | 123,002                              |       |                            | 1.96       | %                               |       | 87,058 |   |   | 1.49 | % |   | 75,782 |   |   | 1.80 | % |   |
| Certificates of  deposit $100,000 or more    |       | 70,271                               |       |                            | 2.54       | %                               |       | 28,034 |   |   | 2.34 | % |   | 29,642 |   |   | 3.13 | % |   |
| Certificates of  deposit < $100,000  |       | 60,544                               |       |                            | 2.50       | %                               |       | 77,417 |   |   | 2.34 | % |   | 60,361 |   |   | 2.89 | % |   |
| Total deposits                                    |       | $                                    | 274,620    |                            |       | 2.10                            | %          |   | $ | 211,626 |   |   | 1.82 | % |   | $ | 175,904 |   |   | 2.32 | % |   |

 

Thefollowing table summarizes the distribution and origination source ofcertificates of deposit for the periods indicated:
| ** **                                      | ** ** | **December 31, 2004**      | ** ** | **December 31, 2003** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **Balance**                          | ** ** | **Weighted  Average  Rate**     | ** ** | **Balance** | ** ** | **Weighted  Average  Rate** | ** ** |
| ** **                                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Retail certificates  of deposit                 |       | $                                    | 79,700     |                            |       | 2.52 | % |   | $ | 58,153 |   |   | 2.32 | % |   |
| Brokered  certificates of deposit               |       | 31,957                               |       |                            | 2.47       | % |   | 21,568 |   |   | 2.36 | % |   |
| Non-brokered  wholesale certificates of deposit |       | 19,158                               |       |                            | 2.57       | % |   | 25,730 |   |   | 2.36 | % |   |
| Total time deposits                             |       | $                                    | 130,815    |                            |       | 2.52 | % |   | $ | 105,451 |   |   | 2.34 | % |   |

 

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Thefollowing schedule shows the maturity of our time deposits as of December 31,2004:
| ** **                      | ** ** | **$100,000 or more**       | ** ** | **Less than $100,000** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **Amount**                           | ** ** | **Weighted  Average  Rate**      | ** ** | **Amount** | ** ** | **Weighted  Average  Rate** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Three months or  less           |       | $                                    | 10,562     |                             |       | 2.04 | % |   | $ | 19,569 |   |   | 2.34 | % |   |
| Over 3 through 6  months        |       | 7,929                                |       |                             | 2.43       | % |   | 9,261 |   |   | 2.23 | % |   |
| Over 6 through 12  months       |       | 26,910                               |       |                             | 2.54       | % |   | 25,287 |   |   | 2.55 | % |   |
| Over 12 months  through 2 years |       | 12,566                               |       |                             | 2.71       | % |   | 13,540 |   |   | 2.87 | % |   |
| Over 2 through 3  years         |       | 2,477                                |       |                             | 3.07       | % |   | 2,309 |   |   | 3.20 | % |   |
| Over 3 through 4  years         |       | —                               |       |                             | 0.00       | % |   | 107 |   |   | 2.78 | % |   |
| Over 4 through 5  years         |       | 100                                  |       |                             | 3.73       | % |   | 198 |   |   | 3.55 | % |   |
| Total                           |       | $                                    | 60,544     |                             |       | 2.50 | % |   | $ | 70,271 |   |   | 2.54 | % |   |

 

**Borrowed Funds**

We have secured advances from the Federal Home LoanBank at December 31, 2004 and December 31, 2003 amounting to $115.8million and $65.1 million, respectively, a 78% increase. The FHLB advances asof December 31, 2004 were secured by $209.1 million of our loan portfolioand our entire investment securities portfolio of $62.9 million. The FHLBadvances as of December 31, 2003 were secured by $118.7 million of ourloan portfolio and our entire investment portfolio of $18.9 million. Theadvances have been outstanding at varying levels during 2004. The maximumamount of FHLB advances outstanding at any month end in 2004 was $144.1 millionin May 2004 and the minimum balance at any month end was $66.0 million in January 2004.Total interest expense on FHLB borrowings for 2004 and 2003 was approximately$2,635,000 and $1,553,000, respectively.

As of December 31, 2004, the maturities of theadvances substantially occur in 2005, 2006, and 2007, with comparativelysmaller amounts maturing in 2008. In 2004 we have endeavored to lengthen theterms of our FHLB borrowings as a means of reducing interest rate risk. In 2004borrowings due in over one year increased by $25.4 million while borrowings duewithin a year increased by $25.3 million. In the first five months of 2004 weincreased the balance of FHLB borrowings in order to deploy the capitalobtained in the common stock offering. In the last seven months of 2004 wedecreased the balance of FHLB borrowings on a monthly basis as retail depositproduction was used in part to pay off maturing FHLB borrowings.

The followingtables set forth certain information regarding our FHLB advances at or for thedates indicated:
| ** **                          | ** ** | **At December 31, 2004** | ** ** | **At December 31, 2003** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **Amount**                              | ** ** | **Weighted  Average  Rate**             | ** ** | **Amount** | ** ** | **Weighted  Average  Rate** | ** ** |
| ** **                          | ** ** | **(Dollars in Thousands)**    | ** ** |
| Three months or less |       | $                                       | 10,000     |                                    |       | 1.77 | % |   | $ | — |   |   | 0.00 | % |   |
| Over 3 through 6  months            |       | 10,821                                  |       |                                    | 2.01       | % |   | 4,000 |   |   | 2.81 | % |   |
| Over 6 through 12  months           |       | 17,500                                  |       |                                    | 2.57       | % |   | 9,000 |   |   | 2.20 | % |   |
| Over 12 months  through 2 years     |       | 44,374                                  |       |                                    | 2.34       | % |   | 31,001 |   |   | 2.41 | % |   |
| Over 2 through 3  years             |       | 28,086                                  |       |                                    | 2.96       | % |   | 15,624 |   |   | 2.17 | % |   |
| Over 3 through 4  years             |       | 5,000                                   |       |                                    | 2.98       | % |   | 5,476 |   |   | 2.94 | % |   |
| Total                               |       | $                                       | 115,781    |                                    |       | 2.47 | % |   | $ | 65,101 |   |   | 2.39 | % |   |

 

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| ** **                                                          | ** ** | **At or For the Year Ended December 31,**                 | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                          | ** ** | **       2004       ** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                          | ** ** | **(Dollars in thousands)**                                                         | ** ** |
| FHLB advances:                                                 |       |                                                                                         |       |   |   |   |   |   |   |
| Average balance outstanding                                         |       |                                                                                         | $          | 110,571 |   |   | $ | 65,403 |   | $ | 37,022 |   |
| Maximum amount outstanding at any month-end during  the period |       |                                                                                         | 144,057    |   |   | 71,266 |   | 79,179 |   |
| Balance outstanding at end of period                                |       |                                                                                         | 115,781    |   |   | 65,101 |   | 69,869 |   |
| Average interest rate during the period                             |       |                                                                                         | 2.38       | % |   | 2.37 | % | 3.01 | % |
| Average interest  rate at end of period                             |       |                                                                                         | 2.47       | % |   | 2.39 | % | 2.33 | % |
|                                                                     |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 

During 2002, we issued$10,310,000 of variable rate junior subordinated debentures. The securitiesmature on June 30, 2032 but are callable after June 30, 2007. We payinterest currently on the junior subordinated debentures, and total interestexpense attributable during the years 2004 and 2003 was $546,000 and $518,000respectively.

**Capital Resources**

Stockholders’ equity increased by $9.3 million to$23.2 million as of December 31, 2004 as compared to $13.9 million as of December 31,2003 due to net proceeds from the sale of common stock of $6.4 million and netincome of $3,448,000, offset by $365,000 in dividends declared during theperiod and a $229,000 decrease in other comprehensive income.

In the first quarter of 2004, the Company completedthe public offering of shares of its common stock. Of the 2 million shares thatwere available in the offering, 510,599 were sold for the benefit of theCompany, and 1,444,290 were sold by Community Bankshares L.P., a limitedpartnership, of which the Chairman/CEO of the Company is the CEO of the generalpartner. Community Bankshares elected to retain 45,111 of its shares, whichwere subsequently distributed to its investors. The Company incurred stockoffering costs of $262,000 which were deducted from the gross amount raised onbehalf of the Company of $6.6 million to equal the net capital infusion of $6.4million. Community Bankshares incurred costs of $715,000 which were deductedfrom the gross amount raised on behalf of Community Bankshares of $18.8 millionto equal the net proceeds to Community Bankshares of $18.0 million. In thesecond quarter of 2004 the Company applied to list its common stock on theNASDAQ Small Cap Market under the symbol “EPIK.”  The stock began trading on the NASDAQ SmallCap Market on August 9, 2004.

On June 27, 2002, Epic Bancorp issued $10,310,000Junior Subordinated Debentures. The variable rate debentures (dividends issuedat a quarterly LIBOR rate plus 3.65%, not to exceed 12% prior to -June 30,2007) mature June 30, 2032. The debentures were issued in concurrence withthe-Cumulative Trust Preferred Securities (the “Trust PreferredSecurities”) of the San Rafael Capital Trust I, a wholly owned non-consolidatedsubsidiary of Epic Bancorp. Proceeds of the Trust Preferred Securities wereinvested in the junior subordinated debentures issued by Epic Bancorp. EpicBancorp has the right, assuming no default has occurred, to defer payments ofinterest on the junior subordinated debentures at any time for a period not toexceed ten consecutive semi-annual periods. As of December 31, 2004 theinterest rate on the Junior Subordinated Debenture was 5.72%.

Under regulatory capital adequacy guidelines, capitaladequacy is measured as a percentage of risk-adjusted assets in whichrisk percentages are applied to assets on the balance sheet as well as off-balancesheet, such as unused loan commitments and standby letters of credit. The guidelinesrequire that a portion of total capital be core, or Tier 1, capital consistingof common stockholders’ equity and perpetual preferred stock, less goodwill andcertain other deductions. Tier 2 capital consists of other elements, primarilynon-perpetual preferred stock, subordinated debt and mandatory convertibledebt, plus the allowance for loan losses, subject to certain limitations. Theguidelines also evaluate the leverage ratio, which is Tier I capital divided byaverage assets.

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Forall reporting periods in the year 2004 and 2003, Tamalpais Bank’s capitalexceeded all minimum regulatory requirements and were considered to be “wellcapitalized” as defined in the regulations issued by the FDIC. Tamalpais Bank’scapital ratios, shown below as of December 31, 2004 and December 31,2003, have been computed in accordance with regulatory accounting guidelines.
| ** **                              | ** ** | **Actual Capital**    | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **Amount**                 | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                       | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(Dollars In Thousands)** | ** ** |
| As of December 31,  2004:          |       |                       |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |   |   |
| Total capital to risk-weighted assets   |       | $                          | 36,699     |                                         | 11.0       | %                                                                                                | $          | 26,618 |   |   | 8.0 | % |   | $ | 33,272 |   | 10.0 | % |
| Tier 1 capital to  risk-weighted assets |       | 33,099                     |       | 10.0                                         | %          | 13,306                                                                                           |       |   | 4.0 | % |   | 19,959 |   | 6.0 | % |
| Tier 1 capital to  average assets       |       | 33,099                     |       | 8.1                                          | %          | 16,386                                                                                           |       |   | 4.0 | % |   | 20,482 |   | 5.0 | % |
| As of  December 31, 2003:          |       |                       |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |   |   |
| Total capital to risk-weighted assets   |       | $                          | 25,432     |                                         | 10.2       | %                                                                                                | $          | 20,004 |   |   | 8.0 | % |   | $ | 25,005 |   | 10.0 | % |
| Tier 1 capital to  risk-weighted assets |       | 22,706                     |       | 9.1                                          | %          | 10,004                                                                                           |       |   | 4.0 | % |   | 15,003 |   | 6.0 | % |
| Tier 1 capital to  average assets       |       | 22,706                     |       | 7.5                                          | %          | 12,109                                                                                           |       |   | 4.0 | % |   | 15,137 |   | 5.0 | % |

 

**Liquidity and Liability Management**

Liquidity management for banks requires that fundsalways be available to pay anticipated deposit withdrawals and maturingfinancial obligations such as certificates of deposit promptly and fully inaccordance with their terms. The major source of the funds required isgenerally provided by payments on loans, sale of loans, liquidation of assets,and the acquisition of additional deposit liabilities. One method that banksutilize for acquiring additional liabilities is through the acceptance of “brokereddeposits” (defined to include not only deposits received through depositbrokers, but also deposits bearing interest in excess of 75 basis points overmarket rates), typically attracting large certificates of deposit at highinterest rates. We had $31,957,000 of “brokered deposits” as of December 31,2004 and $25,568,000 of brokered deposits as of December 31, 2003. Inaddition to brokered deposits, we had $19,158,000 in non-brokered wholesaledeposits and $115,781,000 in FHLB borrowings as of December 31, 2004, ascompared to $25,730,000 in non-brokered wholesale deposits and $65,101,000 in FHLBborrowings as of December 31, 2003.

To meet liquidity needs, we maintain a portion of ourfunds in cash deposits in other banks, Federal Funds sold, and investmentsecurities. As of December 31, 2004, liquid assets were comprised of $16.4million in Federal Funds sold, $1,000,000 in interest-bearing deposits in otherfinancial institutions, $5,295,000 in cash and due from banks, and $22,040,000in available-for-sale securities. As of December 31, 2003, liquid assetswere comprised of $7,681,000 in Federal Funds sold, $12,844,000 ininterest-bearing deposits in other financial institutions, and $7,108,000 incash and due from banks.

Liquidity can be enhanced, if necessary, through shortor long term borrowings. As of December 31, 2004, we had lines of credittotaling $57.2 million available. These consist of $3.0 million in unsecuredlines of credit with two correspondent banks, and approximately $54.2 millionin a line of credit through pledged loans and securities with the Federal HomeLoan Bank of San Francisco. At December 31, 2004 outstanding FHLB advancestotaled $115,780,000. In addition, we have a line of credit with the FederalReserve Bank of San Francisco that allows the Bank to borrow up to the value ofits pledged collateral, although we currently have no loans or securitiespledged.

Net cash provided by operating activities totaled $5.6million in 2004, compared to $4.3 million in 2003. The increase was primarilythe result of increased income, adjusted for the effect of the 

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amortizations of premiumson investment securities, and increased accrued interest payable and otherliabilities, partially offset by an increase in accrued interest receivable andother assets.

Net cash used in investing activities totaled $118.4million in 2004, compared to $23.8 million used by investing activities in 2003.The increase was primarily the result of $80.4 million of loans originated orpurchased, net of prepayment, and mortgage backed securities purchases net ofprincipal reductions and sales of $45.1 million.

Funds provided by financing activities totaled $119.8million in 2004, compared to funds provided by financing activities of $31.0million in 2003. The increase in net cash provided by financing activities wasprimarily the result of a net $63.0 million increase deposits, a $50.7 millionincrease in the volume of FHLB borrowings and a $6.4 million increase incapital from the recently completed capital offering.

The careful planning of asset and liability maturitiesand the matching of interest rates to correspond with this maturity matching isan integral part of the active management of an institution’s net interestmargin. To the extent maturities of assets and liabilities do not match in achanging interest rate environment, net yields may be affected. Even withperfectly matched re-pricing of assets and liabilities, risks remain in theform of prepayment of assets, timing lags in adjusting certain assets andliabilities that have varying sensitivities to market interest rates and basisrisk. In our overall attempt to match assets and liabilities, we take intoaccount rates and maturities to be offered in connection with our certificatesof deposit and our variable rate loans. Because of our ratio of rate sensitiveassets to rate sensitive liabilities, we have been positively affected by thedecreasing interest rate market. Conversely, we would be negatively affected inan increasing rate environment.

We have generally been able to control our exposure tochanging interest rates by maintaining a large percentage of adjustableinterest rate loans and the majority of our time certificates in relativelyshort maturities. The majority of our loans have periodic and lifetime interestrate caps and floors. We have also controlled our interest rate risk exposureby locking in longer term fixed rate liabilities, including FHLB borrowing,brokered certificates of deposit, and non-brokered wholesale certificates ofdeposit.

Since interest rate changes do not affect allcategories of assets and liabilities equally or simultaneously, a cumulativegap analysis alone cannot be used to evaluate our interest rate sensitivityposition. To supplement traditional gap analysis, we perform simulationmodeling to estimate the potential effects of changing interest rates. The processallows us to explore the complex relationships within the gap

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overtime and various interest rate environments. The following table shows ourcumulative gap analysis as of December 31, 2004.
| ** **                                                                            | ** ** | **At December 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                            | ** ** | **Within  Three  Months**               | ** ** | **Three to  Twelve  Months** | ** ** | **One to  Five Years** | ** ** | **Over   Five Years ** | ** ** | **Total** | ** ** |
| ** **                                                                            | ** ** | **(Dollars in Thousands)**    | ** ** |
| *Interest Earning Assets*                                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Securities                                                                            |       | $                                       | 4,917      |   | $ | 12,842 |   | $ | 44,825 |   |   | $ | 307 |   |   | $ | 62,891 |   |
| Federal Funds                                                                         |       | 16,435                                  |       | — |   | — |   |   | — |   |   | 16,435 |   |
| Interest-bearing  deposits in other financial institutions                       |       | 99                                      |       | — |   | 762 |   |   | 139 |   |   | 1,000 |   |
| Loans                                                                                 |       | 146,929                                 |       | 98,106 |   | 81,560 |   |   | 2,656 |   |   | 329,251 |   |
| FHLB and PCBB  Stock                                                                  |       | —                                  |       | — |   | — |   |   | 6,934 |   |   | 6,934 |   |
| Total                                                                                 |       | $                                       | 168,380    |   | $ | 110,948 |   | $ | 127,147 |   |   | $ | 10,036 |   |   | $ | 416,511 |   |
| *Interest-Bearing Liabilities*                                                        |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  checking                                                         |       | $                                       | —     |   | $ | — |   | $ | — |   |   | $ | 13,030 |   |   | $ | 13,030 |   |
| Interest-bearing  checking                                                            |       | 1,739                                   |       | 5,215 |   | 819 |   |   | — |   |   | 7,773 |   |
| Money market and  savings                                                             |       | 26,968                                  |       | 46,276 |   | 49,757 |   |   | — |   |   | 123,001 |   |
| Time deposits                                                                         |       | 30,131                                  |       | 69,388 |   | 31,296 |   |   | — |   |   | 130,815 |   |
| FHLB advances                                                                         |       | 10,000                                  |       | 28,321 |   | 77,460 |   |   | — |   |   | 115,781 |   |
| Junior  Subordinated Debentures                                                       |       | 10,310                                  |       | — |   | — |   |   | — |   |   | 10,310 |   |
| Total                                                                                 |       | $                                       | 79,148     |   | $ | 149,200 |   | $ | 159,332 |   |   | $ | 13,030 |   |   | $ | 400,710 |   |
| Interest rate sensitivity gap                                                         |       | $                                       | 89,232     |   | $ | (38,252 | ) | $ | (32,185 | ) |   | $ | (2,994 | ) |   | $ | 15,801 |   |
| Cummulative  interest rate sensitivity gap as a percentage of interest-earning assets |       | 21.4                                    | %          | –9.2 | % | –7.7 | % |   | –0.7 | % |   | 3.8 | % |

 

Our target cumulative one-year gap ratio is –15%to 15%. The policy limit for net earnings at risk for a +/–200 basis points change in rates is –25%, indicating a worstcase 25% decrease in earnings given a 200 basis point change in interest rates.The policy limit for a +/–200 basis points change in rates is –15%,indicating a 15% decrease in net interest income. Management will strive tomaintain rate sensitive assets on its books. Management will also evaluate theuses of FHLB products including longer-term bullet advances, amortizingadvances, and interest rate swaps as tools to control interest rate risk. Ifone of the interest rate risk measures exceeds the policy limits managementwill adjust product offerings and will reposition assets and liabilities tobring the interest rate risk measure back within policy limits within areasonable timeframe. Our current one year gap ratio is –9.2%.A negative one year gap ratio indicates that in a declining interest rateenvironment it is expected that net interest margin would increase, and in anincreasing interest rate environment net interest margin would decrease.

We believe that there are some inherent weaknesses inutilizing the cumulative gap analysis as a means of monitoring and controllinginterest rate risk. Specifically, the cumulative gap analysis does not addressloans at their floor rates that cannot reset as rates change and does notincorporate varying prepayment speeds as interest rates change. We thereforerely more heavily on our dynamic simulation model to monitor and controlinterest rate risk.

We use a dynamic simulation model to forecast the anticipatedimpact of changes in market interest rates on its net interest income andeconomic value of equity. That model is used to assist management inevaluating, and in determining and adjusting strategies designed to reduce, itsexposure to these market risks, which may include, for example, changing themix of earning assets or interest-bearing deposits. Our 

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current net interestearnings at risk given a +/– 200 basis point rateshock is –6.23%and our current estimated change in the economic value of equity given a +/– 200basis point rate shock is –9.87%.
| **Simulated Rate Changes** | ** ** | ** ** | ** ** | **Estimated Net  Interest  Income   Sensitivity** | ** ** | **Estimated  Change in  Economic  Value of  Equity** | ** ** |
|--------------------------------------|------------|------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| + 200 basis  points                  |       |       | –6.23 | %                                                           |       |                                                           | –9.87 | % |   |
| –  200 basis points             |       |       | 5.68       | %                                                           |       |                                                           | 22.76      | % |   |

 

In an increasing rate environment our available forsale investment portfolio will incur a decrease in market value that will berecorded as a decrease in capital through a decrease in other comprehensiveincome. Meanwhile the increase in value of our long term liabilities is notincluded in other comprehensive income. Therefore, in an increasing rateenvironment the economic value of equity may change by an amount that differsfrom the change in capital as calculated under Generally Accepted Accounting Principals.

Management believes that all of the assumptions usedin the analysis to evaluate the vulnerability of its projected net interestincome and economic value of equity to changes in interest rates approximateactual experiences and considers them to be reasonable. However, the interestrate sensitivity of the Bank’s assets and liabilities and the estimated effectsof changes in interest rates on the Bank’s projected net interest income andeconomic value of equity may vary substantially if different assumptions wereused or if actual experience differs from the projections on which they arebased.

Our Asset LiabilityCommittee meets monthly to monitor our investments, liquidity needs and overseeour asset-liability management. In between meetings of the Committee, ourmanagement oversees our liquidity management.

**Return on equity and assets**

Thefollowing table sets forth key ratios for the periods ending December 31,2004, 2003, and 2002.
| ** **                                                                 | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                 | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income as a  percentage of average assets                              |       | 0.90                                  | %          | 0.97 | % | 1.03 | % |
| Net income as a  percentage of average equity                              |       | 17.19                                 | %          | 22.24 | % | 20.54 | % |
| Average equity as  a percentage of average assets                          |       | 5.25                                  | %          | 4.35 | % | 5.01 | % |
| Dividends declared per  share as a percentage of net income per share |       | 10.59                                 | %          | 0.00 | % | 0.00 | % |

 

Due primarily to costsassociated with the two new retail branches and the new SBA division, costsassociated with the capital offering completed during the first quarter of 2004and listing the Company’s stock on the NASDAQ Small Cap market, and thedilutive affect of the $6.4 million capital infusion from the offering ofcommon stock, annualized net income as a percentage of average assets andaverage equity declined in 2004 from 2003 and 2002.

**Inflation**

The impact of inflation on a financial institution candiffer significantly from that exerted on other companies. Banks, as financialintermediaries, have many assets and liabilities that may move in concert withinflation both as to interest rates and value. However, financial institutionsare affected by inflation’s impact on noninterest expenses, such as salariesand occupancy expenses. During 2003 the problems of inflation remainedrelatively controlled, due primarily to continuous management of the moneysupply by the Federal Reserve, which substantially reduced interest ratesthroughout the last half of 2000 through the 

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first half of 2003 andmaintained the Federal Funds rate at 1.00% until June 2004. From June throughDecember 2004 the Federal Reserve increased the Federal Funds rate from1.00% to 2.25% in five separate rate increases.

We believe that theFederal Reserve will continue to increase the Federal Funds rate into 2005. Becauseof our ratio of rate sensitive assets to rate sensitive liabilities, we tend tobenefit slightly in the short-term from a decreasing interest rate market and,conversely, suffer in an increasing interest rate market. As such, themanagement of the Federal Funds rate by the Federal Reserve has an impact onour earnings. The changes in interest rates may have a corresponding impact onthe ability of borrowers to repay loans with us.

**Accounting Changes**

In December 2004,FASB issued FASB Statement No. 123R “Share-Based Payment”, which is arevision to Statement of Financial Accounting Standards (“SFAS”) No.123, “Accountingfor Stock-Based Compensation”, and addresses the accounting for transactions inwhich an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. This statement eliminates the ability toaccount for share-based compensation transactions using APB No. 25, andgenerally would require instead that such transactions be accounted for using afair-value-based method. The revised statement does not change the accountingin FASB Statement No. 123, Accounting for Stock-Based Compensation, fortransactions in which an enterprise exchanges its equity instruments forservices of parties other than employees or changes the accounting for employeestock ownership plans, which are subject to American Institute of CertifiedPublic Accountants (“AICPA”) Statement of Position 93-6, Employers’Accounting for Employee Stock Ownership Plans. The phase-in period for thisstatement begins in the third quarter of 2005, at which time the Company willaccount for stock-based compensation based on this new pronouncement. TheCompany is in the process of determining the impact that the adoption of SFAS No. 123Rwill have on the financial condition or operating results of the Company.

**Quantitative and Qualitative Disclosures About MarketRisk**

Market risk is the exposure to loss resulting fromchanges in interest rates, foreign currency exchange rates, commodity pricesand equity prices. Although the Company manages other risks, as in creditquality and liquidity risk, in the normal course of business, management considersinterest rate risk to be a principal market risk. Other types of market risks,such as foreign currency exchange rate risk, do not arise in the normal courseof the Company’s business activities. The majority of the Company’s interestrate risk arises from instruments, positions and transactions entered into forpurposes other than trading. They include loans, securities available-for-sale,deposit liabilities, short-term borrowings and long-term debt. Interest raterisk occurs when assets and liabilities reprice at different times as interestrates change.

The Company manages interest rate risk through the Bank’sAsset Liability Committee (ALCO). The ALCO monitors exposure to interest raterisk on a quarterly basis using both a traditional gap analysis and simulationanalysis. Traditional gap analysis identifies short and long-term interest ratepositions or exposure. Simulation analysis uses an income simulation approachto measure the change in interest income and expense under rate shockconditions. The model considers the three major factors of (a) volumedifferences, (b) repricing differences and (c) timing in its incomesimulation. The model begins by disseminating data into appropriate repricingbuckets based on internally supplied algorithms (or overridden by calibration).Next, each major asset and liability type is assigned a “multiplier” or beta tosimulate how much that particular balance sheet category type will reprice wheninterest rates change. The model uses numerous asset and liability multipliersconsisting of bank-specific or default multipliers. The remaining step is tosimulate the timing effect of assets and liabilities by modeling amonth-by-month 

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simulation to estimate thechange in interest income and expense over the next 12-month period. Theresults are then expressed as the change in pre-tax net interest income over a12-month period for +1%, and +2% shocks.

Refer to the Liquidity andLiability Management section of the Management Discussion and Analysis for morequalitative and quantitative disclosures about market risk.

**Off-Balance Sheet Arrangements**

In the normal course of business, the Company is aparty to financial instruments with off-balance-sheet risk. These financialinstruments include commitments to extend credit and letters of credit. Tovarying degrees, these instruments involve elements of credit and interest raterisk in excess of the amount recognized in the statement of financial position.The Company’s exposure to credit loss in the event of non-performance by theother party to the financial instruments for undisbursed loan funds and lettersof credit is represented by the contractual amount of those instruments. At December 31,2004 and 2003, the amounts of the Company’s undisbursed loan funds were $41.8million and $47.1 million, respectively. There were no obligations understandby and commercial letters of credit in either period.

Refer to Note 19 of the Financial Statements Analysisfor more qualitative and quantitative disclosures about financial instrumentswith off-balance sheet risk.

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**Item 7—Financial Statements**

**EPIC BANCORP AND SUBSIDIARY**

**DECEMBER 31, 2004 AND 2003**

**Contents**
| **Report of Independent  Registered Public Accounting Firm**                                                         |   | 70     |   |
|----------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| **Financial  Statements**                                                                                            |   |   |   |
| Consolidated  Balance Sheets  December 31, 2004 and 2003                                                        |   | 71     |   |
| Consolidated  Statements of Income  For the Years Ended December 31, 2004 and 2003                              |   | 72     |   |
| Consolidated Statement of  Changes in Stockholders’ Equity  For the Years Ended December 31, 2004 and 2003 |   | 73     |   |
| Consolidated  Statements of Cash Flows  For the Years Ended December 31, 2004 and 2003                          |   | 74     |   |
| **Notes to Consolidated  Financial Statements**                                                                      |   | 75     |   |

 

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**Report of Independent Registered Public AccountingFirm**

Boardof Directors

EpicBancorp

San Rafael, California

We have audited the accompanying consolidated balancesheets of Epic Bancorp and Subsidiary (the “Company”) as of December 31,2004 and 2003, and the related consolidated statements of income, changes instockholders’ equity and cash flows for each of the two years in the periodended December 31, 2004. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Epic Bancorp andSubsidiary as of December 31, 2004 and 2003, and the results of itsoperations, changes in its stockholders’ equity, and its cash flows for each ofthe two years in the period ended December 31, 2004, in conformity withU.S. generally accepted accounting principles.
| /s/ VAVRINEK,  TRINE, DAY & CO.,  LLP |
|------------------------------------------------|
| Rancho Cucamonga, California                   |
| February 11, 2005                         |

 

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**EPIC BANCORP ANDSUBSIDIARYCONSOLIDATED BALANCE SHEETSDECEMBER 31, 2004 AND 2003**
| ** **                                                                                                                                                         | ** ** | **2004**    | ** **  | **2003**    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **Assets**                                                                                                                                                         |       |        |        |        |       |
| Cash and cash  equivalents:                                                                                                                                        |       |        |        |        |       |
| Cash and due from banks                                                                                                                                            |       | $           | 5,295,051   |        | $          | 7,108,858 |   |
| Federal funds sold                                                                                                                                                 |       | 16,435,481  |        | 7,681,259   |       |
| Investment in money market funds                                                                                                                                   |       | 20          |        | —      |       |
| Total Cash and Cash Equivalents                                                                                                                                    |       | 21,730,552  |        | 14,790,117  |       |
| Interest-bearing  time deposits in other financial institutions                                                                                                    |       | 999,646     |        | 12,844,233  |       |
| Investment securities:                                                                                                                                             |       |        |        |        |       |
| Available for sale                                                                                                                                                 |       | 22,039,802  |        | —      |       |
| Held to maturity, at cost                                                                                                                                          |       | 40,851,486  |        | 18,907,115  |       |
| Federal Home Loan  Bank restricted stock, at cost                                                                                                                  |       | 6,933,500   |        | 3,609,300   |       |
| Pacific Coast  Banker’s Bank stock, at cost                                                                                                                   |       | 50,000      |        | 50,000      |       |
| Loans receivable,  net                                                                                                                                             |       | 329,251,030 |        | 249,144,433 |       |
| Less: Allowance for loan losses                                                                                                                                    |       | (3,600,433  | )           | (2,726,078  | )          |
|                                                                                                                                                               |       | 325,650,597 |        | 246,418,355 |       |
| Bank premises and  equipment, net                                                                                                                                  |       | 2,705,252   |        | 1,518,231   |       |
| Accrued interest  receivable                                                                                                                                       |       | 1,996,677   |        | 1,303,658   |       |
| Other assets                                                                                                                                                       |       | 2,652,159   |        | 2,519,554   |       |
| Total Assets                                                                                                                                                       |       | $           | 425,609,671 |        | $          | 301,960,563 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                     | ** ** | ** **  | ** **  | ** **  | ** ** |
| **Liabilities**                                                                                                                                                    |       |        |        |        |       |
| Deposits:                                                                                                                                                          |       |        |        |        |       |
| Noninterest-bearing deposits                                                                                                                                       |       | $           | 13,029,710  |        | $          | 9,528,413 |   |
| Interest-bearing checking deposits                                                                                                                                 |       | 7,773,492   |        | 9,588,911   |       |
| Money market and saving deposits                                                                                                                                   |       | 123,001,493 |        | 87,057,662  |       |
| Certificates of deposit greater than or equal to  $100,000                                                                                                         |       | 60,544,446  |        | 28,033,838  |       |
| Certificates of deposit less than $100,000                                                                                                                         |       | 70,270,833  |        | 77,417,310  |       |
| Total Deposits                                                                                                                                                     |       | 274,619,974 |        | 211,626,134 |       |
| Federal Home Loan  Bank Advances                                                                                                                                   |       | 115,780,636 |        | 65,101,242  |       |
| Junior  Subordinated Debentures                                                                                                                                    |       | 10,310,000  |        | 10,310,000  |       |
| Accrued interest  payable and other liabilities                                                                                                                    |       | 1,724,383   |        | 1,049,088   |       |
| Total Liabilities                                                                                                                                                  |       | 402,434,993 |        | 288,086,464 |       |
| **Commitment  and Contingencies (Note #14)**                                                                                                                       |       | —      |        | —      |       |
| **Stockholders’  Equity**                                                                                                                                     |       |        |        |        |       |
| Common stock, no par value; 10,000,000 shares authorized;  3,665,702 and 3,136,957 shares issued and outstanding at December 31,  2004 and 2003, respectively |       | 10,159,239  |        | 3,712,516   |       |
| Retained earnings                                                                                                                                                  |       | 13,244,716  |        | 10,161,583  |       |
| Accumulated other comprehensive (loss)                                                                                                                             |       | (229,277    | )           | —      |       |
| Total Stockholders’ Equity                                                                                                                                    |       | 23,174,678  |        | 13,874,099  |       |
| Total Liabilities  and Stockholders’ Equity                                                                                                                   |       | $           | 425,609,671 |        | $          | 301,960,563 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**EPIC BANCORP ANDSUBSIDIARYCONSOLIDATED STATEMENTS OF INCOMEFOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003**
| ** **                                           | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|
| **Interest Income**                                  |       |       |       |       |       |
| Interest and fees on loans                           |       | $          | 19,105,808 |       | $          | 15,517,530 |   |
| Interest on investment securities                    |       | 2,067,808  |       | 1,567,226  |       |
| Interest on Federal funds sold                       |       | 95,287     |       | 22,315     |       |
| Interest on other investments                        |       | 255,639    |       | 177,692    |       |
| Interest on deposits in other financial institutions |       | 78,435     |       | 165,682    |       |
| Total Interest Income                                |       | 21,602,977 |       | 17,450,445 |       |
| **Interest Expense**                                 |       |       |       |       |       |
| Interest expense on deposits                         |       | 4,421,577  |       | 4,231,621  |       |
| Interest expense on borrowed funds                   |       | 2,634,890  |       | 1,553,173  |       |
| Interest expense on Junior Subordinated Debentures   |       | 545,975    |       | 518,116    |       |
| Total Interest Expense                               |       | 7,602,442  |       | 6,302,910  |       |
| Net Interest Income Before Provision For Loan Losses |       | 14,000,535 |       | 11,147,535 |       |
| **Provision for Loan Losses**                        |       | 874,355    |       | 783,956    |       |
| Net Interest Income After Provision for Loan Losses  |       | 13,126,180 |       | 10,363,579 |       |
| **Noninterest  Income**                              |       |       |       |       |       |
| Gain on sale or brokerage of loans                   |       | 342,705    |       | 7,177      |       |
| Net gain (loss) on sale of securities, net           |       | (41,660    | )          | 218,143    |       |
| Loan servicing                                       |       | 155,175    |       | 115,695    |       |
| Loan fees and other income                           |       | 357,787    |       | 218,938    |       |
| Total Noninterest Income                             |       | 814,007    |       | 559,953    |       |
| **Noninterest  Expenses**                            |       |       |       |       |       |
| Salaries and benefits                                |       | 5,051,924  |       | 3,686,046  |       |
| Occupancy                                            |       | 999,185    |       | 587,651    |       |
| Advertising                                          |       | 296,869    |       | 331,041    |       |
| Professional                                         |       | 446,371    |       | 275,471    |       |
| Data processing                                      |       | 247,751    |       | 185,009    |       |
| Equipment and depreciation                           |       | 275,767    |       | 230,486    |       |
| Other administrative                                 |       | 1,464,699  |       | 1,109,216  |       |
| Total Noninterest Expense                            |       | 8,782,566  |       | 6,404,920  |       |
| **Income Before Income Taxes**                       |       | 5,157,621  |       | 4,518,612  |       |
| **Provision  for Income Taxes**                      |       | 1,709,208  |       | 1,721,072  |       |
| **Net  Income**                                      |       | $          | 3,448,413  |       | $          | 2,797,540 |   |
| **Earnings Per Share**                               |       |       |       |       |       |
| **Basic**                                            |       | $          | 0.97       |       | $          | 0.89 |   |
| **Diluted**                                          |       | $          | 0.94       |       | $          | 0.87 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**EPIC BANCORP ANDSUBSIDIARYCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITYFOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003**
| ** **                                                                          | ** ** | ** **            | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                          | ** ** | ** **            | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | **Other **        | ** ** | **Total**  | ** ** |
| ** **                                                                          | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                          | ** ** | **Shares**            | ** ** | **Amount**        | ** ** | **Income**   | ** ** | **Earnings**      | ** ** | **Income, (Loss)**     | ** ** | **Equity** | ** ** |
| **Balance,****January 1, 2003**                                                |       | 3,128,739             |       | $                 | 3,693,716  |         |       |              |       |                   | $          | 7,364,043  |       |   | $ | (44,206 | ) |   |   | $ | 11,013,553 |   |   |
| Stock options exercised                                                             |       | 8,218                 |       | 18,800            |       |         |       |              |       |                   |       |       |       |   |   |   | 18,800 |   |   |
| **Comprehensive income**                                                            |       |                  |       |              |       |         |       |              |       |                   |       |       |       |   |   |   |   |   |   |
| Net Income for the period                                                           |       |                  |       |              |       |         | $          | 2,797,540         |       |                   | 2,797,540  |       |       |   |   |   |   | 2,797,540 |   |   |
| Unrealized security holding gains (net of $116,728  tax)                            |       |                  |       |              |       |         | 175,092    |              |       |                   |       |       | 175,092    |   |   |   | 175,092 |   |   |
| Less reclassification adjustment for gains (net of  $87,257 tax)               |       |                  |       |              |       |         | (130,886   | )                 |       |                   |       |       | (130,886   | ) |   |   | (130,886 | ) |   |
| **Total Comprehensive Income**                                                      |       |                  |       |              |       |         | $          | 2,841,746         |       |                   |       |       |       |   |   |   |   |   |   |   |
| **Balance,****December 31, 2003**                                              |       | 3,136,957             |       | 3,712,516         |       |         |       |              |       | 10,161,583             |       |       | —     |   |   |   | 13,874,099 |   |   |
| Stock options exercised                                                             |       | 18,146                |       | 71,505            |       |         |       |              |       |                   |       |       |       |   |   |   | 71,505 |   |   |
| Sale of stock, net of $262,569 in issuance costs                                    |       | 510,599               |       | 6,375,218         |       |         |       |              |       |                   |       |       |       |   |   |   | 6,375,218 |   |   |
| **Comprehensive income**                                                            |       |                  |       |              |       |         |       |              |       |                   |       |       |       |   |   |   |   |   |   |
| Net Income for the period                                                           |       |                  |       |              |       |         | $          | 3,448,413         |       |                   | 3,448,413  |       |       |   |   |   |   | 3,448,413 |   |   |
| Cash Dividends                                                                      |       |                  |       |              |       |         |       |              |       | (365,280               | )          |       |       |   |   |   | (365,280 | ) |   |
| Unrealized security holding losses (net of $169,516  tax benefit)                   |       |                  |       |              |       |         | (254,273   | )                 |       |                   |       |       | (254,273   | ) |   |   | (254,273 | ) |   |
| Less: reclassification adjustment for realized losses  (net of $16,664 tax benefit) |       |                  |       |              |       |         | 24,996     |              |       |                   |       |       | 24,996     |   |   |   | 24,996 |   |   |
| **Total Comprehensive Income**                                                      |       |                  |       |              |       |         | $          | 3,219,136         |       |                   |       |       |       |   |   |   |   |   |   |   |
| **Balance,****December 31,  2004**                                             |       | 3,665,702             |       | $                 | 10,159,239 |         |       |              |       |                   | $          | 13,244,716 |       |   | $ | (229,277 | ) |   |   | $ | 23,174,678 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**EPIC BANCORP ANDSUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003**
| ** **                                                            | ** ** | **2004**     | ** ** | **2003**    | ** ** |
|-----------------------------------------------------------------------|------------|--------------|------------|-------------|------------|
| **Cash Flows From Operating Activities**                              |       |         |       |        |       |
| Net Income                                                            |       | $            | 3,448,413  |        | $          | 2,797,540 |   |
| Adjustments to Reconcile Net Income to Net                            |       |         |       |        |       |
| Cash Provided by Operating Activities:                                |       |         |       |        |       |
| Depreciation and  amortization of premises and equipment              |       | 370,086      |       | 278,890     |       |
| Provision for loan  losses                                            |       | 874,355      |       | 783,956     |       |
| Deferred income taxes                                                 |       | (340,401     | )          | 317,449     |       |
| Change in deferred  costs, net of amortization                        |       | 315,262      |       | (532,800    | )          |
| Change in loan servicing  asset, net of amortization                  |       | (54,534      | )          | 113,576     |       |
| Net amortization of  investment securities                            |       | 704,753      |       | 1,380,417   |       |
| FHLB stock dividends                                                  |       | (205,500     | )          | (184,200    | )          |
| (Gain)/loss on sale of  investment securities                         |       | 41,660       |       | (218,143    | )          |
| Loss on sale of fixed  assets                                         |       | —       |       | 1,192       |       |
| Net change in accrued  interest receivable and other assets           |       | (277,837     | )          | (467,912    | )          |
| Net change in accrued  interest payable and other liabilities         |       | 675,295      |       | 13,952      |       |
| Net Cash Provided By Operating  Activities                            |       | 5,551,552    |       | 4,283,917   |       |
| **Cash Flows From Investing Activities**                              |       |         |       |        |       |
| Loans originated or  purchased, net of repayments                     |       | (80,421,859  | )          | (71,722,928 | )          |
| Principal reduction in  mortgage-backed securities                    |       | 17,140,249   |       | 33,741,752  |       |
| Purchase of investment  securities available for sale                 |       | (56,011,163  | )          | (20,904,428 | )          |
| Purchase of investment  securities held to maturity                   |       | (33,734,646  | )          | (1,412,706  | )          |
| Net change in interest  earning deposits                              |       | 11,844,587   |       | (5,630,164  | )          |
| Purchase of Federal Home  Loan Bank stock                             |       | (3,118,700   | )          | (339,500    | )          |
| Redemption of Federal  Home Loan Bank stock                           |       | —       |       | 1,247,100   |       |
| Proceeds from sale of  investment securities                          |       | 17,492,845   |       | 41,865,054  |       |
| Proceeds from maturities  of investment securities available for sale |       | 10,000,000   |       | —      |       |
| Purchase of property and  equipment                                   |       | (1,557,107   | )          | (608,948    | )          |
| Net Cash Used By  Investing Activities                                |       | (118,365,794 | )          | (23,764,768 | )          |
| **Cash Flows From Financing Activities**                              |       |         |       |        |       |
| Net increase in deposits                                              |       | 62,993,840   |       | 32,174,045  |       |
| Net change in FHLB  advances                                          |       | 50,679,394   |       | (4,768,192  | )          |
| Proceeds from stock  subscription                                     |       | 6,375,218    |       | 3,547,661   |       |
| Dividends paid                                                        |       | (365,280     | )          | —      |       |
| Stock option exercise  proceeds                                       |       | 71,505       |       | 18,800      |       |
| Net Cash Provided By  Financing Activities                            |       | 119,754,677  |       | 30,972,314  |       |
| **Net Increase in Cash and Cash  Equivalents**                        |       | $            | 6,940,435  |        | $          | 11,491,463 |   |
| **Cash and Cash Equivalents,**Beginning  of Year                      |       | 14,790,117   |       | 3,298,654   |       |
| **Cash and Cash Equivalents,**End  of Year                            |       | $            | 21,730,552 |        | $          | 14,790,117 |   |
| **Supplemental Disclosure of Cash Flow Information**                  |       |         |       |        |       |
| Cash paid during the year for:                                        |       |         |       |        |       |
| Interest paid                                                         |       | $            | 7,498,132  |        | $          | 6,431,567 |   |
| Income taxes paid                                                     |       | $            | 2,020,203  |        | $          | 1,780,000 |   |
| **Non-Cash Investing Activities**                                     |       |         |       |        |       |
| Net change in accumulated other comprehensive income                  |       | $            | (229,277   | )           | $          | 44,206 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2004 AND 2003**

**Note #1—Summary of Significant Accounting Policies**

The accounting andreporting policies of Epic Bancorp and Subsidiary (the “Bancorp”) conform toaccounting principles generally accepted in the United States of America andprevailing practices within the banking industry. A summary of the significantaccounting policies and reporting policies consistently applied in thepreparation of the accompanying financial statements follows:

Principles ofConsolidation

The consolidated financialstatements include the Bancorp and its wholly owned subsidiary, Tamalpais Bank(the “Bank”). All significant intercompany balances and transactions have beeneliminated.

Nature ofOperations

The Bancorp was incorporated on December 20,1988, and is organized as a holding company for the Bank. The Bancorp completeda public offering of common stock in the first quarter of 2004. On August 9,2004 the Bancorp’s common stock began trading on the Nasdaq SmallCap Marketunder the symbol “EPIK.”

The Bank conducts businessas an industrial bank under the California State Banking Law and operates fivebranches in Marin County, California. The Bancorp provides a variety offinancial services to individuals and small-to-medium sized businesses andoffers a full range of commercial banking services including the acceptance ofchecking and savings deposits, and the making of various types of installment,commercial and real estate loans.

Investment inNonconsolidated Subsidiary

The Bancorp accounts forits investment in its wholly owned special purpose entity, San Rafael CapitalTrust I, using the equity method under which the subsidiary’s net earnings arerecognized in the Bancorp’s statements of income.

Use of Estimates

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

Estimates that are particularly susceptible tosignificant change relate to the determination of the allowance for losses onloans and the valuation of real estate acquired in connection with foreclosuresor in satisfaction of loans. In connection with the determination of theallowances for losses on loans and foreclosed real estate, management obtainsindependent appraisals for significant properties.

While management usesavailable information to recognize losses on loans and foreclosed real estate,future additions to the allowances may be necessary based on changes in localeconomic conditions. In addition, regulatory agencies, as an integral part oftheir examination process, periodically review the Bank’s allowances for losseson loans and foreclosed real estate. Such agencies may require the Bank to 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#1—Summary of Significant Accounting Policies (Continued)**

recognizeadditions to the allowances based on their judgments about informationavailable to them at the time of their examination. Because of these factors,it is reasonably possible that the allowances for losses on loans andforeclosed real estate may change.

Cash and CashEquivalents

For purposes of reportingcash flows, cash and cash equivalents include cash on hand, amounts due frombanks, Federal funds sold, money market mutual funds and other investments withoriginal maturities of less than 90 days.

Cash and Due FromBanks

Banking regulations require that all banks maintain apercentage of their deposits as reserves in cash or on deposit with the FederalReserve Bank. The Bank complied with the reserve requirements as of December 31,2004.

The Bank maintains amountsdue from banks that exceed federally insured limits. The Bank has notexperienced any losses in such accounts.

InvestmentSecurities

The Bank classifies its investments in debt securitiesand marketable equity securities as either held to maturity, trading, oravailable for sale, and accounts for them as follows:

Held to maturity:   Debt securities management has thepositive intent and ability to hold until maturity are classified as held tomaturity and are carried at their remaining unpaid principal balance, net ofunamortized premiums or nonaccreted discounts.

Trading Securities:   Debt and equity securities that arebought and held principally for the purposes of selling them in the near termare classified as trading securities and reported at market value, withunrealized gains and losses included in earnings.

Available for sale:   Debt and equity securities that will beheld for indefinite periods of time, including securities that may be sold inresponse to changes in market interest or prepayment rates, needs forliquidity, and changes in the availability of and the yield of alternativeinvestments, are classified as available for sale. These investments arecarried at market value. Market value is determined using published quotes asof the close of business. Unrealized gains and losses are excluded fromearnings and reported net of tax as a separate component of stockholders’equity until realized.

The amortized cost ofinvestment securities adjusted for amortization of premiums and accretion ofdiscounts to maturity or, in the case of mortgage-backed securities, over theestimated life of the security, using a method that approximates the effectiveinterest method. Such amortization and accreted interest are included ininterest income. Gains and losses on sales of investments are recognized basedon specific identification and are included in noninterest income.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #1—Summary of Significant AccountingPolicies (Continued)**

Loans Receivableand Unearned Income

The Bank holds loans primarily for investment purposes.Accordingly, loans held for investment are carried at amortized cost. The Bank’sloan portfolio consists primarily of commercial and multi-family real estateloans generally collateralized by first deeds of trust on real estate.

Interest income is accrued daily on the outstandingloan balances using the simple interest method. When loans become 90 days pastdue or delinquent and management makes a determination that interest may not becollectible, the accrual of interest is discontinued and any amount accrued butuncollected is reversed against interest income. Loans are generally chargedoff at such time the loan is classified as a loss.

The Bank charges fees for originating loans. Loanorigination fees, net of direct underwriting costs, are deferred and amortizedto income by use of a method that approximates a level yield over the lives ofthe related loans. If a loan is paid off prior to maturity, then the remainingunamortized deferred fee is immediately recognized to interest income.

Gains or losses on sales of loans are recognized atthe time of sale and are determined by the difference between the net salesproceeds and the allocated basis of the loans sold (or carrying value). TheCompany capitalizes Mortgage Servicing Rights (MSRs) when mortgage loans aresold. The fair value of MSRs is included as a component of gain on sale ofloans. The MSRs are amortized in proportion to and over the estimated period ofnet servicing income. Such amortization is reflected as a component of loanservicing income.

MSRs are periodically evaluated for impairment andcarried at the lower of amortized cost or fair value through the use ofvaluation allowances. The fair value of the MSRs is measured using a discountedcash flow analysis based on available market quotes, market-adjusted discountrates and anticipated prepayment speeds. Market sources, adjusted forhistorical performance, are used to determine prepayment speeds, the net costof servicing per loan, inflation rates and interest rates for mortgages. As of December 31,2004 the Company had MSRs totaling approximately $81,000 recorded in “OtherAssets” in the Consolidated Statement of Financial Condition. There was no MSRimpairment recorded as of December 31, 2004.

A loan is consideredimpaired if it is probable that the Bank will be unable to collect thescheduled payments of principal or interest when due according to thecontractual terms of the loan agreement. Any allowance for losses on impairedloans is to be measured under one of three prescribed methods. Since most ofthe Bank’s loans are collateral dependent, the calculation of the impairedloans is generally based on the fair value of the collateral. Incomerecognition on impaired loans conforms to the method the Bank uses for incomerecognition on nonaccrual loans.

Allowance for LoanLosses

An allowance for loan losses is maintained at a leveldeemed appropriate by management to provide for known losses as well asunidentified losses in the loan portfolio. The allowance is based uponmanagement’s assessment of various factors affecting the collectibility of theloans, including current and 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#1—Summary of Significant Accounting Policies (Continued)**

projected economicconditions, past credit experience, delinquency status, the value of theunderlying collateral, if any, and continuing review of the portfolio of loansand commitments.

The allowance for loanlosses is based on estimates, and ultimate losses may vary from the currentestimates. These estimates are reviewed periodically and, as adjustments becomenecessary, they are reported in earnings in the periods in which they becomeknown. The allowance is increased by provisions charged to expense and isreduced by net charge-offs.

Loan Servicing

The cost of mortgageservicing rights is amortized in proportion to, and over the period of,estimated net servicing revenues. Impairment of mortgage servicing rights isassessed based on the fair value of those rights. Fair values are estimatedusing discounted cash flow analysis based on current market rates. For purposesof measuring impairment, servicing rights are stratified based on loan type,investor type, and interest rate. The amount of impairment recognized is theamount by which the capitalized mortgage servicing rights for a stratum exceedtheir fair value. Rights to future interest income from serviced loans thatexceeds contractually specified servicing fees are classified as interest-onlystrips and accounted for as debt securities that are available for sale.

Premises andEquipment

Furniture, equipment, andleasehold improvements are recorded at cost and depreciated by the straight-linemethod over the shorter of the estimated useful lives of the assets or leaseterms, which range from two to ten years.

Income Taxes

Provisions for incometaxes are based on amounts reported in the statements of income (afterexclusion of non-taxable income such as interest on state and municipalsecurities) and include deferred taxes on temporary differences in therecognition of income and expense for tax and financial statement purposes. Deferredtaxes are computed on the liability method as prescribed in Statement ofFinancial Accounting Standards (SFAS) No. 109, “Accounting for IncomeTaxes.”

Advertising

Advertising costs arecharged to expense during the year in which they are incurred.

Disclosure about FairValue of Financial Instruments

SFAS No. 107, *“Disclosures About FairValue of Financial Instruments,”* specifies the disclosure of theestimated fair value of financial instruments. The Bancorp’s estimated fairvalue amounts have been determined by the Bancorp using available marketinformation and appropriate valuation methodologies.

However, considerable judgment is required to developthe estimates of fair value. Accordingly, the estimates are not necessarilyindicative of the amounts the Bancorp could have realized in a current 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#1—Summary of Significant Accounting Policies (Continued)**

market exchange. The useof different market assumptions and/or estimation methodologies may have amaterial effect on the estimated fair value amounts.

Although management is notaware of any factors that would significantly affect the estimated fair valueamounts, such amounts have not been comprehensively revalued for purposes ofthese financial statements since the balance sheet date and, therefore, currentestimates of fair value may differ significantly from the amounts presented inthe accompanying notes.

Off-Balance SheetFinancial Instruments

The Bank holds noderivative financial instruments. However, in the ordinary course of business,the Bank enters into off-balance sheet financial instruments consisting ofcommitments to extend credit. These financial instruments are recorded in thefinancial statements when they are funded or related fees are incurred orreceived.

Earnings Per Share(EPS)

Basic EPS excludesdilution and is computed by dividing income available to common stockholders bythe weighted-average number of common shares outstanding for the period. DilutedEPS reflects the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stockor resulted in the issuance of common stock that then shared in the earnings ofthe entity.

Stock-Based Compensation

SFAS No. 123*, “Accounting forStock-Based Compensation,”* as amended by SFAS No. 148, *“Accounting for Stock-Based Compensation—Transitionand Disclosure,”*prescribes accounting and reporting standards forall stock-based**compensationplans, including employee stock option plans. As allowed by SFAS No. 123,the Bancorp has elected to continue to account for it’s employee stock-basedcompensation using the intrinsic value method in accordance with AccountingPrinciples Board (“APB”) Opinion No. 25, *“Accountingfor Stock Issued to Employees,”* and related interpretations, whichdoes not require compensation to be recorded if the consideration to bereceived is at least equal to the fair value of the common stock to be receivedat the measurement date. Under the requirements of SFAS No. 123, non-employeestock-based transactions require compensation to be recorded based on the fairvalue of the securities issued or the services received, whichever is morereliably measurable.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#1—Summary of Significant Accounting Policies (Continued)**

Thefollowing table illustrates the effect on net loss and loss per share hadcompensation costs for the stock-based compensation plan been determined basedon grant date fair values of awards under the provisions of SFAS No. 123,for the years ended December 31:
| ** **                                                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income:                                                                                     |       |     |       |     |       |
| As reported                                                                                     |       | $        | 3,448,413  |     | $          | 2,797,540 |   |
| Stock-based compensation using the intrinsic value  method                                      |       | —   |       | —   |       |
| Stock-based compensation that would have been  reported using the fair value method of SFAS 123 |       | (118,578 | )          | (14,361  | )          |
| Pro forma net income                                                                            |       | $        | 3,329,835  |     | $          | 2,783,179 |   |
| Basic earnings per share:                                                                       |       |     |       |     |       |
| As reported                                                                                     |       | $        | 0.97       |     | $          | 0.89 |   |
| Pro forma                                                                                       |       | $        | 0.93       |     | $          | 0.89 |   |
| Diluted earnings per share:                                                                     |       |     |       |     |       |
| As reported                                                                                     |       | $        | 0.94       |     | $          | 0.87 |   |
| Pro forma                                                                                       |       | $        | 0.91       |     | $          | 0.87 |   |

 

Comprehensive Income

Beginning in 1998, theBank adopted SFAS No. 130, *“ReportingComprehensive Income,”* which requires the disclosure ofcomprehensive income and its components. Changes in unrealized gain (loss) onavailable for sale securities net of income taxes, is the only component ofaccumulated other comprehensive income for the Bank.

Reclassifications

Certain reclassificationshave been made to the December 31, 2003 financial statements to conform tothe current year’s presentation.

Current Accounting Pronouncements

In December 2004, FASB issued SFAS No. 123(R) “Share-BasedPayment”, which is a revision to SFAS No.123, “Accounting for Stock-BasedCompensation”, and addresses the accounting for transactions in which an enterprisereceives employee services in exchange for (a) equity instruments of theenterprise or (b) liabilities that are based on the fair value of theenterprise’s equity instruments or that may be settled by the issuance of suchequity instruments. This statement eliminates the ability to account forshare-based compensation transactions using APB No. 25, and generallywould require instead that such transactions be accounted for using afair-value-based method. This statement is effective as of the beginning of thefirst interim or annual reporting period that begins after December 15,2005, at which time the Bancorp will account for stock-based compensation basedon this new pronouncement. The Bancorp is in the process of determining theimpact that the adoption of SFAS No. 123(R) will have on thefinancial condition or operating results of the Bancorp.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #2—InvestmentSecurities**

At December 31, 2004 and 2003 the investmentsecurities portfolio was comprised of securities classified as available forsale and held to maturity, in accordance with SFAS No. 115, resulting ininvestment securities available for sale being carried at fair value andinvestment securities held to maturity being carried at cost, adjusted foramortization of premiums and accretions of discounts.

Theamortized cost and estimated fair value of available for sale securities at December 31,2004 are as follows. There were no investment securities available for sale at December 31,2003.
| ** **                  | ** ** | **December 31, 2004** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                  | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Mortgage-Backed  Securities |       | $                               | 22,421,931 |   |   | $ | — |   |   | $ | (382,129 | ) | $ | 22,039,802 |   |
|                             |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theamortized cost and estimated fair value of held to maturity securities at December 31,2004 and 2003, are as follows:
| ** **                  | ** ** | **December 31, 2004** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                  | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Mortgage-Backed  Securities |       | $                               | 40,851,486 |   | $ | 78,173 |   | $ | (602,266 | ) | $ | 40,327,393 |   |
|                             |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                  | ** ** | **December 31, 2003** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                  | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Mortgage-Backed  Securities |       | $                               | 18,907,115 |   | $ | 146,352 |   | $ | (47,437 | ) | $ | 19,006,030 |   |
|                             |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

Theamortized cost and fair values of investment securities available for sale andheld to maturity at December 31, 2004, by expected maturity are shownbelow. Expected maturities may differ from contractual maturities becauseborrowers may have the right to call or prepay obligations with or without callor prepayment penalties.
| ** **                 | ** ** | ** **      | ** ** | **Securities** | ** ** |
|----------------------------|------------|-----------------|------------|----------------|------------|
| ** **                 | ** ** | ** **      | ** ** | **Amortized**  | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **Maturity**    | ** ** | **Cost**       | ** ** | **Fair Value** | ** ** |
| Available for  Sale        |       |            |       |           |       |   |   |
| Mortgage-Backed Securities |       | After  10 years |       | $              | 22,421,931 |   | $ | 22,039,802 |   |
| Held to Maturity           |       |            |       |           |       |   |   |
| Mortgage-Backed Securities |       | 0-5  years      |       | 6,558,712      |       | 6,476,135 |   |
|                       |       | After  10 years |       | 34,292,774     |       | 33,851,258 |   |
|                       |       |            |       | $              | 40,851,486 |   | $ | 40,327,393 |   |

 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#2—Investment Securities (Continued)**

Proceeds from sales of investment securities availablefor sale during 2004 and 2003 were $17,492,845 and $41,865,054, respectively. In2004 and 2003, gross gains and gross losses on those sales were $957 and$42,617, and $264,608 and $46,465, respectively.

Proceeds from principal reductions of mortgage-backedsecurities in 2004 and 2003 were $17,140,247 and $33,741,752, respectively.

Included in stockholders’ equity at December 31,2004 and 2003 were $229,277 and $0 of net unrealized losses (net of $152,852and $0 estimated tax benefit), respectively.

All investment securitiesavailable for sale and held to maturity were pledged to secure FHLB advances.

**Note #3—Loans andAllowance for Loan Losses**

Allmortgage loans are collateralized by property located in Northern California. Substantiallyall loans are carried at variable rates. The concentrations of credit by typeof loan are outlined as follows:
| ** **                      | ** ** | **2004**    | ** **  | **2003**    | ** ** |
|---------------------------------|------------|-------------|-------------|-------------|------------|
| One-to-four  family residential |       | $           | 13,878,219  |        | $          | 11,403,378 |   |
| Multifamily  residential        |       | 126,099,047 |        | 97,941,176  |       |
| Commercial real  estate         |       | 147,356,554 |        | 112,216,009 |       |
| Land                            |       | 9,149,772   |        | 8,039,372   |       |
| Construction real  estate       |       | 9,157,214   |        | 12,071,453  |       |
| Consumer loans                  |       | 3,925,084   |        | 2,317,770   |       |
| Commercial, non  real estate    |       | 17,746,178  |        | 3,780,185   |       |
|                            |       | 327,312,068 |        | 247,769,343 |       |
| Net deferred loan costs         |       | 1,938,962   |        | 1,375,090   |       |
|                            |       | $           | 329,251,030 |        | $          | 249,144,433 |   |

 

At December 31, 2004 and 2003, the Bank had loanswith fixed rates of interest amounting to $0 and $1,589,826, and had loans withvariable rates of interest amounting to $327,312,068 and $246,179,517,respectively.

Net unamortized premiums on purchased loans amountedto $1,921 and $3,000, for 2004 and 2003, respectively.

The Bank also originates Small Business Administration(“SBA”) Loans for sale to governmental agencies and institutional investors. AtDecember 31, 2004 the balance of commercial real estate loans included$5,303,875 in SBA Loans.

Nonaccruing loans totaled $392,991 and $0 at December 31,2004 and 2003, respectively. As of December 31, 2004, the one loan onnonaccrual was classified as impaired. If interest on nonaccrual loans had beenrecognized at the original interest rates, interest income would have increased$14,123 and $0 for the years ended 2004 and 2003, respectively. No additionalfunds are committed to be advanced in connection with impaired loans.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#3—Loans and Allowance for Loan Losses (Continued)**

The following is a summaryof information pertaining to impaired loans:
| ** **                                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Impaired loans  with a valuation allowance         |       |     | $          | —   |       |   |   | $ | — |   |   |
| Impaired loans  without a valuation allowance      |       |     | 393        |     |       |   | — |   |   |
| Total impaired loans                               |       |     | $          | 393      |       |   |   | $ | — |   |   |
| Valuation  allowance related to impaired loans     |       |     | $          | —   |       |   |   | $ | — |   |   |
| Average recorded  investment in impaired loans     |       |     | $          | 305      |       |   |   | $ | — |   |   |
| Cash receipts  applied to reduce principal balance |       |     | $          | —   |       |   |   | $ | — |   |   |
| Interest income  recognized for cash payments      |       |     | $          | —   |       |   |   | $ | — |   |   |

 

At December 31, 2004, the Bank had no loans pastdue 90 days or more in principal or interest. At December 31, 2003, theBank had one loan with a principal balance of $120,830 past due 90 days or morein interest or principal and still accruing interest.

The Bank had no loans classified as troubled debtrestructurings for December 31, 2004 and 2003.

Asummary of activity in the allowance for loan losses is as follows:
| ** **                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
| Balance,  Beginning of Year |       | $        | 2,726,078  |     | $          | 1,942,122 |   |
| Provision for  loan losses  |       | 874,355  |       | 783,956  |       |
| Balance, End of Year        |       | $        | 3,600,433  |     | $          | 2,726,078 |   |

 

**Note #4—Loan Servicing**

Mortgage loans serviced for others are not included inthe accompanying balance sheets. The unpaid principal balances of mortgageloans serviced for others were $ 21,692,327 and $32,826,763 at December 31,2004 and 2003, respectively. Included in these amounts are Small BusinessAdministration (“SBA”) Loans for sold to governmental agencies andinstitutional investors. At December 31, 2004 the unpaid principal balanceof SBA Loans serviced for others totaled $3,146,364.

The Bank began to originate Small BusinessAdministration (“SBA”) loans for sale to governmental agencies andinstitutional investors in 2004. At December 31, 2004 the unpaid principalbalance of SBA loans serviced for others totaled $3,146,364. The gain on saleof SBA loans was $344,413 for the year ended December 31, 2004.

The balance of mortgage servicing rights included inother assets as of December 31, 2004 and 2003, was $81,411 and $26,877. Thefair value of these rights as of December 31, 2004 and 2003 was $97,902and $79,545, respectively.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#4—Loan Servicing (Continued)**

The following summarizedservicing rights capitalized and amortized:
| ** **                             | ** ** | **For the year ended  December 31,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                             | ** ** | **2004**                                                 | ** ** | **2003** | ** ** |
| Mortgage  servicing rights capitalized |       | $                                                        | 75,834     |   | $ | — |   |
| Mortgage  servicing rights amortized   |       | 21,300                                                   |       | 113,576 |   |
| Valuations                             |       | —                                                   |       | — |   |
|                                        |            |                                                          |            |  |  |  |  |

 

**Note#5—Premises and Equipment**
| ** **                                      | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-------------------------------------------------|------------|-----------|------------|-----------|------------|
| Furniture and  equipment                        |       | $         | 1,381,983  |      | $          | 873,200 |   |
| Leasehold  improvements                         |       | 2,457,262 |       | 1,477,054 |       |
| Construction-in-progress                        |       | 119,059   |       | 58,685    |       |
|                                            |       | 3,958,304 |       | 2,408,939 |       |
| Less accumulated  depreciation and amortization |       | 1,253,052 |       | 890,708   |       |
| Total                                           |       | $         | 2,705,252  |      | $          | 1,518,231 |   |

 

Depreciation expense andleasehold improvement amortization was $370,086 and $278,890 for the yearsended December 31, 2004 and 2003, respectively.

**Note #6—Certificates ofDeposits**

At December 31,2004, the scheduled maturities of certificates of deposits are as follows:
| **Year Ending December 31,** | ** ** | ** ** | ** **  | **Total** | ** ** |
|---------------------------------------------|------------|------------|-------------|-----------|------------|
| 2005                                        |       | $          | 99,518,931  |      |
| 2006                                        |       | 26,105,979 |        |
| 2007                                        |       | 4,785,725  |        |
| 2008                                        |       | 106,644    |        |
| 2009                                        |       | 298,000    |        |
|                                        |       | $          | 130,815,279 |      |

 

Brokered deposits totaled$31,956,859 and $21,666,684 at December 31, 2004 and 2003, respectively,and are included as a component of certificates of deposit.

**Note #7—JuniorSubordinated Debentures**

On June 27, 2002,Epic Bancorp issued $10,310,000 Junior Subordinated Debentures. The variablerate debentures (dividends issued at a quarterly LIBOR rate plus 3.65%, not toexceed 12% prior to—June 30, 2007) mature June 30, 2032. Thedebentures were issued in concurrence with the—Cumulative Trust PreferredSecurities (the “Trust Preferred Securities”) of the San Rafael Capital TrustI, a wholly owned non-consolidated subsidiary of Epic Bancorp. Proceeds of theTrust Preferred Securities were invested in the junior subordinated debenturesissued by Epic Bancorp. Epic Bancorp has the right, 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#7—Junior Subordinated Debentures (Continued)**

assumingno default has occurred, to defer payments of interest on the juniorsubordinated debentures at any time for a period not to exceed ten consecutivesemi-annual periods. As of December 31, 2004 the interest rate on theJunior Subordinated Debenture was 5.72%.

**Note #8—Federal Home LoanBank (FHLB) Advances**

Pursuant to collateral agreements with the FHLB,advances are secured by loans and investment securities maintained by the Bank.Loans with a carrying value of $209,052,322 have been pledged to secureadvances of $115,780,636, and investment securities of $62,891,288 have beenpledged to secure advances of $9,000,000. Advances have a fixed rate ofinterest, and bear interest at a weighted-average rate of 2.47 percent.

At December 31,2004, the scheduled maturities of FHLB advances are as follows:
| **Year Ending December 31,** | ** ** | ** ** | ** **  | **Total** | ** ** |
|---------------------------------------------|------------|------------|-------------|-----------|------------|
| 2005                                        |       | $          | 38,320,718  |      |
| 2006                                        |       | 44,373,724 |        |
| 2007                                        |       | 28,086,194 |        |
| 2008                                        |       | 5,000,000  |        |
|                                        |       | $          | 115,780,636 |      |

 

**Note #9—SalaryContinuation Plan**

The Salary ContinuationPlan was established in 2002 for a key employee to provide incentive for theemployee to continue their current capacity. The Plan is intended to be anun-funded deferred compensation plan for a select group of management or highlycompensated employees. In 2003, an additional employee was added to the Plan. Thebenefit under this plan for the two key employees would be equal to payments of$100,000 per year commencing on January 1, 2005 and January 1, 2015,respectively, for a period of 15 years. The Bank has determined the net presentvalue of both pension obligations to be $1,062,597, assuming a discount rate ofseven percent, and has a current year expense of $379,500 ($224,000 net oftax).

**Note #10—Fair Value ofFinancial Instruments**

SFAS No. 107 requires disclosure of fair valueinformation about financial instruments, whether or not recognized in thestatement of financial condition. In cases where quoted market prices are notavailable, fair values are based on estimates using present value or othervaluation techniques. Those techniques are significantly affected by theassumptions used, including the discount rate and estimates of future cashflows. In that regard, the derived fair value estimates cannot be substantiatedby comparison to independent markets and, in many cases, could not be realizedin immediate settlement of the instruments. SFAS No. 107 excludes certainfinancial instruments and all nonfinancial instruments from its disclosurerequirements. Accordingly, the aggregate fair value amounts presented do notrepresent the underlying value of the Bancorp.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #10—Fair Value of Financial Instruments**(Continued)

The following table presents the carrying amounts andfair values of financial instruments at December 31, 2004 and 2003. SFAS No. 107defines the fair value of a financial instrument as the amount at which theinstrument could be exchanged in a current transaction between willing parties,other than in a forced or liquidation sale.

Theestimated fair values of the Bancorp’s financial instruments were as follows:
| ** **                                                 | ** ** | **2004**     | ** ** | **2003**            | ** ** |
|------------------------------------------------------------|------------|--------------|------------|---------------------|------------|
| ** **                                                 | ** ** | **Carrying** | ** ** | ** **          | ** ** | **Carrying** | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| Financial assets:                                          |       |         |       |                |       |   |   |   |   |
| Cash and cash equivalents                                  |       | $            | 21,730,552 |                | $          | 21,730,552 |   | $ | 14,790,117 |   | $ | 14,790,117 |   |
| Investment securities                                      |       | 62,891,288   |       | 62,367,195          |       | 18,907,115 |   | 19,006,030 |   |
| Interest-bearing deposits in other financial  institutions |       | 999,646      |       | 999,646             |       | 12,844,233 |   | 12,844,233 |   |
| Federal Home Loan Bank restricted stock                    |       | 6,933,500    |       | 6,933,500           |       | 3,609,300 |   | 3,609,300 |   |
| Pacific Coast Banker’s Bank stock                     |       | 50,000       |       | 50,000              |       | 50,000 |   | 50,000 |   |
| Loans receivable, net                                      |       | 325,650,597  |       | 344,710,000         |       | 246,418,355 |   | 255,112,473 |   |
| Accrued interest receivable                                |       | 1,996,677    |       | 1,996,677           |       | 1,303,658 |   | 1,303,658 |   |
| Financial liabilities:                                     |       |         |       |                |       |   |   |   |   |
| Deposits                                                   |       | 274,619,974  |       | 274,452,974         |       | 211,626,134 |   | 212,806,048 |   |
| Federal Home Loan Advances                                 |       | 115,780,636  |       | 114,948,000         |       | 65,101,242 |   | 65,521,244 |   |
| Junior subordinated debentures                             |       | 10,310,000   |       | 10,310,000          |       | 10,310,000 |   | 10,310,000 |   |
| Accrued interest payable                                   |       | 186,955      |       | 186,955             |       | 73,999 |   | 73,999 |   |
|                                                            |            |              |            |                     |            |  |  |  |  |  |  |  |  |

 
| ** **                     | ** ** | **Notional** | ** ** | **Cost to Cede** | ** ** | **Notional** | ** ** | **Cost to Cede** | ** ** |
|--------------------------------|------------|--------------|------------|------------------|------------|--------------|------------|------------------|------------|
| ** **                     | ** ** | **Amount**   | ** ** | **or Assume**    | ** ** | **Amount**   | ** ** | **or Assume**    | ** ** |
| Off-Balance Sheet  Instruments |       |         |       |             |       |         |       |             |       |
| Commitments to  extend credit  |       | $            | 41,799,141 |             | $          | 417,991      |       | $                | 47,084,351 |   | $ | 470,844 |   |
|                                |            |              |            |                  |            |              |            |                  |            |  |  |  |  |

 

The followingmethods and assumptions were used by the Bancorp in estimating fair valuedisclosures:

·       *Cash and Cash Equivalents*

The carrying amounts reported in the balance sheet forcash and cash equivalents approximate those assets’ fair values due to theshort-term nature of the assets.

·       *Investment Securities*

The fair value of investment securities are based uponquoted market prices, where available.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#10—Fair Value of Financial Instruments (Continued)**

·       *Interest-bearing Deposits with Other Financial Institutions*

The carrying amounts of interest-bearing depositsmaturing within ninety days approximate their fair values. Fair values of otherinterest-bearing deposits are estimated using discounted cash flow analysesbased on current rates for similar types of deposits.

·       *Restricted Stock*

The carrying valuesof restricted equity securities approximate fair values.

·       *Loans*

For variable-rateloans that reprice frequently and with no significant change in credit risk,fair values are based on carrying amounts. The fair values for other loans (forexample, fixed rate commercial real estate loans, variable rate loans withinitial fixed rate periods, and variable rate loans at their contractual cap orfloor rates) are estimated using discounted cash flow analysis, based oninterest rates currently being offered for loans with similar terms toborrowers of similar credit quality. Loan fair value estimates includejudgments regarding future expected loss experience and risk characteristics. Thecarrying amount of accrued interest receivable approximates its fair value.

·       *Deposits*

The fair valuesdisclosed for transaction accounts; for example, interest-bearing checkingdeposits are, by definition, equal to the amount payable on demand at thereporting date (that is, their carrying amounts). The fair values forcertificates of deposit are estimated using a discounted cash flow calculationthat applies interest rates currently being offered on certificates to aschedule of aggregated contractual maturities on such time deposits. Thecarrying amount of accrued interest payable approximates fair value.

·       *Borrowings*

The fair values ofthe Bancorp’s long-term borrowings are estimated using discounted cash flowanalyses based on the Bancorp’s current incremental borrowing rates for similartypes of borrowing arrangements.

·       *Off-balance Sheet Instruments*

Fair values of loancommitments and financial guarantees are based upon fees currently charged toenter similar agreements, taking into account the remaining terms of theagreement and the counterparties’ credit standing.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#11—Income Taxes**
| ** **                  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-----------------------------|------------|-----------|------------|-----------|------------|
| Provision for  income taxes |       |      |       |      |       |
| Federal                     |       |      |       |      |       |
| Current                     |       | $         | 1,691,208  |      | $          | 1,199,072 |   |
| Deferred                    |       | (370,000  | )          | 209,000   |       |
|                        |       | 1,321,208 |       | 1,408,072 |       |
| State                       |       |      |       |      |       |
| Current                     |       | 358,000   |       | 205,000   |       |
| Deferred                    |       | 30,000    |       | 108,000   |       |
|                        |       | 388,000   |       | 313,000   |       |
| Total                       |       | $         | 1,709,208  |      | $          | 1,721,072 |   |

 

Areconciliation of the statutory tax rates to the effective tax rates is asfollows:
| ** **                                                | ** ** | **2004**   | ** ** | **2003**    | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-------------|------------|
| ** **                                                | ** ** | **Amount** | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Federal income  tax at statutory rate                     |       | $          | 1,748,000  |        |       | 34.0 |   |   | $ | 1,536,000 |   |   | 34.0 |   |   |
| State franchise  taxes, net of Federal income tax benefit |       | 145,000    |       |        | 2.8        |   |   | 207,000 |   |   | 4.6 |   |   |
| Other, net                                                |       | (183,792   | )          |        | (3.6       | ) |   | (21,928 | ) |   | (0.5 | ) |   |
|                                                      |       | $          | 1,709,208  |        |       | 33.2 |   |   | $ | 1,721,072 |   |   | 38.1 |   |   |

 

Thenet deferred tax asset is determined as follows:
| ** **                        | ** ** | **2004**                | ** ** | **2003** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                        | ** ** | **(In Thousands)** | ** ** |
| Deferred Tax  Assets              |       |                    |       |     |       |
| Reserve for loan losses           |       | $                       | 1,482      |     | $          | 1,117 |   |
| Accruals                          |       | 486                     |       | 23       |       |
| Investment securities valuation   |       | 153                     |       | —   |       |
| Other assets and liabilities      |       | 324                     |       | —   |       |
| Total Deferred Tax Assets         |       | 2,445                   |       | 1,140    |       |
| *Valuation Allowance              |       | —                  |       | —   |       |
| Total Deferred Tax Assets         |       | 2,445                   |       | 1,140    |       |
| Deferred Tax Liabilities          |       |                    |       |     |       |
| Fixed assets                      |       | 121                     |       | 44       |       |
| Deferred loan costs               |       | 797                     |       | 560      |       |
| FAS 91 loan costs                 |       | 242                     |       | 0        |       |
| Loan origination costs            |       | 251                     |       | 0        |       |
| Other, net assets and liabilities |       | 75                      |       | 70       |       |
| Total Deferred Tax Liabilities    |       | 1,486                   |       | 674      |       |
| Net Deferred Tax Assets           |       | $                       | 959        |     | $          | 466 |   |

 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #12—401(k) SavingsPlan**

The Bank has a 401(k) taxdeferred savings plan under which eligible employees may elect to defer apercentage of their annual salary, subject to limitations imposed by federaltax law. The Bank matches the employee deferrals at a rate set by the Board ofDirectors. Matching contributions vest after three years of employment. TheBank contributed $115,572 and $91,402 to the plan in 2004 and 2003,respectively.

**Note # 13—RegulatoryCapital Requirements**

Banks are subject to various regulatory capitalrequirements administered by Federal banking agencies, specifically, theFederal Deposit Insurance Corporation (FDIC). Failure to meet minimum capitalrequirements can initiate certain mandatory—and possibly additionaldiscretionary—actions by regulators that, if undertaken, could have a directmaterial effect on a Bank’s financial statements. Under capital adequacyguidelines and the regulatory framework for prompt corrective action, a Bankmust meet specific capital requirements that involve quantitative measures of aBank’s assets, liabilities and certain off-balance sheet items as calculatedunder regulatory accounting practices. A Bank’s capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

Quantitative measures established by regulation toensure capital adequacy requires the Bank maintain certain minimum amounts andratios of total and Tier I capital to risk-weighted assets (as defined), and ofTier 1 capital to average assets (as defined). As the Company is not subject toFederal Reserve Board (FRB) supervisory, management believes the capitalrequirements are not applicable, on a consolidated basis, to the Company. Managementbelieves, as of December 31, 2004, the Bank meets all capital adequacyrequirements to which it is subject.

As ofthe most recent formal notification from the FDIC, the Bank was categorized aswell capitalized under the regulatory framework for prompt corrective action. Thereare no conditions or events since that notification that management believeshave changed the Bank’s category. To be categorized as well capitalized, theBank must maintain minimum capital ratios as set forth in the table below. Thefollowing table also sets forth the Bank’s actual regulatory capital amountsand ratios (dollars amounts in thousands):
| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | ** **                           | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                              | ** ** | ** **                           | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                              | ** ** | **Actual Capital**              | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                              | ** ** | **Amount**                           | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                              | ** ** | **(Dollars in Thousands)** | ** ** |
| As of  December 31, 2004:          |       |                                 |       |                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Total capital to risk-weighted assets   |       | $                                    | 36,699     |                       | 11.0       | %                          | $          | 26,618 |   |   | 8.0 | % |   | $ | 33,272 |   |   | 10.0 | % |   |
| Tier 1 capital to  risk-weighted assets |       | 33,099                               |       | 10.0                       | %          | 13,306                     |       |   | 4.0 | % |   | 19,959 |   |   | 6.0 | % |   |
| Tier 1 capital to  average assets       |       | 33,099                               |       | 8.1                        | %          | 16,386                     |       |   | 4.0 | % |   | 20,482 |   |   | 5.0 | % |   |
| As of December 31, 2003:           |       |                                 |       |                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Total capital to risk-weighted assets   |       | $                                    | 25,432     |                       | 10.2       | %                          | $          | 20,004 |   |   | 8.0 | % |   | $ | 25,005 |   |   | 10.0 | % |   |
| Tier 1 capital to  risk-weighted assets |       | 22,706                               |       | 9.1                        | %          | 10,002                     |       |   | 4.0 | % |   | 15,003 |   |   | 6.0 | % |   |
| Tier 1 capital to  average assets       |       | 22,706                               |       | 7.5                        | %          | 12,109                     |       |   | 4.0 | % |   | 15,137 |   |   | 5.0 | % |   |

 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #13—Regulatory Capital Requirements (Continued)**

California State BankingLaw also restricts the payment of dividends if stockholders’ equity at the Bankis below $750,000. Generally, payment of dividends by the Bank is also limitedunder FDIC regulations. In addition, the amount that can be paid in anycalendar year without prior approval of the Department of Financial Institutionscannot exceed the lesser of net profits (as defined) for the year, plus the netprofits of the preceding two calendar years, or retained earnings. Under theserestrictions, the Bank was able to declare dividends for the years ended December 31,2004 and 2003  As of December 31,2004 and 2003 the Bank had declared and paid cash dividends to the Bancorp of$792,000 and $850,400, respectively.

**Note #14—Commitments andContingencies**

*Lease commitments*—The Bank hasentered into seven operating leases with nonaffiliates for office and branchspace, including planned future branch locations, which expire through the year2014. Monthly payments under these seven leases total $61,778, with annualadjustments based on the Consumer Price Index.

Futureminimum rent payments under the seven operating leases are as follows:
| **Year Ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2005                                        |       | $          | 572,079    |       |
| 2006                                        |       | 549,408    |       |
| 2007                                        |       | 549,408    |       |
| 2008                                        |       | 510,329    |       |
| 2009                                        |       | 428,232    |       |
| Thereafter                                  |       | 1,471,674  |       |
|                                        |       | $          | 4,081,130  |       |

 

The above information is given for existing leasecommitments and is not a forecast of future rental expense. Rental expensesincluded in occupancy expense for the years ended December 31, 2004 and2003, were $671,762 and $401,162, respectively.

The Bank has entered intoa sublease arrangement for a portion of the leased space, with monthly rent dueof $1,900. Rental payments for the years ended December 31, 2004 and 2003were $7,599 and $23,721, respectively.

**Note #15—Stock Split**

On January 28, 2003, the Board of Directorsapproved a three-for-two stock split of its common stock. All outstandingshares of stock, stock options, and related per share earnings calculationshave been retroactively adjusted to reflect the stock splits.

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #16—Incentive Stock Option and Stock AppreciationPlans**

1997 Employee Stock Option and Stock Appreciation Plan

The Bancorp maintains an incentive stock option andstock appreciation plan (the “Plan”) in which options to purchase shares of theBancorp’s common stock, or to be paid the appreciation of the options in lieuof exercising the options, are granted at the Board of Directors’ discretion tocertain employees. The Plan was originally established in 1997 for a maximum of27,000 shares (480,543 after stock splits and a revision to the original plan)of the Bancorp’s common stock. The exercise price of the combination plan ofall options shall not be less than 100 percent of the fair value of theunderlying common stock at the time of the grant and the term of the optionshall not exceed ten years. Stock appreciation rights shall be exercisable onlyto the same extent and subjects to the same conditions as the related options,and only when the fair market value of the share of common stock exceeds theexercise price of the related option. The number of shares covered by suchstock appreciation rights shall not exceed the number of shares covered by therelated option. An exercise of option as to the number of shares shall cause acorrelative reduction in the stock appreciation rights held by the employee,and the exercise of a stock appreciation right shall cause a similarcorrelative reduction in the number of shares covered by the related option.

The fair value of each option grant was estimated on thedate of grant using the Black-Scholes option pricing model with the followingassumptions for 2004 and 2003, respectively: dividend yields of 0.77% and 0%, risk free rate of 4.41% and 3.70%,expected life of seven years and seven years, and stock price volatility of28.07% and 40.57%.

Asummary of the status of the Bancorp’s 1997 combination stock option and stockappreciation plan is presented below:
| ** **                                                            | ** ** | **2004**                       | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                            | ** ** | **Number of Shares** | ** ** | **Weighted** | ** ** |
| ** **                                                            | ** ** | **Available**                  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                            | ** ** | **For**                        | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                                            | ** ** | **Granting**                   | ** ** | **Outstanding** | ** ** | **Price** | ** ** |
| Outstanding,  beginning of year                                       |       | 311,215                        |       |   | 120,536 |   |   |   | $ | 4.52 |   |   |
| Granted                                                               |       | (231,400                       | )          |   | 231,400 |   |   |   | 13.03 |   |   |
| Exercised                                                             |       | —                         |       |   | (17,146 | ) |   |   | 3.59 |   |   |
| Cancelled                                                             |       | 5,563                          |       |   | (5,563 | ) |   |   | 10.08 |   |   |
| Outstanding, end  of year                                             |       | 85,378                         |       |   | 329,227 |   |   |   | 10.45 |   |   |
| Options exercisable at year-end                                       |       |                           |       |   | 112,294 |   |   |   |   |   |   |
| Weighted-average fair  value of options granted during the year  |       |                           |       |   | $ | 4.81 |   |   |   |   |   |   |
|                                                                       |            |                                |            |  |  |  |  |  |  |  |  |  |  |

** **

91

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#16—Incentive Stock Option and Stock Appreciation Plans (Continued)**

 
| ** **                                                      | ** ** | **2003**                       | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | **Number of Shares** | ** ** | **Weighted** | ** ** |
| ** **                                                      | ** ** | **Available**                  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                      | ** ** | **For**                        | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                                      | ** ** | **Granting**                   | ** ** | **Outstanding** | ** ** | **Price** | ** ** |
| Outstanding,  beginning of year                                 |       | 87,424                         |       |   | 115,004 |   |   |   | $ | 3.68 |   |   |
| Additional shares  authorized                                   |       | 237,543                        |       |   | — |   |   |   | — |   |   |
| Granted                                                         |       | (16,675                        | )          |   | 16,675 |   |   |   | 9.58 |   |   |
| Exercised                                                       |       | —                         |       |   | (8,220 | ) |   |   | 2.29 |   |   |
| Cancelled                                                       |       | 2,923                          |       |   | (2,923 | ) |   |   | 8.21 |   |   |
| Outstanding, end  of year                                       |       | 311,215                        |       |   | 120,536 |   |   |   | 4.52 |   |   |
| Options exercisable at year-end                                 |       |                           |       |   | 90,383 |   |   |   |   |   |   |
| Weighted-average fair  value of options granted during the year |       |                           |       |   | $ | 4.85 |   |   |   |   |   |   |
|                                                                 |            |                                |            |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information about the 1997 employee stock option andstock appreciation plan as of December 31, 2004:
| ** **                   | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                   | ** ** | ** **                   | ** ** | ** **                   | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Number**                   | ** ** | **Life In**             | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Range of  Exercise Price** | ** ** | ** **                   | ** ** | **Outstanding**              | ** ** | **Years** | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $1.22 - $4.33                |       |                         | 65,655     |                         |       |   | 3.80 |   |   |   | $ | 2.18 |   |   |   | 65,655 |   |   | $ | 2.18 |   |
| $8.33 - $10.00               |       |                         | 33,872     |                         |       |   | 8.05 |   |   |   | 9.03 |   |   |   | 14,639 |   |   | 8.65 |   |
| $13.00 - $16.10              |       |                         | 229,700    |                         |       |   | 9.47 |   |   |   | 13.03 |   |   |   | 32,000 |   |   | 13.00 |   |
|                         |       |                         | 329,227    |                         |       |   | 8.19 |   |   |   | 10.45 |   |   |   | 112,294 |   |   | 6.11 |   |
|                              |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

2003 Non-Employee Directors’ Stock Option Plan

At their meeting on June 17, 2003, the Board ofDirectors of Epic Bancorp approved a Non-Employee Directors’ Stock Option Plan(the “Directors’ Plan”). The Plan provides for the grant of options for up to67,000 shares of Bancorp common stock, subject to adjustment upon certainevents, such as stock splits. However, at no time shall the total number ofshares issuable upon exercise of all outstanding options under the Directors’Plan or any other stock option plan of Bancorp and the total number of sharesprovided for stock bonus of similar plan of Bancorp exceed thirty percent (30%)of its then outstanding shares of common stock. Each director of Bancorp andeach director of Tamalpais Bank who is not otherwise employed by Bancorp orTamalpais Bank or any affiliate of Bancorp or Tamalpais Bank, is eligible toreceive options under the Directors’ Plan. The options will have an exerciseprice equal to the fair market value of the common stock upon the date theoption is granted. The options may vest immediately or may be subject tovesting over a specific period of time, as determined by the Board of Directors.Each option will expire 10 years after the date of grant, or if sooner, upon aspecified period after termination of service as of a director. The exerciseprice of each option will be 100% of the fair market value of the common stocksubject to the option on the date of grant.

92

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#16—Incentive Stock Option and Stock Appreciation Plans (Continued)**

The fair value of each option grant was estimated onthe date of grant using the Black-Scholes option pricing model with the followingassumptions for 2004 and  2003:  dividend yield of 0.77% and 0%, risk freerate of 4.42% and 3.83%, expected life of seven years, and stock pricevolatility of 28.07% and 40.6%.

A summary of the status ofthe Bancorp’s 2003 stock option plan is presented below:
| ** **                                                      | ** ** | **2004**                       | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | **Number of Shares** | ** ** | **Weighted** | ** ** |
| ** **                                                      | ** ** | **Available**                  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                      | ** ** | **For**                        | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                                      | ** ** | **Granting**                   | ** ** | **Outstanding** | ** ** | **Price** | ** ** |
| Outstanding,  beginning of year                                 |       | 48,000                         |       |   | 19,000 |   |   |   | $ | 10.00 |   |   |
| Granted                                                         |       | (48,000                        | )          |   | 48,000 |   |   |   | $ | 13.00 |   |   |
| Exercised                                                       |       | —                         |       |   | (1,000 | ) |   |   | $ | 10.00 |   |   |
| Cancelled                                                       |       | —                         |       |   | — |   |   |   | $ | — |   |   |
| Outstanding, end  of year                                       |       | —                         |       |   | 66,000 |   |   |   | $ | 12.18 |   |   |
| Options exercisable at year-end                                 |       |                           |       |   | 4,400 |   |   |   |   |   |   |
| Weighted-average fair  value of options granted during the year |       |                           |       |   | $ | 4.80 |   |   |   |   |   |   |
|                                                                 |            |                                |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                      | ** ** | **2003**                       | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | **Number of Shares** | ** ** | **Weighted** | ** ** |
| ** **                                                      | ** ** | **Available**                  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                      | ** ** | **For**                        | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                                      | ** ** | **Granting**                   | ** ** | **Outstanding** | ** ** | **Price** | ** ** |
| Outstanding,  beginning of year                                 |       | —                         |       |   | — |   |   |   | $ | — |   |   |
| Initial shares  authorized                                      |       | 67,000                         |       |   | — |   |   |   | $ | — |   |   |
| Granted                                                         |       | (19,000                        | )          |   | 19,000 |   |   |   | $ | 10.00 |   |   |
| Exercised                                                       |       | —                         |       |   | — |   |   |   | $ | — |   |   |
| Cancelled                                                       |       | —                         |       |   | — |   |   |   | $ | — |   |   |
| Outstanding, end  of year                                       |       | 48,000                         |       |   | 19,000 |   |   |   | $ | 10.00 |   |   |
| Options exercisable at year-end                                 |       |                           |       |   | 1,000 |   |   |   |   |   |   |
| Weighted-average fair  value of options granted during the year |       |                           |       |   | $ | 9.04 |   |   |   |   |   |   |
|                                                                 |            |                                |            |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information about the 2003 Non-Employee directors’ stockoption plan as of December 31, 2004:
| ** **                                 | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | ** **                   | ** ** | ** **                   | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Number**                   | ** ** | **Life In**             | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Range of Exercise Price** | ** ** | ** **                   | ** ** | **Outstanding**              | ** ** | **Years** | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $10.00                                     |       |                         | 18,000     |                         |       |   | 8.58 |   |   |   | $ | 10.00 |   |   |   | 4,400 |   |   | $ | 10.00 |   |
| $13.00                                     |       |                         | 48,000     |                         |       |   | 9.50 |   |   |   | $ | 13.00 |   |   |   | — |   |   | $ | 13.00 |   |
|                                       |       |                         | 66,000     |                         |       |   | 9.25 |   |   |   | $ | 12.18 |   |   |   | 4,400 |   |   | $ | 10.00 |   |
|                                            |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

93

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #17—Earnings Per Share (EPS)**

Thefollowing is a reconciliation of net income and shares outstanding to theincome and number of shares used to compare EPS:
| ** **                                            | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                            | ** ** | **Income** | ** ** | **Shares** | ** ** | **Income** | ** ** | **Shares** | ** ** |
| Net Income as Reported                                |       | $          | 3,448,413  |       |       |   | $ | 2,797,540 |   |   |   |
| Shares Outstanding at  Year End                       |       |       |       | 3,665,702  |       |   |   | 3,136,957 |   |
| Impact of Weighting  Shares Purchased During the Year |       |       |       | (94,855    | )          |   |   | (6,566 | ) |
| Used in Basic EPS                                     |       | 3,448,413  |       | 3,570,847  |       | 2,797,540 |   | 3,130,391 |   |
| Dilutive Effect of  Outstanding Stock Options         |       |       |       | 89,073     |       |   |   | 67,598 |   |
| Used in Dilutive EPS                                  |       | $          | 3,448,413  |       | 3,659,920  |   | $ | 2,797,540 |   | 3,197,989 |   |

 

**Note #18—Transactions withRelated Parties**

In the ordinary course of business, the Bank hasgranted loans to, and accepted deposits from, certain directors, officers,principal shareholders and the companies with which they are associated. Allsuch loans and deposits were made under terms which are consistent with theBank’s normal lending and deposit policies.

Ananalysis of the activity with respect to related party loans during 2003 is asfollows. There were no related party loans during 2004.
| ** **                                  | ** ** | **2003**   | ** ** |
|---------------------------------------------|------------|------------|------------|
| Outstanding  Balance, beginning of the year |       | $          | 1,147,858  |   |
| Credit granted,  including renewals         |       | —     |       |
| Repayments                                  |       | (1,147,858 | )          |
| Outstanding Balance, end  of year           |       | $          | —     |   |

 

At December 31, 2004 and 2003, the Bank helddeposits from related parties of $1,211,392 and $731,564 respectively.

The Bank made payments for lease and related expensestotaling $0 and $19,037 for the years ended December 31, 2004 and 2003, toMarin Advisors Investors II (MAI-II), a California limited partnership thatpreviously owned the building in which the Bank’s branch and offices arelocated. The Bank’s Chairman of the Board, who is also the Company’s ChiefExecutive Officer (CEO), is the majority owner of Marin Advisors, Inc.,which  was the general partner of MAI-II.MAI II was liquidated in 2003.

The Bancorp and the Bankinteract with Kit Cole Investment Advisory Services, Inc. (KCIAS), aCalifornia Corporation owned by the Chairman of the Board and CEO of the Company.Payments for miscellaneous office and marketing expenses to KCIAS for 2004 and2003 totaled $28,791 and $7,055, and payments for in branch registeredinvestment advisors totaled $100,261 and $47,451. The Bancorp also paid a cashaward of $26,000 to an employee at KCIAS during 2003, as a recognition foradministrative services that the employee provided to the Bancorp under anemployee sharing agreement. The agreement with KCIAS was terminated on December 31,2004.

 

94

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #18—Transactions withRelated Parties (Continued)**

On June 10, 2003, theCompany filed a Registration Statement with the Securities and ExchangeCommission (Registration Statement No. 333-105991) with respect to apublic offering of the Company’s common stock for an aggregate consideration ofbetween $9,681,113 and $26,000,000. Of the 2,000,000 shares being offered,510,599 shares were sold by Epic Bancorp and 1,444,290 shares were sold byCommunity Bankshares, L.P., a limited partnership, of which Kit M. Cole, theChairman/CEO of Epic Bancorp is the CEO of the general partner, Cole FinancialVentures, Inc. Community Bankshares elected to retain 45,111 of itsshares, which were subsequently distributed to its investors.

Total expenses of $977,320were incurred by the Company in connection with the issuance and distributionof securities registered:  All costsassociated with the offering were shared by Community Bankshares L.P on a prorate basis based on the number of shares sold by each entity, except for theSEC registration fee and the Nasdaq listing fee, which was borne by EpicBancorp. The Company incurred stock offering costs of $262,000 which werededucted from the gross amount raised on behalf of the Company of $6.6 millionto equal the net capital infusion of $6.4 million. Community Banksharesincurred costs of $715,000 which were deducted from the gross amount raised onbehalf of Community Bankshares of $18.8 million to equal the net proceeds toCommunity Bankshares of $18.0 million.

**Note#19—Financial Instruments with Off-Balance Sheet Risk**

The Bank is a party tofinancial instruments with off-balance sheet risk in the normal course ofbusiness to meet the financing needs of its customers. To date, these financialinstruments include commitments to extend credit that involve elements ofcredit risk in excess of the amount recognized in the balance sheet.

At December 31, 2004and 2003, the Bank had undisbursed loan commitments of $41,799,141 and$47,084,351, respectively. Substantially all commitments relate to real estateloans.

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses, and my require payment of a fee.Since many of the commitments are expected to expire without being drawn upon,the total commitment amounts do not necessarily represent future cashrequirements. The Bank evaluates each customer’s creditworthiness on a case-by-casebasis. The amount of collateral obtained, if deemed necessary by the Bank uponcommitments to extend credit, is based on management’s collateral and creditevaluation of the counterparty. Collateral held varies, but primarily consistsof residential and commercial property. Standby letters of credit written areconfidential commitments issued by the bank to guarantee the performance of acustomer to a third party. The credit risk involved in issuing letters ofcredit is essentially the same as that involved in extending loans to customers.The Bank anticipates no losses as a result of such transactions.

At December 31, 2004and 2003, the Bank had no contingent liabilities for letters of creditaccommodations to its customers.

**Note#20—Public Offering of the Common Stock of Epic Bancorp**

On June 10, 2003, theCompany filed a Registration Statement with the Securities and ExchangeCommission (Registration Statement No. 333-105991) with respect to apublic offering of the Company’s 

95

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#20—Public Offering of the Common Stock of Epic Bancorp (Continued)**

commonstock for an aggregate consideration of between $9,681,113 and $26,000,000. Theregistration statement was declared effective on October 20, 2003, and theCompany commenced an offering of 744,701 to 2,000,000 shares of its commonstock at a price of $13.00 per share. This offering was completed in the firstquarter of 2004. Of the 2,000,000 shares being offered, 510,599 shares weresold by Epic Bancorp and 1,444,290 shares were sold by Community Bankshares,L.P., a limited partnership, of which Kit M. Cole, the Chairman/CEO of EpicBancorp is the CEO of the general partner, Cole Financial Ventures, Inc. CommunityBankshares elected to retain 45,111 of its shares, which were subsequentlydistributed to its investors. Priority was given to the 1,489,401 sharesoffered by the limited partnership.

Under the terms of theoffering Epic Bancorp reserved the right, in its sole discretion, to engage theservices of a broker or brokers in connection with the offering. Epic Bancorpsubsequently engaged the services of Cohen Bros. & Company  to act as broker to assist it in sellingshares in the offering on a non-exclusive best efforts basis. In a best effortsoffering, the underwriters were not required to sell any specific number ordollar amount of securities but were to use their best efforts to sell thesecurities offered. As provided in that prospectus,  Epic Bancorp paid Cohen Bros. a commissionequal to 2% of the gross offering proceeds derived from investors introduced toEpic Bancorp by Cohen Bros. The maximum commission that could be paid was$520,000.

Net proceeds of theoffering to Epic Bancorp totaled $6,369,000. The proceeds from the sale of newshares sold in the offering will be utilized by Epic Bancorp and Tamalpais Bankto support their growth and for working capital. Epic Bancorp did not receiveany of the net proceeds from the shares sold by Community Bankshares L.P.

Thefollowing expenses were incurred by the Company in connection with the issuanceand distribution of securities registered: All costs associated with the offering were shared by CommunityBankshares L.P on a pro rate basis based on the number of shares sold by eachentity, except for the SEC registration fee and the Nasdaq listing fee, whichwas borne by Epic Bancorp.
| Underwriting Discounts  and Commissions |   | $       | —  |   |
|-----------------------------------------|--------|---------|---------|--------|
| 2% Placement Fee                        |   | 393,782 |    |
| Legal Fees                              |   | 246,513 |    |
| Accounting Fees                         |   | 54,080  |    |
| Printing and Edgarizing                 |   | 60,448  |    |
| Marketing                               |   | 152,640 |    |
| Other Expenses                          |   | 69,857  |    |
| Total Expenses                          |   | $       | 977,320 |   |

 

All expenses were paid to persons other thandirectors, officers, or 10% shareholders of the Company. However, CommunityBankshares was liquidated in whole or in part from the proceeds of thisoffering. The Company incurred stock offering costs of $262,000 which werededucted from the gross amount raised on behalf of the Company $6.6 million toequal the net capital infusion of $6.4 million. Community Bankshares incurredcosts of $715,000 which were deducted from the gross amount raised on behalf ofCommunity Bankshares of $18.8 million to equal the net proceeds to CommunityBankshares of $18.0 million. In the second quarter of 2004 the Company appliedto list its common stock on the NASDAQ Small Cap Market. The common stock begantrading on the NASDAQ Small Cap Market under the symbol “EPIK” on August 9,2004.

96

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #21**—Condensed Financial Information of Epic Bancorp (Parent Company)

**Balance Sheets**
| ** **                                      | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|
| **Assets**                                      |       |       |       |       |       |
| Cash and cash equivalents                       |       | $          | 154,435    |       | $          | 53,368 |   |
| Investment in subsidiary                        |       | 32,878,543 |       | 22,718,952 |       |
| Investment in nonconsolidated subsidiary        |       | 310,000    |       | 310,000    |       |
| Prepaids and other assets                       |       | 303,650    |       | 5,085,897  |       |
| Total Assets                                    |       | $          | 33,646,628 |       | $          | 28,168,217 |   |
| **Liabilities**                                 |       |       |       |       |       |
| Junior subordinated debentures                  |       | 10,310,000 |       | 10,310,000 |       |
| Accrued interest payable and other liabilities  |       | 161,950    |       | 3,984,118  |       |
| Total Liabilities                               |       | 10,471,950 |       | 14,294,118 |       |
| **Stockholders’  Equity**                  |       |       |       |       |       |
| Common stock                                    |       | 10,159,239 |       | 3,712,516  |       |
| Retained earnings                               |       | 13,244,716 |       | 10,161,583 |       |
| Accumulated other comprehensive (loss)          |       | (229,277   | )          | —     |       |
| Total Stockholders’ Equity                 |       | 23,174,678 |       | 13,874,099 |       |
| Total Liabilities and Stockholders’ Equity |       | $          | 33,646,628 |       | $          | 28,168,217 |   |

 

**Statements ofIncome**
| Equity in  undistributed income of bank             |   | $         | 4,245,651 |      | $      | 3,282,501 |   |
|-----------------------------------------------------|--------|-----------|-----------|-----------|--------|-----------|--------|
| Other income                                        |   | 16,174    |      | 15,336    |   |
| Interest expense  on junior subordinated debentures |   | (547,964  | )         | (522,438  | )      |
| Other expenses                                      |   | (635,648  | )         | (319,859  | )      |
| **Income Before Income Taxes**                      |   | 3,078,213 |      | 2,455,540 |   |
| **Income Tax Benefit**                              |   | 370,200   |      | 342,000   |   |
| **Net  Income**                                     |   | $         | 3,448,413 |      | $      | 2,797,540 |   |

** **

97

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note #21—Condensed FinancialInformation of Epic Bancorp (Parent Company) (Continued)**

**Statementsof Cash Flows**
| ** **                                                                     | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Cash Flows from Operating Activities**                                       |       |       |       |       |       |
| Net income                                                                     |       | $          | 3,448,413  |       | $          | 2,797,540 |   |
| Adjustments to reconcile net income to net cash used  by operating activities: |       |       |       |       |       |
| Equity in undistributed income of Bank                                         |       | (4,245,652 | )          | (3,282,501 | )          |
| Net change in assets and liabilities                                           |       | 960,079    |       | (351,119   | )          |
| Net cash provided/(used) by operating activities                               |       | 162,840    |       | (836,080   | )          |
| **Cash  Flows from Investing Activities**                                      |       |       |       |       |       |
| Capital contributions to Bank                                                  |       | (6,935,216 | )          | —     |       |
| Net cash used by investing activities                                          |       | (6,935,216 | )          | —     |       |
| **Cash  Flows from Financing Activities**                                      |       |       |       |       |       |
| Stock offering proceeds                                                        |       | 6,375,218  |       | —     |       |
| Dividends received from Bank                                                   |       | 792,000    |       | 850,400    |       |
| Cash dividends paid to shareholders                                            |       | (365,280   | )          |       |       |
| Stock options exercised                                                        |       | 71,505     |       | 18,800     |       |
| Net cash provided by financing activities                                      |       | 6,873,443  |       | 869,200    |       |
| **Net Increase in Cash and Cash Equivalents**                                  |       | 101,067    |       | 33,120     |       |
| **Cash  and Cash Equivalents, Beginning of Year**                              |       | 53,368     |       | 20,248     |       |
| **Cash  and Cash Equivalents, End of Year**                                    |       | $          | 154,435    |       | $          | 53,368 |   |
| **Supplemental  Cash Flow Information**                                        |       |       |       |       |       |
| Cash paid during  the year for:                                                |       |       |       |       |       |
| Interest                                                                       |       | $          | 547,964    |       | $          | 514,379 |   |
| **Non-Cash Investing Activities**                                              |       |       |       |       |       |
| Net change in  accumulated other comprehensive income                          |       | $          | (229,227   | )          | $          | 44,206 |   |

 

**Note #22**—SubsequentEvents

In January 2005 the Bank purchased $33.8 millionof participated construction loans originated by a Southern California basedlender pursuant to a Master Loan Participation Agreement as amended on January 3,2005. These loans consist of fifty participated construction loans purchasedwith balances ranging from $360,000 to $1.7 million. All of the loans areresidential construction loans make to individual property developers, and themajority are located in the Southern California beach communities of ManhattanBeach, Hermosa Beach, and Redondo Beach. The Loan Participation Purchase wasfunded on January 5, 2005.

In January 2005, Epic Bancorp established EpicWealth Management, a new subsidiary offering registered investment advisory services to the Bank’s clients and to thegeneral Marin County marketplace. Epic Wealth Management was initiallycapitalized by a $100,000 capital infusion by Epic Bancorp. 

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**EPIC BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) DECEMBER 31, 2004 AND 2003**

**Note#22—Subsequent Events (Continued)**

Additional capitalinfusions to Epic Wealth Management from Epic Bancorp totaled $125,000 in February 2005and $179,000 in March 2005, for a total capital infusion of $404,000 throughMarch 24, 2005. Epic Wealth Management began operations with a staff ofthree full time employees.

As of March 24, 2005 Epic Wealth Management wasin negotiations with Kit Cole Investment Advisory Services (KCIAS) topotentially acquire some of the former clients of KCIAS. Kit M. Cole, theChairman/CEO of Epic Bancorp is the CEO of KCIAS. The potential payment toKCIAS for the acquisition of former KCIAS is unknown. Kit M. Cole is acting asthe interim CEO of Epic Wealth Management.

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***Item 8—ChangesIn and Disagreements with Accountants on Accounting and Financial Disclosure***

Not applicable

***Item 8A—Controls and Procedures***

(a)   Evaluationof Disclosure Controls and Procedures

The Company’smanagement carried out an evaluation, under the supervision and with theparticipation of the Company’s                ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures (assuch term is defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act) as of December 31, 2004, pursuant to Exchange Act Rule 13a-15.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures as of December 31,2004 are effective in timely alerting them to material information relating tothe Company (including its consolidated subsidiaries) required to be includedin the Company’s periodic filings under the Exchange Act.

(b)   Changes inInternal Control Over Financial Reporting

For the year ended December 31,2004, no changes in the Company’s internal control over financial reportinghave come to management’s attention that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

***Item 8B—Other Information***

None

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**PART III**

***Item 9—Directors,Executive Officers, Promoters and Control Person; Compliance with Section 16(a) ofthe Exchange Act***

The information required in response to this item isincorporated by reference from the information contained in the sections captioned“Nominees for Director”, “Executive Officers Who Are Not Directors” and “ExecutiveCompensation—Compliance with Section 16(a) of the Securities ExchangeAct of 1934,” in the Registrant’s Proxy Statement for the 2005 Annual Meetingof Shareholders (the “Proxy Statement”) which will be filed pursuant toRegulation 14A.

The Company has adopted acode of ethics (“Code of Ethics”) that applies to its executive officers. Acopy of the Code of Ethics is filed as an exhibit hereto as Exhibit 14.

***Item 10—Executive Compensation***

The information inresponse to this item is incorporated by reference from the informationcontained in the section captioned “Executive Compensation” in the Registrant’sProxy Statement which will be filed pursuant to Regulation 14A.

***Item 11—SecurityOwnership of Certain Beneficial Owners and Management***

The information requiredin response to this item is incorporated by reference from the informationcontained in the section captioned “Beneficial Ownership of the Common Stock”in the Registrant’s Proxy Statement which will be filed pursuant to Regulation14A. The information required by Item 201(d) of Regulation S-K isincorporated by reference from the information contained in the sectioncaptioned “Executive Compensation-Equity Compensation Plan Information” in theRegistrant’s Proxy Statement which will be filed pursuant to Regulation 14A.

***Item 12—CertainRelationships and Related Transactions***

The information requiredin response to this item is incorporated by reference from the informationcontained in the section captioned “Certain Transactions” in the Registrant’sProxy Statement which will be filed pursuant to Regulation 14A.

***Item 13—Exhibits***

(a)   *Exhibits*

See Index to Exhibits at page 99of this Annual Report on Form 10-KSB.

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

The information required in response to this item isincorporated by reference from the information contained in the sectioncaptioned “Ratification of the Selection of Independent Auditors” in theRegistrant’s Proxy Statement which will be filed pursuant to Regulation 14A.

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**INDEX TO EXHIBITS**
| Exhibit  Number | ** ** | ** **                                                                                                                                                             | ** ** | **Description of Exhibit** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|
| 3.1             |       | Articles of Incorporation of Bancorp(1)                                                                                                                                |
| 3.2             |       | Bylaws of the Bancorp(1)                                                                                                                                               |
| 4.1             |       | Indenture(1)                                                                                                                                                           |
| 4.2             |       | Amended and Restated  Trust Agreement(1)                                                                                                                               |
| 4.3             |       | Trust Preferred Securities  Guarantee Agreement(1)                                                                                                                     |
| 4.4             |       | Floating Rate Cumulative  Trust Preferred Security Certificate of San Rafael Capital Trust I(1)                                                                        |
| 4.5             |       | Floating Rate Cumulative  Trust Preferred Security Certificate of San Rafael Capital Trust I(1)                                                                        |
| 4.6             |       | Floating Rate Junior Subordinated  Deferrable Interest Debenture of Epic Bancorp(1)                                                                                    |
| 10.1            |       | Epic Bancorp Employee  Incentive Stock Option and Stock Appreciation Right Plan(1)*                                                                                    |
| 10.2            |       | Salary Continuation Plan  for Kit M. Cole(1)*                                                                                                                          |
| 10.3            |       | Salary Continuation Plan  for Mark Garwood(1)*                                                                                                                         |
| 10.4            |       | Tamalpais Bank Defined  Contribution Plan; Tamalpais Bank Defined Contribution Trust; EGTRRA  Amendment for 401(k) Plans; Defined Contribution Plan Amendment(1)* |
| 10.5            |       | Epic Bancorp 2003  Non-Employee Directors Stock Option Plan and Agreement(1)*                                                                                          |
| 11.             |       | Statement re computation  of per share earning. Included in footnote 17 to the Registrant’s audited  financial statements included in this Annual Report .        |
| 14.             |       | Code of Ethics, filed                                                                                                                                                  |
| 21.             |       | Subsidiaries of the  Bancorp: Tamalpais Bank; San Rafael Capital Trust I.                                                                                              |
| 23.             |       | Consent of Independent  Registered Public Accounting Firm.                                                                                                             |
| 24              |       | Power of Attorney                                                                                                                                                      |
| 31.1            |       | Certificate of Principal  Executive Officer Pursuant to SEC Release 33-8238.                                                                                           |
| 31.2            |       | Certificate of Principal  Financial Officer Pursuant to SEC Release 33-8238.                                                                                           |
| 32.1            |       | Certificate of Principal  Executive Officer Pursuant to 18 U.S.C. Section 1350.                                                                                   |
| 32.2            |       | Certificate of Principal  Financial Officer Pursuant to 18 U.S.C. Section 1350.                                                                                   |

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*                    Employment Agreementor Compensation Plan.

(1)          Attached as Exhibits3.1, 3.2, 41., 4.2, 4.3, 4.4, 4.5, 4.6, 10.1, 10.2, 10.3, 10.4, and 10.5,respectively, to Registration Statement No. 333-105991  filed by Epic Bancorp with the Securities andExchange Commission under the Securities Act of 1933, and incorporatedherein  by reference.

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**SIGNATURES**

Inaccordance with the requirements of Section 13  of the Securities Exchange Act of 1934, EpicBancorp has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
| By: /s/ KIT  M. COLE            |                            | By: /s/ MICHAEL  MOULTON |   |
|---------------------------------|---------------------------------|--------------------------|--------|
| *Chief Executive Officer*       | *Chief Financial Officer*       |
| *Chairman of the Board*         | *(Principal Financial Officer)* |
| *(Principal Executive Officer)* | March 30, 2005             |
| March 30, 2005             |                            |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.
|                        | **Signature** | ** **                          | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------|---------------|-------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ KIT  M. COLE       |          | Chief Executive Officer,            |       | March 30,  2005 |
| Kit M. Cole            |          | Chairman of the Board, and Director |       |                 |
|                   |          | (Principal Executive Officer)       |       |                 |
| /s/ CAROLYN  HORAN     |          | Director                            |       | March 30,  2005 |
| Carolyn Horan          |          |                                |       |                 |
| /s/ RICHARD  E. SMITH  |          | Director                            |       | March 30,  2005 |
| Richard E. Smith       |          |                                |       |                 |
| /s/ W.  JEFFERY TAPPAN |          | Director                            |       | March 30,  2005 |
| W. Jeffery Tappan      |          |                                |       |                 |
| /s/ ALLAN  BORTEL      |          | Director                            |       | March 30,  2005 |
| Allan Bortel           |          |                                |       |                 |
| /s/ ROBERT  HELLER     |          | Director                            |       | March 30,  2005 |
| Robert Heller          |          |                                |       |                 |

 

 

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