** **

**U.S. SECURITIES AND EXCHANGE COMMISSION**

**WashingtonD.C.  20549**

**FORM 10-KSB**

 

| **x**      | **Annual report under Section 13 or 15(d) of the Securities  Exchange Act of 1934 (Fee required) for fiscal year ended December 31,  2007**                                                                                                                                                                     |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                                                                                                                                                                     |
| **o**      | **Transition report under Section 13 or 15(d) of the  Securities Exchange Act of 1934 (No fee required) for the period from                     to          ** |
| ** ** | ** **                                                                                                                                                                                                                                                                                                                     |

 

**Commission File Number 0-27666**

 

**NORTHERN CALIFORNIA BANCORP, INC.**

(Name of Small Business Issuer in its Charter)

 

**Incorporated in the State of California**

**IRS Employer Identification Number 77-0421107**

**Address: 601 Munras Avenue, Monterey, CA 93940**

**Telephone: (831) 649-4600**

 

                Securities registered under Section 12(b) ofthe Exchange Act:  **None**

                Securities registered under Section 12(g) ofthe Exchange Act:  **Common stock**

** **

                Check whether the issuer: (1) filedall reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   Yes  x     No  o

 

                Check if there is no disclosureof delinquent filers in response to Item 405 of Regulation S-B contained inthis form, and no disclosure will be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB

 

                    Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act.  Yes  o     No  x

 

                Revenues for the year ended December 31, 2007;$21,277,000.

 

                As of March 1, 2008, theCorporation had 1,845,918 shares of common stock out-standing.  The aggregate market value of voting stockheld by non-affiliates of the Corporation was $7,743,000, based on the mostrecent sale at $11.00 per share on February 29, 2008.

 

                    The following documents areincorporated by reference to the parts indicated of this Form 10-KSB:

 

                    1.     Portions of the Independent Auditor’s Report for the fiscal yearended December 31, 2007 are incorporated by reference in Part II Item7.

 

Transitional Small BusinessDisclosure Format (check one):  Yes  o     No  x

 

 

----

 

FORM 10-KSBCROSS REFERENCE INDEX

 
| ** **        | ** ** | ** **                                                                                                                              | ** ** | **PAGE**   |
|-------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **PART I**   | ** ** | ** **                                                                                                                              | ** ** | ** ** |
| ITEM 1            |       | Business                                                                                                                                |       | 3          |
| ITEM 2            |       | Properties                                                                                                                              |       | 20         |
| ITEM 3            |       | Legal Proceedings                                                                                                                       |       | 20         |
| ITEM 4            |       | Submission of  Matters to a Vote of Security Holders                                                                                    |       | 20         |
|              |       |                                                                                                                                    |       |       |
| **PART II**  | ** ** | ** **                                                                                                                              | ** ** | ** ** |
| ITEM 5            |       | Market for the  Corporation’s Common stock and Related Stockholder Matters                                                         |       | 20         |
| ITEM 6            |       | Management’s Discussion  and Analysis of Financial Condition and Results of Operations                                             |       | 22         |
| ITEM 7            |       | Financial Statements  and Supplementary Data                                                                                            |       | 43         |
|              |       | Independent  Auditors’ Report on the Financial Statements                                                                          |       | FS 1       |
|              |       | Consolidated  Balance Sheets at December 31, 2007 and 2006                                                                         |       | FS 2       |
|              |       | Consolidated Statements of Income for each of the  three years in the period ended December 31, 2007                               |       | FS 3       |
|              |       | Consolidated Statements of Changes in Stockholders’  Equity for each of the three years in the period ended December 31, 2007 |       | FS 4       |
|              |       | Consolidated Statements of Cash Flows for each of the  three years in the period ended December 31, 2007                           |       | FS 5-6     |
|              |       | Notes to Consolidated Financial Statements                                                                                              |       | FS 7-49    |
| ITEM 8            |       | Changes in and Disagreements with Accountants and  Financial Disclosure                                                                 |       | 43         |
| ITEM 8A           |       | Controls and  Procedures                                                                                                                |       | 44         |
| ITEM 8B           |       | Other Information                                                                                                                       |       | 45         |
| ** **        | ** ** | ** **                                                                                                                              | ** ** | ** ** |
| **PART III** | ** ** | ** **                                                                                                                              | ** ** | ** ** |
| ITEM 9            |       | Directors,  Executive Officers, Promoters and Control Persons: Compliance with  Section 16(a) of the Exchange Act             |       | 46         |
| ITEM 10           |       | Executive and Director Compensation                                                                                                     |       | 48         |
| ITEM 11           |       | Security  Ownership of Certain Beneficial Owners and Management, and Related  Stockholder Matters                                       |       | 51         |
| ITEM 12           |       | Certain Relationships and Related Transactions                                                                                          |       | 52         |
| ITEM 13           |       | Exhibits and Reports                                                                                                                    |       | 53         |
| ITEM 14           |       | Principal  Accountant Fees and Services                                                                                                 |       | 54         |
|              |       | Signatures                                                                                                                              |       | 55         |

 

----

 

 

 

**PART I**

 

Certain matters discussed or incorporated byreference in this Annual Report of Form 10-KSB including, but not limitedto, those described in “Item 6 - Management’s Discussion and Analysis ofFinancial Condition and Results of Operations”, are forward-looking statementsthat are subject to risks and uncertainties that could cause actual results todiffer materially from those projected in the forward-looking statements. Suchrisks and uncertainties include, among others, (1) competitive pressure inthe banking industry increasing significantly; (2) changes in the interestrate environment reduces margins; (3) general economic conditions, eithernationally or regionally, are less favorable than expected, resulting in, amongother things, a deterioration in credit quality; (4) changes in theregulatory environment; (5) changes in business conditions and inflation;and (6) changes in securities markets. Therefore, the information setforth therein should be carefully considered when evaluating the businessprospects of the Corporation.

 

**ITEM 1.BUSINESS**

 

**GENERAL**

 

Northern California Bancorp, Inc. (the “Corporation”) wasincorporated on August 29, 1995, as a for-profit corporation under theCalifornia Corporate laws for the principal purpose of engaging in banking andnon-banking activities as allowed for a bank holding company.  The Corporation owns 100% of Monterey County Bank (the “Bank”).   The Corporation’s sources of revenues atthis time are dividends on investments, gains on securities transactions andpotential dividends, management fees and tax equalization payments, if any,from the Bank.

 

Compliance with environmental laws has nothad a material impact on the operations of the Bank or the Corporation,although the Bank faces potential liability or losses if itsborrowers fail to comply with such laws and the Bank acquires contaminatedproperties in foreclosure.

 

**BANK SUBSIDIARY**

 

Monterey County Bank, an independent, California chartered commercialbanking corporation was chartered by the State of California on July 30,1976.  The Bank’s customer base includesindividuals, small and medium sized businesses and a variety of governmentagencies with residences, offices orother relationships located in or about the city and county of Monterey, California,including the cities of Carmel, Pacific Grove and Salinas.  The Bank offers its customers a wide varietyof the normal personal, consumer and commercial services expected of a locallyowned, independently operated bank.  TheBank’s deposits are insured by the Federal Deposit Insurance Corporation “FDIC”,and, as such, the Bank is subject to regulations by that federal agency and toperiodic audits of its operations and documentary compliance by “FDIC”personnel.  As a state chartered bank,which is not a member of the Federal Reserve System, it is also regulated andperiodically examined by the California State Department of FinancialInstitutions.

 

The Bank’s activities are conducted at itsprincipal offices, 601 Munras Ave., Monterey, California and at its threebranch offices in Carmel-By-The-Sea, Carmel Valley and Pacific Grove,California and a loan production office in Monterey, California.

 

 

----

 

At December 31, 2007 the Bank had total assets,deposits and shareholders’ equity of approximately $252,215,000, $167,818,000and $20,781,000, respectively.

 

**Northern California Bancorp, Inc.Trust I**

 

On March 27, 2003, Northern California Bancorp, Inc.Trust I, a newly formed Delaware statutory business trust and a wholly ownedsubsidiary of the Company (Trust I), issued an aggregate of $3.0 million ofprincipal amount of Floating Rate TRUPSâ (Capital Trust Pass-through Securitiesof the Trust) (the Trust Preferred Securities). Bear Stearns & Co., Inc. acted as placement agent inconnection with the offering of the Trust Preferred Securities.  The securities issued by Trust I are fullyguaranteed by the Company with respect to distributions and amounts payableupon liquidation, redemption or repayment. The entire proceeds to Trust I from the sale of the Trust PreferredSecurities were used by Trust I in order to purchase $3.0 million in principalamount of the Floating Rate Junior Subordinated Deferrable Interest Debenturesdue 2033 issued by the Company (the Subordinated Debt Securities).

 

Pursuant to FinancialAccounting Standards Board (FASB) Interpretation No. 46, “Consolidation ofVariable Interest Entities (VIE’s) (FIN 46),” this trust is not reflected on aconsolidated basis in our financial statements.

 

The Subordinated Debt Securities bear a variableinterest rate equal to the three-month LIBOR plus 3.25%.  The effective rate at December 31, 2007was 8.49%.  Total broker and legal costsassociated with the issuance of $115,000 are being amortized over a 30 yearperiod.

 

# **Northern California Bancorp, Inc. Trust II**

#  

On November 13,2003, Northern California Bancorp, Inc. Trust II, a newly formedDelaware statutory business trust and a wholly owned subsidiary of the Company(Trust II), issued an aggregate of $5.0 million of principal amount of FloatingRate TRUPSâ (Capital Trust Pass-through Securitiesof the Trust) (the Trust Preferred Securities). Citigroup Global Markets, Inc. acted as placement agent inconnection with the offering of the Trust Preferred Securities.  The securities issued by Trust II are fullyguaranteed by the Company with respect to distributions and amounts payableupon liquidation, redemption or repayment. The entire proceeds to Trust II from the sale of the Trust PreferredSecurities were used by Trust II in order to purchase $5.0 million in principalamount of the Floating Rate Junior Subordinated Deferrable Interest Debenturesdue 2033 issued by the Company (the Subordinated Debt Securities).

 

Pursuant to FinancialAccounting Standards Board (FASB) Interpretation No. 46, “Consolidation ofVariable Interest Entities (VIE’s) (FIN 46),” this trust is not reflected on aconsolidated basis in our financial statements.

 

The Subordinated Debt Securities bear a variableinterest rate equal to the three-month LIBOR plus 2.85%.  The effective rate at December 31, 2007was 7.76%. Total broker and legal costs associated with the issuance of $54,000are being amortized over a 30 year period.

 

**EMPLOYEES**

 

At December 31, 2007 the Northern California Bancorp, Inc. and its subsidiary Monterey CountyBank employed a total of 52 full time equivalent persons.

 

4

----

 

**COMPETITION**

 

All phases of the Bank’s business have been, since inception, and willcontinue to be subject to significant competitive forces.  Although the Bank has increasing recognitionin its primary service area and Monterey County, it nevertheless has to competewith other independent local banking institutions, including commercial banksand savings and loan associations, as well as branch offices of regionalcommercial banks, some of which have assets, capital and lending limitssubstantially larger than the Bank, as well as wider geographic markets, moresupport services and larger media advertising capabilities.  The Bank will also compete with respect toits lending activities, as well as inattracting demand deposits, with savings banks, savings and loan associations,insurance companies, regulated small loan companies and credit unions, as wellas securities brokerage offices which can issue commercial paper and othersecurities (such as shares in money market funds).

 

Among the advantages such institutions haveover the Bank are their ability to finance wide ranging advertising campaignsand to allocate their investment assets to regions of highest yields anddemand.  Many institutions offer certainservices, such as trust services and international banking, which the Bank doesnot currently offer or plan to offer.  Byvirtue of their greater total capital, such institutions have substantiallyhigher lending limits than the Bank (legal lending limits to an individualcustomer being limited to a percentage of a bank’s total capitalaccounts).  These competitors mayintensify their advertising and marketing activities to counter any efforts bythe Bank to further attract new business as a commercial bank.  In addition, as a result of legislationenacted earlier in the decade, there is increased competition between banks,savings and loan associations and credit unions for the deposit and loanbusiness of individuals.  Theseactivities may hinder the Bank’s ability to capture a significant market share.

 

To compete with the financial institutionsin its primary service area, the Bank intends to use the flexibility, which itsindependent status will permit.  Itsactivities in this regard include an ability and intention to respond quicklyto changes in the interest rates paid on time and savings deposits and chargedon loans, and to charges imposed on depository accounts, so as to remain competitivein the market place.  It also willcontinue to emphasize specialized services for the small business person andprofessional and personal contacts by the Bank’s officers, directors andemployees.  If there are customers whoseloan demands exceed the Bank’s lending limits, the Bank has the ability toarrange for such loans on a participation basis with other financialinstitutions.  No assurance can be given,however, that the Bank’s efforts to compete with other financial institutionsin its primary service area will be successful.

 

The Bank provides a range of competitiveretail and commercial banking services. The deposit services offered include various types of personal andbusiness checking accounts, savings accounts, money market investment accounts,certificates of deposit, and retirement accounts.  Lending services include consumer loans,various type of mortgage loans for residential and commercial real estate,personal lines of credit, home equity loans, real estate construction, accountsreceivable financing, commercial loans to small and medium size businesses andprofessionals.  The Bank also providesdrive-through facilities, at its Monterey and Carmel offices, and nightdepository facilities for customer convenience. The Bank offers safe deposit box facilities, cashiers’ checks, travelers’checks, U.S. Savings Bonds, and wire transfers. The Bank does not provide trust services.

 

5

----

 

While the Bank has the authority to engagein a wide range of banking activities, and offers most of the types of bankingservices of a commercial bank, over the past three years it hasderived much of its profitability and differentiated itself from itscompetitors through (i) commercial and real estate loans guaranteed by theSmall Business Administration (“SBA”); and (ii) credit card depositoryservices for merchants.

 

TheBank entered into an agreement with Genesis Financial Solutions, a purchaser ofcharged-off consumer credit card balances, to market a MasterCard credit cardprogram.  The Bank issued the cards, butthe credit card balances are 100 percent owned by Genesis FinancialSolutions.  The program was implementedin the first quarter of 2005 with the initial card solicitations being mailedin February 2005 resulting in 14,741 active cards on file at December 31,2005.  The Bank’s fee revenue from theprogram in 2007, 2006 and 2005 were approximately $106,000, $71,000 and$95,000, respectively.  Genesis FinancialSolutions maintains deposits with the Bank equal to the sum of the totalavailable credit of the portfolio plus the total of five days averagesettlement activity for the prior month. The average deposits maintained during 2007, 2006 and 2005 were $645,000,$648,000 and $276,000, respectively.  Itis anticipated the number of accounts in the portfolio will continue to declineas no new accounts are being added. Program revenues in 2008 will approximate $8,000 per month until theexpiration of the agreement in September 2008.

 

TheBank entered into an agreement in February 2006 with GC Acquisitions, LLC (“GCA”), the owner of a portfolio of consumercredit card contracts and receivables, under which the Bank offered MasterCard®credit cards to qualifying GCA credit card contract holders.  GCA,through its affiliates, agents and vendors, established new credit cardaccounts with the Bank for certain of its existing credit card contractholders. GCA services the credit card accounts and owns the receivablesgenerated from the accounts.  A total ofapproximately 252,000 cards were issued during March and April 2006,as a result of GCA’s purchase of a credit card portfolio.  GCA requested and the Bank granted permissionfor GCA to transfer a total of approximately 87,000 accounts from the portfolioto another card issuer.  In considerationfor the Bank granting permission to transfer the accounts GCA paid a one timetransfer fee totaling approximately $382,000. The Bank’s fee revenue from the program in 2007 and 2006 wasapproximately $473,000 and $1,209,000, respectively.  Included in both 2007 and 2006 revenues wereone time transfer fees of $204,000 and $382,000, respectively. GCA maintainedaverage reserve deposits with the Bank of $2,050,000 $7,488,000 at December 31,2007 and 2006, respectively.  The Bank’s2008 revenues from the program will be based on monthly minimum fee payments ofapproximately $10,000.

 

TheBank has entered into agreements with two additional companies, who arepurchasers of charged off debt, to market credit cards to their customerbases.  The Bank anticipates its 2008revenues from these programs will be derived from the minimum monthly feepayments due under the agreements.

 

TheBank has implemented a pre-paid debit card program.  The program is marketed by third parties throughemployer payroll programs and check cashing facilities, through Internetwebsites for purchasers of the websites’ products and services.  Holders of the pre-paid cards will be able tohave additional funds added to the card balance, make point of sale purchasesand withdraw cash through automated teller machines.  The Bank will be issuing the pre-paid cardsand maintaining the funds held on the cards. The Bank’s revenues from the program will be in the form of transactionfees and earnings from investing the funds held on the cards.  The fee revenues from the program were$293,000, $75,000 and $14,000 in 2007, 2006 and 2005, respectively.

 

6

----

 

TheBank depends largely on rate differentials. In general, the difference between the interest rate paid by the Bank onits deposits and its other borrowings, and the interest rate received by theBank on loans extended to its customers and securities held in the Bank’sportfolio, comprise the major portion of the Bank’s earnings.  These rates are highly sensitive to manyfactors that are beyond the control of the Bank.  Accordingly, the earnings and growth of theBank are subject to the influence of domestic and foreign economic conditions,including inflation, recession and unemployment.

 

Monetary and fiscal policies of the federal government and the policiesof regulatory agencies, particularly the Federal Reserve Board, also impact the Bank’s business.  The Federal Reserve Board implements nationalmonetary policies (with objectives such as curbing inflation and combatingrecession) by its open-market operations in U.S. Government securities, byadjusting the required level of reserves for financial intermediaries subjectto its reserve requirements and by varying the discount rates applicable toborrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence thegrowth of bank loans, investments and deposits and also affect interest ratescharged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannotbe predicted.

 

**SUPERVISIONAND REGULATION**

 

**TheCorporation**

 

Future offers or sales of the stock of the Corporation will be subjectto the registration requirements of the Securities Act of 1933, andqualification under the California Corporate Securities Act of 1968, andpossibly other state Blue Sky laws, (unless an exemption is available), although the Bank’s common stock is exempt fromsuch requirements.

 

On December 29, 1995, after receipt ofappropriate approvals, and/or passage of notice periods without objection, fromthe California Superintendent of Banks, the Federal Deposit InsuranceCorporation, the Board of Governors of the Federal Reserve System and theshareholders of the Bank, the Corporation acquired the Bank through a reversetriangular merger (the “Merger”).  As aresult, by operation of law, each outstanding share of common stock of the Bankprior to the Merger was converted into a share of common stock of the Corporation,while the Corporation became the sole owner of the newly issued shares ofcommon stock of the Bank.

 

The Bank Holding Company Act of 1956, asamended, places the Corporation under the supervision of the Board of Governorsof the Federal Reserve System (the “FRB”). The Corporation must generallyobtain the approval of the FRB before acquiring all or substantially all of theassets of any bank, or ownership or control of any voting securities of anybank if, after giving effect to such acquisition, the Corporation would own orcontrol more than 5% of the voting shares of such bank.

 

A bank holding company is generallyprohibited from engaging in, or acquiring direct or indirect control of morethan 5% of the voting shares of any company engaged in non-banking activitiesunless the FRB, by order or regulation, has found such activities to be soclosely related to banking, managing or controlling banks as to be a properincident thereto. In making such determinations, the FRB considers whether theperformance of such activities by a bank holding company would offer advantagesto the public, which outweigh possible adverse effects.

 

7

----

 

The FRB’s Regulation “Y” sets out thenon-banking activities that are permissible for bank holding companies underthe law, subject to the FRB’s approval in individual cases.  Most of these activities are now permittedfor California banks that are well-capitalized.   The Corporation and its subsidiaries willalso be subject to certain restrictions with respect to engaging in theunderwriting, public sale and distribution of securities.  The Gramm-Leach-Bliley Act (the “Act”) wassigned by the President and enacted into law on November 12, 1999.  The Act does three fundamental things: 1) itrepeals key provisions of the Glass Steagal Act to permit commercial banks toaffiliate with investment banks, 2) it substantially modifies the Bank HoldingCompany Act of 1956 to permit companies that own commercial banks to engage inany type of financial activity and 3) it allows subsidiaries of banks to engagein a broad range of financial activities that are not permitted by banks.  Management cannot predict what effect thesechanges will have on the Bank or the Corporation.

 

The Corporation will be required to filereports with the FRB and provide such additional information as the FRB mayrequire. The FRB will also have the authority to examine the Corporation andeach of its subsidiaries with the cost thereof to be borne by the Corporation.  Under California banking law, the Corporationand its subsidiaries are also subject to examination by, and may be required tofile reports with, the Superintendent Department of Financial Institutions.

 

The Corporation and any subsidiaries which it mayacquire or organize after the reorganization will be deemed affiliates of theBank within the meaning of the Federal Reserve Act.  Pursuant thereto, loans by the Bank toaffiliates, investments by the Bank in affiliates’ stock, and taking affiliates’stock by the Bank as collateral for loans to any borrower will be limited to10% of the Bank’s capital, in the case of any one affiliate, and will belimited to 20% of the Bank’s capital, in the case of all affiliates.  Federal and State law place other limitationson transactions between the Bank and its affiliates designed to ensure that theBank receives treatment in such transactions comparable to that available fromunaffiliated third parties.

 

TheCorporation and its subsidiaries are prohibited from engaging in certain tie-inarrangements in connection with any extension of credit, sale or lease ofproperty or furnishing of services.  Forexample, with certain exceptions, the Bank may not condition an extension of crediton a customer’s obtaining other services provided by it, the Corporation or anyother subsidiary, or on a promise from its customer not to obtain otherservices from a competitor.

 

**Sarbanes-Oxley Act**

 

The Sarbanes-Oxley Act of 2002 (the Act) was enacted into law on July 30,2002.  The Act was in response to recentissues in corporate governance and accountability.  Key provisions of the Act provide for:

 

·                  Expanded oversight of the accountingprofession by creating a new independent public company oversight board to bemonitored by the SEC.

·                  Revised rules on auditor independence torestrict the nature of non-audit services provided to audit clients and torequire such services to be pre-approved by the audit committee.

·                  Improved corporate responsibility throughmandatory listing standards relating to audit committees, certifications ofperiodic reports by the Chief Executive Officer and Chief Financial Officer,and making issuer interference with an audit a crime.

·                  Enhanced financial disclosures, includingperiodic reviews for the largest issuers and real time disclosure of materialcompany information.

·                  Enhanced criminal penalties for a broad arrayof white-collar crimes and increases in the statute of limitations forsecurities fraud lawsuits.

·                  Provides for mandated internal control reportand assessment with the annual report and an attestation and a report on suchreport by the company’s auditor.

 

8

----

 

Theeffect of the Act upon corporations is uncertain; however, it is likely thatcompliance costs may increase as corporations modify procedures if required toconform to the provisions of the Act. The Company does not currently anticipate that compliance with the Actwill have a material effect upon its financial position or results or its operationsor its cash flows.

 

**SubsidiaryBank**

 

Both federal and state laws provide extensive regulation of the bankingbusiness.  State and federal statutes andregulations apply to many aspects ofthe Bank’s operations, including minimum capital requirements, reserves againstdeposits, interest rates payable on deposits, loans, investments, mergers andacquisitions, borrowings, dividends and locations of branch offices. TheCalifornia Superintendent of Banks and the FDIC provide primary supervision,periodic examination and regulation of the Bank.

 

The FDIC, through its Bank Insurance Fund(the “BIF”) insures the Bank’s deposits, currently up to a maximum of $100,000per depositor, except that individual retirement accounts are insured up to amaximum of $250,000 per depositor.  Forthis protection, the Bank, like all insured banks, pays a semi-annual statutoryassessment and is subject to the rules and regulations of the FDIC.  Although the Bank is not a member of theFederal Reserve System, certain regulations of the Federal Reserve Board alsoapply to its operations.

 

California law restricts the amountavailable for cash dividends by state-chartered banks to the lesser of retainedearnings or the bank’s net income for its last three fiscal years (less anydistributions to stockholders made during such period).  Cash dividends may also be paid in an amountnot exceeding the net income for such bank’s last preceding fiscal year afterobtaining the prior approval of the Superintendent.  The FDIC also has authority to prohibit theBank from engaging in unsafe or unsound practices.  The FDIC can use this power, under certaincircumstances, to restrict or prohibit a bank from paying dividends.

 

Federal law imposes restrictions on bankswith regard to transactions with affiliates, including any extensions of creditto, or the issuance of a guarantee or letter of credit on behalf of, itsaffiliates, as well as the purchase of or investments in stock or othersecurities thereof, or the taking of such securities as collateral for loans,and the purchase of assets from affiliates. These restrictions have the effect of preventing affiliates (such as theCorporation) from borrowing from the Bank unless the loans are secured by marketableobligations of designated amounts. Secured loans and investments by the Bank are limited to 10% of the Bank’scapital and surplus (as defined by federal regulations) in the case of any oneaffiliate, and 20% thereof in the case of all affiliates.  California law also imposes certain restrictionswith respect to transactions involving other controlling persons of the Bank.

 

From time to time, legislation is enactedwhich has the effect of increasing the cost of doing business, limiting orexpanding permissible activities or affecting the competitive balance betweenbanks and other financial intermediaries. Proposals to change the laws and regulations governing the operationsand taxation of banks, bank holding companies and other financial intermediariesare frequently made in Congress, in the California legislature and beforevarious bank regulatory and other professional agencies. The Bank cannotpredict what, if any legislation or regulations will be enacted, or the impactthereof on its business and profitability.

 

9

----

 

**Capital Adequacy Standards**

 

Government agencies have traditionally regulated bank capital throughexplicit and implicit guidelines and rules. State law requires “adequate”capital, without objective definition. Federal law and regulations require minimum levels of risk-based andso-called “Leverage” capital.

 

FDIC guidelines implement the risk-basedcapital requirements. The guidelines establish a systematic analyticalframework that makes regulatory capital requirements more sensitive todifferences in risk profiles (using the rough measures set forth therein) amongbanking organizations, take certain off-balance sheet items into account inassessing capital adequacy and minimize disincentives to holding liquid,low-risk assets. Under these guidelines, assets and credit equivalent amountsof off-balance sheet items, such as letters of credit and outstanding loancommitments, are assigned to one of several risk categories, which range from0% for risk-free assets, such as cash and certain U.S. government securities,to 100% for relatively high-risk assets, such as loans and investments in fixedassets, premises and other real estate owned. The aggregate dollar amount ofeach category is then multiplied by the risk-weight associated with thatcategory. The resulting weighted values from each of the risk categories arethen added together to determine the total risk-weighted assets.

 

A banking organization’s risk-based capitalratios are obtained by dividing its qualifying capital by its total riskadjusted assets, including dollar equivalents for certain off-balance sheetassets.

 

The guidelines require a minimum ratio ofqualifying total capital to risk-weighted assets of 8%, of which at least 4%must consist of Tier I capital.  Higherrisk-based ratios are required to be considered “well capitalized” under promptcorrective action provisions.

 

A banking organization’s qualifying totalcapital consists of two components: Tier 1 capital (core capital) and Tier 2capital (supplementary capital).  Tier 1capital consists primarily of common stock, related surplus and retainedearnings, qualifying noncumulative perpetual preferred stock and minorityinterests in the equity accounts of consolidated subsidiaries. Trust preferredsecurities qualify as Tier 1 capital up to a maximum of 25% of capital.  Any additional portion will qualify as Tier 2capital.  Intangibles, such as goodwill,are generally deducted from Tier 1 capital; however, purchased mortgageservicing rights and purchased credit card relationships may be included,subject to certain limitations. At least 50% of the banking organization’stotal regulatory capital must consist of Tier 1 capital.

 

Tier 2 capital may consist of (i) theallowance for loan and lease losses in an amount up to 1.25% of risk-weightedassets; (ii) cumulative perpetual preferred stock and long-term preferredstock and related surplus; (iii) hybrid capital instruments (instrumentswith characteristics of both debt and equity), perpetual debt and mandatoryconvertible debt securities; and (iv) eligible term subordinated debt andintermediate-term preferred stock with an original maturity of five years ormore, including related surplus, in an amount up to 50% of Tier 1 capital. Theinclusion of the foregoing elements of Tier 2 capital is subject to certainrequirements and limitations of the federal banking agencies.

 

10

----

 

The FDIC imposes a minimum leverage ratio ofTier I capital to average total assets of 3% for the highest rated banks, and4% for all other banks.  Institutionsexperiencing or anticipating significant growth or those with other thanminimum risk profiles are expected to maintain capital at least 100-200 basispoints above the minimum level.

 

In addition, the Federal Reserve Board andthe FDIC have issued or proposed rules to take account of interest raterisk, concentration of credit risk and the risks of nontraditional activitiesin calculating risk-based capital.

 

For capital adequacy purposes, deferred taxassets that can be realized from taxes paid in prior carry-back years, and fromthe future reversal of temporary differences, are generallyunlimited.  However, deferred tax assetsthat can only be realized through future taxable earnings, including theimplementation of a tax planning strategy, count toward regulatory capitalpurposes only up to the lesser of (i) the amount that can be realizedwithin one year of the quarter-end report date or (ii) 10% of Tier Icapital.  The amount of deferred taxes inexcess of this limit, if any, would be deducted from Tier I capital and totalassets in regulatory capital calculations.

 

Effective January 17,1995, the federal banking agencies issued a final rule relating to capitalstandards and the risks arising from the concentration of credit andnontraditional activities.  Institutionswhich have significant amounts of their assets concentrated in high risk loansor nontraditional banking activities and who fail to adequately manage theserisks, will be required to set aside capital in excess of the regulatoryminimums.  The federal banking agencieshave not imposed any quantitative assessment for determining when these risksare significant, but have identified these issues as important factors they willreview in assessing an individual bank’s capital adequacy.  Management of the Company does not believethat the Bank’s assets and activities, as currently structured, would lead theFDIC to require additional capital under this rule.

 

Future changes in regulations or practicescould further reduce the amount of capital recognized for purposes of capitaladequacy.  Such a change could affect theability of the Bank to grow and could restrict the amount of profits, if any,available for the payment of dividends.

 

**Prompt Corrective Action and OtherEnforcement Mechanisms**

 

Under Section 38 of the FDIA, as added by the Federal DepositInsurance Corporation Improvement Act of 1991 (“FDICIA”), each federal bankingagency is required to implement a system of prompt corrective action forinstitutions which it regulates.  Thefederal banking agencies have promulgated substantially similar regulations toimplement this system of prompt corrective action.  Underthe regulations, an institution shall generally be deemed to be: (i) “wellcapitalized” if it has a total risk-based capital ratio of 10.0% or more, has aTier I risk-based capital ratio of 6.0% or more, has a Tier Ileverage capital ratio of 5.0% or more and is not subject to specifiedrequirements to meet and maintain a specific capital level for any capitalmeasure; (ii) “adequately capitalized” if it has a total risk-basedcapital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0%or more and a Tier I leverage capital ratio of 4.0% or more (3.0% undercertain circumstances) and does not meet the definition of “well capitalized;” (iii) “undercapitalized”if it has a total risk-based capital ratio that is less than 8.0%, a Tier Irisk-based capital ratio that is less than 4.0% or a Tier I leveragecapital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) “significantlyundercapitalized” if it has a total risk-based capital ratio that is less than6.0%, a Tier I risk-based capital ratio that is less than 3.0% or aTier I leverage capital ratio that is less than 3.0%; and (v) “criticallyundercapitalized” if it has a ratio of tangible equity to total assets that isequal to or less than 2.0%.

 

11

----

 

Section 38 of the FDIA and the implementingregulations also provide that a federal banking agency may, after notice and anopportunity for a hearing, reclassify a well capitalized institution asadequately capitalized and may require an adequately capitalized institution oran undercapitalized institution to comply with supervisory actions as if itwere in the next lower category if the institution is in an unsafe or unsoundcondition or engaging in an unsafe or unsound practice.  (The FDIC may not, however, reclassify asignificantly undercapitalized institution as critically undercapitalized.)

 

An institution generally must file a writtencapital restoration plan which meets specified requirements, as well as aperformance guaranty by each company that controls the institution, with theappropriate federal banking agency within 45 days of the date that theinstitution receives notice or is deemed to have notice that it isundercapitalized, significantly undercapitalized or criticallyundercapitalized.  Immediately uponbecoming undercapitalized, an institution shall become subject to theprovisions of Section 38 of the FDIA, which sets forth various mandatoryand discretionary restrictions on its operations.

 

At December 31, 2007, the Bank met thetests to be categorized as “well capitalized” under the prompt correctiveaction regulations of the FDIC.

 

**Safety and Soundness Standards**

 

Federal law requires the federal banking regulatory agencies toprescribe, by regulation, standards for all insured depository institutionsrelating to: (i) internal controls, information systems and internal auditsystems; (ii) loan documentation; (iii) credit underwriting; (iv) interestrate risk exposure; (v) asset growth; and (vi) compensation, fees andbenefits.  The federal banking agenciesrecently adopted final regulations and Interagency Guidelines PrescribingStandards for Safety and Soundness (“Guidelines”) to implement safety andsoundness standards required bythe FDIA.  The Guidelines set forth thesafety and soundness standards that the federal banking agencies use toidentify and address problems at insured depository institutions before capitalbecomes impaired.  The agencies alsoproposed asset quality and earnings standards which, if adopted in final, wouldbe added to the Guidelines.  Under thefinal regulations, if the FDIC determines that the Bank fails to meet anystandard prescribed by the Guidelines, the agency may require the Bank tosubmit to the agency an acceptable plan to achieve compliance with thestandard, as required by the FDIA.  The finalregulations establish deadlines for the submission and review of such safetyand soundness compliance plans.

 

**Premiums for Deposit Insurance**

 

The FDIC adopted regulations implementing a risk-based premium systemrequired by federal law.  Under the regulationswhich cover the assessment periods commencing on and after January 1,1994, insured depository institutions are required to pay insurance premiumswithin a range of $.23 cents per $100 of deposits to $.31 cents per $100 ofdeposits depending on their risk classification.  The FDIC, effective September 30, 1995,lowered assessments from their rates of $.23 to $.31 per $100 of insureddeposits to rates of $.04 to $.31, depending on the health of the bank, as aresult of the re-capitalization of the BIF. The FDIC may alter the existing assessment rate structure for deposit insurance and may changethe base assessment rate (currently, 4 to 31 basis points per year) byrulemaking with notice and comment. Without notice or comment, the FDIC may increase or decrease the currentrate schedule uniformly by as much as 5 basis points, as deemed necessary tomaintain the target designated reserve ratio 1.25 percent (fund balance toestimated insured deposits).  The insureddeposit rates for 2007 were $.05 to $.43 per $100 of deposits.

 

12

----

 

OnFebruary 8, 2006, the President signed The Federal Deposit InsuranceReform Act of 2005 (the Reform Act) into law. The Federal Deposit InsuranceReform Conforming Amendments Act of 2005, which the President signed into lawon February 15, 2006, contains necessary technical and conforming changesto implement deposit insurance reform, as well as a number of study and surveyrequirements.

 

TheReform Act provides for the following changes:

 

·                              Merging theBank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF)into a new fund, the Deposit Insurance Fund (DIF). This change was madeeffective March 31, 2006.

 

·                              Increasing thecoverage limit for retirement accounts to $250,000 and indexing the coveragelimit for retirement accounts to inflation as with the general depositinsurance coverage limit. This change was made effective April 1, 2006.

 

·                              Establishing a range of 1.15percent to 1.50 percent within which the FDIC Board of Directors may set theDesignated Reserve Ratio (DRR).

 

·                              Allowing theFDIC to manage the pace at which the reserve ratio varies within this range.

 

1.               If the reserveratio falls below 1.15 percent—or is expected to within 6 months—the FDIC mustadopt a restoration plan that provides that the DIF will return to 1.15 percentgenerally within 5 years.

 

2.               If the reserveratio exceeds 1.35 percent, the FDIC must generally dividend to DIF membershalf of the amount above the amount necessary to maintain the DIF at 1.35percent, unless the FDIC Board, considering statutory factors, suspends thedividends.

 

3.               If the reserveratio exceeds 1.5 percent, the FDIC must generally dividend to DIF members allamounts above the amount necessary to maintain the DIF at 1.5 percent.

 

·                              Eliminating therestrictions on premium rates based on the DRR and granting the FDIC Board thediscretion to price deposit insurance according to risk for all insuredinstitutions regardless of the level of the reserve ratio.

 

·                              Granting aone-time initial assessment credit (of approximately $4.7 billion) to recognizeinstitutions’ past contributions to the fund.

 

·                              The FederalDeposit Insurance Reform Conforming Amendments Act of 2005 requires the FDIC toconduct studies of three issues: (1) further potential changes to thedeposit insurance system, (2) the appropriate deposit base in designatingthe reserve ratio, and (3) the Corporation’s contingent loss reservingmethodology and accounting for losses.

 

·                              The 2005 actrequires the Comptroller General to conduct studies of (1) federal bankregulators’ administration of the prompt corrective action program and recentchanges to the FDIC deposit insurance system, and (2) the organizationalstructure of the FDIC.

 

13

----

 

The final rule consolidates the existing nine risk categories intofour and names them Risk Categories I, II, III and IV. Risk CategoryI replaces the 1A risk category.

 

Within Risk Category I, the final rule combines supervisoryratings with other risk measures to differentiate risk. For most institutions,the final rule combines CAMELS component ratings with financial ratios todetermine an institution’s assessment rate. For large institutions that havelong-term debt issuer ratings, the final rule differentiates risk bycombining CAMELS component ratings with these ratings. For large institutionswithin Risk Category I, initial assessment rate determinations may be modifiedwithin limits upon review of additional relevant information.

 

The final rule defines a large institution as an institution thathas $10 billion or more in assets. With certain exceptions, beginning in 2010,the final rule treats new institutions (those established for less thanfive years) in Risk Category I the same, regardless of size, and assesses themat the maximum rate applicable to Risk Category I institutions.

 

The final rule setsactual rates beginning January 1, 2007, as follows:

 
| ** **                     | ** ** | **Risk Category** | ** ** |
|--------------------------------|------------|-------------------|------------|
| ** **                     | ** ** | **I***            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Minimum**       | ** ** | **Maximum** | ** ** | **II** | ** ** | **III** | ** ** | **IV** | ** ** |
| Annual Rates (in basis points) |       | 5                 |       | 7 |   | 10 |   | 28 |   | 43 |   |

----

*Rates for institutions that do not pay the minimum or maximum rate vary betweenthese rates.

 

These rates are three basispoints above the base rate schedule adopted in the final rule:

 
| ** **                     | ** ** | **Risk Category** | ** ** |
|--------------------------------|------------|-------------------|------------|
| ** **                     | ** ** | **I***            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Minimum**       | ** ** | **Maximum** | ** ** | **II** | ** ** | **III** | ** ** | **IV** | ** ** |
| Annual Rates (in basis points) |       | 2                 |       | 4 |   | 7 |   | 25 |   | 40 |   |

----

*Rates for institutions that do not pay the minimum or maximum rate vary betweenthese rates.

 

The final rule continues to allow the FDIC Board to adjust ratesuniformly from one quarter to the next, except that no single adjustment canexceed three basis points. In addition, cumulative adjustments cannot exceed amaximum of three basis points higher or lower than the base rates without furthernotice-and-comment rulemaking.

 

The billing for deposit insurance is now quarterly and in thearrears.   Payment for the first quarter2007 deposit insurance premiums will be collected in June 2007. The Bank’s portion of the one-time initial assessment credit isestimated to be approximately $49,000, which will be used to offset depositinsurance premiums; the assessment credit cannot be used to offset FICOpremiums.

 

14

----

 

 

 

The Financing Corporation(FICO), established by the Competitive Equality Banking Act of 1987, is amixed-ownership government corporation whose sole purpose was to function asthe financing vehicle for the Federal Savings and Loan Insurance Corporation (FSLIC).  Effective December 12, 1991, as providedby the Resolution Trust Corporation Refinancing, Restructuring and ImprovementAct of 1991, the FICO’s ability to issue new debt was terminated.  Outstanding FICO bonds, which are 30-yearnon-callable bonds with a principal amount of approximately $8.1 billion,mature in 2017 through 2019.

 

TheFICO has assessment authority, separate from the FDIC’s authority to assessrisk-based premiums for deposit insurance, to collect funds from FDIC-insuredinstitutions sufficient to pay interest on FICO bonds.  The FDIC acts as collection agent for theFICO.  The Deposit Insurance Funds Act of1996 (DIFA) authorized the FICO to asses both Bank Insurance Fund (BIF) andSavings Association Insurance Fund (SAIF) insured deposits, and required theBIF rate to equal one-fifth the SAIF rate through the year 1999, or until theinsurance funds are merged, whichever occurs first.  Thereafter, BIF and SAIF insured depositswill be assessed at the same rate by FICO.

 

TheFICO assessment rate is adjusted quarterly to reflect changes in the assessmentbasis of the respective funds based on the quarterly Call Report and the ThriftFinancial Report submissions.  The FICOquarterly rates for 2007 were 1.22, 1.22, 1.14 and 1.14.  The FICO quarterly rate for the first quarterof 2008 is 1.14.

 

**Interstate Banking and Branching**

 

On September 29,1994, the President signed into law the Riegle-Neal Interstate Banking andBranching Efficiency Act of 1994 (the “Interstate Act”).  Under the Interstate Act, beginning one yearafter the date of enactment, a bank holding company that is adequatelycapitalized and managed may obtain regulatory approval to acquire an existingbank located in another state without regard to state law.  A bank holding company would not be permittedto make such an acquisition if, upon consummation, it would control (a) morethan 10% of the total amount of deposits of insured depository institutions inthe United States or (b) 30% or more of the deposits in the state in whichthe bank is located.  A state may limitthe percentage of total deposits that may be held in that state by any one bankor bank holding company if application of such limitation does not discriminateagainst out-of-state banks.  Anout-of-state bank holding company may not acquire a state bank in existence forless than a minimum length of time that may be prescribed by state law exceptthat a state may not impose more than a five year existence requirement.

 

The Interstate Act alsopermitted affective June 1, 1997, mergers of insured banks located indifferent states and conversion of the branches of the acquired bank intobranches of the resulting bank.  Eachstate may permit such combinations earlier than June 1, 1997, and mayadopt legislation to prohibit interstate mergers after that date in that stateor in other states by that state’s banks. The same concentration limits discussed in the preceding paragraphapply.  The Interstate Act also permits anational or state bank to establish branches in a state other than its homestate if permitted by the laws of that state, subject to the same requirementand conditions as for a merger transaction.

 

The Interstate Act islikely to increase competition in the Bank’s market areas especially fromlarger financial institutions and their holding companies.  It is difficult to asses the impact suchlikely increased competition will have on the Bank’ operations.

 

15

----

 

On October 2, 1995,the “California Interstate Banking and Branching Act of 1995” (the “1995 Act”)became effective.  The 1995 Act generallyallows out-of-state banks to enter California by merging with, or purchasing, aCalifornia bank or industrial loan company which is at least five years old.  Also, the 1995 Act repeals the CaliforniaInterstate (National) Banking Act of 1986, which previously regulated theacquisition of California banks by out-of-state bank holding companies.  In addition, the 1995 Act permits Californiastate banks, with the approval of the Superintendent of Banks, to establishagency relationships with FDIC-insured banks and savings associations.  Finally, the 1995 Act provides for regulatoryrelief, including (i) authorization for the Superintendent to exempt banksfrom the requirement of obtaining approval before establishing or relocating abranch office or place of business, (ii) repeal of the requirement ofdirectors’ oaths (Financial Code Section 682), and (iii) repeal ofthe aggregate limit on real estate loans (Financial Code Section 1230).

 

**Community Reinvestment Act and Fair LendingDevelopments**

 

The Bank is subject tocertain fair lending requirements, reporting obligations involving homemortgage lending operations and Community Reinvestment Act (the “CRA”).  The CRA generally requires the federalbanking agencies to evaluate the record of financial institutions in meetingthe credit needs of their local community, including low and moderate incomeneighborhoods.  In addition to substantialpenalties and corrective measures that may be required for a violation ofcertain fair lending laws, the federal banking agencies may take compliancewith such laws and CRA into account when regulating and supervising otheractivities.

 

In May, 1995, the federalbanking agencies issued final regulations which change the manner in which theymeasure a bank’s compliance with its CRA obligations.  The final regulations adopt aperformance-based evaluation system which bases CRA ratings on an institution’sactual lending service and investment performance rather than the extent towhich the institution conducts needs assessments, documents community outreachor complies with other procedural requirements. In March 1994, the Federal Interagency Task Force on Fair Lendingissued a policy statement on discrimination in lending.  The policy statement describes the threemethods that federal agencies will use to prove discrimination: overt evidenceof discrimination, evidence of disparate treatment and evidence of disparateimpact.  Management of the Bank believesthat the Bank is in substantial compliance with all requirements under theseprovisions.  Following the Bank’s mostrecent CRA examination, the Bank’s rating was “satisfactory”.

 

**Other Regulations and Policies**

 

The federal regulatory agencieshave adopted regulations that implement Section 304 of FDICIA whichrequires federal banking agencies to adopt uniform regulations prescribingstandards for real estate lending.  Eachinsured depository institution must adopt and maintain a comprehensive writtenreal estate lending policy, developed in conformance with prescribedguidelines, and each agency has specified loan-to-value limits in guidelinesconcerning various categories of real estate loans.

 

Section 24 of theFederal Deposit Insurance Act (the “FDIA”), as amended by the FDICIA, generallylimits the activities and equity investments of FDIC-insured, state-charteredbanks to those that are permissible for national banks.  Under regulations dealing with equity investments,an insured state bank generally may not directly or indirectly acquire orretain any equity investment of a type, or in an amount, that is notpermissible for a national bank.  Aninsured state bank is not prohibited from, among other things, (i) acquiringor retaining a majority interest in a subsidiary, (ii) investing as alimited partner in a partnership the sole purpose of which is direct orindirect investment in the acquisition, rehabilitation or new construction of aqualified housing project, provided that such limited partnership investmentsmay not exceed 2% of the bank’s total assets, (iii) acquiring up to 10% ofthe voting stock of a company that solely provides or reinsures directors’,trustees’ and officers’ liability insurance coverage or bankers’ blanket bondgroup insurance coverage for insured depository institutions, and (iv) acquiringor retaining the voting shares of a depository institution if certainrequirements are met.

 

16

----

 

FDIC regulationsimplementing Section 24 of the FDIA provide that an insuredstate-chartered bank may not, directly, or indirectly through a subsidiary,engage as “principal” in any activity that is not permissible for a nationalbank unless the FDIC has determined that such activities would pose no risk tothe insurance fund of which it is a member and the bank is in compliance withapplicable regulatory capital requirements. Any insured state-chartered bank directly or indirectly engaged in anyactivity that is not permitted for a national bank must cease the impermissibleactivity.

 

**Financial ModernizationAct**

** **

Effective March 11, 2000, the Gramm-Leach-BlileyAct eliminated most barriers to affiliations among banks and securities firms,insurance companies, and other financial service providers, and enabled fullaffiliations to occur between such entities. This new legislation permits bank holding companies to become “financialholding companies” and thereby acquire securities firms and insurance companiesand engage in other activities that are financial in nature.  A bank holding company may become a financialholding company if each of its subsidiary banks is well capitalized under theprompt corrective action provisions discussed above, is well managed, and hasat least a satisfactory rating under the Community Reinvestment Act by filing adeclaration that the bank holding company wishes to become a financial holdingcompany.  No regulatory approval will berequired for a financial holding company to acquire a company, other than abank or savings association, engaged in activities that are financial in natureor incidental to activities that are financial in nature, as determined by theFederal Reserve Board.  The Bank has nocurrent intention of becoming a financial holding company, but may do so atsome point in the future if deemed appropriate in view of opportunities orcircumstances at the time.

 

The Gramm-Leach-Bliley Act defines “financial innature” to include securities underwriting, dealing and market making;sponsoring mutual funds and investment companies; insurance underwriting andagencies; merchant banking activities; and activities that the Federal ReserveBoard has determined to be closely related to banking.  A national bank (and therefore, a state bankas well) may also engage, subject to limitations on investment, in activitiesthat are financial in nature, other than insurance underwriting, insurancecompany portfolio investment, real estate development and real estateinvestment, through a financial subsidiary of the bank, if the bank is wellcapitalized, well managed and has at least a satisfactory CommunityReinvestment Act rating.  Subsidiarybanks of a financial holding company or national banks with financial subsidiariesmust continue to be well capitalized and well managed in order to continue toengage in activities that are financial in nature without regulatory actions orrestrictions, which could include divestiture of the financial in naturesubsidiary or subsidiaries.  In addition,a financial holding company or a bank may not acquire a company that is engagedin activities that are financial in nature unless each of the subsidiary banksof the financial holding company or the bank has a Community Reinvestment Actrating of satisfactory or better.

 

17

----

 

The Gramm-Leach-Bliley Act also imposes significantnew requirements on financial institutions with respect to the privacy ofcustomer information, and modifies other existing laws, including those relatedto community reinvestment.

 

**USA Patriot Act of 2001**

** **

On October 26, 2001, President Bush signed theUSA Patriot Act of 2001.  Enacted inresponse to the terrorist attacks in New York, Pennsylvania and Washington,D.C. on September 11, 2001, the USA Patriot Act is intended to strengthenU.S. law enforcement’s and the intelligence communities’ ability to workcohesively to combat terrorism on a variety of fronts.  The potential impact of the USA Patriot Acton financial institutions of all kinds is significant and wide ranging.  The USA Patriot Act contains sweepinganti-money laundering and financial transparency laws and requires variousregulations applicable to financial institutions, including:

 

·                                          due diligence requirements for financial institutionsthat administer, maintain, or manage private bank accounts or correspondentaccounts for non-U.S. persons;

 

·                                          standards for verifying customer identification ataccount opening; and

 

·                                          rules to promote cooperation among financialinstitutions, regulators, and law enforcement entities in identifying partiesthat may be involved in terrorism or money laundering.

 

The Bank implemented the requirements under the USAPatriot Act during 2001 and 2002.  Compliancewith such requirements has all been accomplished with existing staff, so thefinancial impact on the Bank has been negligible.

 

# **Regulatory Enforcement Powers**

#  

Commercial bankingorganizations, such as the Bank, may be subject to enforcement actions by theFDIC and the Superintendent for engaging in unsafe or unsound practices in theconduct of their businesses or for violations of any law, rule, regulation orany condition imposed in writing by the agency or any written agreement withthe agency.  Enforcement actions mayinclude the imposition of a conservator or receiver, the issuance of acease-and-desist order that can be judicially enforced, the termination ofinsurance of deposits, the imposition of civil money penalties, the issuance ofdirectives to increase capital, the issuance of formal and informal agreements,the issuance of removal and prohibition orders against institution-affiliatedparties and the imposition of restrictions and sanctions under the promptcorrective action provisions of the FDICIA.

 

# **California and Federal Banking Law**

#  

The Federal Change inBank Control Act of 1978 prohibits a person or group of persons “acting inconcert” from acquiring “control” of a bank or holding company unless theappropriate federal regulatory agency has been given 60 days’ prior writtennotice of such proposed acquisition and, within that time period, has notissued a notice disapproving the proposed acquisition or extending for up toanother 30 days the period during which such a disapproval may be issued. Anacquisition may be made prior to the expiration of the disapproval period ifthe agency issues written notice of its intent not to disapprove theaction.  The acquisition of more than 10%of a class of voting stock of a bank (or holding company) with a class ofsecurities registered under Section 12 of the Securities Exchange Act of1934, as amended (such as the Common stock), is generally presumed, subject torebuttal to constitute the acquisition of control.

 

18

----

 

Under the CaliforniaFinancial Code, no person shall, directly or indirectly, acquire control of aCalifornia licensed bank or a bank holding company unless the Superintendenthas approved such acquisition of control. A person would be deemed to have acquired control of the Corporationunder this state law if such person, directly or indirectly, has the power (i) tovote 25% or more of the voting power of the Corporation or (ii) to director cause the direction of the management and policies of the Corporation.  For purposes of this law, a person whodirectly or indirectly owns or controls 10% or more of the Common stock wouldbe presumed to control the Corporation, subject to rebuttal.

 

                Inaddition, any “company” would be required to obtain the approval of the FederalReserve under the Bank Holding Company Act of 1956, as amended (the “BHC Act”),before acquiring 25% (5% in the case of an acquirer that is, or is deemed tobe, a bank holding company) or more of the outstanding Common stock of, or suchlesser number of shares as constitute control over, the Bank or theCorporation.

 

The CommunityReinvestment Act of 1977 (“CRA”) and the related Regulations of the Comptrollerof the Currency, the Board of Governors of the Federal Reserve and the FederalDeposit Insurance Corporation (“FDIC”) are intended to encourage regulatedfinancial institutions to help meet the credit needs of their local communityor communities, including low and moderate income neighborhoods, consistentwith the safe and sound operation of such financial institutions.  The CRA and such regulations provide that theappropriate regulatory authority will assess the records of regulated financialinstitutions in satisfying their continuing and affirmative obligations to helpmeet the credit needs of their local communities as part of their regulatoryexamination of the institution.  Theresults of such examinations are made public and are taken into account uponthe filing of any application to establish a domestic branch, to merge or toacquire the assets or assume the liabilities of a bank.  In the case of a bank holding company, theCRA performance record of the subsidiary bank(s) involved in thetransaction is reviewed in connection with the filing of an application to acquireownership or control of shares or assets of a bank or to merge with any otherbank holding company.  An unsatisfactoryrecord can substantially delay or block the transaction.

 

**RESEARCH**

 

Neither the Corporationnor the Bank makes any material expenditures for research and development.

 

**DEPENDENCEUPON A SINGLE CUSTOMER**

 

Neither the Corporationnor the Bank is dependent upon a single customer or very few customers.  The Bank’s business is concentrated in, andlargely dependent upon the strength of the local economy in, the MontereyPeninsula area of Northern California. The local economy is affected by both national trends and by localfactors.  Tourism and the activities at theformer Fort Ord military base are among the major contributors to the localeconomy.

 

19

----

 

**ITEM 2.PROPERTIES**

 

The main office of theBank, which also serves as the principal office of the Corporation, is locatedat 601 Munras Ave., Monterey, California 93940. This facility contains a lobby, executive and customer service offices,teller stations, safe deposit boxes and related non-vault area, vault,operations area, lounge and miscellaneous areas.  A drive-through facility and adequate paved parkingare also on the premises.  Both the landand all improvements thereto are owned by the Bank**.**  The Bank also owns a building located at 556Abrego St., Monterey, CA which houses a loan production office and additionaloffice space.  The Bank currentlyoperates three branch offices in Carmel-By-The-Sea, Carmel Valley and PacificGrove, California, all within approximately 10 miles from the Bank’s mainoffice.  The Bank has received regulatoryapproval to establish a full service branch office in Salinas, California.  The land and improvements dedicated to theCarmel-By-The-Sea, Carmel Valley, Pacific Grove and Salinas branch offices areleased.  See Footnote 12 to theCorporation’s financial statements included herewith.

 

Generally, neither theBank nor the Corporation may invest in equity interests in real estate, exceptfor the direct use of the Bank or the Corporation in their business.  The Bank makes and/or purchases loans securedby real estate, subject to normal banking practices, its own policies and therestrictions described above under Item 1.

 

**ITEM 3.LEGAL PROCEEDINGS**

 

Thereare no known pending legal proceedings to which the Corporation or itssubsidiary is a party, or to which any of their properties is subject, otherthan ordinary litigation arising in the normal course of business activities.Although the amount of any ultimate liability with respect to such proceedingscannot be determined, in the opinion of management, any such liability will nothave a material effect on the consolidated financial position of the Corporationand its subsidiary.

 

**ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters were submittedto a vote of security holders during the fourth quarter.

 

**PART II**

 

**ITEM 5. MARKET FOR THE CORPORATION’S COMMON STOCKAND RELATED STOCKHOLDER MATTERS.**

 

TheCorporation’s stock, symbol NRLB is traded on the OTCBB (over-the-counterbulletin board) aquotation service for securities not listed or traded on NASDAQ or a nationalsecurities exchange.  TheCorporation also has knowledge of a limited number of transactions conductedbetween individual shareholders.

 

TheCorporation currently has one company which makes a market for its common stock,Howe Barnes Hoeffer &Arnett.

 

AtDecember 31, 2007 there were 530 record holders of common stock of the Company. Thisdoes not reflect the number of persons or entities who hold their stock innominee or street name through various brokerage firms.

 

20

----

 

The Corporation repurchased 3,795 shares of common stock at $4.00 pershare in 2005; no shares were repurchased in 2007 or 2006.

 

Thefollowing table sets forth, according to information known to the Corporation,the price paid per share in, and volume of, transactions in the Corporation’sstock during the quarters ended March 31, 2005 to December 31, 2007.

 

| ** ** | **Quarter/Year**    | ** ** | **Price**   | ** ** | **Volume****(1)** | ** ** |
|------------|---------------------|------------|-------------|------------|-------------------|------------|
|       |                |       |        |       |              |       |
|       | 1st quarter of 2005 |       | —      |       | —            |       |
|       | 2nd quarter of 2005 |       | 3.00-6.75   |       | 2,913             |       |
|       | 3rd quarter of 2005 |       | 4.00-5.35   |       | 6,873             |       |
|       | 4th quarter of 2005 |       | 4.00-8.15   |       | 8,083             |       |
|       |                |       |        |       |              |       |
|       | 1st quarter of 2006 |       | 7.70-10.70  |       | 13,941            |       |
|       | 2nd quarter of 2006 |       | 8.00-12.15  |       | 902               |       |
|       | 3rd quarter of 2006 |       | 8.00-13.05  |       | 1,593             |       |
|       | 4th quarter of 2006 |       | 8.00-13.25  |       | 5,452             |       |
|       |                |       |        |       |              |       |
|       | 1st quarter of 2007 |       | 12.00-17.00 |       | 42,225            |       |
|       | 2nd quarter of 2007 |       | 17.00-18.50 |       | 25,738            |       |
|       | 3rd quarter of 2007 |       | 16.00-18.35 |       | 8,793             |       |
|       | 4th quarter of 2007 |       | 11.00-16.05 |       | 92,520            |       |

----

(1)          For the periodpresented, the information indicated might not include information on shareswhich may have been traded directly by shareholders or through dealers.

 

Theprincipal source of cash flow of the Corporation, including cash flow to paydividends on its stock or principal and interest on debt, is interest anddividends on investments and tax benefit payments and dividends from the Bank.  There are statutory and regulatorylimitations on the payment of dividends by the Bank to the Corporation, as wellas by the Corporation to its shareholders.

 

Ifin the opinion of the applicable federal and/or state regulatory authority, adepository institution or holding company is engaged in or is about to engagein an unsafe or unsound practice (which, depending on the financial conditionof the depository institution or holding company, could include the payment ofdividends), such authority may require, after notice and hearing (except in thecase of an emergency proceeding where there is in no notice or hearing), thatsuch institution or holding company cease and desist from such practice.  Moreover, the Federal Reserve and the FDIChave issued policy statements which provide that bank holding companies andinsured depository institutions generally should only pay dividends out ofcurrent operating earnings.

 

Underthe Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”),an FDIC insured depository institution may not pay any dividend once it isundercapitalized or if payment would cause it to become undercapitalized.

 

21

----

 

TheBank’s payment of dividends, as a California chartered commercial bankingcorporation, is regulated by the California Financial Code.  Under the California Financial Code, fundsavailable for cash dividend payments by the Bank are restricted to the lessorof: (i) retained earnings; or (ii) the Bank’s net income for its lastthree fiscal years (less any distributions to the stockholders made during suchperiod).  As of December 31, 2007the Bank had $13,050,000 in retained earnings. The Bank’s net income for the last three fiscal years less distributionsto stockholders was $8,160,000.

 

InDecember 2007, 2006 and 2005 the Corporation paid cash dividends toshareholders of $0.25, $0.35 and $0.20 per share, respectively.  The Bank paid cash dividends totaling$800,000 and $625,000 to the Corporation during 2007 and 2006, respectively; nodividends were paid in 2005.

 

**ITEM 6.****            ****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION**

 

**Statements RegardingForward-Looking Information**

 

Exceptfor historical information contained herein, the matters discussed orincorporated by reference in this report contain forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, asamended (the “Securities Act”), and Section 21E of the Securities ExchangeAct of 1934 (the “Exchange Act”), that involve substantial risks anduncertainties.  When used in this report, or in the documents incorporatedby reference herein, the words “anticipate,” “believe,” “estimate,” “may,” “intend,”“expect,” and similar expressions identify certain of such forward-looking statements. Actual results of Monterey County Bank could differ materially from suchforward-looking statements contained herein.  Factors that could causefuture results to vary from current expectations include, but are not limitedto, the following: changes in economic conditions (both generally and morespecifically in the markets in which the Bank operates); changes in interestrates, deposit flows, loan demand, real estate values and competition; changesin accounting principles, policies or guidelines and in government legislationand regulation (which change from time to time and over which the Bank has nocontrol); other factors affecting the Bank’s operations, markets, products andservices; and other risks detailed in this Form 10-KSB and in the Bank’sother reports filed with the Comptroller of the Currency pursuant to the rules andregulations of the Securities and Exchange Commission.  Readers arecautioned not to place undue reliance on these forward-looking statements,which reflect management’s analysis only as of the date hereof.  The Bankundertakes no obligation to publicly revise these forward-looking statements toreflect events or circumstances that arise after the date thereof.

 

**OVERVIEW**

 

Thefollowing discussion reviews and analyzes the operating results and financialcondition of the Corporation, focusing on the Bank.  It should be read in conjunction with thefinancial statements and the other financial data presented elsewhere herein.

 

Netincome for each of the last three years was $1,929,000 in 2007, $3,837,000 in2006, and $1,929,000 in 2005.  Theprimary net income per share for each of the last three years was $1.08, $2.31,and $1.20 respectively.  The diluted netincome per share for the same time periods was $1.03, $2.09 and $1.00,respectively.  Return on averageshareholders’ equity was 14.09%, 34.94% and 24.15% in 2007, 2006 and 2005,respectively.  Return on average assetswas 0.91%, 2.24%, and 1.24% in 2007, 2006 and 2005, respectively.

 

Thedecrease in earnings in 2007 was due to decreases of $79,000 in net interestincome after provision for loan losses, $2,841,000 in non-interest income and$1,390,000 in income tax expense; while non-interest expense increased$378,000.

 

Theincrease in earnings in 2006 was due to increases of $1,284,000 in net interestincome after provision for loan losses, $2,815,000 in non-interest income,$814,000 in non-interest expense and $1,377,000 in income tax expense.

 

Theincrease in earnings in 2005 was due to increases of $2,135,000 in net interestincome after provision for loan losses, $135,000 in non-interest income,$697,000 in non-interest expense and $709,000 in income tax expense.

 

22

----

 

The following table provides a summary of the consolidated incomestatement, balance sheet, and selected ratios for the last five years.  A more detailed analysis of each component ofnet income is included under the appropriate captions, which follows.

 
| ** **                                                     | ** ** | **As of and for the years Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                     | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                     | ** ** | **(Dollars in thousands except per share data)**    | ** ** |
| Summary of Operating Results:                                  |       |                                                |       |   |   |   |   |   |   |   | ** ** |
| Total interest income                                          |       | $                                                   | 16,941     |   | $ | 13,760 |   | $ | 10,691 |   | $ | 7,355 |   | $ | 5,569 | ** ** |
| Total interest expense                                         |       | 8,002                                               |       | 5,197 |   | 3,672 |   | 2,435 |   | 1,920 |   |
| Net interest income                                            |       | 8,938                                               |       | 8,563 |   | 7,019 |   | 4,920 |   | 3,649 |   |
|                                                           |       |                                                |       |   |   |   |   |   |   |   |   |
| Provision for possible loan losses                             |       | 865                                                 |       | 410 |   | 150 |   | 185 |   | 155 |   |
| Net interest income after provision for loan losses            |       | 8,074                                               |       | 8,153 |   | 6,869 |   | 4,735 |   | 3,494 |   |
|                                                           |       |                                                |       |   |   |   |   |   |   |   |   |
| Total non-interest income                                      |       | 4,336                                               |       | 7,177 |   | 4,362 |   | 4,227 |   | 2,403 |   |
| Total non-interest expenses                                    |       | 9,005                                               |       | 8,627 |   | 7,813 |   | 7,116 |   | 4,399 |   |
|                                                           |       |                                                |       |   |   |   |   |   |   |   |   |
| Income before taxes                                            |       | 3,405                                               |       | 6,703 |   | 3,418 |   | 1,846 |   | 1,498 |   |
| Provision for income taxes                                     |       | 1,476                                               |       | 2,866 |   | 1,489 |   | 781 |   | 659 |   |
|                                                           |       |                                                |       |   |   |   |   |   |   |   |   |
| Net income                                                     |       | $                                                   | 1,929      |   | $ | 3,837 |   | $ | 1,929 |   | $ | 1,065 |   | $ | 840 |   |
|                                                           |       |                                                |       |   |   |   |   |   |   |   |   |
| Per Common Share Data:                                         |       |                                                |       |   |   |   |   |   |   |   |   |
| Net income - Primary (1)                                       |       | $                                                   | 1.08       |   | $ | 2.31 |   | $ | 1.20 |   | $ | 0.68 |   | $ | 0.55 |   |
| Net income - Diluted (2)                                       |       | $                                                   | 1.03       |   | $ | 2.09 |   | $ | 1.00 |   | $ | 0.56 |   | $ | 0.48 |   |
| Book value, end of period                                      |       | 7.82                                                |       | 7.20 |   | 5.55 |   | 4.55 |   | 4.09 |   |
| Avg shares outstanding (3)                                     |       | 1,785,812                                           |       | 1,658,675 |   | 1,614,196 |   | 1,576,589 |   | 1,528,268 |   |
|                                                           |       |                                                |       |   |   |   |   |   |   |   |   |
| Balance Sheet Data:                                            |       |                                                |       |   |   |   |   |   |   |   |   |
| Total loans, net of unearned income (4)                        |       | $                                                   | 168,748    |   | $ | 130,050 |   | $ | 107,300 |   | $ | 95,036 |   | $ | 76,908 |   |
| Total assets                                                   |       | 253,865                                             |       | 190,570 |   | 162,645 |   | 134,039 |   | 107,872 |   |
| Total deposits                                                 |       | 167,333                                             |       | 131,628 |   | 118,120 |   | 97,263 |   | 78,132 |   |
| Stockholders’ equity                                      |       | 14,434                                              |       | 12,402 |   | 8,931 |   | 7,321 |   | 6,411 |   |
|                                                           |       |                                                |       |   |   |   |   |   |   |   |   |
| Selected Financial Ratios (4):                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Return on average assets (5)                                   |       | 0.91                                                | %          | 2.24 | % | 1.24 | % | 0.88 | % | 0.88 | % |
| Return on average stockholders’ equity (5)                |       | 14.09                                               | %          | 34.94 | % | 24.15 | % | 15.35 | % | 13.84 | % |
| Net interest spread                                            |       | 4.07                                                | %          | 4.82 | % | 4.63 | % | 4.02 | % | 3.92 | % |
| Net yield on interest earning assets (5)                       |       | 4.69                                                | %          | 5.58 | % | 5.09 | % | 4.47 | % | 4.30 | % |
| Avg. shareholders’ equity to average assets (5)           |       | 6.44                                                | %          | 6.40 | % | 5.15 | % | 5.75 | % | 6.35 | % |
| Risked-Based capital ratios                                    |       |                                                |       |   |   |   |   |   |   |   |   |
| Tier 1                                                         |       | 9.23                                                | %          | 9.50 | % | 9.50 | % | 8.22 | % | 9.00 | % |
| Total                                                          |       | 12.63                                               | %          | 14.90 | % | 14.90 | % | 14.83 | % | 17.30 | % |
| Total loans to total deposits at end of period (4)             |       | 100.85                                              | %          | 98.80 | % | 90.84 | % | 97.71 | % | 98.43 | % |
| Allowance for loan losses to total loans at end of  period (4) |       | 1.19                                                | %          | 1.07 | % | 1.02 | % | 1.00 | % | 1.00 | % |
| Nonperforming loans to total loans at end of period  (4)       |       | 1.98                                                | %          | 0.12 | % | 0.00 | % | 0.04 | % | 0.04 | % |
| Net charge-offs to average loans (4)                           |       | 0.17                                                | %          | 0.09 | % | 0.01 | % | 0.00 | % | 0.03 | % |

 

23

----

 

----

(1)          Basicearnings per share amounts were computed on the basis of the weighted averagenumber of shares of common stock during the year.  The weighted average number of shares usedfor this computation was 1,785,812 for 2007, 1,658,675 for 2006, 1,614,196 for2005, 1,576,589 for 2004 and 1,528,268 for 2003.

 

(2)          Fullydiluted earnings per share amounts were computed on the basis of the weightedaverage number of shares of common stock and common stock equivalentsoutstanding during the year.  Commonstock equivalents include employee stock options.  The weighted average number of shares usedfor this computation was 1,881,004, 1,831,892, 1,923,532, 1,919,512 and1,796,859 in 2007, 2006, 2005, 2004 and 2003, respectively.

 

(3)   Weighted average common shares.

 

(4)   Includes loans being held for sale.

 

(5)          Averages are of daily balances.

 

**CriticalAccounting Policies**

 

The preparation of financialstatements in accordance with accounting principles generally accepted in theUnited States of America requires management to make a number of judgments,estimates and assumptions that affect the reported amount of assets,liabilities, income and expenses in the Bank’s financial statements andaccompanying notes.  Management believes that the judgments, estimates andassumptions used in preparation of the Bank’s financial statements areappropriate given the factual circumstances as of December 31, 2007.

 

Variouselements of the Bank’s accounting policies, by their nature, are inherentlysubject to estimation techniques, valuation assumptions and other subjectiveassessments.  Critical accounting policies are those that involve the mostcomplex and subjective decisions and assessments and have the greatestpotential impact of the Bank’s results of operation.  In particular,management has identified one accounting policy that, due to judgments,estimates and assumptions inherent in this policy, and the sensitivity of theBank’s financial statements to those judgments, estimates and assumptions, arecritical to an understanding of the Bank’s financial statements.  Thispolicy relates to the methodology that determines the allowance for loan andlease losses.

 

24

----

 

Management has discussed thedevelopment and selection of this critical accounting policy with the AuditCommittee of the Board of Directors.  Although Management believes thelevel of the allowance at December 31, 2007 is adequate to absorb lossesinherent in the loan portfolio, a decline in the regional economy may result inincreasing losses that cannot reasonably be predicted at this time.  For further information regarding the allowance for loan losses see “Provisionand Allowance for Loan Losses,” and Note 6 to the Bank’s audited financialstatements included elsewhere herein.

 

**RecentlyIssued Accounting Standards**

 

                Refer to Note 1 to the Financial Statements — “Summaryof Significant Accounting Policies” for discussion of the recently issuedaccounting standards.

 

**NET INTEREST INCOME**

 

                Net interest income, the difference between (a) interestand fees earned on interest-earning assets and (b) interest paid oninterest-bearing liabilities, is the most significant component of the Bank’searnings.  Changes in net interest incomefrom period to period result from increases or decreases in the averagebalances of interest earning assets portfolio, the availability of particularsources of funds and changes in prevailing interest rates.

 

                Thefollowing table summarizes the Corporation’s net interest income.

 
| ** **          | ** ** | **Years Ended**            | ** ** | **Increase (Decrease)** | ** ** |
|---------------------|------------|----------------------------|------------|-------------------------|------------|
| ** **          | ** ** | **December 31,**      | ** ** | **From Prior Year**     | ** ** |
| ** **          | ** ** | **2007**                   | ** ** | **2006**                | ** ** | **2005** | ** ** | **2007/2006** | ** ** | **2006/2005** | ** ** |
| ** **          | ** ** | ** **                 | ** ** | ** **              | ** ** | ** ** | ** ** | **Amt** | ** ** | **%** | ** ** | **Amt** | ** ** | **%** | ** ** |
| ** **          | ** ** | **(Dollars in thousands)** | ** ** |
| Interest Income     |       | $                          | 16,941     |                    | $          | 13,760 |   | $ | 10,691 |   | $ | 3,181 |   | 23.1 |   | $ | 3,069 |   | 28.7 |   |
| Interest Expense    |       | 8,002                      |       | 5,197                   |       | 3,672 |   | 2,805 |   | 54.0 |   | 1,525 |   | 41.6 |   |
| Net Interest Income |       | $                          | 8,939      |                    | $          | 8,563 |   | $ | 7,019 |   | $ | 376 |   | 4.4 |   | $ | 1,544 |   | 22.0 |   |

 

                Netinterest income increased $376,000 or 4.4% from 2006 to 2007.  Average interest bearing assets increased23.71%, while the average rate earned decreased 8 basis points, resulting in anincrease of $3,181,000 in total interest income.  Interest expense increased $2,805,000 theresult of a 32.02% increase in average interest bearing liabilities, while theaverage rate paid increased 68 basis points.

 

                Netinterest income increased $1,544,000 or 22.0% from 2005 to 2006.  Average interest bearing assets increased11.30%, while the average rate earned increased 120 basis points, resulting inan increase of $3,069,000 in total interest income.  Interest expense increased $1,525,000 theresult of a 6.56% increase in average interest bearing liabilities, while theaverage rate paid increased 100 basis points.

 

                The following table shows the components of netinterest income, setting forth, for each of the three years ended December 31,2007, 2006 and 2005 (i) average assets, liabilities and investments, (ii) interestincome earned on interest-earning assets and interest expense paid oninterest-bearing liabilities, (iii) average yields earned oninterest-earning assets and average rates paid on interest-bearing liabilities,(iv) the net interest spread (i.e., the average yield earned oninterest-earning assets less the average rate paid on interest-bearingliabilities) and (v) the net interest yield on average interest-earningassets (i.e., net interest income divided by average interest-earningassets).  Yields are computed on atax-equivalent basis, resulting in adjustments to interest earned onnon-taxable securities of $330,000, $149,000 and $138,000 in 2007, 2006 and2005, respectively.  Non-accrual loansand overdrafts are included in average loan balances.  Average loans are presented net of unearnedincome.

 

25

----

 

**DISTRIBUTION, RATE AND YIELDANALYSIS OF NET INTEREST INCOME:**

 

The following table showsthe consolidated average balances of earning assets, and interest-bearingliabilities; the amount of interest income and interest expense; the averageyield or rate for each category of interest-earning assets and interest-bearingliabilities; and the net interest income and the net interest spread for theperiods indicated:

 
| ** **                                                  | ** ** | **As of  and for the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2007**                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                  | ** ** | ** **                                           | ** ** | **Int** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Int** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Int** | ** ** | **Avg** | ** ** |
| ** **                                                  | ** ** | **Avg**                                              | ** ** | **Earn** | ** ** | **%** | ** ** | **Avg** | ** ** | **Earn** | ** ** | **%** | ** ** | **Avg** | ** ** | **Earn** | ** ** | **%** | ** ** |
| ** **                                                  | ** ** | **Bal**                                              | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Bal** | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Bal** | ** ** | **Paid** | ** ** | **Rate** | ** ** |
| Assets:                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                                       |       | $                                                    | 146,944    |   | $ | 14,442 |   | 9.83 | % | $ | 118,699 |   | $ | 11,954 |   | 10.07 | % | $ | 108,963 |   | $ | 9,561 |   | 8.77 | % |
| Time deposits -  in other banks                             |       | 1,359                                                |       | 66 |   | 4.89 | % | 1,000 |   | 50 |   | 4.97 | % | 1,000 |   | 29 |   | 2.92 | % |
| Invest securities  - taxable                                |       | 28,777                                               |       | 1,627 |   | 5.66 | % | 15,145 |   | 730 |   | 4.82 | % | 13,237 |   | 441 |   | 3.33 | % |
| Invest securities  - nontaxable                             |       | 7,260                                                |       | 477 |   | 6.58 | % | 7,019 |   | 480 |   | 6.83 | % | 7,026 |   | 445 |   | 6.33 | % |
| Federal funds  sold                                         |       | 9,401                                                |       | 476 |   | 5.06 | % | 14,745 |   | 721 |   | 4.89 | % | 10,481 |   | 352 |   | 3.36 | % |
| Total  interest-earning assets                              |       | 193,741                                              |       | 17,088 |   | 8.82 | % | 156,607 |   | 13,933 |   | 8.90 | % | 140,707 |   | 10,828 |   | 7.70 | % |
|                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Allowance for  credit losses                                |       | (1,471                                               | )          |   |   |   |   | (1,162 | ) |   |   |   |   | (1,023 | ) |   |   |   |   |
| Non-interest  bearing assets:                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                    |       | 6,663                                                |       |   |   |   |   | 5,187 |   |   |   |   |   | 5,523 |   |   |   |   |   |
| Premises and  equipment                                     |       | 4,867                                                |       |   |   |   |   | 4,441 |   |   |   |   |   | 4,362 |   |   |   |   |   |
| Accrued interest  receivable                                |       | 1,139                                                |       |   |   |   |   | 797 |   |   |   |   |   | 699 |   |   |   |   |   |
| Other assets                                                |       | 7,689                                                |       |   |   |   |   | 5,726 |   |   |   |   |   | 5,822 |   |   |   |   |   |
| Total average  assets                                       |       | $                                                    | 212,628    |   |   |   |   |   | $ | 171,596 |   |   |   |   |   | $ | 156,090 |   |   |   |   |   |
|                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  Shareholders’ Equity:                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Bearing  Liabilities:                              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  demand                                    |       | $                                                    | 14,564     |   | $ | 37 |   | 0.25 | % | $ | 13,243 |   | $ | 42 |   | 0.31 | % | $ | 12,584 |   | $ | 32 |   | 0.26 | % |
| Money market  savings                                       |       | 1,732                                                |       | 13 |   | 0.73 | % | 3,589 |   | 27 |   | 0.75 | % | 4,818 |   | 32 |   | 0.66 | % |
| Savings deposits                                            |       | 4,759                                                |       | 49 |   | 1.03 | % | 7,355 |   | 74 |   | 1.00 | % | 7,476 |   | 80 |   | 1.07 | % |
| Time deposits  >$100M                                    |       | 46,609                                               |       | 2,405 |   | 5.16 | % | 32,372 |   | 1,479 |   | 4.57 | % | 29,908 |   | 990 |   | 3.31 | % |
| Time deposits  <$100M                                    |       | 50,814                                               |       | 2,590 |   | 5.10 | % | 33,174 |   | 1,370 |   | 4.13 | % | 31,981 |   | 971 |   | 3.04 | % |
| Other Borrowing                                             |       | 50,017                                               |       | 2,911 |   | 5.82 | % | 37,894 |   | 2,207 |   | 5.82 | % | 32,998 |   | 1,567 |   | 4.75 | % |
| Total interest-bearing  liabilities                         |       | 168,495                                              |       | 8,005 |   | 4.75 | % | 127,626 |   | 5,198 |   | 4.07 | % | 119,765 |   | 3,672 |   | 3.07 | % |
|                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing liabilities:                          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  checking                               |       | 25,774                                               |       |   |   |   |   | 30,155 |   |   |   |   |   | 24,857 |   |   |   |   |   |
| Accrued interest  payable                                   |       | 1,628                                                |       |   |   |   |   | 995 |   |   |   |   |   | 664 |   |   |   |   |   |
| Other liabilities                                           |       | 3,044                                                |       |   |   |   |   | 1,838 |   |   |   |   |   | 2,816 |   |   |   |   |   |
| Total Liabilities                                           |       | 198,941                                              |       |   |   |   |   | 160,614 |   |   |   |   |   | 148,102 |   |   |   |   |   |
| Total  shareholders equity                                  |       | 13,687                                               |       |   |   |   |   | 10,982 |   |   |   |   |   | 7,988 |   |   |   |   |   |
| Total average  liabilities and shareholders equity          |       | $                                                    | 212,628    |   |   |   |   |   | $ | 171,596 |   |   |   |   |   | $ | 156,090 |   |   |   |   |   |
| Net interest  income                                        |       |                                                 |       | $ | 9,083 |   |   |   |   |   | $ | 8,735 |   |   |   |   |   | $ | 7,156 |   |   |   |
|                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense  as a percentage of average earning assets |       |                                                 |       |   |   | 4.13 | % |   |   |   |   | 3.32 | % |   |   |   |   | 2.61 | % |
| Net yield on  interest earning assets                       |       |                                                 |       |   |   | 4.69 | % |   |   |   |   | 5.58 | % |   |   |   |   | 5.09 | % |
| Net interest  spread                                        |       |                                                 |       |   |   | 4.07 | % |   |   |   |   | 4.82 | % |   |   |   |   | 4.63 | % |

 

26

----

 

Thefollowing table shows a rate and volume analysis for changes in interestincome, interest expense, and net interest income for the periods indicated.

** **
| ** **                                 | ** ** | **Increase (decrease) in the twelve months ended**              | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                 | ** ** | **December 31, 2007 compared with December 31, 2006** | ** ** |
| ** **                                 | ** ** | **Volume**                                                      | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase (decrease) in interest income:    |       |                                                            |       |   |   |   |   |
| Loans                                      |       | $                                                               | 2,844      |   | $ | (356 | ) | $ | 2,488 |   |
| Time deposits - in other banks             |       | 18                                                              |       | (1 | ) | 17 |   |
| Invest securities - taxable                |       | 657                                                             |       | 241 |   | 898 |   |
| Invest securities - nontaxable             |       | 16                                                              |       | (19 | ) | (3 | ) |
| Federal funds sold                         |       | (261                                                            | )          | 16 |   | (245 | ) |
| Total interest-earning assets              |       | 3,274                                                           |       | (119 | ) | 3,155 |   |
|                                       |       |                                                            |       |   |   |   |   |
| Increase (decrease) in interest expense:   |       |                                                            |       |   |   |   |   |
| Interest-bearing demand                    |       | 4                                                               |       | (9 | ) | (5 | ) |
| Money market savings                       |       | (14                                                             | )          | — |   | (14 | ) |
| Savings deposits                           |       | (26                                                             | )          | 1 |   | (25 | ) |
| Time deposits >$100M                    |       | 650                                                             |       | 276 |   | 926 |   |
| Time deposits <$100M                    |       | 729                                                             |       | 492 |   | 1,221 |   |
| Other borrowing                            |       | 707                                                             |       | (3 | ) | 704 |   |
| Total interest-bearing liabilities         |       | 2,050                                                           |       | 757 |   | 2,807 |   |
| Increase (decrease) in net interest income |       | $                                                               | 1,224      |   | $ | (876 | ) | $ | 348 |   |

 
| ** **                               | ** ** | **Increase  (decrease) in the twelve months ended**              | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                               | ** ** | **December 31,  2006 compared with December 31, 2005** | ** ** |
| ** **                               | ** ** | **Volume**                                                       | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase in interest income:             |       |                                                             |       |   |   |   |   |
| Loans                                    |       | $                                                                | 854        |   | $ | 1,538 |   | $ | 2,392 |   |
| Time deposits - in other banks           |       | —                                                           |       | 20 |   | 20 |   |
| Invest securities - taxable              |       | 63                                                               |       | 225 |   | 288 |   |
| Invest securities - nontaxable           |       | —                                                           |       | 35 |   | 35 |   |
| Federal funds sold                       |       | 145                                                              |       | 225 |   | 370 |   |
| Total interest-earning assets            |       | 1,062                                                            |       | 2,043 |   | 3,105 |   |
|                                     |       |                                                             |       |   |   |   |   |
| Increase (decrease) in interest expense: |       |                                                             |       |   |   |   |   |
| Interest-bearing demand                  |       | 2                                                                |       | 7 |   | 9 |   |
| Money market savings                     |       | (8                                                               | )          | 3 |   | (5 | ) |
| Savings deposits                         |       | (1                                                               | )          | (5 | ) | (6 | ) |
| Time deposits >$100M                  |       | 82                                                               |       | 407 |   | 489 |   |
| Time deposits <$100M                  |       | 36                                                               |       | 363 |   | 399 |   |
| Other borrowing                          |       | 232                                                              |       | 408 |   | 640 |   |
| Total interest-bearing liabilities       |       | 343                                                              |       | 1,183 |   | 1,526 |   |
| Increase in net interest income          |       | $                                                                | 719        |   | $ | 860 |   | $ | 1,579 |   |

 

27

----

 

**Provision and Allowance for LoanLosses**

 

                The provision for loan losses is an expense chargedagainst operating income and added to the allowance for loan losses.  The allowance for loan losses representsamounts which have been set aside for the specific purpose of absorbing losseswhich may occur in the Bank’s loan portfolio.

 

                The allowance for loan losses reflects management’songoing evaluation of the risks inherent in the loan portfolio both generallyand with respect to specific loans, the state of the economy, and the level ofnet loan losses experienced in the past. Management and the Board of Directors review the results of the StateBanking Department and FDIC examinations, independent accountants’observations, and the Bank’s internal review as additional indicators todetermine if the amount in the allowance for loan losses is adequate to protectagainst estimated future losses.  It isthe Bank’s current practice, which could change in accordance with the factorsmentioned above, to maintain an allowance which is at least equal to the sum ofthe following percentage of loan balances by loan category.  Additionally, specific loss allocations aremade for classified loans.

 

| **Loan Category**                            | ** ** | **Reserve %** | ** ** |
|----------------------------------------------|------------|---------------|------------|
|                                         |       |          |       |
| Classified Loans:                            |       |          |       |
| Loans classified loss                        |       | 100.00        | %          |
| Loans classified doubtful                    |       | 50.00         | %          |
| Loans classified substandard                 |       |          |       |
| Real Estate  Secured                         |       | 5.00          | %          |
| Non Real Estate  Secured                     |       | 20.00         | %          |
|                                         |       |          |       |
| Unclassified Loans:                          |       |          |       |
| Real Estate - Loan to value 80% or less      |       | 0.10          | %          |
| Real Estate - Loan to value over 80%         |       | 0.70          | %          |
| Real Estate - Construction                   |       | 0.25          | %          |
| Loans to Individuals                         |       | 3.00          | %          |
| Commercial                                   |       | 2.00          | %          |
| SBA Loans — Unguaranteed portion        |       | 2.00          | %          |
| Unfunded Loan Commitments                    |       | .10           | %          |
| Concentration Risk Factor — Real Estate |       | .50           | %          |
| Economic Risk Factor                         |       | .25           | %          |
| SBA Loans - Guaranteed portion               |       | 0.00          | %          |
| Cash Secured Loans                           |       | 0.00          | %          |

 

                Although no assurance can be given that actual losseswill not exceed the amount provided for in the allowance, Management believesthat the allowance is adequate to provide for all estimated credit losses in lightof all known relevant factors.  At theend of 2007, 2006 and 2005, the Bank’s allowance stood at 1.19%, 1.07%, and1.02% of gross loans, respectively. Provisions were made to the allowance for loan losses in 2007, 2006 and2005 of $865,000, $410,000, and $150,000, respectively.  Loans charged off in 2007, 2006 and 2005totaled $250,000, $109,000 and $14,000, respectively.  Recoveries for these same periods were$4,000, $7,000, and $2,000, respectively.

 

28

----

 

                The Bank’s non-performing (delinquent 90 days or moreand on non-accrual) loans as a percentage of total loans were 2.01 percent,0.12 percent, and 0.00 percent as of the end of 2007, 2006 and 2005,respectively.  The significant increasein non-accrual loans consisted of a single $3,200,000 real estate loanparticipation purchased.  The foreclosureprocess has been initiated with a foreclosure sale anticipated in April.  We do not at this time anticipate anymaterial loss due to expressions of interest by two entities in purchasing theproperty.

 

**Non-Interest Income**

 

                The following table presents a summary of the Bank’snon-interest income:

 
| ** **                                             | ** ** | **Years  Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                             | ** ** | **2007**                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(Dollars  in thousands)**        | ** ** |
|                                                   |       |                               |       |   |   |   |   |
| Service charges on deposit accounts                    |       | $                                  | 634        |   | $ | 547 |   | $ | 564 |   |
| Gain on sale of Pacific Coast Bankers’ Bank Stock |       | —                             |       | 1,313 |   | — |   |
| Other service charges, commissions and fees            |       | 3,222                              |       | 4,627 |   | 2,807 |   |
| Income from sales and servicing of SBA loans           |       | 480                                |       | 690 |   | 991 |   |
|                                                   |       |                               |       |   |   |   |   |
| Total  non-interest income                             |       | $                                  | 4,336      |   | $ | 7,177 |   | $ | 4,362 |   |

 

                Total non-interest income decreased $2,841,000 or39.58% in 2007 when compared with 2006. The decrease resulted from the gain on sale of the Bank’s investment inPacific Coast Bankers’ Bank of $1,313,000 reported in 2006, decreases in otherservice charges, commissions and fees of $1,405,000, and $210,000 in incomefrom sales and servicing of Small Business Administration Loans; partiallyoffset by an increase in service charges on deposit accounts of $87,000.  The decrease in other service charges,commissions and fees was due primarily to a $686,000 in losses on tradingassets compared with a gain of $283,000 in 2006, and decreases of $624,000 infee income from credit card programs, $191,000 in merchant discount fees andcommercial banking origination fees decreased $104,000, while stored value cardprograms increased $218,000.

 

                Total non-interest income increased $2,815,000 or64.84% in 2006 when compared with 2005. The increase resulted from the gain on sale of the Bank’s investment inPacific Coast Bankers’ Bank of $1,313,000, an increase in income from otherservice charges, commissions and fees of $1,820,000, and decreases of $302,000in income from sales and servicing of Small Business Administration Loans and $16,000in service charges on deposit accounts. The increase in other service charges, commissions and fees was dueprimarily to a $50,000 mark to market gain on trading assets compared with a$427,000 mark to market loss in 2005, and increases of $1,100,000 in fee incomefrom credit card programs, $272,000 in merchant discount fees and $29,800 fromstored value card programs, while commercial banking origination fees decreased$287,000.

 

                Total non-interest income increased $135,000 or 3.20%in 2005 when compared with 2004.  Incomefrom sales and servicing of SBA loans increased $275,000 and service charges ondeposit accounts increased $47,000; while other income decreased $187,000.  The decrease in other income was dueprimarily to a mark to market loss of $427,000 in trading asset activities;partially offset by increases of $102,000 in credit card program fees and$138,000 in commercial banking origination fees.

 

29

----

 

                The sale of Small Business Administration (SBA)guaranteed loans is a significant contributor to the Bank’s income.  SBA guaranteed loans yield up to 3 3/4% overthe New York prime rate, and the guaranteed portions can be sold at premiumswhich vary with market conditions.  SBAloans are guaranteed by the full faith of the United States Government up to 85percent of the principal amount.  Theguaranteed portion has risks comparable for an investor to a U. S. Governmentsecurity and can usually be sold in the secondary financial market, either at apremium or at a yield which allows the Bank to maintain a significant spreadfor itself.

 

                There can be no assurance that the gains on sale willcontinue at, or above, the levels realized in the past three years.  The Small Business Administration hasrecently increased the guarantee fees borrowers must pay.  Increasing competition among lenders forqualified SBA borrowers makes it difficult for the Bank to continually expandits program in this area, and may limit the level of premium that can be earnedwith regard thereto.

 

                The following table presents a summary of theactivity in SBA loans for the years ended 2007, 2006 and 2005:

 

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |     |       |
| SBA loans authorized       |       | $        | 3,065      |     | $          | 3,645    |       | $ | 6,274 |   |
| SBA loans sold             |       | $        | 1,933      |     | $          | 4,428    |       | $ | 7,945 |   |

 

**Summary of Income from sales and Servicing of SBALoans**

 
| **(Dollars in thousands)**                         | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                               |       |     |       |     |       |     |       |
| Income from premium                                |       | $        | 147        |     | $          | 350      |       | $ | 665 |   |
| Income from servicing                              |       | 333      |       | 340      |       | 326      |       |
| Total income from sales and servicing of SBA loans |       | $        | 480        |     | $          | 690      |       | $ | 991 |   |

 

**Non-Interest Expense**

 

                The following table presents a summary of the Bank’sother non-interest expense:

 
| ** **                      | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|
| ** **                      | ** ** | **2007**                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)**        | ** ** |
| Salaries and benefits           |       | $                                 | 4,049      |   | $ | 3,854 |   | $ | 3,282 |   |
| Occupancy and equipment expense |       | 866                               |       | 790 |   | 665 |   |
| Professional fees               |       | 165                               |       | 149 |   | 141 |   |
| Data processing                 |       | 361                               |       | 322 |   | 356 |   |
| Other expenses                  |       | 3,564                             |       | 3,512 |   | 3,369 |   |
| Total other  expenses           |       | $                                 | 9,005      |   | $ | 8,627 |   | $ | 7,813 |   |

 

30

----

 

                Salary and benefits expenseincreased $195,000 in 2007 as a result the addition of a Loan Processor, a fullyear’s salary for a Marketing Officer hired in November 2006 and meritincreases.  Salary and benefits expenseincreased $572,000 in 2006 as a result the addition of a Marketing Officer,Business Development Officer and a Credit Analyst, increased commission paiddue to increased credit card and stored value card program revenues, and meritincreases and bonus payments.  Salary andbenefits expense increased $278,000 in 2005 as a result merit increases andbonus payments.

 

                Occupancy and equipment expensesincreased $76,000 in 2007, primarily due to increases of $17,000 indepreciation expense, $11,000 in premises rent, $12,000 merchant terminalexpense, repairs and maintenance $11,000 and $12,000 in storage facilitiesrent; while sublease rental income decreased $5,000.  Occupancy and equipment expenses increased$125,000 in 2006, primarily due to increases of net merchant terminal expense$40,000, $16,000 in depreciation expense, $11,000 in premises rent and $6,000in property taxes; while sublease rental income decreased $45,000.  Occupancy and equipment expenses increased$68,000 in 2005, primarily due to increases of $48,000 in depreciation expense,$18,000 in property taxes, $11,000 in premises rent, $10,000 in premises otherexpense and $9,000 in janitorial expense; while net merchant terminal decreased$31,000.

 

                Data processing expenseincreased $39,000 in 2007, the result of offering new services to customers andgrowth in the numbers of customer accounts. Data processing expense decreased $34,000 in 2006, the result ofcontinued efforts to implement more cost effective programs.  Data processing expense decreased $8,000 in2005, the result of renegotiation of the data services contract during thefourth quarter of 2004.

 

                In 2007, professional feesincreased $16,000 due to increased legal fees. In 2006, professional fees increased $8,000 due to increased legalfees.  In 2005, professional feesincreased $27,000 due to accounting/audit fees increasing $22,000 while legalfees increased $5,000.

 

                Other general and administrativeexpense for 2007 totaled $3,564,000 compared with $3,512,000 for 2006, anincrease of $52,000.  The Bankestablished a reserve of $110,000 for its liability associated with thesettlement by VISA of litigation brought by American Express and Discover.  Significant changes occurred in the followingcategories with increases in director fees of $72,000, business development of$47,000, stationary/supplies of $25,000 and entertainment and meals of $16,000;while decreases occurred in merchant processing expense of $126,000,advertising of $60,000, donations $52,000, operational losses of $51,000 andtravel $15,000.   Additionally noprovision for debt securities losses was made in 2007 compared with a credit of$110,000 in 2006.

 

                Other general and administrativeexpense 2006 totaled $3,512,000 compared with $3,369,000 for 2005, an increaseof $143,000.  Significant changesoccurred in the following categories with increases in merchant processingexpense of $104,000, advertising of $83,000, operational losses of $62,000,business development of $61,000, stationary/supplies of $42,000, loan expenseof $36,000, travel expense of $23,000, bank fees of $21,000, dues andmemberships of $13,000, and collection expense of $10,000; while decreasesoccurred in provision for debt securities losses of $229,000, provision forloss unfunded loan commitments of $71,000, director fees of $13,000, and mealsof $10,000.

 

31

----

 

**Income Taxes**

 

                In 2007, the Bank’s provisionfor federal and state income taxes was $1,476,000, while the provision was$2,866,000 and $1,489,000 for 2006 and 2005, respectively.  This represents 43.35% of income before taxesin 2007, 42.76% in 2006 and 43.57% in 2005. The decrease in the tax provision from 2006 to 2007 was due to a $591,000provision related to the gain on sale of the Bank’s investment in Pacific CoastBankers’ Bank in 2006 and other decreased income.    The increase in the tax provision from 2005to 2006 was due to a $591,000 provision related to the gain on sale of the Bank’sinvestment in Pacific Coast Bankers’ Bank and increased income.

 

                The amount of the tax provision is determined byapplying the Bank’s statutory income tax rates to pre-tax book income, adjustedfor permanent differences between pre-tax book income and actual taxableincome.  Such permanent differencesinclude but are not limited to tax-exempt interest income, increases in thecash surrender value of life insurance, and certain other expenses that are notallowed as tax deductions.

 

**LOANS**

 

                Loans, the largest component ofearning assets, represented 75.85% of average earning assets, and 69.11% ofaverage total assets during 2007, compared with 75.79% and 69.17%, respectivelyduring 2006.  In 2007, average loansincreased 23.80% from $118,699,000 in 2006 to $146,944,000.  Average real estate loans increased$16,590,000 or 20.69%, average construction loans increased $9,117,000 or75.89%, average commercial loans increased $2,687,000 or 10.48%; while averageinstallment loans decreased $149,000 or 17.68%.

 

                Loans represented 75.79% ofaverage earning assets, and 69.17% of average total assets during 2006,compared with 77.44% and 69.81%, respectively during 2005.  In 2006, average loans increased 8.94% from$108,963,000 in 2005 to $118,699,000. Average real estate loans increased $10,893,000 or 15.72%, averageconstruction loans increased $2,063,000 or 20.73% while average commercialloans decreased $3,210,100 or 11.12%, and average installment loans decreased$9,000 or 1.06%.

 

                Loan policies and proceduresprovide the overall direction to the administration of the loan portfolio.  The Bank’s loan underwriting process isintended to encourage sound and consistent credit decisions are made.  Emphasis is placed upon credit quality, theborrower’s ability to repay through cash flow, secondary and (occasionallytertiary) repayment sources, and the value of collateral.

 

                The Bank’s commercial andindustrial loans are generally made for the purpose of providing workingcapital, financing the purchase of equipment or inventory, and other businesspurposes. Such loans generally have maturities ranging from one year to severalyears.  Short-term business loans aregenerally intended to finance current transactions and typically provide formonthly interest payments with principal being payable at maturity or at 90-dayintervals. Term loans (usually for a term of two to five years) normallyprovide for monthly installments of principal and interest.  The Bank from time to time utilizes accountsreceivable and inventory as security for loans.

 

32

----

 

                The Bank is the recognized leader for Small BusinessAdministration lending in Monterey County, and holds SBA’s coveted PreferredLender Status.  Generally, SBA loans areguaranteed by the SBA for up to 85 percent of their principal amount, which canbe retained in portfolio or sold to investors. Such loans are made at floating interest rates, but generally for longerterms (up to 25 years) than are available on a conventional basis to smallbusinesses.  The unguaranteed portion of the loans, although generallysupported by collateral, is considered to be more risky than conventionalcommercial loans because they may be based upon credit standards the Bank wouldnot otherwise apply, such as lower cash flow coverage, or longer repaymentterms.

 

                The Bank’s real estate loan portfolio consists bothof real estate construction loans and real estate mortgage loans.  The Bank has initiated a program to generatemore commercial and industrial real estate loans, which generally yield higherreturns than normal commercial loans. The Bank has also developed a broker program for generating residentialreal estate loans.  The Bank does notmake real estate development loans.  Real estate construction loans aremade for a much shorter term, and often at higher interest rates, thanconventional single-family residential real estate loans.  The cost of administering such loans is oftenhigher than for other real estate loans, as principal is drawn on periodicallyas construction progresses.

 

                The Bank also makes real estate loans secured by afirst deed of trust on single family residential properties and commercial andindustrial real estate.  None of theloans are sub-prime loans.  California commercialbanks are permitted, depending on the type and maturity of the loan, to lend upto 90 percent of the fair market value of real property (or more if the loan isinsured either by private mortgage insurers or governmental agencies).  In certain instances, the appraised value mayexceed the actual amount which could be realized on foreclosure, or declines inmarket value subsequent to making the loan can impair the Bank’s security.

 

                Consumer loans are made for the purpose of financingthe purchase of various types of consumer goods, home improvement loans, autoloans and other personal loans.  Consumerinstallment loans generally provide for monthly payments of principal andinterest, at a fixed rate.  Most of theBank’s consumer installment loans are generally secured by the personalproperty being purchased.  The Bank generallymakes consumer loans to those customers with a prior banking relationship withthe Bank.

 

                The following table presents the composition of theloan portfolio, including loans held for sale, at December 31 for the lastfive years.

 
| ** **                            | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | **2007**                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                            | ** ** | **(Dollars  in thousands)**       | ** ** |
| Commercial and industrial             |       | $                                 | 30,197     |   | $ | 27,543 |   | $ | 26,236 |   | $ | 23,854 |   | $ | 18,607 |   |
| Construction                          |       | 23,396                            |       | 17,326 |   | 10,456 |   | 7,373 |   | 5,934 |   |
| Real estate, mortgage                 |       | 116,625                           |       | 86,207 |   | 71,006 |   | 64,339 |   | 52,698 |   |
| Installment                           |       | 876                               |       | 694 |   | 942 |   | 622 |   | 580 |   |
| Government guaranteed loans purchased |       | 32                                |       | 39 |   | 45 |   | 51 |   | 57 |   |
|                                  |       | 171,126                           |       | 131,809 |   | 108,685 |   | 96,239 |   | 77,876 |   |
| Allowance for loan losses             |       | (2,028                            | )          | (1,409 | ) | (1,101 | ) | (963 | ) | (775 | ) |
| Deferred origination fees, net        |       | (350                              | )          | (350 | ) | (284 | ) | (240 | ) | (193 | ) |
|                                  |       |                              |       |   |   |   |   |   |   |   |   |
| Loans, net                            |       | $                                 | 168,748    |   | $ | 130,050 |   | $ | 107,300 |   | $ | 95,036 |   | $ | 76,908 |   |

 

33

----

 

The following table showsthe maturity distribution and repricing intervals of the Bank’s outstandingloans at December 31, 2007. Balances of fixed rate loans are displayed in the column representativeof the loan’s stated maturity date. Balances for variable rate loans are displayed in the columnrepresentative of the loan’s next interest rate change.

 
| ** **                                             | ** ** | **Loan  Maturities and Repricing Schedule  ($ in thousands)** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                                         | ** ** |
| ** **                                             | ** ** | **Within One Year**                                                | ** ** | **After One But Within Five Years** | ** ** | **After Five Years** | ** ** | **Total** | ** ** |
| Construction                                           |       | $                                                                  | 23,396     |   | $ | — |   | $ | — |   | $ | 23,396 |   |
| Commercial, industrial and guaranteed loans  purchased |       | 23,845                                                             |       | 3,033 |   | 3,351 |   | 30,229 |   |
| Real estate                                            |       | 55,773                                                             |       | 30,311 |   | 30,541 |   | 116,625 |   |
| Installment                                            |       | 645                                                                |       | 108 |   | 123 |   | 876 |   |
| Total Gross Loans                                      |       | $                                                                  | 103,659    |   | $ | 33,454 |   | $ | 34,015 |   | $ | 171,126 |   |
| Loans with variable (floating) interest rates          |       | $                                                                  | 89,123     |   | $ | 5,976 |   | $ | — |   | $ | 95,099 |   |
| Loans with predetermined (fixed) interest rates        |       | $                                                                  | 14,536     |   | $ | 27,476 |   | $ | 34,015 |   | $ | 76,027 |   |

 

**Non-performing and Non-accrualLoans**

 

                The Bank’s present policy is to cease accruinginterest on loans which are past due as to principal or interest 90 days or more,except for loans which are well secured or when collection of interest andprincipal is deemed likely.  When a loanis placed on non-accrual, previously accrued and unpaid interest is generallyreversed out of income unless adequate collateral from which to collect theprincipal of and interest on, the loan appears to be available.

 

34

----

 

 

 

The following tablepresents information with respect to loans which, as of the dates indicated,were past due 90 days or more or were placed on non-accrual status (referred tocollectively as “non-performing loans”):

 

 
| ** **                                                    | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                    | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)**  | ** ** |
| Accruing,past due 90 days  or more:                           | ** ** | ** **                  | ** ** |
|                                                          |       |                        |       |   |   |   |   |   |   |
|                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Real Estate                                                   |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial                                                    |       | —                      |       | — |   | — |   | — |   | — |   |
| Installment                                                   |       | —                      |       | — |   | — |   | — |   | — |   |
| Other                                                         |       | —                      |       | — |   | — |   | — |   | — |   |
| Total accruing                                                |       | —                      |       | — |   | — |   | — |   | — |   |
|                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Nonaccrual Loans:                                             |       |                        |       |   |   |   |   |   |   |   |   |
|                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Real Estate                                                   |       | 3,200                       |       | — |   | — |   | — |   | — |   |
| Commercial                                                    |       | 41                          |       | — |   | — |   | 43 |   | 28 |   |
| Installment                                                   |       | 155                         |       | 155 |   | — |   | — |   | — |   |
| Other                                                         |       | —                      |       | — |   | — |   | — |   | — |   |
| Total nonaccrual                                              |       | 3,396                       |       | 155 |   | — |   | 43 |   | 28 |   |
|                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Total nonperforming                                           |       | 3,396                       |       | 155 |   | — |   | 43 |   | 28 |   |
|                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Total loans end of period                                     |       | 171,126                     |       | 131,809 |   | 108,685 |   | 96,239 |   | 77,876 |   |
|                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Ratio of  nonperforming loans to total loans at end of period |       | 1.98                        | %          | 0.12 | % | 0.00 | % | 0.04 | % | 0.04 | % |
|                                                               |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

If interest onnon-accrual loans had been accrued, such income would have approximated$133,000, $11,000, $0, $8,000 and $3,000 for 2007, 2006, 2005, 2004 and 2003,respectively.  There were no non-accrualloans at December 31, 2005.

 

The Bank does not haveany foreign loans or loans for highly leveraged transactions.

 

 

35

----

 

**Summaryof Loan Loss Experience**

 
| ** **                                                                     | ** ** | **For the Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                     | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)**                | ** ** |
| Average loans  outstanding                                                     |       | $                                         | 146,944    |   | $ | 118,699 |   | $ | 108,963 |   | $ | 86,870 |   | $ | 67,949 |   |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Allowance,  beginning of period                                                |       | $                                         | 1,409      |   | $ | 1,101 |   | $ | 963 |   | $ | 775 |   | $ | 637 |   |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Loans charged off during period:                                               |       |                                      |       |   |   |   |   |   |   |   |   |
| Commercial                                                                     |       | 249                                       |       | — |   | — |   | — |   | — |   |
| Installment                                                                    |       | 1                                         |       | 109 |   | 14 |   | — |   | 18 |   |
| Real estate                                                                    |       | —                                    |       | — |   | — |   | — |   | — |   |
| Other                                                                          |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total charge  offs                                                             |       | 250                                       |       | 109 |   | 14 |   | — |   | 18 |   |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Recoveries during period:                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Commercial                                                                     |       | —                                    |       | — |   | — |   | — |   | — |   |
| Installment                                                                    |       | —                                    |       | 7 |   | 2 |   | 3 |   | 1 |   |
| Real estate                                                                    |       | —                                    |       | — |   | — |   | — |   | — |   |
| Other                                                                          |       | 4                                         |       | — |   | — |   | — |   | — |   |
| Total recoveries                                                               |       | 4                                         |       | 7 |   | 2 |   | 3 |   | 1 |   |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Net loans  charged off during the period                                       |       | 246                                       |       | 102 |   | 12 |   | (3 | ) | 17 |   |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Additions to  allowance for possible loan losses                               |       | 865                                       |       | 410 |   | 150 |   | 185 |   | 155 |   |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Allowance, end  of period                                                      |       | $                                         | 2,028      |   | $ | 1,409 |   | $ | 1,101 |   | $ | 963 |   | $ | 775 |   |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Ratio of net  loans charged off to average loans outstanding during the period |       | 0.17                                      | %          | 0.09 | % | 0.01 | % | 0.00 | % | 0.03 | % |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Ratio of  allowance to total loans at end of period                            |       | 1.19                                      | %          | 1.07 | % | 1.02 | % | 1.00 | % | 1.00 | % |

 

 

36

----

 

**Funding Sources**

 

Average depositsincreased 20.32% to $144,252,000 in 2007 from $119,887,000 in 2006.  In 2007 average certificates of depositincreased 48.63% while average demand deposits decreased 14.53% and averageinterest checking, money market and savings accounts as a group decreased12.95%.  Average certificates of depositrepresented 67.54% of average deposits in 2007 compared with 54.67% in 2006.  Average interest checking, money market andsavings accounts as a group were 14.60% of average deposits in 2007 comparedwith 20.17% in 2006.  Average demanddeposits represented 17.87% of average deposits in 2007 compared with 25.15% in2006.

 

The followingtable summarizes the distribution of average daily deposits and the averagedaily rates paid for the years ended December 31, 2007, 2006, 2005,respectively.

 
|                          |   | **Average deposits**       |       |
|-------------------------------|--------|----------------------------|------------|
|                          |   |                       |       | **For the year ended** |   |   |   |
|                          |   | **For the year ended**     |       | **December 31, 2006** |   | **For the year ended** |   |
|                          |   | **December 31, 2007** |       | **($ in thousands)** |   | **December 31, 2005** |   |
|                          |   | **Average   Balance**      | ** ** | **Average  Rate** |   | **Average  Balance** | ** ** | **Average  Rate** |   | **Average  Balance** |   | **Average  Rate** |   |
| Non-interest-bearing checking |   | $                          | 25,774     |   |   |   | $ | 30,155 |   |   |   | $ | 24,857 |   |   |   |
|                          |   |                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing demand       |   | 14,564                     |       | 0.25 | % | 13,243 |   | 0.31 | % | 12,584 |   | 0.26 | % |
| Money market savings          |   | 1,732                      |       | 0.73 | % | 3,589 |   | 0.75 | % | 4,818 |   | 0.66 | % |
| Savings deposits              |   | 4,759                      |       | 1.03 | % | 7,355 |   | 1.00 | % | 7,476 |   | 1.07 | % |
| Time deposits >$100M       |   | 46,609                     |       | 5.16 | % | 32,372 |   | 4.57 | % | 29,908 |   | 3.31 | % |
| Time deposits <$100M       |   | 50,814                     |       | 5.10 | % | 33,174 |   | 4.13 | % | 31,981 |   | 3.04 | % |
|                          |   | 118,478                    |       | 4.30 | % | 89,733 |   | 3.33 | % | 86,767 |   | 2.46 | % |
|                          |   |                       |       |   |   |   |   |   |   |   |   |   |   |
| Total deposits                |   | $                          | 144,252    |   | 3.56 | % | $ | 119,888 |   | 2.50 | % | $ | 111,624 |   | 1.89 | % |

 

The following table setsforth the scheduled maturities of the Company’s time deposits in denominationsof $100,000 or greater which amounted to $62,620,000 at December 31, 2007:

 

Maturities of Time Deposits of $100,000 ormore

At December 31, 2007

($ in thousands)

 

| Three months or less                  |   | $      | 11,236 |   |
|---------------------------------------|--------|--------|--------|--------|
| Over three months through six months  |   | 12,334 |   |
| Over six months through twelve months |   | 16,770 |   |
| Over twelve months                    |   | 22,280 |   |
|                                  |   | $      | 62,620 |   |

 

The Bank has lines ofcredit from the Federal Home Loan Bank (FHLB) of San Francisco, Bank of theWest, Pacific Coast Bankers’ Bank and The Independent Bank with remaining availableborrowing capacity on December 31, 2007 of $4,236,000 (based on pledgedcollateral), $4,500,000, $6,000,000 and $5,000,000, respectively.  The Federal Home Loan Bank line of credit hasa maximum borrowing capacity of 25% of the Bank’s total assets, adjustedquarterly.  The Federal Home Loan Bankline of credit is secured by a portion of the Bank’s real estate secured loansand securities at December 31, 2007. The total principal balance of pledged loans was $41,309,000 andsecurities of $31,576,000.  The followingtable provides information on seventeen FHLB advances totaling $52,500,000 andoutstanding at December 31, 2007.

 

 

37

----

 

| **Advance** | ** ** | **Fixed Interest** | ** ** | **Funding** | ** ** | **Maturity** |
|-------------|------------|--------------------|------------|-------------|------------|--------------|
| **Amount**  | ** ** | **Rate**           | ** ** | **Date**    | ** ** | **Date**     |
| $           | 3,000,000  |               | 4.30       | %           | 6/17/05    |         | 6/17/10 |
| 2,500,000   |       | 4.88               | %          | 8/20/07     |       | 8/20/10      |
| 5,000,000   |       | 4.96               | %          | 11/14/05    |       | 11/15/10     |
| 2,250,000   |       | 4.75               | %          | 1/26/06     |       | 1/26/11      |
| 1,750,000   |       | 4.72               | %          | 1/26/06     |       | 1/26/11      |
| 1,500,000   |       | 5.52               | %          | 7/17/06     |       | 7/18/11      |
| 3,500,000   |       | 5.49               | %          | 7/17/06     |       | 7/18/11      |
| 1,000,000   |       | 5.22               | %          | 8/25/06     |       | 8/25/11      |
| 5,000,000   |       | 5.20               | %          | 7/30/07     |       | 7/30/12      |
| 3,000,000   |       | 4.85               | %          | 10/1/07     |       | 10/1/12      |
| 5,000,000   |       | 5.00               | %          | 9/18/07     |       | 9/18/14      |
| 1,000,000   |       | 7.72               | %          | 8/21/01     |       | 6/3/30       |
| 4,000,000   |       | 5.96               | %          | 8/2/04      |       | 7/28/34      |
| 5,000,000   |       | 5.63               | %          | 12/24/04    |       | 12/22/34     |
| 2,000,000   |       | 5.13               | %          | 5/4/05      |       | 5/1/35       |
| 2,000,000   |       | 5.31               | %          | 11/17/06    |       | 11/17/36     |
| 5,000,000   |       | 5.88               | %          | 6/29/07     |       | 6/29/37      |
|        |       |               |       |        |       |         |
| $           | 52,500,000 |               |       |        |       |         |   |

 

The Bank of the West,Pacific Coast Bankers’ Bank and The Independent Bank lines of credit are unsecured. The Bank did not utilize any overnight borrowings in 2007, 2006 or 2005.

 

The Bank has a$330,000 letter of credit issued by the Federal Home Loan Bank of San Franciscoto secure the uninsured portion of local agency deposits maintained with theBank.  The letter of credit matures April 17,2011.

 

**CapitalResources**

 

The Corporationmaintains capital to comply with legal requirements, to provide a margin ofsafety for its depositors and stockholders, and to provide for future growthand the ability to pay dividends.  At December 31,2007, stockholders’ equity was $14,434,000 versus $12,402,000 at December 31,2006.  The Corporation paid cashdividends to shareholders of $0.25, $0.35 and $0.20 per share in 2007, 2006 and2005, respectively.  The Bank paid cashdividends totaling $800,000 and $625,000 to the Corporation in 2007 and 2006,respectively; no cash dividends were paid in 2005.

 

The FDIC andFederal Reserve Board have adopted capital adequacy guidelines for use in theirexamination and regulation of banks and bank holding companies.  If the capital of a bank or bank holdingcompany falls below the minimum levels established by these guidelines, it maybe denied approval to acquire or establish additional banks or non-bankbusinesses, or the FDIC or Federal Reserve Board may take other administrativeactions.  The guidelines employ twomeasures of capital:  (1) risk-basedcapital and (2) leverage capital.

 

 

38

----

 

In general, therisk-based capital guidelines provide detailed definitions of which obligationswill be treated as capital, and assign different weights to various assets andoff-balance sheet items, depending upon the perceived degree of credit riskassociated with each asset.  Each assetis assigned to one of four risk-weighted categories.  For example, 0 percent for cash andunconditionally guaranteed government securities; 20 percent for deposits withother banks and fed funds; 50 percent for state bonds and certain residentialreal estate loans; and 100 percent for commercial loans and other assets.  Capital is categorized as either Tier 1capital, consisting of common stock and retained earnings (or deficit), or Tier2 capital, which includes limited-life preferred stock and allowance for loanlosses (subject to certain limitations). The guidelines also define and set minimum capital requirements(risk-based capital ratios), which increased over a transition period, ended December 31,1992.  Under the final 1992 rules, allbanks were required to maintain Tier 1 capital of at least 4 percent and totalcapital of 8.0% of risk-adjusted assets. The Bank had a Tier 1 capital to totalrisk-adjusted assets capital ratio of 10.77% and 12.40% at December 31,2007 and 2006, respectively.  The Bank’sTier 1 capital exceeds the minimum regulatory requirement by $12,681,000.  The Bank had a Total Risk-Based capital torisk-adjusted assets ratio of 11.86% and 13.40% at December 31, 2007 and2006, respectively.  The Bank’s TotalRisk-Based capital exceeds the minimum regulatory requirement by $7,220,000.

 

The Tier 1 leveragecapital ratio guidelines require a minimum leverage capital ratio of 4% of Tier1 capital to total assets less goodwill. The Bank had a leverage capital ratio of 8.59% and 10.20% at December 31,2007 and 2006, respectively.  The Bank’sTier 1 leverage capital exceeds the minimum regulatory requirement by$10,776,000.

 

Asof the end of 2007, the Bank was considered to be “well capitalized” byregulatory standards.  We do not foreseeany circumstances that would cause either the Corporation or the Bank to beless than “well capitalized”, although no assurance can be given that this willnot occur.

 

OnMarch 27, 2003, the Corporation’s wholly owned special-purpose trustsubsidiary, Northern California Bancorp, Inc. Trust I (“Trust I”) issued$3 million in cumulative Trust Preferred Securities.  The securities bear a floating rate ofinterest of 3.25% over the three month LIBOR rate, payable quarterly.  The effective rate at December 31, 2007and 2006 was 8.49% and 8.62%, respectively. Concurrent with the issuance of theTrust Preferred Securities, Trust I used the proceeds from the Trust PreferredSecurities offering to purchase a like amount of Junior Subordinated Debenturesof the Corporation.  The Corporation will pay interest on theJunior Subordinated Debentures to Trust I, which represents the sole revenueand sole source of dividend distributions to the holders of the Trust PreferredSecurities.  The Corporation has the right,assuming no default has occurred, to defer payments of interest on the JuniorSubordinated Debentures at any time for a period not to exceed 20 consecutivequarters.  The Trust Preferred Securitieswill mature on April 7, 2033, but can be redeemed under certaincircumstances at a premium prior to April 7, 2008, and can be redeemed, inwhole or in part, on any January 7, April 7, July 7 or October 7on or after April 7, 2008 at par. The Corporation fully and unconditionally guarantees the obligationsTrust I, on a subordinated basis.

 

The Corporation received $2.91 million from Trust I upon issuance of theJunior Subordinated Debentures, of which $1 million was contributed by theCorporation to the Bank to increase its capital, $1.14 million was used toretire existing Corporation debt and the remainder held as working capital.

 

 

39

----

 

On November 13, 2003, the Corporation’s wholly owned special-purposetrust subsidiary, Northern California Bancorp, Inc. Trust II (“Trust II”)issued $5 million in cumulative Trust Preferred Securities.  The securities bear a floating rate ofinterest of 2.85% over the three month LIBOR rate, payable quarterly.  Theeffective rate at December 31, 2007 and 2006 was 7.76% and 8.22%,respectively.  Concurrent with the issuance of the TrustPreferred Securities, Trust II used the proceeds from the Trust PreferredSecurities offering to purchase a like amount of Junior Subordinated Debenturesof the Corporation.  The Corporation willpay interest on the Junior Subordinated Debentures to Trust II, whichrepresents the sole revenue and sole source of dividend distributions to theholders of the Trust Preferred Securities. The Corporation has the right, assuming no default has occurred, todefer payments of interest on the Junior Subordinated Debentures at any timefor a period not to exceed 20 consecutive quarters.  The Trust Preferred Securities will mature onAugust 8, 2033, but can be redeemed under certain circumstances at apremium prior to August 8, 2008, and can be redeemed, in whole or in part,on any February 8, May 8, August 8 or November 8 on orafter August 8, 2008 at par.  TheCorporation fully and unconditionally guarantees the obligations of Trust II,on a subordinated basis.

 

The Corporation received $4.96 million from Trust II upon issuance of theJunior Subordinated Debentures, of which $2.5 million was contributed by theCorporation to the Bank to increase its capital and the remainder held asworking capital.

 

Under applicable regulatory guidelines, a portion of the Trust PreferredSecurities will qualify as Tier I Capital, and the remainder as Tier IICapital.

 

**Liquidity**

 

Liquidityrepresents a bank’s ability to provide sufficient cash flows or cash resourcesin a manner that enables it to meet obligations in a timely fashion andadequately provides for anticipated future cash needs.  For the Bank, liquidity considerationsinvolve the capacity to meet expected and potential requirements of depositorsseeking access to balances and to provide for the credit demands of borrowingcustomers.  In the ordinary course of theBank’s business, funds are generated from the repayment of loans, maturitieswithin the investment securities portfolio and the acquisition of depositbalances and short-term borrowings.  Inaddition, the Bank has a line of credit from the Federal Home Loan Bank of SanFrancisco of approximately $57,066,000, based on twenty five per cent of theBank’s total assets as reported in the most recent quarterly ConsolidatedReports of Condition and Income for a bank with Domestic Offices Only.  The line of credit is subject to pledging ofacceptable collateral.  Additionally theBank has unsecured federal funds lines of credit with Bank of theWest $4,500,000, Pacific Coast Bankers’ Bank $6,000,000 and The IndependentBank $5,000,000 tomeet temporary liquidity requirements.  Availableborrowing capacities on December 31, 2007 were $4,500,000, $6,000,000 and$5,000,000, respectively.

 

As a matter ofpolicy, the Bank seeks to maintain a level of liquid assets, includingmarketable investment securities, equal to a least 15 percent of total assets (“primaryliquidity”), while maintaining sources of secondary liquidity (borrowing linesfrom other institutions) equal to at least an additional 10 percent of assets.  In addition, it seeks to generally limitloans to not more than 110 percent of deposits.  Within these ratios, theBank generally has excess funds available to sell as federal funds on a dailybasis, and is able to fund its own liquidity needs without the need ofshort-term borrowing.  The Bank’s totalliquidity at December 31, 2007, 2006 and 2005 was 27.09%, 24.31%, and27.09%, respectively, while its loan to deposit ratio for such years was100.85%, 98.80% and 90.84%, respectively.

 

 

40

----

 

Brokered deposits aredeposit instruments, such as certificates of deposit, deposit notes, bankinvestment contracts and certain municipal investment contracts that are issuedthrough brokers and dealers who then offer and/or sell these depositinstruments to one or more investors. Additionally, deposits on which a financial institution pays an interestrate significantly higher than prevailing rates are considered to be brokereddeposits.  Federal law and regulationrestricts banks from soliciting or accepting brokered deposits, unless the bankis well capitalized under Federal guidelines. The Bank had no brokered deposits at December 31, 2007; brokereddeposits totaled approximately $5,046,000 or 3.83% at December 31, 2006and $12,849,300 or 10.82% at December 31, 2005. None of the Bank’sbrokered deposits paid an interest rate significantly higher than prevailingrates.

 

Management of interest rate sensitivity(asset/liability management) involves matching and repricing rates ofinterest-earning assets with interest-bearing liabilities in a manner designedto optimize net interest income within the constraints imposed by regulatoryauthorities, liquidity determinations and capital considerations.  The Bank instituted formal asset/liabilitypolicies at the end of 1989.

 

The purpose forasset/liability management is to provide stable net interest income growth byprotecting the Bank’s earnings from undue interest rate risk.  The Bank expects to generate earnings fromincreasing loan volume, appropriate loan pricing and expense control and notfrom trying to accurately forecast interest rates.  Another important function of asset/liabilitymanagement is managing the risk/return relationships between interest raterisk, liquidity, market risk and capital adequacy.  The Bank gives priority to liquidity concernsfollowed by capital adequacy, then interest rate risk and market risk in theinvestment portfolio.  The policy of theBank will be to control the exposure of the Bank’s earnings to changinginterest rates by generally maintaining a position within a narrow range aroundan “earnings neutral position.” An earnings neutral position is defined as themix of assets and liabilities that generate a net interest margin that is notaffected by interest rate changes. However, Management does not believe that the Bank can maintain atotally earnings neutral position. Further, the actual timing of repricing of assets and liabilities doesnot always correspond to the timing assumed by the Bank for analyticalpurposes.  Therefore, changes in marketrates of interest will generally impact on the Bank’s net interest income andnet interest margin for long or short periods of time.

 

The Bank monitors itsinterest rate risk on a quarterly basis through the use of a model whichcalculates the effect on earnings of changes in the fed funds rate.  The model converts a fed funds rate changeinto rate changes for each major class of asset and liability, then simulatesthe bank’s net interest margin based on the bank’s actual repricing over a oneyear period, assuming that maturities are reinvested in instruments identicalto those maturing during the period.  Thefollowing table shows the affect on net interest income of a 100 and a 200basis point rate shock at December 31, 2007.

 

| **Rate Shock Increase(Decrease)  in Basis Points** | ** ** | **Percent Increase(Decrease)  in Net Interest Income** |
|----------------------------------------------------|------------|--------------------------------------------------------|
| 100                                                |       | 5.8%                                                   |
| (100)                                              |       | (6.7)%                                                 |
| 200                                                |       | 11.6%                                                  |
| (200)                                              |       | (13.5)%                                                |

 

 

41

----

 

The Corporation’s sourcesof revenues and liquidity are the dividends, tax equalization payments ormanagement fees from the Bank and gains on securities held in a trading accountand other investments.  The ability ofthe Bank to pay such items to the Corporation is subject to limitations understate and Federal law.

 

**InvestmentSecurities**

 

TheCorporation maintains a trading account, at fair value, consisting ofmarketable securities.  At December 31,2007 and 2006 the account value was $1,224,000 and $1,762,000, respectively.  The Corporation has investments of $20,000 inAT Service LLC, which provides title insurance services for commercial,industrial and residential properties, as well as other real estate relatedfinancial and informational services, including escrow, real estateinformation, trustee sale guarantees and real estate tax exchanges, and $10,000in Metrocities Mortgage, LLC.  Inaddition the Corporation has investments in Northern California Bancorp Trust Iof $93,000 and Northern California Bancorp Trust II of $155,000, these arespecial-purpose trust subsidiaries which were formed to facilitate the issuanceof trust preferred securities.

 

The following table setsforth the book and market value of the consolidated investment securities as ofDecember 31, 2007 and 2006:

 
| ** **                                       | ** ** | INVESTMENT  PORTFOLIO MIX | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | (Dollars  in thousands)   | ** ** |
| ** **                                       | ** ** |                      | ** ** |
| ** **                                       | ** ** | **2007**                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **Book**                  | ** ** | **Market** | ** ** | **Book** | ** ** | **Market** | ** ** | **Book** | ** ** | **Market** | ** ** |
| ** **                                       | ** ** | **value**                 | ** ** | **value** | ** ** | **value** | ** ** | **value** | ** ** | **value** | ** ** | **value** | ** ** |
| Available for  sale:                             |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Government  National Mortgage Association        |       | $                         | 386        |   | $ | 385 |   | $ | 641 |   | $ | 626 |   | $ | 857 |   | $ | 837 |   |
| State/Local  Agency Securities                   |       | 225                       |       | 225 |   | — |   | — |   | — |   | — |   |
| U.S. Government  Agencies                        |       | 36,027                    |       | 36,191 |   | 14,724 |   | 14,660 |   | 9,714 |   | 9,597 |   |
| Total                                            |       | $                         | 36,638     |   | $ | 36,801 |   | $ | 15,365 |   | $ | 15,286 |   | 11,202 |   | 11,065 |   |
|                                             |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Held to  maturity:                               |       |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| State/Local  Agency Securities                   |       | $                         | 7,869      |   | $ | 8,105 |   | $ | 7,012 |   | $ | 7,280 |   | 7,025 |   | 7,162 |   |
|                                             |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Other  Securities:                               |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Federal Home  Loan Bank Stock                    |       | $                         | 2,495      |   | $ | 2,495 |   | $ | 1,633 |   | $ | 1,633 |   | $ | 1,183 |   | $ | 1,183 |   |
| AT Services, LLC                                 |       | 20                        |       | 20 |   | 20 |   | 20 |   | 40 |   | 40 |   |
| Metrocities  Mortgage, LLC                       |       | 10                        |       | 10 |   | 10 |   | 10 |   | 10 |   | 10 |   |
| The Independent  Bankers’ Financial Corp.   |       | 51                        |       | 51 |   | 50 |   | 50 |   | — |   | — |   |
| MasterCard Inc  Class “B” Stock   |       | —                    |       | — |   | 6 |   | 6 |   | — |   | — |   |
| Northern  California Bancorp, Inc. Trust I  |       | 93                        |       | 93 |   | 93 |   | 93 |   | 93 |   | 93 |   |
| Northern  California Bancorp, Inc. Trust II |       | 155                       |       | 155 |   | 155 |   | 155 |   | 155 |   | 155 |   |
| Pacific Coast  Bankers’ Bank Stock          |       | —                    |       | — |   | — |   | — |   | 440 |   | 1,757 |   |
| Pan Pacific Bank                                 |       | —                    |       | — |   | — |   | — |   | 100 |   | 100 |   |
| Total                                            |       | $                         | 2,824      |   | $ | 2,824 |   | $ | 1,967 |   | $ | 1,967 |   | $ | 2,021 |   | $ | 3,338 |   |

 

 

42

----

 

 

The followingtables summarize the maturity of the consolidated investment securities at December 31,2007:

 
| ** **                        | ** ** | **INVESTMENT  PORTFOLIO MATURITIES** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **(Dollars  in thousands)**          | ** ** |
| ** **                        | ** ** | ** **                           | ** ** |
| ** **                        | ** ** | **Available for Sale**               | ** ** |
| ** **                        | ** ** | **Amortized**                        | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                             | ** ** | **Value** | ** ** |
| Due within one year               |       | $                                    | 1,000      |   | $ | 999 |   |
| Due between five and ten years    |       | 11,250                               |       | 11,311 |   |
| Due in over ten years             |       | 24,002                               |       | 24,106 |   |
| GNMA - Mortgage Backed Securities |       | 386                                  |       | 385 |   |
|                              |       | $                                    | 36,638     |   | $ | 36,801 |   |
|                              |       |                                 |       |   |   |
|                              |       |                                 |       |   |   |
| ** **                        | ** ** | **Held to Maturity**                 | ** ** |
| ** **                        | ** ** | **Amortized**                        | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                             | ** ** | **Value** | ** ** |
| Due in over ten years             |       | $                                    | 7,869      |   | $ | 8,105 |   |

 

**ITEM 7. FINANCIAL STATEMENTS**

 

The followingconsolidated financial statements included in the Consolidated Financial Reportissued by Hutchinson and Bloodgood LLP, Certified Public Accountants at the pages indicatedare incorporated herein by reference:

 
| Independent  Auditors’ Report on the Financial Statements                                                                          | 1      |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                    |   |
| Consolidated  Balance Sheets at December 31, 2007 and 2006                                                                         | 2      |
|                                                                                                                                    |   |
| Consolidated Statements of Income for each of the  three years in the period ended December 31, 2007                               | 3      |
|                                                                                                                                    |   |
| Consolidated Statements of Changes in Stockholders’  Equity for each of the three years in the period ended December 31, 2007 | 4      |
|                                                                                                                                    |   |
| Consolidated Statements of Cash Flows for each of the  three years in the period ended December 31, 2007                           | 5-6    |
|                                                                                                                                    |   |
| Notes to Consolidated Financial Statements                                                                                              | 7-49   |

#  

#  

**ITEM 8. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS AND FINANCIAL DISCLOSURE**

 

The Company had nodisagreements with its independent accountants on any matter of accountingprinciples, practices or financial statement disclosure during 2007, 2006 or2005.

 

43

----

 

**ITEM8A.  CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

We maintain “disclosure controls and procedures,” as such term isdefined in Rule 13a-15(e) under the Securities Exchange Act of 1934(the “Exchange Act”), that are designed to ensure that information required tobe disclosed in our Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure. We conducted an evaluation (the “Evaluation”), under thesupervision and with the participation of our Chief Executive Officer (“CEO”)and Chief Financial Officer (“CFO”), of the effectiveness of the design andoperation of our disclosure controls and procedures (“Disclosure Controls”) asof the end of the period covered by this report pursuant to Rule 13a-15(e) ofthe Exchange Act. Based on this Evaluation, our CEO and CFO concluded that ourDisclosure Controls were effective as of the end of the period covered by thisreport.

 

**Changes in Internal Controls**

 

We have also evaluated our internal controls for financial reporting,and there have been no significant changes in our internal controls or in otherfactors that could significantly affect those controls subsequent to the dateof their last evaluation.

 

**Limitations on the Effectiveness of Controls**

 

Our management, including our CEO and CFO, does not expect that our DisclosureControls and internal controls will prevent all errors and all fraud. A controlsystem, no matter how well conceived and operated, can provide only reasonable,not absolute, assurance that the objectives of the control system are met.Further, the design of a control system must reflect the fact that there areresource constraints, and the benefits of controls must be considered relativeto their costs. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the Company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty, and that breakdowns can occur because of a simple error ormistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management or boardoverride of the control.

 

The design of any system of controls also is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions; over time, controls may become inadequate becauseof changes in conditions, or the degree of compliance with the policies orprocedures may deteriorate. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

**CEO and CFO Certifications**

 

Appearing immediately following the Signatures section of this reportthere are Certifications of the CEO and the CFO. The Certifications arerequired in accordance with Section 302 of the Sarbanes-Oxley Act of 2002(the Section 302 Certifications). This Item of this report, which you arecurrently reading is the information concerning the Evaluation referred to inthe Section 302 Certifications and this information should be read inconjunction with the Section 302 Certifications for a more complete understandingof the topics presented.

 

44

----

 

**Management’s Report on Internal Control over FinancialReporting**

 

The management of Northern California Bancorp, Inc. is responsiblefor establishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rule 13a-15(f). TheCompany’s internal control over financial reporting is a process designed toprovide reasonable assurance to the Company’s management and board of directorsregarding the reliability of financial reporting and the preparation of thefinancial statements for external purposes in accordance with accountingprinciples generally accepted in the United States of America.

 

The Company’s internal control over financial reporting includes thosepolicies and procedures that (i) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company; (ii) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with accounting principles generally accepted in theUnited States of America, and that receipts and expenditures of the Company arebeing made only in accordance with authorizations of management and directorsof the Company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the Company’s assets that could have a material effect on the financialstatements.

 

Because of its inherent limitations, internal controls over financialreporting may not prevent or detect misstatements. All internal controlsystems, no matter how well designed, have inherent limitations, including thepossibility of human error and the circumvention of overriding controls.Accordingly, even effective internal control over financial reporting canprovide only reasonable assurance with respect to financial statementpreparation. Also, projections of any evaluation of effectiveness to futureperiods are subject to the risk that controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

Our management assessed the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2007. In making thisassessment, it used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) in *Internal Control-Integrated Framework*. Based on ourassessment, we believe that, as of December 31, 2007, the Company’sinternal control over financial reporting was effective based on thosecriteria.

 

This annual report does not include an attestationreport of our registered public accounting firm regarding internal control overfinancial reporting. Management’s report was not subject to attestation by ourregistered public accounting firm pursuant to temporary rules of theSecurities and Exchange Commission that permit us to provide only management’sreport in this annual report.

 

**ITEM8B.  OTHER INFORMATION**

 

Not Applicable

 

45

----

 

**PART III**

 

**ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROLPERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT**

 

**Code of Ethics**

 

The Bank has adopted a code of ethics applicable to all of itsofficers, directors and employees, including its principal executive officer,principal financial officer, principal accounting officer and personsperforming similar functions.

 

The name, age,title and five-year business background of each director, executive officersand significant employees of the Corporation (including the Bank) as of December 31,2007, are as follows:

 
| **Name &  Position with Bank**                                                                          | ** ** | **Age** | ** ** | **Principal Occupation During Past Five Years**                                                                                                                                                                                                 |
|------------------------------------------------------------------------------------------------------------------|------------|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Charles  T. Chrietzberg, Jr.  Director since 1985, Chairman of the Board & Chief Executive Officer |       | 66      |       | Chairman of the  Board & Chief Executive Officer Monterey County Bank since 3/87                                                                                                                                                       |
|                                                                                                             |       |    |       |                                                                                                                                                                                                                                            |
| Sandra  G. Chrietzberg  Director, 1988 to 1994 and since 1995                                                    |       | 64      |       | Formerly President and  CEO Queen of Chardonnay, Inc., dba La Reina Winery 8/84-12/93                                                                                                                                                      |
|                                                                                                             |       |    |       |                                                                                                                                                                                                                                            |
| Stephanie  G. Chrietzberg  Director since 2007                                                                   |       | 40      |       | Vice President,  Business Development Officer of Monterey County Bank since 5/06, Accounting  Manager/Assistant Controller, Portola Plaza Hotel 9/94-4/06, Reservation  Agent, Accounts Receivable Clerk, Payroll, Doubletree Hotel 12/91-9/94. |
|                                                                                                             |       |    |       |                                                                                                                                                                                                                                            |
| Peter  J. Coniglio, Esq.  Director since 1976                                                               |       | 78      |       | Partner - Hudson, Martin,  Ferrante & Street, Monterey, CA                                                                                                                                                                             |
|                                                                                                             |       |    |       |                                                                                                                                                                                                                                            |
| Carla  S. Hudson, CPA  Director since 1994                                                                       |       | 54      |       | Partner — Bianchi, Kasavan & Pope, LLP                                                                                                                                                                                            |
|                                                                                                             |       |    |       |                                                                                                                                                                                                                                            |
| John  M. Lotz  Director since 1991                                                                               |       | 66      |       | Chairman, Chief  Executive Officer & President Del Monte Aviation, Inc. dba.  Monterey Bay Aviation, President and Chief Executive Officer, of Couroc of  Monterey 1996-2001.                                                     |
|                                                                                                             |       |    |       |                                                                                                                                                                                                                                            |
| Mark  A. Briant  Director since 2006                                                                             |       | 60      |       | Owner Fashion Streaks  Screenprinting, Embroidery, Signs and Banners, Sand City, CA  Owner, Sandy Creek Olive Ranch, Carmel Valley, CA                                                                                                          |
|                                                                                                             |       |    |       |                                                                                                                                                                                                                                            |
| David  A. Bernahl  Director since 2006                                                                           |       | 29      |       | Chief Executive  Officer & President, Pacific Tweed, Inc. Carmel, CA                                                                                                                                                              |

 

46

----

 
| Timothy  M. Leveque  Executive Vice President  Chief Lending Officer                              |   | 64     |   | Executive Vice  President, Chief Lending Officer of Monterey County Bank since 11/03, Senior  Executive Vice President, Chief Lending Officer, Pacific Coast Bankers’ Bank  1997-2003                                               |
|---------------------------------------------------------------------------------------------------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                              |   |   |   |                                                                                                                                                                                                                                     |
| Bruce  N. Warner  Executive Vice President,  Chief Financial Officer  and Chief Operating Officer |   | 60     |   | Executive Vice  President, Chief Financial Officer and Chief Operating Officer of Monterey  County Bank since 2002; Senior Vice President, Chief Financial Officer and  Chief Operating Officer of Monterey County Bank since 1993-2002. |
|                                                                                              |   |   |   |                                                                                                                                                                                                                                     |
| Mary  Ellen Stanton  Senior Vice President                                                        |   | 69     |   | Senior Vice President,  Loan Administration, Monterey County Bank Since 10/98.                                                                                                                                                           |
|                                                                                              |   |   |   |                                                                                                                                                                                                                                     |
| Andre  G. Herrera  Senior Vice President                                                          |   | 42     |   | Senior Vice President,  Chief Information Officer, Manager BankCard Service 12/04, Vice President,  Chief Information Officer 11/01.                                                                                                     |
|                                                                                              |   |   |   |                                                                                                                                                                                                                                     |
| Patricia  D. Weber  Senior Vice President  Senior Operations Manager                              |   | 47     |   | Senior Vice President,  Senior Operations Manager 12/04, Vice President, Operations Manager 6/97.                                                                                                                                        |

 

Directors of theCorporation serve in similar capacities with the Bank.  The Chairman of the Board, Chief ExecutiveOfficer and Executive Vice President, Chief Financial Officer of theCorporation serve in similar capacities with the Bank, although the limitedoperations of the Corporation do not require significant amounts of theirtime.  There is no family relationshipsamong the persons listed above, except that Mr. and Mrs. Chrietzbergare spouses and Stephanie g. Chrietzberg is their daughter.

 

Director Bernahl resigned fromhis position as a member of the Board of Directors of Northern CaliforniaBancorp, Inc. and its wholly owned subsidiary Monterey County Bank on January 17,2008.  Director Bernahl cited timedemands from his involvement in a start-up venture and the planned expansion ofhis existing business which would impact his ability to attend to Boardmatters.

 

Based solely upona review of the relevant forms furnished to the Bank and the Corporation,except as disclosed below, the Corporation believes that all officers,directors and principal shareholders filed appropriate forms as required by Section 16(a) ofthe Exchange Act, and related regulations, during 2007.

 

47

----

 

**ITEM 10. EXECUTIVE COMPENSATION**

 

The followingtable sets forth certain information regarding the compensation, in thousands,paid to the Chief Executive Officer, Executive Officers and the next twohighest compensated officer of the Corporation/Bank whose total compensationexceeded $100,000 for 2006.

 
| ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Nonquailified** | ** ** | ** **       | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|---------------------|------------|-------------------|------------|------------------|------------|------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Non-Equity**      | ** ** | **Deferred**      | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Stock**  | ** ** | **Incentive  Plan** | ** ** | **Compensation**  | ** ** | **All  Other**   | ** ** | ** ** | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Salary** | ** ** | **Bonus**  | ** ** | **Awards** | ** ** | **Compensation**    | ** ** | **Earnings**      | ** ** | **Compensation** | ** ** | **Total**  | ** ** |
| **Name & Principal Position** | ** ** | **Year**   | ** ** | **($)**    | ** ** | **($)**    | ** ** | **($)**    | ** ** | **($)**             | ** ** | **($)**           | ** ** | **($)**          | ** ** | **($)**    | ** ** |
| Charles T. Chrietzberg, Jr.       |       | 2007       |       | 311        |       | 300        |       | None       |       | None                |       | None              |       | 27               | (1)        | 639        |       |
| Chairman,  President & CEO    |       | 2006       |       | 308        |       | 300        |       | None       |       | None                |       | None              |       | 56               | (1)        | 664        |       |
|                                   |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
| Timothy M. Leveque                     |       | 2007       |       | 182        |       | 65         |       | None       |       | None                |       | None              |       | 25               | (2)        | 272        |       |
| Executive Vice  President,             |       | 2006       |       | 173        |       | 75         |       | None       |       | None                |       | None              |       | 28               | (2)        | 276        |       |
| Chief Lending  Officer                 |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
|                                   |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
| Bruce N. Warner                        |       | 2007       |       | 164        |       | 65         |       | None       |       | None                |       | None              |       | 16               | (3)        | 246        |       |
| Executive Vice  President,             |       | 2006       |       | 153        |       | 75         |       | None       |       | None                |       | None              |       | 14               | (3)        | 241        |       |
| Chief Financial  Officer               |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
| Chief Operating  Officer               |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
|                                   |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
| Andre G. Herrera                       |       | 2007       |       | 196        |       | None       |       | None       |       | None                |       | None              |       | 13               | (4)        | 210        |       |
| Senior Vice  President,                |       | 2006       |       | 219        |       | None       |       | None       |       | None                |       | None              |       | 14               | (4)        | 232        |       |
| Chief Information  Officer             |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
| Manager BankCard  Services             |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
|                                   |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |
| Patricia D. Weber                      |       | 2007       |       | 100        |       | 33         |       | None       |       | None                |       | None              |       | 9                | (5)        | 143        |       |
| Senior Vice  President,                |       | 2006       |       | 98         |       | 30         |       | None       |       | None                |       | None              |       | 8                | (5)        | 136        |       |
| Senior Operations  Manager             |       |       |       |       |       |       |       |       |       |                |       |              |       |             |       |       |       |

----

| (1)    | 2007 includes $13,000 in  matching 401K plan contributions, health insurance premiums of $7,000,  personal use of a Bank owned automobile of $4,000 and life/disability  insurance premiums of $3,000.                                                                                                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 2006 includes $29,000 in  expense accrued in the Salary Continuation Plan net of earnings on life  insurance policies as more fully described in the Long Term Incentive Plan  Table, $15,000 in matching 401K plan contributions, health insurance premiums  of $6,000, $4,000 in personal use of a Bank owned automobile and $2,000 in  life/disability insurance premiums. |
| (2)    | 2007 includes $12,000 in  matching 401K plan contributions, health insurance premiums of $4,000,  automobile allowance of $6,000 and life/disability insurance premiums of  $3,000.                                                                                                                                                                                           |
|   | 2006 includes $11,000 in  matching 401K plan contributions, health insurance premiums of $9,000, $6,000  in automobile allowance and $2,000 in life/disability insurance premiums.                                                                                                                                                                                            |
| (3)    | 2007 includes $13,000 in  matching 401K plan contributions and $3,000 in life/disability insurance  premiums.                                                                                                                                                                                                                                                                 |
|   | 2006 includes $12,000 in  matching 401K plan contributions and $2,000 in life/disability insurance  premiums.                                                                                                                                                                                                                                                                 |
| (4)    | 2007 includes $11,000 in  matching 401K plan contributions and $2,000 in life/disability insurance  premiums.                                                                                                                                                                                                                                                                 |
|   | 2006 includes $13,000 in  matching 401K plan contributions and $1,000 in life/disability insurance  premiums.                                                                                                                                                                                                                                                                 |
| (5)    | 2007 includes $7,000 in  matching 401K plan contributions and $2,000 in life/disability insurance  premiums.                                                                                                                                                                                                                                                                  |
|   | 2006 includes $7,000 in  matching 401K plan contributions and $1,000 in life/disability insurance  premiums.                                                                                                                                                                                                                                                                  |

 

The Bankfurnishes, on a non-discriminatory basis, to the employees: (i) insurancebenefits; and (ii) other benefits. The value of these benefits for the respective persons is included inthe table if the aggregate of value of the benefits exceeded $10,000.

 

48

----

 

The Board ofDirectors authorized the Bank to enter into a three year employment contractwith Mr. Chrietzberg, effective January 1, 2005.  It provides for a base salary of $240,000 peryear, a Bank furnished automobile or automobile allowance, and a bonus based onprofits.  The bonus, not to exceed$250,000 annually, will equal $10,000 for each 0.1 percent that the Bank’sprofits exceed 1 percent return on average assets plus $10,000 for each 1percent that the Bank’s return on equity exceeds 10 percent.  Under the terms of the contract, if Mr. Chrietzbergis terminated other than for cause (as defined in the contract), he is entitledto severance compensation for his monthly salary plus a pro rated incentivebonus for the greater of 24 months or the remaining term of his contract (whichends in December, 2008); however, if the termination follows within 12 monthsafter a change in control transaction (as defined in the contract), he isentitled to such severance compensation for the greater of 24 months or theremainder of the term of the contract.

 

The Board ofDirectors authorized the Bank to execute Addendum 1 to the three yearemployment contract with Mr. Chrietzberg effective January 1,2006.   Addendum 1 provides for a basesalary of $300,000 and a bonus not to exceed $300,000.  All other terms of the employment contractremain the same.

 

The followingtable sets forth certain information regarding the long term incentive planprovided for Mr. Chrietzberg.

 
| ** **                 | ** ** | ** **                    | ** ** | **Performance or**                                                              | ** ** | ** **                         | ** ** |
|----------------------------|------------|-------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **Number of**                 | ** ** | **Other Period**                                                                | ** ** | **Estimated Future Payouts under** | ** ** |
| ** **                 | ** ** | **Shares, Units**             | ** ** | **Until**                                                                       | ** ** | **Non-Stock Price-Based Plans**    | ** ** |
| ** **                 | ** ** | **or Other Rights**           | ** ** | **Maturation or**                                                               | ** ** | **Threshold**                      | ** ** | **Target** | ** ** | **Maximum** | ** ** |
| **Name**                   | ** ** | **(#)**                       | ** ** | **Payment**                                                                     | ** ** | **($ or #)**                  | ** ** | **($ or #)** | ** ** | **($ or #)** | ** ** |
| Charles T. Chrietzberg, Jr |       | Salary Continuation Agreement |       | Retirement at age 65, subject to provisions for  earlier payout described below |       | None                               |       | None |   | $90,000/yr. lifetime |   |

 

In December 1993, the Board of Directors approved a SalaryContinuation Agreement for the benefit of Mr. Chrietzberg that providedfor payments of $75,000 per year, for 15 years, if he remains with the Bankuntil normal retirement, commencing age 65.  After consideration of the impact of such anagreement on the Bank’s income, the Bank amended the Agreement to provide forone half the original benefit amounts, but adopted Surviving Income Agreementswhich provide benefits upon the death of the executive to his beneficiary in asingle payment, in an amount equal to the retirement benefit.  The Salary Continuation Agreement providesfor lesser payments in the event of early retirement, generally designated tocoincide with increases in the anticipated surrender value for the lifeinsurance policies described below.

 

In August, 2001,the Board of Directors amended the Salary Continuation Agreement for thebenefit of Mr. Chrietzberg which was approved in December, 1993 andamended in August 1999.   The amendedSalary Continuation Agreement provides for payments of $90,000 per year, for Mr. Chrietzberg’slifetime.  The amended SalaryContinuation Agreement provides the following with regard to the division ofdeath proceeds should Mr. Chrietzberg die before his 65th birthday; hisbeneficiary(ies) shall be entitled to an amount equal to $2,940,000 or the netat risk insurance portion of the proceeds, whichever amount is less.  The net at risk insurance portion is thetotal proceeds less the cash value of the policy.  Should Mr. Chrietzberg die on orsubsequent to his 65th birthday, his beneficiary(ies) shall beentitled to an amount equal to $1,000,000 plus the present value of theremaining retirement benefits due to Mr. Chrietzberg or the net at riskinsurance portion of the proceeds, whichever is less, and the Bank shall beentitled to the remainder of such proceeds.

 

49

----

 

The Bank’sobligations under the Salary Continuation Agreement are not secured by anysegregated amounts, but are informally funded by the purchase of single-premiumlife insurance policies.  The Bank didnot incur any salary continuation expense in 2007, net earnings on the lifeinsurance policies totaled $124,000 for the year.  The salary continuation expense accrued netof earnings on life insurance policies in 2006 and 2005 was $28,900, $28,900,respectively.  Based upon the currentprojected earnings of the insurance used to informally fund the Bank’s obligationsunder the Agreement, and the anticipated salary continuation expense to bebooked, net of tax benefits, the Bank anticipates (based upon current tax lawsand assumptions regarding the yield on alternative investment(s)) that the costof the benefits to be provided under the agreement will not have a materialadverse impact on the Bank’s net income after taxes in the future, although noassurance can be given in this regard. The Surviving Income Agreement was terminated upon adoption of theamended Salary Continuation Agreement.

 

The Corporationdid not grant any stock options under the Corporation’s 1998 Amended StockOption Plan or the Northern California Bancorp 2007 Stock Option Plan duringthe year ended December 31, 2007.

 

The followingtable sets forth the number of shares of Common stock represented byoutstanding stock options and stock awards held by each of the named executiveofficers as of December 31, 2007 under the Coporation’s 1998 Amended StockOption Plan.

 
| ** **                       | ** ** | **Option  Awards**                                                       | ** ** | **Stock  Awards**                                                          | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **Name**                         | ** ** | **Number  of Securities Underlying Unexercised Options (#) Exercisable** | ** ** | **Number  of Securities Underlying Unexercised Options (#) Unexercisable** | ** ** | **Equity Incentive  Plan Awards: Number of Securities Underlying Unerercised Unearned Options (#)** | ** ** | **Option Exercise  Price ($)** | ** ** | **Option Expiration  Date** | ** ** | **Number of  Shares or Units of Stock That Have Not Vested (#)** | ** ** | **Market Value  of Shares of Stock That Have Not Vested (#)** | ** ** | **Equity Incentive  Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested  (#)** | ** ** | **Equity Incentive  Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights  That Have Not Vested ($)** | ** ** |
| Charles T. Chrietzberg, Jr. |       | 25,000                                                                   | (1)        | NONE                                                                       |       | NONE |   | 110,000 |   | 2/2/09 |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Timothy Leveque                  |       | —                                                                   |       | NONE                                                                       |       | NONE |   | N/A |   | N/A |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Bruce N. Warner                  |       | —                                                                   |       | NONE                                                                       |       | NONE |   | N/A |   | N/A |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Andre G. Herrera                 |       | —                                                                   |       | NONE                                                                       |       | NONE |   | N/A |   | N/A |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Patricia D. Weber                |       | 1,500                                                                    | (2)        | NONE                                                                       |       | NONE |   | 4,500 |   | 3/20/08 |   | NONE |   | NONE |   | NONE |   | NONE |   |
|                             |       | 2,500                                                                    | (2)        | NONE                                                                       |       | NONE |   | 10,000 |   | 2/2/09 |   | NONE |   | NONE |   | NONE |   | NONE |   |

----

(1)  The vesting datefor Mr. Chrietzberg’s options was February 2, 2004.

(2)  The vestingdates for Ms. Weber’s options were March 20, 2003 andFebruary 2, 2004.

 

50

----

 

 

The following table sets forth certaininformation regarding the compensation, in thousands, paid to each directorduring 2007.

 
| **Name**                         | ** ** | **Fees  Earned  or Paid  in  Cash  ($)** | ** ** | **Stock  Awards   ($)** | ** ** | **Option  Awards  ($)** | ** ** | **Non-Equity  Incentive Plan  Compensation  ($)** | ** ** | **Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation  ($)** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|-------------------------|------------|-------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------|------------|
| David A. Berhnal                 |       | 20                                       | (1)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |
| Mark A. Briant                   |       | 21                                       | (2)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |
| Charles T. Chrietzberg, Jr. |       | 20                                       | (3)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |
| Sandra G. Chrietzberg            |       | 20                                       | (4)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |
| Stephanie G. Chrietzberg         |       | 20                                       | (5)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |
| Peter J. Coniglio                |       | 20                                       | (6)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |
| Carla S. Hudson                  |       | 22                                       | (7)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |
| John M. Lotz                     |       | 21                                       | (8)        | None                    |       | None                    |       | None                                              |       | None                                               |       | None                             |       |

----

1.  Includes a retainer of $11,000 and $9,000 infees for monthly Board of Director meetings.

2.  Includes a retainer of $11,000, $9,000 infees for monthly Board of Director meetings and $1,000 in meeting fees forattendance as a member of the Audit Committee.

3.  Includes a retainer of $11,000 and $9,000 infees for monthly Board of Director meetings.

4.  Includes a retainer of $11,000 and $9,000 infees for monthly Board of Director meetings.

5.  Includes a retainer of $11,000 and $9,000 infees for monthly Board of Director meetings.

6.  Includes a retainer of $11,000, $8,000 infees for monthly Board of Director meetings and $1,000 in meeting fees forattendance as a member of the Audit Committee.

7.  Includes a retainer of $11,000, $9,000 infees for monthly Board of Director meetings and $2,000 in meeting fees forattendance as chair member of the Audit Committee.

8.  Includes a retainer of $11,000, $9,000 infees for monthly Board of Director meetings and $1,000 in meeting fees forattendance as a member of the Audit Committee.

 

**ITEM 11. SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS**

 

                To the knowledge of themanagement of the Company, the following shareholders own more than fivepercent (5%) of the outstanding common stock of the Company, its only class ofvoting securities.

 
| ** **                       | ** ** | **Amount and Nature of** | ** ** | **Percent of** | ** ** |
|----------------------------------|------------|--------------------------|------------|----------------|------------|
| **Name and Address**             | ** ** | **Beneficial Ownership** | ** ** | **Class**      | ** ** |
| Charles T. Chrietzberg, Jr. |       | 748,874                  | (1)        | 40.03          | %          |
| P.O. Box 1344               |       |                     |       |           |       |
| Carmel, CA 93921                 |       |                     |       |           |       |
|                             |       |                     |       |           |       |
| David S. Lewis Trust             |       | 153,863                  |       | 8.34           | %          |
| 13500 N. Rancho Vistoso #3560    |       |                     |       |           |       |
| Tucson, AZ 85755                 |       |                     |       |           |       |
|                             |       |                     |       |           |       |
| Bruce N. Warner                  |       | 114,530                  |       | 6.20           | %          |
| 601 Munras Ave.                  |       |                     |       |           |       |
| Monterey, CA 93940               |       |                     |       |           |       |

----

(1)          Includes 25,000 shares subject to employee stockoptions and 18,414 shares held beneficially for Mr. Chrietzberg and Mrs. Chrietzbergin Individual Retirement Accounts where voting power is shared with thecustodian of the account.  400,000 sharesof the Common stock owned by Mr. Chrietzberg are pledged to secure a loanfrom an unaffiliated bank.

 

51

----

 

                The following table sets forthsimilar information regarding the beneficial ownership, both by numericalholding and percentage interest of each of the Company’s directors and all ofits directors and executive officers as a group.  All addresses are in care of the Corporationat 601 Munras Ave. Monterey, CA  93940.

 
| ** **                       | ** ** | **Amount and** | ** ** | ** **     | ** ** | **Shares**     | ** ** | ** **             | ** ** |
|----------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|------------------------|------------|
| ** **                       | ** ** | **Nature of**  | ** ** | ** **     | ** ** | **Subject to** | ** ** | **Percent of**         | ** ** |
| ** **                       | ** ** | **Beneficial** | ** ** | **Percent of** | ** ** | **Purchase**   | ** ** | **Class without** | ** ** |
| **Name**                         | ** ** | **Ownership**  | ** ** | **Class**      | ** ** | **Options**    | ** ** | **Option Shares**      | ** ** |
| Charles T. Chrietzberg, Jr. |       | 748,874        | (1)(2)(3)  | 40.03          | %          | 25,000         |       | 39.21                  | %          |
| Sandra G. Chrietzberg            |       | 748,874        | (2)(3)     | 40.03          | %          | 25,000         |       | 39.21                  | %          |
| Stephanie G. Chrietzberg         |       | 26,640         |       | 1.44           | %          | —         |       | 1.44                   | %          |
| Peter J. Coniglio                |       | 76,355         | (4)(5)     | 4.11           | %          | 13,161         |       | 3.42                   | %          |
| Carla S. Hudson                  |       | 39,899         | (6)        | 2.16           | %          | 2,500          |       | 2.03                   | %          |
| John M. Lotz                     |       | 11,395         |       | 0.61           | %          | 10,500         |       | 0.05                   | %          |
| Mark A. Briant                   |       | 2,534          | (7)        | 0.14           | %          | —         |       | 0.14                   | %          |
| All Directors and Executive      |       |           |       |           |       |           |       |                   |       |
| Officers as a  group             |       | 1,082,238      | (8)        | 57.05          | %          | 51,161         |       | 55.86                  | %          |

----

| (1)    | Includes  25,000 shares subject to his employee stock options. 400,000 shares of the  Common stock owned by Mr. Chrietzberg are pledged to secure a loan from  an unaffiliated bank. Should he default under such credit, the shares could  be acquired by the lender, or sold pursuant to applicable terms of the  Uniform Commercial Code, in a transaction that could result in a change of  control of the Corporation. Such transaction may require approval under  provisions of Federal and California change in bank control laws. |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (2)    | The shares include an  aggregate of 18,414 shares held beneficially by Mr. Chrietzberg and  Mrs. Chrietzberg in Individual Retirement Accounts, where voting power  is also shared with the custodian of the account.                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (3)    | Includes shares of  spouse pursuant to California’s community property laws.                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (4)    | Sole voting power.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (5)    | Includes 13,161 shares  subject to the respective director’s stock options. Of the remaining shares,  28,211 are held by Mr. Coniglio, 26,530 are held in a family trust  controlled by Mr. Coniglio, as to which he has sole voting and  investment power, while 8,453 shares are held by Hudson, Martin,  Ferrante & Street, a partnership of which Mr. Coniglio is the  managing partner, with voting and investment power.                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (6)    | Includes 2,500 shares  subject to the respective director’s stock options. The remaining shares are  held jointly with family members, other than 1,610 shares held in a corporate  pension, as to which Ms. Hudson has voting and investment power.                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (7)    | Shares are held in a  profit sharing plan, as to which Mr. Briant has voting and investment  power.                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (8)    | Includes 176,541 shares  held by executive officers who are not also directors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

 

**ITEM 12. CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

                The Bank has had, and expects tohave in the future, banking transactions in the ordinary course of its businesswith directors, officers, principal shareholders and their associates.  Management of the Bank believes that thesetransactions have been (and those in the future are intended to be) onsubstantially the same terms, including interest rates, collateral andrepayment terms on extensions of credit, as those prevailing at the same timefor comparable transactions with others and did not involve more than thenormal risk of collectibility or present other unfavorable features.  Management does not believe that any suchloans are outside the ordinary course of business.  The following table sets forth information onextensions of credit to directors, principal shareholders, officers and theirrelated parties.

 
| ** **                                                                | ** ** | ** **  | ** ** | ** **                 | ** ** | **Outstanding as of** | ** ** |
|---------------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **Maximum** | ** ** | **December 31, 2007** | ** ** |
| ** **                                                                | ** ** | ** **  | ** ** | **Percent of**             | ** ** | ** **            | ** ** | **Percent of** | ** ** |
| ** **                                                                | ** ** | ** **  | ** ** | **Equity**                 | ** ** | ** **            | ** ** | **Equity** | ** ** |
| **Name**                                                                  | ** ** | **Amount**  | ** ** | **Capital**                | ** ** | **Amount**            | ** ** | **Capital** | ** ** |
| Peter J. Coniglio                                                         |       | $           | 3,339      |                       | 16.10      | %                     | $          | 3,196 |   | 22.14 | % |
| Carla S. Hudson                                                           |       | 300         |       | 2.42                       | %          | 300                   |       | 2.08 | % |
| John M. Lotz                                                              |       | 5           |       | 0.03                       | %          | 5                     |       | 0.04 | % |
| David A. Bernhal                                                          |       | 286         |       | 2.24                       | %          | 278                   |       | 1.93 | % |
| Mark A. Briant                                                            |       | 420         |       | 2.94                       | %          | 354                   |       | 2.45 | % |
| Directors, Principal Shareholder, and Officers as a  Group (10 in number) |       | $           | 4,350      |                       | 30.14      | %                     | $          | 4,132 |   | 28.63 | % |

 

 

52

----

 

 

**Item 13. EXHIBITS AND REPORTS**

 

A.            EXHIBITS

 
| **Item**       | ** ** | **Description**                                                                                                                                                 |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2              |       | Plan of Merger and  Merger Agreement, Monterey County Bank with Monterey                                                                                        |
|           |       | County Merger  Corporation un the Charter of Monterey County Bank under                                                                                         |
|           |       | the Title of Monterey  County Bank, joined in by Northern California Bancorp,                                                                                   |
|           |       | Inc. dated  November 1, 1995.                                                                                                                              |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1995.                                                                                              |
| 3 (i)          |       | Articles of  Incorporation                                                                                                                                      |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1995.                                                                                              |
| 3 (ii)         |       | Bylaws                                                                                                                                                          |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1995.                                                                                              |
| 10 (i) D  |       | (1)  Lease  agreement Carmel Branch Office                                                                                                                 |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1995.                                                                                              |
|           |       | (2)  Lease  agreement Carmel By The Sea Office                                                                                                             |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2002.                                                                                              |
|           |       | (3)  Lease  agreement 301 Webster Street, Monterey, CA 93924                                                                                               |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2004.                                                                                              |
| 10 (ii) A |       | (1)  First Addendum toEmployment Contract of Charles T.  Chrietzberg, Jr.                                                                             |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2005.                                                                                              |
|           |       | (2)  Employment  Contract of Charles T. Chrietzberg, Jr., dated January 1, 2005                                                                  |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2004.                                                                                              |
|           |       | (3)  Deferred  Compensation Agreement, dated December 31, 1993                                                                                        |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1995.                                                                                              |
|           |       | (4)  Northern  California Bancorp, Inc. 1998 Stock Option Plan and Stock Option Agreements                                                            |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1998.                                                                                              |
|           |       | (5)  Amendment to  the Salary Continuation Agreement Dated December 31, 1993                                                                          |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1999.                                                                                              |
|           |       | (6) Life Insurance  Endorsement Method Split Dollar Plan Agreement                                                                                         |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 1999.                                                                                              |
|           |       | (7) Amendment to  the Life Insurance Endorsement Method Split Dollar Plan Agreement                                                                        |
|           |       | Dated January 5,  2000                                                                                                                                     |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2001                                                                                               |
|           |       | (8) Amendment to  the Life Insurance Endorsement Method Split Dollar Plan                                                                                  |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2001                                                                                               |
|           |       | (9) Amendment to  the Salary Continuation Agreement Dated December 31, 1993                                                                           |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2001                                                                                               |
|           |       | (10) Monterey  County Bank Supplemental Life Insurance Agreement Dated October 26, 2006                                                               |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2006                                                                                               |
|           |       | (11) First Amendment to  the Monterey County Bank Supplemental Life Insurance Agreement                                                                         |
|           |       | Dated October 31,  2006                                                                                                                                    |
|           |       | Filed as exhibit to  Form 10KSB dated December 31, 2006                                                                                               |
| 11             |       | Statement Reference  Computation of Per Share Earnings                                                                                                          |
| 21             |       | Subsidiaries                                                                                                                                                    |
| 23.1           |       | Consent  of Hutchinson and Bloodgood, LLP                                                                                                                       |
| 31.1           |       | Certification  of the Chief Executive Officer of Northern California Bancorp, Inc.  pursuant toSection 302  of the Sarbannes-Oxley Act of 2002.       |
| 31.2           |       | Certification  of the Chief Financial Officer of Northern California Bancorp, Inc.  pursuant to Section 302 of the Sarbannes-Oxley Act of 2002.       |
| 32.1           |       | Certification  of the Chief Executive Officer of Northern California Bancorp, Inc.  pursuant to Section 906 of  the Sarbannes-Oxley Act of 2002. |
| 32.2           |       | Certification  of the Chief Financial Officer of Northern California Bancorp, Inc.  pursuant to Section 906 of the Sarbannes-Oxley Act of 2002.       |

 

 

53

----

 

 

B.            REPORTS

 

                    None

 

**ITEM 14.  PRINCIPALACCOUNTANT FEES AND SERVICES**

 

**Fees**

 

**Audit Fees.**Aggregate fees billed by Hutchinson and Bloodgood for professionalservices rendered in connection with the audit of the Bank’s annual financialstatements for the fiscal year ended December 31, 2007 and for therequired review of the Bank’s financial statements included in its Form 10-QSB’sfor that same year totaled $75,325.

 

**FinancialInformation System Design and Implementation Fees.**No fees werepaid to Hutchinson and Bloodgood for financial information system design andimplementation services rendered for the 2007 fiscal year.

 

**All OtherFees.**$2,900 was paid to Hutchinson & Bloodgood for all tax servicesrendered for the 2007 fiscal year.

 

 

54

----

 

 

**SIGNATURES**

 

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

 
|   |                 | NORTHERN CALIFORNIA  BANCORP, INC. |
|--------|----------------------|------------------------------------|
|   |                 |                               |
| Date:  | March 26,  2008 | By:                                | /s/  Charles T. Chrietzberg, Jr. |
|   |                 |                               | Charles T.  Chrietzberg, Jr. |
|   |                 |                               | Chief Executive Officer |
|   |                 |                               | and President |
|   |                 |                               |   |
| Date:  | March 26,  2008 | By:                                | /s/  Bruce N. Warner |
|   |                 |                               | Bruce N. Warner |
|   |                 |                               | Chief Financial Officer |
|   |                 |                               | and Principal  Accounting Officer |

 

 

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

 
| **Name**                              | ** ** | **Position** | ** ** | **Date**             |
|---------------------------------------|------------|--------------|------------|----------------------|
|                                  |       |         |       |                 |
| /s/  Charles T. Chrietzberg, Jr. |       |         |       | March 26,  2008 |
| Charles  T. Chrietzberg, Jr.     |       | Director     |       |                 |
|                                  |       |         |       |                 |
| /s/ Sandra G.  Chrietzberg            |       |         |       | March 26,  2008 |
| Sandra G. Chrietzberg                 |       | Director     |       |                 |
|                                  |       |         |       |                 |
| /s/ Peter J. Coniglio                 |       |         |       | March 26,  2008 |
| Peter J. Coniglio                     |       | Director     |       |                 |
|                                  |       |         |       |                 |
| /s/ Carla S. Hudson                   |       |         |       | March 26,  2008 |
| Carla S. Hudson                       |       | Director     |       |                 |
|                                  |       |         |       |                 |
| /s/ John M. Lotz                      |       |         |       | March 26,  2008 |
| John M. Lotz                          |       | Director     |       |                 |
|                                  |       |         |       |                 |
| /s/ Mark A. Briant                    |       |         |       | March 26,  2008 |
| Mark A. Briant                        |       | Director     |       |                 |
|                                  |       |         |       |                 |
| /s/ Stephanie G.  Chrietzberg         |       |         |       | March 26,  2008 |
| Stephanie G.  Chrietzberg             |       | Director     |       |                 |

 

 

55

----

 

**NORTHERN CALIFORNIA BANCORP, INC.**

**AND SUBSIDIARY**

 

**CONSOLIDATED FINANCIAL REPORT**

 

**Years Ended December 31, 2007 and 2006**

 

 

----

 

**TABLE OF CONTENTS**

 
| ** **                                                         | **Page**   |
|--------------------------------------------------------------------|------------|
| **INDEPENDENT  AUDITORS’ REPORT ON THE FINANCIAL STATEMENTS** | 1          |
|                                                               |       |
|                                                               |       |
| **FINANCIAL  STATEMENTS**                                          | ** ** |
|                                                               |       |
| Consolidated  Balance Sheets                                       | 2          |
| Consolidated  Statements of Income                                 | 3          |
| Consolidated  Statements of Changes in Shareholders’ Equity   | 4          |
| Consolidated  Statements of Cash Flows                             | 5-6        |
| Notes  to Consolidated Financial Statements                        | 7-49       |

 

 

----

 

 

**Independent Auditors’ Report**

 

Tothe Board of DirectorsNorthern California Bancorp, Inc. and SubsidiaryMonterey, California

 

Wehave audited the accompanying consolidated balance sheets of NorthernCalifornia Bancorp, Inc. and its wholly owned subsidiary, Monterey CountyBank, as of December 31, 2007 and 2006 and the related consolidatedstatements of income, changes in shareholders’ equity, and cash flows for eachof the years in the three-year period ended December 31, 2007. Theseconsolidated financial statements are the responsibility of the Corporation’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

Weconducted our audits in accordance with standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audits to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Northern CaliforniaBancorp, Inc. and its wholly owned subsidiary, as of December 31,2007 and 2006, and the results of their operations and their cash flows foreach of the years in the three-year period ended December 31, 2007 inconformity with accounting principles generally accepted in the United Statesof America.

 

Watsonville,California

March 21,2008

 

1

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATEDBALANCE SHEETS**

**December 31,2007 and 2006**

**(Dollarsin Thousands, Except Share Data)**

 
| ** **                                                                                                                                                                 | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **ASSETS**                                                                                                                                                                 |       |       |       |       |       |
| Cash and due from banks                                                                                                                                                    |       | $          | 8,063      |       | $          | 4,979 |   |
| Federal funds sold                                                                                                                                                         |       | 12,090     |       | 17,455     |       |
| Total cash and cash equivalents                                                                                                                                            |       | 20,153     |       | 22,434     |       |
| Time deposits with other  financial institutions                                                                                                                           |       | —     |       | 1,000      |       |
| Trading assets                                                                                                                                                             |       | 1,224      |       | 1,762      |       |
| Investment securities  available for sale                                                                                                                                  |       | 36,801     |       | 15,286     |       |
| Investment securities held to maturity, at cost (fair value  approximates $8,105,000 in 2007; $7,280,000 in 2006)                                                          |       | 7,869      |       | 7,012      |       |
| Other investments                                                                                                                                                          |       | 2,824      |       | 1,967      |       |
| Loans held for sale                                                                                                                                                        |       | 1,887      |       | 1,182      |       |
| Loans, net of allowance  for loan losses of $2,028,000 in 2007; $1,409,000 in 2006                                                                                         |       | 166,861    |       | 128,868    |       |
| Premises and equipment,  net                                                                                                                                               |       | 4,874      |       | 4,613      |       |
| Cash surrender value of  life insurance                                                                                                                                    |       | 3,845      |       | 3,671      |       |
| Interest receivable and  other assets                                                                                                                                      |       | 7,527      |       | 2,775      |       |
|                                                                                                                                                                       |       |       |       |       |       |
| Total assets                                                                                                                                                               |       | $          | 253,865    |       | $          | 190,570 |   |
|                                                                                                                                                                       |       |       |       |       |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                                                                                                                                       |       |       |       |       |       |
| Deposits:                                                                                                                                                                  |       |       |       |       |       |
| Non interest-bearing demand                                                                                                                                                |       | $          | 24,814     |       | $          | 30,079 |   |
| Interest-bearing demand                                                                                                                                                    |       | 15,600     |       | 17,262     |       |
| Savings                                                                                                                                                                    |       | 5,487      |       | 5,326      |       |
| Time less than $100,000                                                                                                                                                    |       | 58,812     |       | 43,135     |       |
| Time in denominations of $100,000 or more                                                                                                                                  |       | 62,620     |       | 35,826     |       |
| Total deposits                                                                                                                                                             |       | 167,333    |       | 131,628    |       |
|                                                                                                                                                                       |       |       |       |       |       |
| Federal Home Loan Bank  borrowed funds                                                                                                                                     |       | 52,500     |       | 34,750     |       |
| Junior subordinated debt  securities                                                                                                                                       |       | 8,248      |       | 8,248      |       |
| Payable for investment  securities purchased                                                                                                                               |       | 5,225      |       | —     |       |
| Interest payable and other  liabilities                                                                                                                                    |       | 6,125      |       | 3,542      |       |
| Total liabilities                                                                                                                                                          |       | 239,431    |       | 178,168    |       |
|                                                                                                                                                                       |       |       |       |       |       |
| Commitments (Note 12)                                                                                                                                                      |       |       |       |       |       |
|                                                                                                                                                                       |       |       |       |       |       |
| Shareholders’ equity                                                                                                                                                  |       |       |       |       |       |
| Common stock, no stated par value, authorized: 2,500,000 shares, issued  and outstanding: 1,845,918 and 1,721,715 shares at December 31, 2007 and  2006, respectively |       | 5,502      |       | 5,060      |       |
| Retained earnings                                                                                                                                                          |       | 8,831      |       | 7,363      |       |
| Accumulated other comprehensive income (loss)                                                                                                                              |       | 101        |       | (21        | )          |
|                                                                                                                                                                       |       |       |       |       |       |
| Total shareholders’ equity                                                                                                                                            |       | 14,434     |       | 12,402     |       |
|                                                                                                                                                                       |       |       |       |       |       |
| Total liabilities and shareholders’ equity                                                                                                                            |       | $          | 253,865    |       | $          | 190,570 |   |

 

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

 

2

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF INCOME**

**YearsEnded December 31, 2007, 2006, and 2005**

**(Dollarsin Thousands, Except Share Data)**

 
| ** **                                                              | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest income                                                         |       |     |       |     |       |     |       |
| Loans and fee income on loans                                           |       | $        | 14,442     |     | $          | 11,953   |       | $ | 9,562 |   |
| Time deposits with other financial institutions                         |       | 66       |       | 50       |       | 29       |       |
| Investment securities                                                   |       | 1,957    |       | 1,036    |       | 748      |       |
| Federal funds sold                                                      |       | 476      |       | 721      |       | 352      |       |
| Total interest income                                                   |       | 16,941   |       | 13,760   |       | 10,691   |       |
|                                                                    |       |     |       |     |       |     |       |
| Interest expense                                                        |       |     |       |     |       |     |       |
| Interest-bearing transaction accounts                                   |       | 49       |       | 68       |       | 64       |       |
| Savings and time deposit accounts                                       |       | 2,638    |       | 1,443    |       | 1,051    |       |
| Time deposits in denominations of $100,000 or more                      |       | 2,405    |       | 1,479    |       | 990      |       |
| Notes payable and other borrowings                                      |       | 2,910    |       | 2,207    |       | 1,567    |       |
| Total interest expense                                                  |       | 8,002    |       | 5,197    |       | 3,672    |       |
|                                                                    |       |     |       |     |       |     |       |
| Net interest income                                                     |       | 8,939    |       | 8,563    |       | 7,019    |       |
| Provision for loan losses                                               |       | 865      |       | 410      |       | 150      |       |
| Net interest income, after provision for loan losses                    |       | 8,074    |       | 8,153    |       | 6,869    |       |
|                                                                    |       |     |       |     |       |     |       |
| Non-interest income                                                     |       |     |       |     |       |     |       |
| Service charges on deposit accounts                                     |       | 634      |       | 547      |       | 564      |       |
| Income from sales and servicing of Small Business Administration  loans |       | 480      |       | 690      |       | 991      |       |
| Gain on sale of Pacific Coast Bankers’ Bank Stock                  |       | —   |       | 1,313    |       | —   |       |
| Other income                                                            |       | 3,222    |       | 4,627    |       | 2,807    |       |
| Total non-interest income                                               |       | 4,336    |       | 7,177    |       | 4,362    |       |
|                                                                    |       |     |       |     |       |     |       |
| Non-interest expenses                                                   |       |     |       |     |       |     |       |
| Salaries and employee benefits                                          |       | 4,049    |       | 3,854    |       | 3,282    |       |
| Occupancy and equipment expense                                         |       | 866      |       | 790      |       | 665      |       |
| Professional fees                                                       |       | 165      |       | 149      |       | 141      |       |
| Data processing                                                         |       | 361      |       | 322      |       | 356      |       |
| Other general and administrative                                        |       | 3,564    |       | 3,512    |       | 3,369    |       |
| Total non-interest expenses                                             |       | 9,005    |       | 8,627    |       | 7,813    |       |
|                                                                    |       |     |       |     |       |     |       |
| Income before tax  provision                                            |       | 3,405    |       | 6,703    |       | 3,418    |       |
| Income tax provision                                                    |       | 1,476    |       | 2,866    |       | 1,489    |       |
|                                                                    |       |     |       |     |       |     |       |
| Net income                                                              |       | $        | 1,929      |     | $          | 3,837    |       | $ | 1,929 |   |
|                                                                    |       |     |       |     |       |     |       |
| Earnings per common share                                               |       |     |       |     |       |     |       |
|                                                                    |       |     |       |     |       |     |       |
| Basic                                                                   |       | $        | 1.08       |     | $          | 2.31     |       | $ | 1.20 |   |
|                                                                    |       |     |       |     |       |     |       |
| Diluted                                                                 |       | $        | 1.03       |     | $          | 2.09     |       | $ | 1.00 |   |

 

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

 

3

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**

**YearsEnded December 31, 2007, 2006, and 2005**

**(Dollarsin Thousands, Except Share Data)**

 
| ** **                                                                                                       | ** ** | ** **    | ** ** | ** ** | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                                                                       | ** ** | ** **    | ** ** | ** ** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                                                                       | ** ** | **Number of** | ** ** | **Common** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                                                       | ** ** | **Shares**    | ** ** | **Stock**  | ** ** | **Earnings** | ** ** | **Income (loss)** | ** ** | **Total**  | ** ** |
| Balance at  December 31, 2004                                                                               |       | 1,608,019     |       | $          | 4,720      |         | $          | 2,526             |       | $          | 75         |   | $ | 7,321 |   |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| Comprehensive income:                                                                                            |       |          |       |       |       |         |       |              |       |       |       |
| Net income for the year                                                                                          |       | —        |       | —     |       | 1,929        |       | —            |       | 1,929      |       |
| Change in net unrealized gain on securities and other assets, net of reclassification  adjustment and tax effect |       | —        |       | —     |       | —       |       | (45               | )          | (45        | )          |
| Total comprehensive income                                                                                       |       |          |       |       |       |         |       |              |       | 1,884      |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| $.20 per share cash dividend                                                                                     |       | —        |       | —     |       | (326         | )          | —            |       | (326       | )          |
| Repurchase of stock options                                                                                      |       | (3,795        | )          | (15        | )          | —       |       | —            |       | (15        | )          |
| Exercise of stock options, including tax benefit                                                                 |       | 27,215        |       | 67         |       | —       |       | —            |       | 67         |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| Balance at  December 31, 2005                                                                               |       | 1,631,439     |       | 4,772      |       | 4,129        |       | 30                |       | 8,931      |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| Comprehensive income:                                                                                            |       |          |       |       |       |         |       |              |       |       |       |
| Net income for the year                                                                                          |       | —        |       | —     |       | 3,837        |       | —            |       | 3,837      |       |
| Change in net unrealized gain on securities and other assets, net of reclassification  adjustment and tax effect |       | —        |       | —     |       | —       |       | (51               | )          | (51        | )          |
| Total comprehensive income                                                                                       |       |          |       |       |       |         |       |              |       | 3,786      |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| $.35 per share cash dividend                                                                                     |       | —        |       | —     |       | (603         | )          | —            |       | (603       | )          |
| Stock compensation expense, net of tax benefit                                                                   |       | —        |       | 18         |       | —       |       | —            |       | 18         |       |
| Exercise of stock options, including tax benefit                                                                 |       | 90,276        |       | 270        |       | —       |       | —            |       | 270        |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| Balance at  December 31, 2006                                                                               |       | 1,721,715     |       | 5,060      |       | 7,363        |       | (21               | )          | 12,402     |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| Comprehensive income:                                                                                            |       |          |       |       |       |         |       |              |       |       |       |
| Net income for the year                                                                                          |       | —        |       | —     |       | 1,929        |       | —            |       | 1,929      |       |
| Change in net unrealized gain on securities and other assets, net of reclassification  adjustment and tax effect |       | —        |       | —     |       | —       |       | 122               |       | 122        |       |
| Total comprehensive income                                                                                       |       |          |       |       |       |         |       |              |       | 2,051      |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| $.25 per share cash dividend                                                                                     |       | —        |       | —     |       | (461         | )          | —            |       | (461       | )          |
| Exercise of stock options, including tax benefit                                                                 |       | 124,203       |       | 442        |       | —       |       | —            |       | 442        |       |
|                                                                                                             |       |          |       |       |       |         |       |              |       |       |       |
| Balance at  December 31, 2007                                                                               |       | 1,845,918     |       | $          | 5,502      |         | $          | 8,831             |       | $          | 101        |   | $ | 14,434 |   |

 

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

 

4

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2007, 2006, and 2005**

**(Dollarsin Thousands, Except Share Data)**

 
| ** **                                                                                 | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                 |       | $          | 1,929      |       | $          | 3,837      |       | $ | 1,929 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:         |       |       |       |       |       |       |       |
| Depreciation and amortization expense                                                      |       | 293        |       | 277        |       | 241        |       |
| Provision for loan losses                                                                  |       | 865        |       | 410        |       | 150        |       |
| Realized (gain) loss on sales of available for sale securities and  other investments, net |       | (216       | )          | (1,308     | )          | 92         |       |
| Amortization of deferred loan costs                                                        |       | 372        |       | 334        |       | 224        |       |
| Net amortization (accretion) of securities                                                 |       | (4         | )          | (3         | )          | 7          |       |
| Stock based compensation                                                                   |       | —     |       | 18         |       | —     |       |
| Deferred income tax benefit                                                                |       | (91        | )          | (32        | )          | (179       | )          |
| (Gain) loss on sale of equipment                                                           |       | —     |       | 12         |       | (1         | )          |
| Increase in cash surrender value of life insurance                                         |       | (124       | )          | (104       | )          | (85        | )          |
| (Increase) decrease in assets:                                                             |       |       |       |       |       |       |       |
| Trading assets                                                                             |       | 538        |       | (735       | )          | (224       | )          |
| Loans held for sale                                                                        |       | (705       | )          | 4,133      |       | (776       | )          |
| Interest receivable                                                                        |       | (392       | )          | (187       | )          | (210       | )          |
| Other assets                                                                               |       | (4,361     | )          | (465       | )          | 94         |       |
| Increase in liabilities:                                                                   |       |       |       |       |       |       |       |
| Interest payable                                                                           |       | 904        |       | 589        |       | 376        |       |
| Other liabilities                                                                          |       | 1,748      |       | 357        |       | 665        |       |
| Net cash provided by operating activities                                                  |       | 756        |       | 7,133      |       | 2,303      |       |
|                                                                                       |       |       |       |       |       |       |       |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net change in time deposits with other financial institutions                              |       | 1,000      |       | —     |       | (1,000     | )          |
| Proceeds from maturity of investment securities                                            |       | 24,217     |       | 5,831      |       | 597        |       |
| Purchase of investments                                                                    |       | (41,863    | )          | (8,575     | )          | (6,020     | )          |
| Net increase in loans                                                                      |       | (70,019    | )          | (43,118    | )          | (60,467    | )          |
| Loan purchases                                                                             |       | (11,001    | )          | (19,150    | )          | (13,448    | )          |
| Proceeds from loan sales                                                                   |       | 41,790     |       | 34,642     |       | 62,052     |       |
| Proceeds from sale of equipment                                                            |       | —     |       | 49         |       | 1          |       |
| Purchase of life insurance policies                                                        |       | (50        | )          | (1,100     | )          | —     |       |
| Additions to bank premises and equipment                                                   |       | (547       | )          | (584       | )          | (2,379     | )          |
| Net cash used by investing activities                                                      |       | (56,473    | )          | (32,005    | )          | (20,664    | )          |
|                                                                                            |            |            |            |            |            |            |            |  |  |  |

 

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

 

5

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2007, 2006, and 2005**

**(Dollarsin Thousands, Except Share Data)**

 
| ** **                                           | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **CASH FLOWS FROM FINANCING  ACTIVITIES**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net increase in deposits                             |       | 35,705     |       | 13,508     |       | 20,857     |       |
| Proceeds from FHLB borrowings                        |       | 20,500     |       | 12,000     |       | 10,000     |       |
| Repayments of FHLB borrowings                        |       | (2,750     | )          | (2,000     | )          | (4,900     | )          |
| Proceeds from exercise of stock options              |       | 442        |       | 270        |       | 67         |       |
| Repurchase of common stock and stock options         |       | —     |       | —     |       | (15        | )          |
| Cash dividends paid on common stock                  |       | (461       | )          | (603       | )          | (326       | )          |
| Net cash provided by financing activities            |       | 53,436     |       | 23,175     |       | 25,683     |       |
|                                                 |       |       |       |       |       |       |       |
| Net increase (decrease) in cash and cash equivalents |       | (2,281     | )          | (1,697     | )          | 7,322      |       |
|                                                 |       |       |       |       |       |       |       |
| **CASH AND CASH EQUIVALENTS,  BEGINNING**            |       | 22,434     |       | 24,131     |       | 16,809     |       |
|                                                 |       |       |       |       |       |       |       |
| **CASH AND CASH EQUIVALENTS,  ENDING**               |       | $          | 20,153     |       | $          | 22,434     |       | $ | 24,131 |   |
|                                                 |       |       |       |       |       |       |       |
| **OTHER CASH FLOW INFORMATION**                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                 |       |       |       |       |       |       |       |
| Interest paid                                        |       | $          | 7,100      |       | $          | 3,296      |       | $ | 2,412 |   |
|                                                 |       |       |       |       |       |       |       |
| Income taxes paid                                    |       | $          | 1,262      |       | $          | 1,520      |       | $ | 815 |   |

 

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

 

6

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Years Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

***Nature of Business***

 

The Bank provides a varietyof financial services to individuals and small businesses through its fouroffices on the Monterey Peninsula.  Itsprimary deposit products are demand and term certificate accounts.  Its primary lending products are residential,commercial, and Small Business Administration (SBA) loans.

 

***Basis of Presentation and Consolidation***

 

The consolidated financialstatements include the accounts of Northern California Bancorp, Inc. (the “Corporation”)and its wholly owned subsidiary, Monterey County Bank (the “Bank”).  All****significantinter-company balances and transactions have been eliminated in consolidation.

 

The Corporation determineswhether it has a controlling financial interest in an entity by firstevaluating whether the entity is a voting interest entity or a variableinterest entity under accounting principles generally accepted in the UnitedStates of America. Voting interest entities are entities in which the totalequity investment at risk is sufficient to enable the entity to finance itselfindependently and provides the equity holders with the obligation to absorblosses, the right to receive residual returns and the right to make decisionsabout the entity’s activities. The Corporation consolidates voting interestentities in which it has all, or at least a majority of, the votinginterest.  As defined in applicableaccounting standards, variable interest entities (VIEs) are entities that lackone or more of the characteristics of a voting interest entity.  A controlling financial interest in an entityis present when an enterprise has a variable interest, or a combination ofvariable interests, that will absorb a majority of the entity’s expectedlosses, receive a majority of the entity’s expected residual returns, orboth.  The enterprise with a controllingfinancial interest, known as the primary beneficiary, consolidates theVIE.  The Corporation’s wholly ownedsubsidiaries, Northern California Bancorp, Inc. Trust I and NorthernCalifornia Bancorp, Inc. Trust II, are VIEs for which the Corporation isnot the primary beneficiary. Accordingly, the accounts of these entities are not included in theCorporation’s consolidated financial statements at December 31, 2007 and2006.

 

7

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Use of Estimates***

 

In preparing consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States of America, management is required to makeestimates and assumptions that affect the reported amounts of assets andliabilities as of the date of the balance sheet and reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ from thoseestimates.  Material estimates that areparticularly susceptible to significant change in the near term relate to thedetermination of the allowance for loan losses, and the valuation of deferredtax assets.

 

***Cash and Cash Equivalents***

 

For purposes of reportingcash flows, cash and cash equivalents include cash, amounts due from banks andFederal funds sold on a daily basis, all of which mature within ninety days.

 

***Time Deposits with Other Financial Institutions***

 

Interest-bearing deposits inbanks mature within one year and are carried at cost.

 

***Trading Activities***

 

The Corporation engages intrading activities consisting of securities that are held principally forresale in the near term.  The securitiesare recorded in the trading assets account at fair value with changes in fairvalue recorded in earnings.  Interest anddividends are included in net interest income.

 

Quoted market prices, whenavailable, are used to determine the fair value of trading instruments.  If quoted market prices are not available,then the fair values are estimated using pricing models, quoted prices ofinstruments with similar characteristics, or discounted cash flows.

 

8

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Investment Securities***

 

Investments in debtsecurities that management has the positive intent and ability to hold tomaturity are classified as “held to maturity” and reflected at cost, adjustedfor amortization of premiums and accretion of discounts, which are recognizedas adjustments to interest income.  Othermarketable securities are classified as “available for sale” and are reflectedat fair value, with unrealized gains and losses excluded from earnings andreported in other comprehensive income.

 

Purchase premiums anddiscounts are recognized in interest income using the interest method over theterms of the securities. Declines in the fair value of held-to-maturity andavailable for sale securities below their cost that are deemed to be other thantemporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairmentlosses, management considers (1) the length of time and the extent towhich the fair value has been less than cost, (2) the financial conditionand near-term prospects of the issuer, and (3) the intent and ability ofthe Bank to retain its investment in the issuer for a period of time sufficientto allow for any anticipated recovery in fair value.  Gains and losses on disposition are generallyrecognized on the trade date, based on the net proceeds and the adjustedcarrying amount of the securities sold using the specific identificationmethod.

 

***Sales and Servicing of SBA Loans***

 

The Bank originates loans tocustomers under the Small Business Administration (SBA) program that generallyprovides for SBA guarantees of 70% to 85% of each loan.  The Bank generally sells the guaranteedportion of each loan to a third party and retains only the non-guaranteedportion in its own portfolio.  A gain isrecognized on these loans through collection on sale of a premium over theadjusted carrying value, or through retention of an ongoing rate differential,less a normal service fee between the rate paid by the borrower to the Bank andthe rate paid by the Bank to the purchaser (excess servicing fee).  In calculating the gain, the Bank assumesthat the loans sold will be outstanding for one-half of their contractuallives.

 

9

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Sales and Servicing of SBA Loans (Continued)***

 

The Bank’s investment in anSBA loan is allocated among the retained portion of the loan, excess servicingretained, and the sold portion of the loan, based on the relative fair marketvalue of each portion at the time of loan origination, adjusted for paymentsand other activities.  Since the portionretained does not carry an SBA guarantee, part of the gain recognized on thesold portion of the loan is deferred and amortized as a yield enhancement onthe retained portion of the loan.  Excessservicing fees are reflected as an asset which is amortized over an expectedhalf life; in the event future prepayments are significant and future expectedcash flows are inadequate to cover the unamortized excess servicing asset,additional amortization is recognized.

 

***Loans Held for Sale***

 

Loans held for sale consistof the portion of loans that are guaranteed by the SBA and are carried at thelower of cost or market.  Market valuefor loans guaranteed by the SBA is generally determined based on the price atwhich the loans were committed to be sold on the trade date.  Direct loan origination costs are recorded atsettlement as an adjustment to gain or loss on sale.

 

***Loans and Loan Fees***

 

The Bank grants mortgage,commercial, construction, and consumer loans to customers.  A substantial portion of the loan portfoliois represented by****mortgage loanson the Monterey Peninsula.  The abilityof the Bank’s debtors to honor their contracts is dependent upon the realestate and general economic conditions in the area.

 

Loans, as reported, havebeen reduced by****undisbursed loanfunds, net deferred loan fees, and the allowance for loan losses.

 

Loans that management hasthe intent and ability to hold for the foreseeable future or until maturity orpay-off generally are reported at their outstanding unpaid principal balancesadjusted for charge-offs, the allowance for loan losses, and any deferred feesor cost on originated loans.  Interestincome is accrued on the unpaid principal balance.  Loan origination fees, net of certain directorigination costs, are deferred and recognized as an adjustment of the relatedloan yield using the interest method.

 

10

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Loans and Loan Fees (Continued)***

 

The accrual of interest onmortgage and commercial loans is discontinued at the time the loan is 90 dayspast due unless the credit is well-secured and in process of collection.  Credit card loans and other personal loansare typically charged off no later than 180 days past due.  Past due status is based on contractual termsof the loan.  In all cases, loans areplaced on nonaccrual or charged-off at an earlier date if collection ofprincipal or interest is considered doubtful.

 

All interest accrued but notcollected for loans that are placed on nonaccrual or charged off is reversedagainst interest income.  The interest onthese loans is accounted for on the cash-basis or cost-recovery method, untilqualifying for return to accrual.  Loansare returned to accrual status when all the principal and interest amountscontractually due are brought current and future payments are reasonablyassured.

 

***Allowance for Loan Losses***

 

The allowance for loanlosses is established through a provision for loan losses charged to earningsand is maintained at a level considered adequate to provide for reasonablyforeseeable loan losses.

 

The provision and the levelof the allowance are evaluated on a regular basis by management and are basedupon management’s periodic review of the collectibility of the loans in lightof historical experience, known and inherent risks in the nature and volume ofthe loan portfolio, adverse situations that may affect the borrower’s abilityto repay, estimated value of any underlying collateral, and prevailing economicconditions.  This evaluation isinherently subjective as it requires estimates that are susceptible tosignificant change.  In addition, variousregulatory agencies, as an integral part of their examination process,periodically review the Bank’s allowance for losses on loans and other realestate owned. Such agencies may require the Bank to recognize additions to theallowance based on their judgment of information available to them at the timeof their examination.  Ultimately, lossesmay vary from current estimates and future additions to the allowance may benecessary.

 

Loan losses are chargedagainst the allowance when management believes the collectibility of the loanbalance is unlikely.  Subsequentrecoveries, if any, are credited to the allowance.

 

11

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Allowance for Loan Losses (Continued)***

 

The allowance consists ofspecific, general and unallocated components. The specific component relates to loans that are classified as eitherdoubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance isestablished when the discounted cash flows (or collateral value or observablemarket price) of the impaired loan is lower than that of the carrying value ofthat loan.  The general component coversnon-classified loans and is based on historical loss experience adjusted forqualitative factors.  An unallocatedcomponent is maintained to cover uncertainties that could affect management’sestimate of probable losses.  Theunallocated component of the allowance reflects the margin of imprecisioninherent in the underlying assumptions used in the methodologies for estimatingspecific and general losses in the portfolio.

 

A loan is consideredimpaired when, based on current information and events, it is probable that acreditor will be unable to collect the scheduled payments of principal orinterest when due according to the contractual terms of the loan agreement.  Factors considered by management indetermining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments whendue.  Loans that experience insignificantpayment delays and payment shortfalls generally are not classified asimpaired.  Management determines thesignificance of payment delays and payment shortfalls on a case-by-case basis,taking into consideration all of the circumstances surrounding the loan and theborrower, including the length of the delay, the reasons for the delay, theborrower’s prior payment record, and the amount of the shortfall in relation tothe principal and interest owed. Impairment is measured on a loan-by-loan basis by either the presentvalue of expected future cash flows discounted at the loan’s effective interestrate, the loan’s obtainable market price, or the fair value of the collateralif the loan is collateral dependent. Substantially, all of the Bank’s loans that have been identified asimpaired have been measured by the fair value of existing collateral.

 

Large groups of smallerbalance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Bank does not separatelyidentify individual consumer loans for impairment disclosures.

 

***Loan Servicing***

 

Rights to service loans forothers are capitalized as separate assets, whether acquired through purchase ororigination, if such loans are sold or securitized with servicing rightsretained.  Accordingly, the total cost ofthe loan is allocated to the related servicing right and to the loan based onthe relative fair values if it is practicable to estimate those fair values.

 

12

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Loan Servicing (Continued)***

 

The Bank estimates fairvalue based on the present value of estimated expected future cash flows usingprepayment speeds and discount rates commensurate with the risks involved, andservicing costs determined on an incremental cost basis.

 

Capitalized mortgageservicing rights are reported in other assets and amortized to servicingrevenue in proportion to, and over the period of, estimated future netservicing revenues of the underlying assets. Impairment of mortgage servicing rights is assessed based on the fairvalue of those rights.  For purposes ofmeasuring impairment, the rights are stratified based on the followingpredominant risk characteristics of the underlying loans: loan type, size, noterate, date of origination, term, and geographic location.  Impairment is recognized through a valuationallowance for an individual stratum, to the extent that fair value is less thanthe capitalized amount for the stratum.

 

***Premises and Equipment***

 

The Banks premises andequipment are stated at cost less accumulated depreciation andamortization.  Depreciation is providedfor in amounts sufficient to relate the cost of depreciable assets tooperations over their estimated service lives. Leasehold improvements are amortized over the term of the lease or theservice lives of the improvements, whichever is shorter.  The straight-line method of depreciation isfollowed for financial reporting purposes, while both accelerated andstraight-line methods are followed for income tax purposes.

 

It is general practice tocharge the cost of****maintenance andrepairs to earnings when incurred; major expenditures for betterments are capitalizedand depreciated.

 

***Income Taxes***

 

Deferred income taxes arerecognized for estimated future tax effects attributable to income tax carryforwards as well as temporary differences between income tax and financialreporting purposes. Valuation allowances are established when necessary toreduce the deferred tax asset to the amount expected to be realized.  Deferred tax assets and liabilities arereflected at currently enacted income tax rates applicable to the period inwhich the deferred tax assets or liabilities are expected to be realized orsettled. As changes in tax laws or rates are enacted, deferred tax assets andliabilities are adjusted accordingly through the provision for income taxes.

 

13

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Transfers of Financial Assets***

 

Transfers of financialassets are accounted for as sales when control over the assets has beensurrendered. Control over transferred assets is deemed to be surrendered when1) the assets have been isolated from the Bank, 2) the transferee (buyer)obtains the right to pledge or exchange the transferred assets, free ofconditions that would constrain it from taking advantage of that right, and 3)the Bank does not maintain effective control over the transferred assetsthrough an agreement to repurchase them before their maturity.

 

***Stock Option Plans***

 

Under the Corporation’s 1998Stock Option Plan, the Corporation may grant incentive stock options andnon-qualified stock options to directors, officers, and employees of theCorporation and its subsidiary, so long as the Corporation owns a majority ofthe equity interest of such subsidiary. Incentive stock options are granted at fair value of the common stock onthe date of grant.  However, an incentivestock option granted to an individual owning 10% or more of the Corporation’sstock after such grant must have an exercise price of at least 110%****of such fair market value and an exerciseperiod of not more than five years. Non-qualified stock options may be granted at prices not lower than 85%of the fair market value of the common stock on the date of grant.  The Board of Directors is authorized todetermine when options become exercisable within a period not exceeding 10years from the date of grant.  Under thePlan, 211,081 shares of common stock have been reserved for the granting ofthese options.  At December 31,2007, 76,534 options were outstanding. During 2007, no options were granted, and 124,203 options were exercisedby officers, employees, and board members. As of December 31, 2007, all options have been vested.

 

Under the Corporation’s 2007Stock Option Plan, the Corporation may grant incentive stock options andnon-qualified stock options to directors, officers, and employees of theCorporation and its subsidiary, so long as the Corporation owns a majority ofthe equity interest of such subsidiary. Incentive stock options are granted at fair value of the common stock onthe date of grant.  However, an incentivestock option granted to an individual owning 10% or more of the Corporation’sstock after such grant must have an exercise price of at least 110%****of such fair market value and an exerciseperiod of not more than five years.  TheBoard of Directors is authorized to determine when options become exercisablewithin a period not exceeding 10 years from the date of grant.  Under the Plan, 300,000 shares of commonstock have been reserved for the granting of these options.  At December 31, 2007, no options wereissued or outstanding.

 

14

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Stock Option Plan (Continued)***

 

The Corporation adopted theprovisions of SFAS No. 123R, effective January 1, 2006, using themodified prospective method and began recording compensation expense associatedwith stock-based awards in accordance with SFAS No. 123R.  SFAS No. 123R requires all share-basedpayments to employees, including grants of employee stock options, to berecognized as compensation expense through the income statement based on theirfair values at issue date. SFAS No. 123R also requires the benefits of taxdeductions in excess of recognized compensation cost to be reported as afinancing cash flow, rather than as an operating cash flow required undercurrent guidelines.  Pre-tax stock-basedcompensation expense was $0 and $18,000 for the years ended December 31,2007 and 2006.  There were no optionsgranted during both of the years ended December 31, 2007 and 2006.

 

Future levels ofcompensation cost recognized related to stock-based compensation awards(including the aforementioned expected costs during the period of adoption) maybe impacted by new awards and/or modifications, repurchases and cancellationsof existing awards before and after the adoption of this standard.

 

The Corporation had appliedAccounting Principles Board Opinion No. 25 and related Interpretations, inaccounting for the stock option plan prior to January 1, 2006. Under APBOpinion No. 25, stock options issued under the Corporation’s stock optionplan have no intrinsic value at the grant date, and therefore, no compensationcost is recognized for them.

 

The following tableillustrates the effect on the Corporation’s reported net income and earningsper share if the Company had applied the fair value recognition provision ofSFAS No. 123 to stock-based employee compensation for the year ended December 31,2005:

 

15

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Stock Option Plan (Continued)***

 
| Reported net earnings                                            |   | $       | 1,929,300 |   |
|------------------------------------------------------------------|--------|---------|-----------|--------|
| Additional expense had the Corporation adopted SFAS No. 123 |   | (52,400 | )         |
| Related income tax benefit                                       |   | 22,000  |      |
| Pro forma net earnings                                           |   | $       | 1,898,900 |   |
|                                                             |   |    |      |
| Earnings per share as reported:                                  |   |    |      |
| Basic                                                            |   | $       | 1.20      |   |
| Diluted                                                          |   | $       | 1.00      |   |
| Pro forma earnings per share:                                    |   |    |      |
| Basic                                                            |   | $       | 1.18      |   |
| Diluted                                                          |   | $       | 1.11      |   |

 

The fair value of theseoptions was estimated at the grant date using the Black-Scholes option pricingmodel with the following weighted-average assumptions for 2005: risk-freeinterest rate of 4.6%; dividend yield of 1.3%; expected option life of 4 years;and volatility of 20%.

 

The expected volatility isbased on historical volatility. The risk-free interest rates for periods withinthe contractual life of the awards are based on the U.S. Treasury yield curvein effect at the time of the grant. The expected life is based on historicalexercise experience. The dividend yield assumption is based on the Company’shistory and expectation of dividend payouts.

 

16

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Earnings per share***

 

Basic earnings per sharerepresent income available to common shareholders divided by theweighted-average number of common shares outstanding during the period.  Diluted earnings per share reflect additionalcommon shares that would have been outstanding if dilutive potential commonshares had been issued, as well as any adjustment to income that would resultfrom the assumed issuance.  Potentialcommon shares that may be issued by the Corporation relate solely tooutstanding stock options, and are determined using the treasury stockmethod.  The weighted average number ofshares outstanding for basic earnings per share amounted to 1,785,812for 2007, 1,658,675 for2006, and 1,614,196 for 2005.  Theweighted average number of shares outstanding for dilutive earnings per shareamounted to 1,881,004 for 2007, 1,831,892 for 2006, and 1,923,532 for2005.  The Corporation paid cashdividends of $.25, $.35, and $.20 per share in 2007, 2006 and 2005,respectively.

 

***Recent Accounting Pronouncements***

 

In June 2006, theFinancial Accounting Standards Board (FASB) issued FASB Interpretation No. 48*“Accounting for Uncertainty in Income Taxes(an interpretation of SFAS Statement No. 109”)*.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006 with earlier adoption encouraged.  FIN 48 was issued to clarify the accountingfor uncertainty in income taxes recognized in the consolidated financialstatements by prescribing a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. The adoption of FIN 48 did not have an impact on the Corporation’sconsolidated financial statements and results of operations.

 

In March of 2006, theFASB issued SFAS No. 156, *Accountingfor Servicing of Financial Assets*, which amends SFAS No. 140, *Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities*, with respect to theaccounting for servicing of financial assets. SFAS No. 156 requires thatall separately recognized servicing rights be initially measured at fair value,if practicable. For each class of separately recognized servicing assets andliabilities, SFAS No. 156 permits an entity to choose either of thefollowing subsequent measurement methods: (1) the amortization ofservicing assets or liabilities in proportion to and over the period ofestimated net servicing income or net servicing loss or (2) the reportingof servicing assets or liabilities at fair value at each reporting date andreporting changes in fair value in earnings in the period in which the changesoccur. SFAS No. 156 also requires additional disclosures for allseparately recognized servicing rights. Early adoption is permitted as of thebeginning of an entity’s fiscal year, provided the entity has not yet issuedconsolidated financial statements, including interim consolidated financialstatements, for any period of that fiscal year.

 

17

----

 

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Recent Accounting Pronouncements (Continued)***

 

SFAS No. 156 iseffective the earlier of the date an entity adopts the requirements of SFAS No. 156,or as of the beginning of its first fiscal year beginning after September 15,2006. An entity should apply the requirements for recognition and initialmeasurement of servicing assets and servicing liabilities prospectively to alltransactions after the effective date of SFAS No. 156.  The adoption of SFAS No. 156 did nothave an impact on the Corporation’s consolidated financial statements andresults of operations.

 

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157 (“SFAS 157”),*“Fair Value Measurements”*,effective for the Corporation beginning on January 1, 2008, with earlieradoption permitted. This Statement defines fair value, establishes a frameworkfor measuring fair value, and expands disclosures about fair valuemeasurements.

 

This statement establishes afair value hierarchy that distinguishes between valuations obtained fromsources independent of the entity and those from the entity’s own unobservableinputs that are not corroborated by observable market data. SFAS 157 expandsdisclosures about the use of fair value to measure assets and liabilities ininterim and annual periods subsequent to initial recognition.  The disclosures focus on the inputs used tomeasure fair value and for recurring fair value measurements using significantunobservable inputs, the effect of the measurements on earnings or changes innet assets for the period. This statement encourages an entity to combine thefair value information disclosed under this statement with the fair valueinformation disclosed under other accounting pronouncements, including SFAS107, “Disclosures about Fair Value of Financial Instruments”, wherepracticable. The Corporation is currently assessing the impact of this guidanceon its financial statements.

 

On September 7, 2006,the Task Force reached a consensus on EITF Issue No. 06-4, Accounting forDeferred Compensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements (“EITF 06-4”) and on March 15, 2007, the TaskForce reached a consensus on EITF Issue No. 06-10, Accounting forCollateral Assignment Split-Dollar Life Insurance Arrangements(“EITF 06-10”).The scope of these two issues relates to the recognition of a liability andrelated compensation costs for endorsement split-dollar life insurancearrangements and for collateral assignment split-dollar life insurancearrangements, respectively.  EITF 06-4and EITF 06-10 are both effective for fiscal years beginning after December 15,2007, although early adoption is permitted. The financial impact of adoption of EITF 06-04 and EITF 06-10 isestimated at $361,000.

 

18

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Recent Accounting Pronouncements (Continued)***

 

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities — including an amendment of FASB Statement No. 115”which is effective for the Corporation as of the beginning of the first fiscalyear that begins after November 15, 2007. Early adoption is permitted as of the fiscal year that begins on orafter November 15, 2006, provided that the Corporation also elects toapply the provisions of FASB Statement No. 157, “Fair Value Measurements”.  The Corporation is currently evaluating theimpact of adopting this Statement on the Bank’s financial statements.

 

***Comprehensive Income (Loss)***

 

Accounting principlesgenerally require that recognized revenue, expenses, gains, and losses beincluded in net income.  Although certainchanges in assets and liabilities, such as unrealized gains and losses onavailable-for-sale securities, are reported as a separate component of theequity section of the balance sheet, such items, along with net income, arecomponents of comprehensive income.

 

The components of othercomprehensive income (loss) and related tax effects for the years ended December 31,are as follows:

** **
| ** **                                                                                | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                | ** ** | **(Dollars in thousands)** | ** ** |
| Unrealized holding gains (losses) on available for sale securities  and other assets, net |       | $                          | 438        |     | $          | (98      | )          | $ | (82 | ) |
| Reclassification adjustment for losses (gains) realized in income                         |       | (216                       | )          | 5        |       | —   |       |
| Net unrealized gains (losses)                                                             |       | 222                        |       | (93      | )          | (82      | )          |
| Tax effect                                                                                |       | (100                       | )          | 42       |       | 37       |       |
|                                                                                      |       |                       |       |     |       |     |       |
| Net-of-tax amount                                                                         |       | $                          | 122        |     | $          | (51      | )          | $ | (45 | ) |

 

19

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 1.****                            ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

 

***Comprehensive Income (Loss) (Continued)***

 

The components ofaccumulated other comprehensive income (loss) and related tax effects for theyears ended December 31, 2007 and 2006 are as follows:

** **
| ** **                                                             | ** ** | **2007**                   | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------|------------|----------|------------|
| ** **                                                             | ** ** | **(Dollars in thousands)** | ** ** |
| Unrealized holding gains  (losses) on available for sale securities    |       | $                          | 163        |     | $          | (79 | ) |
| Unrealized holding gains  on available for sale asset strip receivable |       | 21                         |       | 41       |       |
| Tax effect                                                             |       | (83                        | )          | 17       |       |
|                                                                   |       |                       |       |     |       |
| Net-of-tax amount                                                      |       | $                          | 101        |     | $          | (21 | ) |

 

***Advertising Costs***

 

Advertising costs arecharged to operations when incurred.  Theamount expensed for advertising as of December 31, 2007, 2006, and 2005was $164,000, $224,000, and $141,000, respectively.

 

***Reclassification***

 

Certain amounts have beenreclassified in the 2006 and 2005 financial statements to conform to the 2007presentation.

 

**Note 2.****                            ****CASH AND DUE FROM BANKS**

 

The Corporation is requiredto maintain aggregate reserves (in the form of cash and deposits with theFederal Reserve Bank) to satisfy federal regulatory requirements.  At December 2007 and 2006, these reservebalances amounted to $790,000 and $1,184,000, respectively.

 

20

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 3.****                            ****TRADING ASSETS**

 

At December 31, 2007and 2006, the Corporation’s trading assets consisted of marketable equitysecurities in the amount of $1,224,000 and $1,762,000, respectively.

 

**Note 4.****                            ****INVESTMENT SECURITIES AND OTHER INVESTMENTS**

 

The following is acomparison of amortized cost and approximate fair value of investmentsecurities at December 31, 2007 and 2006:

** **
| ** **                          | ** ** | ** **                 | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-------------------------------------|------------|----------------------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                          | ** ** | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                          | ** ** | **Cost**                   | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| ** **                          | ** ** | **December 31, 2007** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| **Securities Available for Sale**   | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** ** | ** ** |
| GNMA - Mortgage Backed Securities   |       | $                          | 386        |           | $          | —         |       | $          | (1         | ) | $ | 385 |   |
| State/Local Agency Securities       |       | 225                        |       | —         |       | —         |       | 225        |       |
| Government Agency Securities        |       | 36,027                     |       | 179            |       | (15            | )          | 36,191     |       |
|                                |       |                       |       |           |       |           |       |       |       |
| Total securities available for sale |       | $                          | 36,638     |           | $          | 179            |       | $          | (16        | ) | $ | 36,801 |   |
|                                |       |                       |       |           |       |           |       |       |       |
| **Securities Held to Maturity**     | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** ** | ** ** |
| State/Local Agency Securities       |       | $                          | 7,869      |           | $          | 239            |       | $          | (3         | ) | $ | 8,105 |   |

 

21

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 4.****                            ****INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)**

 
| ** **                                          | ** ** | ** **                 | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                          | ** ** | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                                          | ** ** | **Cost**                   | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| ** **                                          | ** ** | **December 31, 2007** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)** | ** ** |
| **Other Investments, at cost**                      | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** ** | ** ** |
| AT Services LLC                                     |       | $                          | 20         |           | $          | —         |       | $          | —     |   | $ | 20 | ** ** |
| Federal Home Loan Bank stock, restricted            |       | 2,495                      |       | —         |       | —         |       | 2,495      | ** ** |
| Metrocities Mortgage, LLC                           |       | 10                         |       | —         |       | —         |       | 10         | ** ** |
| Northern California Bancorp, Inc. Trust I           |       | 93                         |       | —         |       | —         |       | 93         | ** ** |
| Northern California Bancorp, Inc. Trust II          |       | 155                        |       | —         |       | —         |       | 155        | ** ** |
| The Independent Bankers’ Financial Corporation |       | 51                         |       | —         |       | —         |       | 51         | ** ** |
|                                                |       |                       |       |           |       |           |       |       | ** ** |
| Total other investments                             |       | $                          | 2,824      |           | $          | —         |       | $          | —     |   | $ | 2,824 | ** ** |
|                                                |       |                       |       |           |       |           |       |       | ** ** |
|                                                |       |                       |       |           |       |           |       |       | ** ** |
|                                                |       | ** **                 | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|                                                |       | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
|                                                |       | **Cost**                   | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| ** **                                          | ** ** | **December 31, 2006** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)** | ** ** |
| **Securities Available for Sale**                   | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** ** | ** ** |
| GNMA - Mortgage Backed Securities                   |       | $                          | 641        |           | $          | —         |       | $          | (15        | ) | $ | 626 | ** ** |
| Government Agency Securities                        |       | 14,724                     |       | 2              |       | (66            | )          | 14,660     | ** ** |
|                                                |       |                       |       |           |       |           |       |       | ** ** |
| Total securities available for sale                 |       | $                          | 15,365     |           | $          | 2              |       | $          | (81        | ) | $ | 15,286 | ** ** |
|                                                |       |                       |       |           |       |           |       |       | ** ** |
| **Securities Held to Maturity**                     | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** ** | ** ** |
| State/Local Agency Securities                       |       | $                          | 7,012      |           | $          | 268            |       | $          | —     |   | $ | 7,280 | ** ** |

 

22

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 4.****                            ****INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)**

** **
|                                                |       | ** **                 | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|----------------|------------|----------------|------------|------------|------------|
|                                                |       | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
|                                                |       | **Cost**                   | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| ** **                                          | ** ** | **December 31, 2006** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)** | ** ** |
| **Other Investments, at cost**                      | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** ** | ** ** |
| AT Services LLC                                     |       | $                          | 20         |           | $          | —         |       | $          | —     |   | $ | 20 | ** ** |
| Federal Home Loan Bank stock, restricted            |       | 1,633                      |       | —         |       | —         |       | 1,633      | ** ** |
| Metrocities Mortgage, LLC                           |       | 10                         |       | —         |       | —         |       | 10         | ** ** |
| Northern California Bancorp, Inc. Trust I           |       | 93                         |       | —         |       | —         |       | 93         | ** ** |
| Northern California Bancorp, Inc. Trust II          |       | 155                        |       | —         |       | —         |       | 155        | ** ** |
| The Independent Bankers’ Financial Corporation |       | 50                         |       | —         |       | —         |       | 50         | ** ** |
| MasterCard Inc. Class “B” Stock      |       | 6                          |       | —         |       | —         |       | 6          | ** ** |
|                                                |       |                       |       |           |       |           |       |       | ** ** |
| Total other investments                             |       | $                          | 1,967      |           | $          | —         |       | $          | —     |   | $ | 1,967 | ** ** |

 

The amortized cost and fairvalue of debt securities by contractual maturity date at December 31, 2007follows:

** **
| ** **                              | ** ** | **Available for Sale**     | ** ** |
|-----------------------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | **Amortized**              | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **Cost**                   | ** ** | **Value** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)** | ** ** |
| Due within one year                     |       | $                          | 1,000      |   | $ | 999 |   |
| Due after five years  through ten years |       | 11,250                     |       | 11,311 |   |
| Due after ten years                     |       | 24,002                     |       | 24,106 |   |
| GNMA - Mortgage Backed  Securities      |       | 386                        |       | 385 |   |
|                                    |       | $                          | 36,638     |   | $ | 36,801 |   |

 

23

----

 

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 4.****                            ****INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)**

** **

| ** **          | ** ** | **Held to Maturity**       | ** ** |
|---------------------|------------|----------------------------|------------|
| ** **          | ** ** | **Amortized**              | ** ** | **Fair** | ** ** |
| ** **          | ** ** | **Cost**                   | ** ** | **Value** | ** ** |
| ** **          | ** ** | **(Dollars in thousands)** | ** ** |
| Due after ten years |       | $                          | 7,869      |   | $ | 8,105 |   |
|                     |            |                            |            |  |  |  |  |

 

Proceeds from maturity andsales of investment securities for the years ended December 31, 2007,2006, and 2005 were $24,217,000, $5,831,000, and $597,000, respectively.  Realized gains (losses) for the years ended December 31,2007, 2006, and 2005 were $216,000, $1,312,000, and $(92,000), respectively.

 

On January 31, 2006,Monterey County Bank, a wholly owned subsidiary of Northern California Bancorp, Inc.,sold its shares of common stock in Pacific Coast Banker’s Bancshares (“PCBB”).  The gross sales proceeds were $1,757,000.After subtracting the book value of $440,000, the resulting pretax gain was$1,313,000. The after tax gain will approximate $790,000. Monterey County Bankowned 3,699 shares of PCBB that sold for $475.00 per share less a $4,000 salescharge.

 

As a member of the FederalHome Loan Bank (FHLB) system, the Bank is required to maintain an investment inFHLB stock in an amount equal to the greater of 1% of its outstanding mortgageloans or 5% of advances from the FHLB. As of December 31, 2007 and 2006,the Bank had advances from the FHLB totaling $52,500,000 and $34,750,000,respectively. No ready market exists for FHLB stock, and it has no quotedmarket value. FHLB stock is evaluated for impairment based on an estimate ofthe ultimate recoverability of par value.

 

At December 31, 2007and 2006, U.S. Government obligations with a carrying value of $31,576,000 and$15,286,000, respectively, were pledged to secure advances from the FHLB.

 

In December 2007, thebank purchased two debt securities totaling $5,225,000 that have settlementdates in January 2008.  The bankrecords their investment purchases as of the trade date and has recorded thecorresponding payable for investment securities purchased of $5,225,000 at December 31,2007.

 

 

24

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 4.****                            ****INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)**

 

Information pertaining tosecurities with gross unrealized losses at December 31, 2007, aggregatedby investment category and length of time that individual securities have beenin a continuous loss position follows:

 
| ** **                        | ** ** | **Less than 12 Months**    | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|----------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                        | ** ** | **Fair**                   | ** ** | **Unrealized**        | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                        | ** ** | **Value**                  | ** ** | **Loss**              | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
| ** **                        | ** ** | **(Dollars in thousands)** | ** ** |
| Securities Available for Sale:    |       |                       |       |                  |       |      |       |   |   |   |   |   |   |
| GNMA - Mortgage Backed Securities |       | $                          | 385        |                  | $          | (1        | )          | $ | — |   | $ | — |   | $ | 385 |   | $ | (1 | ) |
| Government Agencies               |       | 2,147                      |       | (14                   | )          | 1,000     |       | (1 | ) | 3,147 |   | (15 | ) |
|                              |       |                       |       |                  |       |      |       |   |   |   |   |   |   |
| Total                             |       | $                          | 2,532      |                  | $          | (15       | )          | $ | 1,000 |   | $ | (1 | ) | $ | 3,532 |   | $ | (16 | ) |
|                              |       |                       |       |                  |       |      |       |   |   |   |   |   |   |
| Securities Held to Maturity:      |       |                       |       |                  |       |      |       |   |   |   |   |   |   |
| State/Local Agency Securities     |       | $                          | 867        |                  | $          | (3        | )          | $ | — |   | $ | — |   | $ | 867 |   | $ | (3 | ) |

 

 

25

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2007 and 2006**

 

**Note 4.****                            ****INVESTMENT SECURITIES AND OTHER INVESTMENTS (Continued)**

 

Information pertaining tosecurities with gross unrealized losses at December 31, 2006, aggregatedby investment category and length of time that individual securities have beenin a continuous loss position follows:

** **
| ** **                        | ** ** | **Less than 12 Months**    | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|----------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                        | ** ** | **Fair**                   | ** ** | **Unrealized**        | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                        | ** ** | **Value**                  | ** ** | **Loss**              | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
| ** **                        | ** ** | **(Dollars in thousands)** | ** ** |
| Securities Available for Sale:    |       |                       |       |                  |       |      |       |   |   |   |   |   |   |
| GNMA - Mortgage Backed Securities |       | $                          | 626        |                  | $          | (15       | )          | $ | — |   | $ | — |   | $ | 626 |   | $ | (15 | ) |
| Government Agencies               |       | 5,983                      |       | (6                    | )          | 5,675     |       | (60 | ) | 11,658 |   | (66 | ) |
|                              |       |                       |       |                  |       |      |       |   |   |   |   |   |   |
| Total                             |       | $                          | 6,609      |                  | $          | (21       | )          | $ | 5,675 |   | $ | (60 | ) | $ | 12,284 |   | $ | (81 | ) |

 

There were no unrealizedlosses at December 31, 2006 pertaining to securities held to maturity.

 

Management evaluatessecurities for other-than-temporary impairment at least on a quarterly basis,and more frequently when economic or market concerns warrant such evaluation.Consideration is given to (1) the length of time and the extent to whichthe fair value has been less than cost, (2) the financial condition andnear-term prospects of the issuer, and (3) the intent and ability of theBank to retain its investment in the issuer for a period of time sufficient toallow for any anticipated recovery in fair value.

 

On December 31, 2007,four securities had an unrealized loss with aggregate depreciation of 0.05%from the Bank’s amortized cost basis. On December 31, 2006, sevensecurities had an unrealized loss with aggregate depreciation of 0.65% from theBank’s amortized cost basis. The unrealized losses relate to a mortgage backedsecurity issued by federally sponsored agencies, which are fully secured byconforming residential loans, securities issued by agencies of the UnitedStates and securities issued by local government agencies.  Since the Bank has the ability to hold thesesecurities until estimated maturity, no decline is deemed to be other thantemporary.

 

 

26

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 5.****                            ****SALES AND SERVICING OF SBA LOANS**

 

A summary of the activity ofSBA loans follows:

 
| ** **           | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **           | ** ** | **(Dollars in thousands)** | ** ** |
| SBA loans originated |       | $                          | 3,065      |     | $          | 3,645    |       | $ | 6,274 |   |
| SBA loans sold       |       | $                          | 1,933      |     | $          | 4,428    |       | $ | 7,945 |   |

 

 

A summary of income from SBAloans sold is as follows:

 

 
| ** **                            | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|----------|------------|----------|------------|
|                                  | ** ** | **(Dollars  in thousands)** | ** ** |
| Income from premiums                  |       | $                           | 147        |     | $          | 350      |       | $ | 665 |   |
| Income from servicing                 |       | 333                         |       | 340      |       | 326      |       |
|                                  |       |                        |       |     |       |     |       |
| Total SBA sales and  servicing income |       | $                           | 480        |     | $          | 690      |       | $ | 991 |   |
|                                  |       |                        |       |     |       |     |       |

 

27

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 6.****                            ****LOANS AND ALLOWANCE FOR LOAN LOSSES**

 

A summary of loan balancesfollows:

** **
| ** **                             | ** ** | **2007**                   | ** ** | **2006** | ** ** |
|----------------------------------------|------------|----------------------------|------------|----------|------------|
| ** **                             | ** ** | **(Dollars in thousands)** | ** ** |
| Commercial and industrial              |       | $                          | 28,310     |     | $          | 26,361 |   |
| Construction                           |       | 23,396                     |       | 17,326   |       |
| Real estate, mortgage                  |       | 116,625                    |       | 86,207   |       |
| Installment                            |       | 876                        |       | 694      |       |
| Government guaranteed  loans purchased |       | 32                         |       | 39       |       |
|                                   |       | 169,239                    |       | 130,627  |       |
| Allowance for loan losses              |       | (2,028                     | )          | (1,409   | )          |
| Deferred origination fees,  net        |       | (350                       | )          | (350     | )          |
| Loans, net                             |       | $                          | 166,861    |     | $          | 128,868 |   |

 

An analysis of the allowancefor loan losses follows:

** **
| ** **                | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning balance         |       | $                          | 1,409      |     | $          | 1,101    |       | $ | 963 |   |
| Recoveries                |       | 4                          |       | 7        |       | 2        |       |
| Loans charged off         |       | (250                       | )          | (109     | )          | (14      | )          |
| Provision for loan losses |       | 865                        |       | 410      |       | 150      |       |
| Ending balance            |       | $                          | 2,028      |     | $          | 1,409    |       | $ | 1,101 |   |

 

As of December 31, 2007and 2006, there were $3,396,000 and $155,000 in impaired loans,respectively.  No additional amounts arecommitted to be advanced in connection with impaired loans.

 

During the years ended December 31,2007 and 2006, the average recorded investment in impaired loans amounted toapproximately $702,000 and $142,000, respectively.  At December 31, 2007 and 2006 there were$3,396,000 and $155,000 in impaired loans with an allowance of $212,000 and$31,000, respectively. If interest on non-accrual loans had been accrued, suchincome would have approximated $133,000 and $11,000 for 2007 and 2006,respectively.  There were no non-accrualloans at December 31, 2005.

 

28

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 6.****                            ****LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)**

 

As of December 31, 2007and 2006, there were no loans past due ninety days or more and still accruinginterest.

 

Loans serviced for othersare not included in the accompanying balance sheets.  The unpaid principal balance of loansserviced for others was $109,294,000 and $101,138,000 at December 31, 2007and 2006, respectively.

 

**Note 7.****                            ****PREMISES AND EQUIPMENT**

 

A summary of the cost andaccumulated depreciation of banking premises and equipment and their estimateduseful lives follows:

** **
| ** **               | ** ** | ** **                 | ** ** | ** ** | ** ** | **Estimated**    | ** ** |
|--------------------------|------------|----------------------------|------------|------------|------------|------------------|------------|
| ** **               | ** ** | **2007**                   | ** ** | **2006**   | ** ** | **Useful Lives** | ** ** |
| ** **               | ** ** | **(Dollars in thousands)** | ** ** | ** ** | ** ** |
| Land                     |       | $                          | 1,174      |       | $          | 1,174            |       |   |   |
| Building                 |       | 1,808                      |       | 1,808      |       | 40  years        |       |
| Building improvements    |       | 1,114                      |       | 897        |       | 40  years        |       |
| Leasehold improvements   |       | 835                        |       | 833        |       | Lease  term      |       |
| Furniture and equipment  |       | 2,243                      |       | 1,932      |       | 3-8  years       |       |
|                     |       | 7,174                      |       | 6,644      |       |             |       |
| Accumulated depreciation |       | (2,300                     | )          | (2,031     | )          |             |       |
|                     |       | $                          | 4,874      |       | $          | 4,613            |       |   |   |

 

Depreciation andamortization expense for the years ending December 31, 2007, 2006, and2005 amounted to $293,000, $277,000, and $241,000, respectively.

 

29

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 8.****                            ****DEPOSITS**

 

AtDecember 31, 2007, the scheduled maturities of time deposits are asfollows:

** **

| **(Dollars  in thousands)** | ** ** |
|-----------------------------|------------|
| ** **                  | ** ** |
| 2008                        |       | $ | 67,675 |   |
| 2009                        |       | 31,006 |   |
| 2010                        |       | 18,965 |   |
| 2011                        |       | 1,748 |   |
| 2012                        |       | 1,964 |   |
| Thereafter                  |       | 74 |   |
|                        |       |   |   |
|                        |       | $ | 121,432 |   |
|                        |       |   |   |

 

**Note 9.****                            ****JUNIOR SUBORDINATED DEBT SECURITIES**

 

On March 27, 2003, theCorporation’s wholly owned special-purpose trust subsidiary, NorthernCalifornia Bancorp, Inc. Trust I (“Trust I”) issued $3 million incumulative Trust Preferred Securities. The securities bear a floating rate of interest of 3.25% over the threemonth LIBOR rate, payable quarterly.  Theeffective rate at December 31, 2007 and 2006 was 8.49% and 8.62%,respectively.  Concurrent with theissuance of the Trust Preferred Securities, Trust I used the proceeds from theTrust Preferred Securities offering to purchase a like amount of JuniorSubordinated Debentures of the Corporation. The Corporation will pay intereston the Junior Subordinated Debentures to Trust I, which represents the solerevenue and sole source of dividend distributions to the holders of the TrustPreferred Securities.  The Corporationhas the right, assuming no default has occurred, to defer payments of intereston the Junior Subordinated Debentures at any time for a period not to exceed 20consecutive quarters.

 

The Trust PreferredSecurities will mature on April 7, 2033, but can be redeemed under certaincircumstances at a premium prior to April 7, 2008, and can be redeemed, inwhole or in part, on any January 7, April 7, July 7 or October 7occurring after April 7, 2008 at par. The Corporation fully and unconditionally guarantees the obligations ofTrust I, on a subordinated basis.

 

The Corporation received$2.91 million from Trust I upon issuance of the Junior Subordinated Debentures,of which $1 million was contributed by the Corporation to the Bank to increaseits capital, $1.14 million was used to retire existing Corporation debt and theremainder was held as working capital. Under applicable regulatory guidelines, a portion of the Trust PreferredSecurities will qualify as Tier I Capital and the remainder as Tier II Capital.

 

 

30

----

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 9.****                            ****JUNIOR SUBORDINATED DEBT SECURITIES (Continued)**

 

On November 13, 2003,the Corporation’s wholly owned special-purpose trust subsidiary, NorthernCalifornia Bancorp, Inc. Trust II (“Trust II”) issued $5 million incumulative Trust Preferred Securities. The securities bear a floating rate of interest of 2.85% over the threemonth LIBOR rate, payable quarterly.  Theeffective rate at December 31, 2007 and 2006 was 7.76% and 8.22%,respectively. Concurrent with the issuance of the Trust Preferred Securities,Trust II used the proceeds from the Trust Preferred Securities offering topurchase a like amount of Junior Subordinated Debentures of the Corporation.The Corporation will pay interest on the Junior Subordinated Debentures toTrust II, which represents the sole revenue and sole source of dividenddistributions to the holders of the Trust Preferred Securities.  The Corporation has the right, assuming nodefault has occurred, to defer payments of interest on the Junior SubordinatedDebentures at any time for a period not to exceed 20 consecutive quarters.  The Trust Preferred Securities will mature onNovember 8, 2033, but can be redeemed under certain circumstances at apremium prior to November 8, 2008, and can be redeemed, in whole or inpart, on any February 8, May 8, August 8 or November 8occurring after November 8, 2008 at par. The Corporation fully and unconditionally guarantees the obligations ofTrust II on a subordinated basis.

 

The Corporation received$4.96 million from Trust II upon issuance of the Junior SubordinatedDebentures, of which $2.5 million was contributed by the Corporation to theBank to increase its capital and the remainder was held as working capital.

 

Issuance costs of $116,000and $54,000 related to Trust I and Trust II, respectively have been capitalizedand are being amortized over the 30-year life of the securities.

 

During the years ended December 31,2007, 2006 and 2005 interest expense on Junior Subordinated Debentures totaled$696,000, $676,000, and $526,000, respectively. The amortization of the issuance cost totaled $6,000 for each year endedDecember 31, 2007, 2006 and 2005, respectively.

 

**Note 10.****                     ****FUNDING SOURCES**

 

The Bank has lines of creditfrom the Federal Home Loan Bank (FHLB) of San Francisco, Bank of the West,Pacific Coast Bankers’ Bank and The Independent Bank with remaining availableborrowing capacity on December 31, 2007 of $4,236,000, $4,500,000,$6,000,000 and $5,000,000, respectively. The Federal Home Loan Bank line of credit has a maximum borrowingcapacity of 25% of the Bank’s total assets, adjusted quarterly.  The Federal Home Loan Bank line of credit issecured by a portion of the Bank’s real estate secured loans and securities at December 31,2007.  At December 31, 2007, thetotal principal balance of pledged loans and securities was $41,309,000 and$31,576,000, respectively.

 

31

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 10.****                     ****FUNDING SOURCES (Continued)**

 

At December 31, 2006,the total principal balance of pledged loans and securities was $33,464,000 and$15,286,000, respectively.

 

The following table providesinformation on seventeen FHLB advances outstanding at December 31, 2007.

** **
| ** **                 | ** **       | **Fixed**    | ** ** | ** **  | ** ** | ** **   | ** ** |
|----------------------------|------------------|--------------|------------|-------------|------------|--------------|------------|
| **Advance**                | ** **       | **Interest** | ** ** | **Funding** | ** ** | **Maturity** | ** ** |
| **Amount**                 | ** **       | **Rate**     | ** ** | **Date**    | ** ** | **Date**     | ** ** |
| **(Dollars in thousands)** | ** **       |
| $                          |  3,000,000  |         | 4.30       | %           | 06/17/05   |         | 06/17/10   |   |
| 2,500,000                  |             | 4.88         | %          | 08/20/07    |       | 08/20/10     |       |
| 5,000,000                  |             | 4.96         | %          | 11/14/05    |       | 11/15/10     |       |
| 2,250,000                  |             | 4.75         | %          | 01/26/06    |       | 01/26/11     |       |
| 1,750,000                  |             | 4.72         | %          | 01/26/06    |       | 01/26/11     |       |
| 1,500,000                  |             | 5.52         | %          | 07/17/06    |       | 07/18/11     |       |
| 3,500,000                  |             | 5.49         | %          | 07/17/06    |       | 07/18/11     |       |
| 1,000,000                  |             | 5.22         | %          | 08/25/06    |       | 08/25/11     |       |
| 5,000,000                  |             | 5.20         | %          | 07/30/07    |       | 07/30/12     |       |
| 3,000,000                  |             | 4.85         | %          | 10/01/07    |       | 10/01/12     |       |
| 5,000,000                  |             | 5.00         | %          | 09/18/07    |       | 09/18/14     |       |
| 1,000,000                  |             | 7.72         | %          | 08/21/01    |       | 06/03/30     |       |
| 4,000,000                  |             | 5.96         | %          | 08/02/04    |       | 07/28/34     |       |
| 5,000,000                  |             | 5.63         | %          | 12/24/04    |       | 12/22/34     |       |
| 2,000,000                  |             | 5.13         | %          | 05/04/05    |       | 05/01/35     |       |
| 2,000,000                  |             | 5.31         | %          | 11/17/06    |       | 11/17/36     |       |
| 5,000,000                  |             | 5.88         | %          | 06/29/07    |       | 06/29/37     |       |
| $                          |  52,500,000 |         |       |        |       |         |       |   |

 

The Bank of the West,Pacific Coast Bankers’ Bank and The Independent Bank lines of credit areunsecured.  The Bank did not utilize anyovernight borrowings in 2007 or 2006.

 

The Bank has a $330,000letter of credit issued by the Federal Home Loan Bank of San Francisco tosecure the uninsured portion of local agency deposits maintained with theBank.  The letter of credit matures April 17,2011.

 

32

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 11.****                     ****INCOME TAXES**

 

Allocation of federal andCalifornia income taxes between current and deferred portions is as follows:

** **
| ** **                         | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Current tax provision:             |       |                       |       |     |       |     |       |
| Federal                            |       | $                          | 1,099      |     | $          | 2,130    |       | $ | 1,218 |   |
| California                         |       | 468                        |       | 768      |       | 450      |       |
|                               |       | 1,567                      |       | 2,898    |       | 1,668    |       |
| Deferred tax provision  (benefit): |       |                       |       |     |       |     |       |
| Federal                            |       | (259                       | )          | (117     | )          | (213     | )          |
| California                         |       | (110                       | )          | (50      | )          | (41      | )          |
| Increase in valuation allowance    |       | 278                        |       | 135      |       | 75       |       |
|                               |       | (91                        | )          | (32      | )          | (179     | )          |
|                               |       | $                          | 1,476      |     | $          | 2,866    |       | $ | 1,489 |   |

 

The differences between thestatutory federal income tax rate and the effective tax rates are summarized asfollows:
|                                         |       |     |       |     |       |     |       |   |   |   |
|----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|--------|--------|--------|
| ** **                                   | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Statutory federal tax rate                   |       | 34.00    | %          | 34.00    | %          | 34.00    | %          |
| California taxes, net of federal tax benefit |       | 7.20     |       | 7.20     |       | 7.20     |       |
| Other, net                                   |       | 2.15     |       | 1.56     |       | 2.37     |       |
| Effective tax rates                          |       | 43.35    | %          | 42.76    | %          | 43.57    | %          |

 

33

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 11.****                     ****INCOME TAXES (Continued)**

 

The components of the netdeferred tax asset, included in other assets, are as follows:

** **
| ** **                                                                                                 | ** ** | **2007**                    | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------|------------|
| ** **                                                                                                 | ** ** | **(Dollars in thousands)**  | ** ** |
| Deferred tax asset                                                                                         |       |                        |       |     |       |
| Federal                                                                                                    |       | $                           | 1,194      |     | $          | 842 |   |
| California                                                                                                 |       | 371                         |       | 232      |       |
|                                                                                                       |       |                        |       |     |       |
| Total deferred tax asset                                                                                   |       | 1,565                       |       | 1,074    |       |
| Valuation allowance                                                                                        |       | (823                        | )          | (545     | )          |
|                                                                                                       |       |                        |       |     |       |
| Net deferred tax asset                                                                                     |       | $                           | 742        |     | $          | 529 |   |
|                                                                                                       |       |                        |       |     |       |
| The tax effects of each  type of income and expense items that give rise to deferred taxes are as  follows |
|                                                                                                       |
|                                                                                                       | ** ** | **2007**                    | ** ** | **2006** | ** ** |
|                                                                                                       | ** ** | **(Dollars  in thousands)** | ** ** |
| Deferred tax assets  (liabilities)                                                                         |       |                        |       |     |       |
| Net unrealized gain on securities                                                                          |       | $                           | 310        |     | $          | 8 |   |
| California franchise tax                                                                                   |       | 100                         |       | 182      |       |
| Allowance for loan losses                                                                                  |       | 860                         |       | 601      |       |
| Accrued salary continuation liability                                                                      |       | 383                         |       | 383      |       |
| Depreciation                                                                                               |       | (88                         | )          | (100     | )          |
|                                                                                                       |       |                        |       |     |       |
| Total deferred tax asset                                                                                   |       | 1,565                       |       | 1,074    |       |
| Valuation allowance                                                                                        |       | (823                        | )          | (545     | )          |
|                                                                                                       |       |                        |       |     |       |
| Net deferred tax asset                                                                                     |       | $                           | 742        |     | $          | 529 |   |

 

The Bank establishes avaluation allowance if, based on the weight of evidence, it is more likely thannot that some portion or all of the deferred tax assets will not be realized.

 

34

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 12.****                     ****COMMITMENTS**

 

In the normal course ofbusiness, there are outstanding commitments that are not reflected in theconsolidated financial statements.

 

***Operating lease commitments***

 

The Bank leases its branchoffices in Carmel By-The-Sea, Carmel Valley, Pacific Grove and a Salinas branchoffice which is scheduled to open during the second quarter of 2008.  The Carmel By-The-Sea office has a five andone half year lease with four, five year options and commenced in April 2002.  The Carmel Valley building has a twenty-fiveyear lease which commenced in March 1981 and an addendum to the leaseexecuted in 2005 provides for two options to renew the lease for an additional10 years each, and may be adjusted annually for changes in the Consumer PriceIndex.  The Pacific Grove building has afive-year lease with five, five-year options and commenced in April 1997.  The Salinas building has a five-year leasewith four, five-year options and commenced in November 2007.      The Bank leases approximately 1,000 squarefeet at 321 Webster Street, Monterey, CA. The 321 Webster Street lease has a term of three years commencing September 2000,with a three-year option.  An addendum tothe lease was executed in 2004 and provided for two, five year options toextend the lease, which commenced in September 2006.  The Bank also leases certain equipment usedin the normal course of business.

 

Rent expense for operatingleases is included in occupancy and equipment expense and amounted toapproximately $286,000, $275,000, and $286,000 in 2007, 2006, and 2005,respectively.

 

Effective April 1,2000, the Bank entered into a five year sublease agreement to rent one of theunits in the Carmel Valley branch, upon expiration of the sublease in 2005 theBank elected to retain the space for its own use.  Sublease rental income for the year ending2005 was approximately $27,000.

 

Effective July 1, 2002,the Bank entered into a five year and three months sublease agreement to rentone of the units in the Carmel-By-The-Sea branch.  The sublease was terminated in 2006 due todefault for non-payment of rent. Sublease rental income for the years ending 2006 and 2005 wasapproximately $24,000 and $40,000, respectively.  In 2007 approximately $18,000 in delinquent2006 rent was collected.  The Bank hasdecided to retain the subleased portion of the facility for its own use.

 

35

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 12.****                     ****COMMITMENTS (Continued)**

 

Future minimum leasecommitments for all non-cancelable operating leases are as follows:

** **

| **Year Ending**      | ** ** | **Minimum Lease** | ** ** |
|----------------------|------------|-------------------|------------|
| **December 31** | ** ** | **Commitments**   | ** ** |
| 2008                 |       | $                 | 363,500    |   |
| 2009                 |       | 363,500           |       |
| 2010                 |       | 363,500           |       |
| 2011                 |       | 267,000           |       |
| 2012                 |       | 168,700           |       |
|                 |       | $                 | 1,526,200  |   |

 

***Loan commitments***

 

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.  These financial instruments includecommitments to extend credit.  Suchcommitments involve, to varying degrees, elements of credit and interest raterisk in excess of the amount recognized in the consolidated balance sheets.

 

The Bank’s exposure tocredit loss is represented by the contractual amount of these commitments.  The Bank uses the same credit policies inmaking commitments as it does for on-balance-sheet instruments.

 

At December 31, 2007and 2006, such commitments to extend credit were $20,794,000 and $35,434,000,respectively, of undisbursed lines of credit, undisbursed loans in process, andcommitment letters.

 

36

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 13.****                     ****CONCENTRATION OF RISK**

 

The Bank grants commercial,construction, real estate and installment loans to businesses and individualsprimarily in the Monterey Peninsula area of Northern California.  Most loans are secured by business assets, andcommercial and residential real estate. Real estate and construction loans heldfor investment represented 83% and 79% of total loans held for investment at December 31,2007 and 2006, respectively.  The Bankhas no concentration of loans with any one customer.

 

The Bank does haveconcentrations of loans in the real estate and accommodation and food servicesindustries.  Loans held for investment inthe real estate industry represented 28.49% and 35.65% of total loans held forinvestment at December 31, 2007 and 2006, respectively.  Loans held for investment in theaccommodation and food services industry represented 17.85% and 16.58% of totalloans held for investment at December 31, 2007 and 2006, respectively.

 

**Note 14.****                     ****OTHER INCOME AND OTHER GENERAL AND ADMINISTRATIVE EXPENSES**

 

Other income for the yearsended December 31, 2007, 2006, and 2005 totaled $3,222,000, $4,627,000,and $2,807,000, respectively. Significant categories comprising other income were as follows:

** **
| ** **                                                 | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                                                 | ** ** | **(Dollars in thousands)** | ** ** |
| Merchant discount fees                                     |       | $                          | 2,423      |     | $          | 2,614    |       | $ | 2,343 |   |
| Commercial banking broker  fees                            |       | $                          | 21         |     | $          | 125      |       | $ | 412 |   |
| Life insurance cash  surrender value earnings              |       | $                          | 126        |     | $          | 108      |       | $ | 80 |   |
| Credit card marketing  program income                      |       | $                          | 684        |     | $          | 1,308    |       | $ | 222 |   |
| Stored value card  marketing program income                |       | $                          | 293        |     | $          | 75       |       | $ | 14 |   |
| Trading asset activities                                   |       | $                          | (686       | )        | $          | 283      |       | $ | (392 | ) |
| Net gain (loss) realized  on available for sale securities |       | $                          | 216        |     | $          | (5       | )          | $ | — |   |

** **

37

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 14.****                     ****OTHER INCOME AND OTHER GENERAL AND ADMINISTRATIVE EXPENSES (Continued)**

 

Other general andadministrative expenses for the years ended December 31, 2007, 2006, and2005 totaled $3,564,000, $3,512,000, and $3,369,000, respectively.  Significant categories comprising othergeneral and administrative expenses were as follows:

** **

| ** **                          | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Merchant credit processing  expense |       | $                          | 2,028      |     | $          | 2,154    |       | $ | 2,050 |   |
| Advertising                         |       | $                          | 164        |     | $          | 224      |       | $ | 141 |   |
| Business development                |       | $                          | 171        |     | $          | 124      |       | $ | 63 |   |
| Insurance                           |       | $                          | 118        |     | $          | 111      |       | $ | 117 |   |
| Stationary and supplies             |       | $                          | 148        |     | $          | 123      |       | $ | 81 |   |

 

**Note 15.****                     ****MINIMUM REGULATORY CAPITAL REQUIREMENTS**

 

The Corporation (on aconsolidated basis) and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material effect on theCorporation’s and Bank’s financial statements.

 

Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCorporation and the Bank must meet specific capital guidelines that involvequantitative measures of their assets, liabilities, and certainoff-balance-sheet items as calculated under regulatory accounting practices.  The capital amounts and classifications arealso subject to qualitative judgments by the regulators about components, riskweightings, and other factors. Under applicable regulatory guidelines, aportion of the Trust Preferred Securities qualify as Tier I Capital, and theremainder as Tier II Capital.   Promptcorrective action provisions are not applicable to bank holding companies.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Corporationand the Bank to maintain minimum amounts and ratios (set forth in the followingtable) of total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined) and of Tier 1 capital (as defined) to averageassets (as defined).  Management believes,as of December 31, 2007 and 2006, that the Corporation and the Bank metall capital adequacy requirements to which they are subject.

 

 

38

----

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 15.****                     ****MINIMUM REGULATORY CAPITAL REQUIREMENTS (Continued)**

 

As of December 31,2007, the most recent notification from the Federal Deposit InsuranceCorporation categorized the Bank as well capitalized under the regulatoryframework for prompt corrective action. To be categorized as well capitalized, an institution must maintainminimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as setforth in the following tables.  There areno conditions or events since the notification that management believes havechanged the Bank’s category.  TheCorporation’s and the Bank’s actual capital amounts and ratios as of December 31,2007 and 2006 are also presented in the tables.

 

| **December 31, 2007**               |
|------------------------------------------|
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Minimum To Be** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Well Capitalized** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Under Prompt** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Minimum** | ** ** | **Corrective** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Capital** | ** ** | **Action** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Requirement** | ** ** | **Provisions** | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                               | ** ** | **(Dollars in thousands)** | ** ** |
| Total Capital to Risk  Weighted Assets:  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                             |   | $ | 23,849 |   | 12.6 | % | $ | 15,108 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | $ | 22,197 |   | 11.9 | % | $ | 14,977 |   | 8.0 | % | $ | 18,721 |   | 10.0 | % |
|                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Risk  Weighted Assets: |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                             |   | $ | 17,429 |   | 9.2 | % | $ | 7,554 |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | $ | 20,169 |   | 10.8 | % | $ | 7,488 |   | 4.0 | % | $ | 11,232 |   | 6.0 | % |
|                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Average  Assets:       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                             |   | $ | 17,429 |   | 7.4 | % | $ | 9,410 |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | $ | 20,169 |   | 8.6 | % | $ | 9,393 |   | 4.0 | % | $ | 11,742 |   | 5.0 | % |

 

 

39

----

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 15.****                     ****MINIMUM REGULATORY CAPITAL REQUIREMENTS (Continued)**

** **

** **

| **December 31, 2006**               |
|------------------------------------------|
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Minimum To Be** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Well Capitalized** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Under Prompt** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Minimum** | ** ** | **Corrective** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Capital** | ** ** | **Action** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Requirement** | ** ** | **Provisions** | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                               | ** ** | **(Dollars in thousands)** | ** ** |
| Total Capital to Risk  Weighted Assets:  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                             |   | $ | 21,439 |   | 14.5 | % | $ | 11,812 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | $ | 19,559 |   | 13.4 | % | $ | 11,652 |   | 8.0 | % | $ | 14,565 |   | 10.0 | % |
|                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Risk  Weighted Assets: |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                             |   | $ | 15,097 |   | 10.2 | % | $ | 5,906 |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | $ | 18,117 |   | 12.4 | % | $ | 5,826 |   | 4.0 | % | $ | 8,739 |   | 6.0 | % |
|                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Average  Assets:       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                             |   | $ | 15,097 |   | 8.8 | % | $ | 6,882 |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | $ | 18,117 |   | 10.2 | % | $ | 7,137 |   | 4.0 | % | $ | 8,921 |   | 5.0 | % |

 

**Note 16.****                     ****OTHER REGULATORY MATTERS**

 

The Corporation is subjectto regulation by the Board of Governors of the Federal Reserve System under theBank Holding Corporation Act.  The Bankis subject to regulation, supervision, and regular examination by theCalifornia Department of Financial Institutions and the Federal DepositInsurance Corporation.  The regulationsof these agencies affect most aspects of the Corporation’s business andprescribe permissible types of loans and investments, the amount of requiredreserves, requirements for branch offices, the permissible scope of theCorporation’s activities, and various other requirements.  The Corporation is also subject to certainregulations of the Federal Reserve Bank dealing primarily with check clearingactivities, establishment of banking reserves, Truth-in-Lending (Regulation Z),and Equal Credit Opportunity (Regulation B).

 

 

40

----

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 17.****                     ****STOCK OPTIONS AND STOCK DIVIDENDS**

 

At December 31, 2007,options for the purchase of 76,534 shares of the Corporation’s common stockwere outstanding and exercisable at prices ranging from $2.25 - $ 4.40.  The status of all stock options is asfollows:

** **

| ** **                             | ** ** | ** ** | ** ** | ** **               | ** **    | **Weighted**         | ** ** |
|----------------------------------------|------------|------------|------------|--------------------------|---------------|----------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** **               | ** **    | **Average**          | ** ** |
| ** **                             | ** ** | ** ** | ** ** | ** **               | ** **    | **Remaining**        | ** ** |
| ** **                             | ** ** | **Shares** | ** ** | **Exercise Price Range** | ** **    | **Contractual Life** | ** ** |
| Outstanding at  December 31, 2005 |       | 293,140    |       | $                        | 1.71  - $4.40 |                 | 4  Years   |   |
|                                   |       |       |       |                     |          |                 |       |
| Exercised                              |       | (90,276    | )          | $                        | 1.71  - $4.00 |                 |       |   |
|                                   |       |       |       |                     |          |                 |       |
| Outstanding at  December 31, 2006 |       | 202,864    |       | $                        | 1.86  - $4.40 |                 | 2.3  Years |   |
|                                   |       |       |       |                     |          |                 |       |
| Exercised                              |       | (124,203   | )          | $                        | 1.86  - $3.30 |                 |       |   |
| Expired unexercised                    |       | (2,127     | )          | $                        | 3.00          |                 |       |   |
|                                   |       |       |       |                     |          |                 |       |
| Outstanding at  December 31, 2007 |       | 76,534     |       | $                        | 2.25  - $4.40 |                 | 2.2  Years |   |

 

The weighted averageexercise price was $3.56, $3.19, and $2.47 for the years ending December 31,2007, 2006, and 2005, respectively.  Nooptions were granted in both 2007 and 2006, the weighted average fair value ofoptions granted during the year ending December 31, 2005 was $4.00.  All of the options are exercisable as of December 31,2007.

 

There were no non-vestedoptions at both December 2007 and 2006.

 

The intrinsic value ofoptions exercised during the year ended December 31, 2007 was $912,000.The aggregate intrinsic values of stock options outstanding and exercisable at December 31,2007 were $556,000. The aggregate intrinsic value represents the total pretaxintrinsic value based on stock options with an exercise price less than theCorporation’s closing stock price of $11 as of December 31, 2007, whichwould have been received by the option holders had those option holdersexercised those options as of that date.

 

 

41

----

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 18.****                     ****RELATED PARTY TRANSACTIONS**

 

The Corporation has andexpects to have in the future, banking transactions in the ordinary course ofits business with directors, officers, principal shareholders, and theirassociates.  These transactions,including loans and deposits, are granted on substantially the same terms,including interest rates and collateral on loans, as those prevailing at thesame time for comparable transactions with others and do not involve more thanthe normal risk of collectibility or present other unfavorable features.

 

Aggregate loan transactionswith related parties are approximately as follows:

** **

| **(Dollars  in thousands)**           |
|---------------------------------------|
|                                  |   |   |   |
| Balance as of  December 31, 2005 |   | $ | 1,176 |   |
| New loans                             |   | 497 |   |
| Advances on lines of credit           |   | 71 |   |
| Repayments                            |   | (115 | ) |
|                                  |   |   |   |
| Balance as of  December 31, 2006 |   | 1,629 |   |
| New loans                             |   | 3,761 |   |
| Advances on lines of credit           |   | 19 |   |
| Repayments                            |   | (1,277 | ) |
|                                  |   |   |   |
| Balance as of  December 31, 2007 |   | $ | 4,132 |   |

 

Related party depositstotaled $1,103,000 and $259,000 at December 31, 2007 and 2006,respectively.

 

**Note 19.****                     ****EMPLOYEE BENEFIT PLANS**

 

During 1995, the Corporationestablished an employee stock ownership plan (ESOP) to invest in theCorporation’s common stock for the benefit of eligible employees.  The Board of Directors determines theCorporation’s contribution to the plan. Shares in the plan generally vest after seven years.  The Corporation did not contribute to theESOP trust in 2007, 2006, or 2005.  Therewere no shares in the plan as of December 31, 2007.

 

 

42

----

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 19.****                     ****EMPLOYEE BENEFIT PLANS (Continued)**

 

The Bank has a salaryreduction plan under Section 401(k) of the Internal RevenueCode.  The plan covers substantially allfull-time employees who have completed one year of service with the Bank.  Employees are allowed to defer up to 15% oftheir compensation subject to certain limits based on federal tax laws.  Under the provisions of the plan, the Bank’scontribution policy is discretionary. The Bank initiated a matching contribution in 2001 of 100% of eachemployee’s contribution up to 6% of the employee’s compensation.  The Bank’s matching contributions in 2007,2006, and 2005 totaled $114,000, $129,000, and $107,000, respectively.

 

**Note 20.****                     ****RESTRICTION ON DIVIDENDS, LOANS AND ADVANCES**

 

Federal and state bankingregulations place certain restrictions on dividends paid and loans or advancesmade by the Bank to the Corporation.  Thetotal amount of dividends which may be paid by the Bank to the Corporation atany date is generally limited to the lesser of: (i) retained earnings; or (ii) theBank’s net income for its last three fiscal years (less any distributions tothe stockholders made during such period), and loans or advances are limited to25% of the Bank’s primary capital plus the allowance for loan losses on asecured basis and 15% on an unsecured basis.

 

**Note 21.****                     ****SALARY CONTINUATION PLANS**

 

The Corporation hasestablished salary continuation plans, which provide for payments to a certainofficer at retirement.  Included in otherliabilities is $855,000 of deferred compensation related to the continuationplans at both December 31, 2007 and 2006. The plans are funded through life insurance  policies that generate value to fund thefuture benefits.

 

**Note 22.****                     ****NON-CASH TRANSACTION**

 

The Bank had non-cashtransactions relating to the purchase of two debt securities totaling$5,225,000 for the year ended December 31, 2007.

 

The Bank had a non-cash transactionrelating to the trade in of a vehicle of $13,000 for the year ended December 31,2006.

 

 

43

----

 

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 23.****                     ****FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

SFAS No. 107, “Disclosuresabout Fair Value of Financial Instruments” requires disclosure of estimatedfair values of all financial instruments where it is practicable to estimatesuch values.  In cases where quotedmarket prices are not available, fair values are based on estimates usingpresent value or other valuation techniques. Those techniques are significantly affected by the assumptions used,including the discount rate and estimates of future cash flows.  Accordingly, the derived fair value estimatescannot be substantiated by comparison to independent markets and, in manycases, could not be realized in immediate settlement of the instrument.  Statement No. 107 excludes certainfinancial instruments and all non-financial instruments from its disclosurerequirements.  Accordingly, the aggregatefair value amounts presented do not represent the underlying value of theCorporation.

 

The Corporation inestimating fair value disclosures for financial instruments used the followingmethods and assumptions:

 

***Cash and cash equivalents:*** The carrying amounts ofcash and short-term instruments approximate fair values.

 

***Investment securities:*** Fair values for investmentsecurities, excluding Federal Home Loan Bank stock and Pacific Coast Banker’sBank stock, are based on quoted market prices. The carrying value of Federal Home Loan Bank stock approximates fairvalue based on the redemption provisions of the Federal Home Loan Bank.

 

***Loans:*******Forvariable-rate loans that reprice frequently and with no significant change incredit risk, fair values are based on carrying values.  The fair value of performing fixed-rate loansis estimated by discounting future cash flows using the Corporation’s currentoffering rate for loans with similar characteristics.  The fair value of performing adjustable-rateloans is considered the same as book value. The fair value of non-performing loans is estimated at the fair value ofthe related collateral or, when in management’s opinion foreclosure upon thecollateral is unlikely, by discounting future cash flows using rates which takeinto account management’s estimate of credit risk.

 

 

44

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 23.****                     ****FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)**

 

***Commitments to Extend Credit and Standby Letters of Credit:*****The Corporation does not generally enter into long-term fixed ratecommitments or letters of credit.  Thesecommitments are generally priced at current prevailing rates.  These rates are generally variable and,therefore, there is no interest rate exposure. Accordingly, the fair market value of these instruments is equal to thecarrying value amount of their net deferred fees.  The net deferred fees associated with theseinstruments are not material.  TheCorporation has no unusual credit risk associated with these instruments.

 

***Deposit liabilities:*** The fair values disclosedfor demand deposits (e.g., interest and non-interest checking, savings, andcertain types of money market accounts) are, by definition, equal to the amountpayable on demand at the reporting date (i.e., their carrying amounts).  Fair values for fixed-rate certificates ofdeposit are estimated using a discounted cash flow calculation that appliesinterest rates currently being offered on certificates to a schedule ofaggregated expected monthly maturities on time deposits.

 

***Accrued interest:*** The carrying amounts ofaccrued interest approximate fair value.

 

***Cash Surrender Value of Life Insurance:*******The carrying amount of life insurance approximate fair value.

 

***Short-term borrowing:*** The carrying amounts offederal funds purchased, borrowings under repurchase agreements, and othershort-term borrowings maturing within ninety days approximate their fairvalues.  Fair values of other borrowingsare estimated using discounted cash flow analyses based on the Corporation’scurrent incremental borrowing rates for similar types of borrowingarrangements.

 

***Long-term borrowing:***  The fair values of the Corporation’slong-term borrowings are estimated using discounted cash flow analyses based onthe Corporation’s current incremental borrowing rates for similar types ofborrowing arrangements

 

45

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 23.****                     ****FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)**

 

The estimated fair values,and related carrying amounts, of the Corporation’s financial instruments as of December 31,2007 and 2006 are as follows:

** **
| ** **                                      | ** ** | **2007**                   | ** ** | **2006**  | ** ** |
|-------------------------------------------------|------------|----------------------------|------------|-----------|------------|
| ** **                                      | ** ** | **Carrying**               | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                      | ** ** | **Amount**                 | ** ** | **Value** | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                      | ** ** | **(Dollars in thousands)** | ** ** |
| Financial Assets:                               |       |                       |       |      |       |   |   |   |   |
| Cash and cash equivalents                       |       | $                          | 20,153     |      | $          | 20,153 |   | $ | 22,434 |   | $ | 22,434 |   |
| Time deposits with other financial institutions |       | —                     |       | —    |       | 1,000 |   | 1,000 |   |
| Trading assets                                  |       | 1,224                      |       | 1,224     |       | 1,762 |   | 1,762 |   |
| Debt and Other Securities                       |       | 47,108                     |       | 47,345    |       | 23,639 |   | 23,789 |   |
| GNMA - Mortgage Backed Security                 |       | 385                        |       | 385       |       | 626 |   | 626 |   |
| Loans, held for sale                            |       | 1,887                      |       | 1,887     |       | 1,182 |   | 1,182 |   |
| Loans, net                                      |       | 166,861                    |       | 177,199   |       | 128,868 |   | 122,346 |   |
| Accrued interest receivable                     |       | 1,352                      |       | 1,352     |       | 964 |   | 964 |   |
|                                            |       |                       |       |      |       |   |   |   |   |
| Financial Liabilities:                          |       |                       |       |      |       |   |   |   |   |
| Deposits                                        |       | 167,333                    |       | 167,017   |       | 131,628 |   | 131,437 |   |
| Long-term debt                                  |       | 60,748                     |       | 63,640    |       | 42,998 |   | 43,464 |   |
| Accrued interest payable                        |       | 2,250                      |       | 2,250     |       | 1,346 |   | 1,346 |   |
|                                                 |            |                            |            |           |            |  |  |  |  |  |  |  |  |

 

46

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 24.****                     ****NORTHERN CALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY)**

 

The following are thefinancial statements of Northern California Bancorp, Inc. (ParentCorporation only) as of December 31, 2007 and 2006:

 
| **Balance Sheets**                                 | ** ** | **2007**                   | ** ** | **2006** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|----------|------------|
| ** **                                         | ** ** | **(Dollars in thousands)** | ** ** |
| Assets                                             |       |                       |       |     |       |
| Cash and due from banks                            |       | $                          | 485        |     | $          | 143 |   |
| Investment in common stock of Monterey County Bank |       | 20,781                     |       | 18,522   |       |
| Investment securities - trading account            |       | 1,224                      |       | 1,762    |       |
| Investment in Metrocities Mortgage, LLC Stock      |       | 10                         |       | 10       |       |
| Investment in AT Services LLC Acquisition Corp.    |       | 20                         |       | 20       |       |
| Northern California Bancorp, Inc. Trust I     |       | 93                         |       | 93       |       |
| Northern California Bancorp, Inc. Trust II    |       | 155                        |       | 155      |       |
| Debt issue costs, net                              |       | 144                        |       | 150      |       |
| Accounts receivable                                |       | 4                          |       | 4        |       |
|                                               |       | $                          | 22,916     |     | $          | 20,859 |   |
| Liabilities and  Shareholders’ Equity         |       |                       |       |     |       |
| Accounts payable and accrued expenses              |       | $                          | 124        |     | $          | 124 |   |
| Dividend payable                                   |       | 41                         |       | 75       |       |
| Deferred tax liability                             |       | 69                         |       | 10       |       |
| Junior subordinated debt securities                |       | 8,248                      |       | 8,248    |       |
| Total liabilities                                  |       | 8,482                      |       | 8,457    |       |
| Shareholders’ equity                          |       | 14,434                     |       | 12,402   |       |
|                                               |       | $                          | 22,916     |     | $          | 20,859 |   |

 

47

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Years Ended December 31, 2007 and 2006**

 

**Note 24.****                     ****NORTHERN CALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY) (Continued)**

** **
| **Statements of Income**                                                      | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Income:                                                                       |       |                       |       |     |       |     |       |
| Interest and fees on loans                                                    |       | $                          | —     |     | $          | —   |       | $ | 23 |   |
| Gain on sale of securities                                                    |       | 108                        |       | 233      |       | 35       |       |
| Gain (loss) on trading asset                                                  |       | (794                       | )          | 50       |       | (427     | )          |
| Other                                                                         |       | 64                         |       | 58       |       | 86       |       |
|                                                                          |       |                       |       |     |       |     |       |
|                                                                          |       | (622                       | )          | 341      |       | (283     | )          |
| Expense:                                                                      |       |                       |       |     |       |     |       |
| Interest                                                                      |       | 713                        |       | 685      |       | 527      |       |
| Other                                                                         |       | 72                         |       | 54       |       | 54       |       |
|                                                                          |       |                       |       |     |       |     |       |
|                                                                          |       | 785                        |       | 739      |       | 581      |       |
|                                                                          |       |                       |       |     |       |     |       |
| Loss before income taxes and equity in undistributed net income of subsidiary |       | (1,407                     | )          | (398     | )          | (864     | )          |
| Income tax benefit                                                            |       | (399                       | )          | (175     | )          | (205     | )          |
|                                                                          |       |                       |       |     |       |     |       |
|                                                                          |       | (1,008                     | )          | (223     | )          | (659     | )          |
| Equity in undistributed  net income of subsidiary                             |       | 2,937                      |       | 4,060    |       | 2,588    |       |
|                                                                          |       |                       |       |     |       |     |       |
| Net income                                                                    |       | $                          | 1,929      |     | $          | 3,837    |       | $ | 1,929 |   |

 

48

----

 

**NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2007 and 2006**

 

**Note 24.****                     ****NORTHERN CALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY) (Continued)**

 
| **Statements of Cash Flows**                                                   | ** ** | **2007**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Cash flows from operating activities:                                          |       |                       |       |     |       |     |       |
| Net income                                                                     |       | $                          | 1,929      |     | $          | 3,837    |       | $ | 1,929 |   |
| Adjustments to reconcile net income to net cash used by operating  activities: |       |                       |       |     |       |     |       |
| Equity in undistributed income of Monterey County Bank                         |       | (2,937                     | )          | (4,060   | )          | (2,588   | )          |
| Stock based compensation                                                       |       | —                     |       | 18       |       | —   |       |
| (Increase) decrease in trading securities                                      |       | 538                        |       | (735     | )          | (224     | )          |
| Decrease in other assets                                                       |       | 6                          |       | 8        |       | 3        |       |
| Increase in accrued expenses                                                   |       | —                     |       | 18       |       | 31       |       |
| Increase (decrease) in other liabilities                                       |       | 26                         |       | 65       |       | (7       | )          |
| Net cash used by operating activities                                          |       | (438                       | )          | (849     | )          | (856     | )          |
| Cash flows from investing activities:                                          |       |                       |       |     |       |     |       |
| Cash dividends received from subsidiary                                        |       | 800                        |       | 625      |       | —   |       |
| Decrease in investments                                                        |       | —                     |       | 120      |       | 52       |       |
| Net cash provided by investing activities                                      |       | 800                        |       | 745      |       | 52       |       |
| Cash flows from financing activities:                                          |       |                       |       |     |       |     |       |
| Cash dividends paid on common stock                                            |       | (462                       | )          | (603     | )          | (326     | )          |
| Exercise of stock options                                                      |       | 442                        |       | 270      |       | 67       |       |
| Stock repurchase                                                               |       | —                     |       | —   |       | (15      | )          |
| Net cash used by financing activities                                          |       | (20                        | )          | (333     | )          | (274     | )          |
|                                                                           |       |                       |       |     |       |     |       |
| Net increase (decrease) in cash and cash equivalents                           |       | 342                        |       | (437     | )          | (1,078   | )          |
| Cash and cash equivalents, beginning of year                                   |       | 143                        |       | 580      |       | 1,658    |       |
| Cash and cash equivalents, end of year                                         |       | $                          | 485        |     | $          | 143      |       | $ | 580 |   |

 

49

----