** **

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

**WashingtonD.C.  20549**

**FORM 10-KSB**

**x**                              Annualreport under Section 13 or 15(d) of the Securities Exchange Act of 1934 (Feerequired) for fiscal year ended December 31, 2006

**o**                                 Transitionreport under Section 13 or 15(d) of the Securities Exchange Act of 1934 (No feerequired) for the period from *           *to            

**CommissionFile Number 0-27666**

**NORTHERN CALIFORNIA BANCORP, INC.**

(Name of Small Business Issuer in its Charter)

Incorporated inthe State of **California**

IRS EmployerIdentification Number **77-0421107**

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

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

**Securities registered under Section 12(b) of the ExchangeAct:**                            None

**Securities registered under Section12(g) of the Exchange Act:**                            Common stock

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

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

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 yearended December 31, 2006; $ 20,937,200.

As of March 1, 2007, theCorporation had 1,732,238 shares of common stock out-standing.  The aggregate market value of voting stockheld by non-affiliates of the Corporation was $11,809,600, based on the mostrecent sale at $17.00 per share on February 21, 2007.

The following documentsare incorporated by reference to the parts indicated of this Form 10-KSB:

1.    Portions of the Independent Auditor’s Reportfor the fiscal year ended December 31, 2006 are incorporated by reference inPart II Item 7.

 

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FORM 10-KSB CROSSREFERENCE 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                                                                                | 21       |
|         |                                                                                                                                |     |
| **PART II**  |                                                                                                                                |     |
| ITEM 5       | Market for the  Corporation’s Common stock and Related Stockholder Matters                                                     | 21       |
| ITEM 6       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                         | 22       |
| ITEM 7       | Financial Statements  and Supplementary Data                                                                                        | 46       |
|         | Independent Auditors’ Report on  the Financial Statements                                                                      | FS 1     |
|         | Consolidated Balance  Sheets at December 31, 2006 and 2005                                                                          | FS 2     |
|         | Consolidated  Statements of Income for each of the three years in the period ended December  31, 2006                               | FS 3     |
|         | Consolidated  Statements of Changes in Stockholders’ Equity for each of the three years in  the period ended December 31, 2006 | FS 4     |
|         | Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2006                           | FS 5-6   |
|         | Notes to  Consolidated Financial Statements                                                                                         | FS 7-48  |
| ITEM 8       | Changes in and  Disagreements with Accountants and Financial Disclosure                                                             | 46       |
| ITEM 8A      | Controls and  Procedures                                                                                                            | 46       |
| ITEM 8B      | Other Information                                                                                                                   | 47       |
| ** **   |                                                                                                                                |     |
| **PART III** |                                                                                                                                |     |
| ITEM 9       | Directors,  Executive Officers, Promoters and Control Persons: Compliance with Section  16(a) of the Exchange Act                   | 48       |
| ITEM 10      | Executive and  Director Compensation                                                                                                | 50       |
| ITEM 11      | Security  Ownership of Certain Beneficial Owners and Management, and Related  Stockholder Matters                                   | 53       |
| ITEM 12      | Certain  Relationships and Related Transactions                                                                                     | 54       |
| ITEM 13      | Exhibits and Reports                                                                                                                | 56       |
| ITEM 14      | Principal  Accountant Fees and Services                                                                                             | 57       |
|         | Signatures                                                                                                                          | 58       |

 

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**PART I**

Certainmatters discussed or incorporated by reference in this Annual Report of Form10-KSB including, but not limited to, those described in “Item 6 - Management’sDiscussion and Analysis of Financial Condition and Results of Operations”, areforward-looking statements that are subject to risks and uncertainties thatcould cause actual results to differ materially from those projected in theforward-looking statements. Such risks and uncertainties include, among others,(1) competitive pressure in the banking industry increasing significantly; (2)changes in the interest rate environment reduces margins; (3) general economicconditions, either nationally or regionally, are less favorable than expected,resulting in, among other things, a deterioration in credit quality; (4)changes in the regulatory environment; (5) changes in business conditions andinflation; and (6) changes in securities markets. Therefore, the informationset forth therein should be carefully considered when evaluating the businessprospects of the Corporation.

**ITEM 1.BUSINESS**

**GENERAL**

NorthernCalifornia Bancorp, Inc. (the “Corporation”) was incorporated on August 29,1995, as a for-profit corporation under the California Corporate laws for theprincipal purpose of engaging in banking and non-banking activities as allowedfor a bank holding company.  TheCorporation owns 100% of Monterey County Bank (the “Bank”).   The Corporation’s sources of revenues atthis time are dividends on investments, gains on securities transactions and potentialdividends, management fees and tax equalization payments, if any, from theBank.

Compliancewith environmental laws has not had a material impact on the operations of theBank or the Corporation, although the Bank faces potential liability or lossesif its borrowers fail to comply with such laws and the Bank acquirescontaminated properties in foreclosure.

**BANKSUBSIDIARY**

MontereyCounty Bank, an independent, California chartered commercial bankingcorporation 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 or other relationships located in or aboutthe city and county of Monterey, California, including the cities of Carmel andPacific Grove.  The Bank offers itscustomers a wide variety of the normal personal, consumer and commercialservices expected of a locally owned, independently operated bank.  The Bank’s deposits are insured by theFederal Deposit Insurance Corporation “FDIC”, and, as such, the Bank is subjectto regulations by that federal agency and to periodic audits of its operationsand documentary compliance by “FDIC” personnel. As a state chartered bank, which is not a member of the Federal ReserveSystem, it is also regulated and periodically examined by the California StateDepartment of Financial Institutions.

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TheBank’s activities are conducted at its principal offices, 601 Munras Ave.,Monterey, California and at its three branch offices in Carmel-By-The-Sea,Carmel Valley and Pacific Grove, California and a loan production office inMonterey, California.

AtDecember 31, 2006 the Bank had total assets, deposits and shareholders’ equityof approximately $188,375,900, $131,770,800 and $18,522,100, respectively.

**NorthernCalifornia 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 Securities of the Trust) (the Trust PreferredSecurities).  Bear Stearns & Co.,Inc. acted as placement agent in connection with the offering of the TrustPreferred Securities.  The securitiesissued by Trust I are fully guaranteed by the Company with respect todistributions and amounts payable upon liquidation, redemption orrepayment.  The entire proceeds to TrustI from the sale of the Trust Preferred Securities were used by Trust I in orderto purchase $3.0 million in principal amount of the Floating Rate JuniorSubordinated Deferrable Interest Debentures due 2033 issued by the Company (theSubordinated 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, 2006 was8.62%.  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-throughSecurities of the Trust) (the Trust Preferred Securities).  Citigroup Global Markets, Inc. acted asplacement agent in connection with the offering of the Trust PreferredSecurities.  The securities issued byTrust II are fully guaranteed by the Company with respect to distributions andamounts payable upon liquidation, redemption or repayment.  The entire proceeds to Trust II from the saleof the Trust Preferred Securities were used by Trust II in order to purchase$5.0 million in principal amount of the Floating Rate Junior SubordinatedDeferrable Interest Debentures due 2033 issued by the Company (the SubordinatedDebt 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, 2006 was8.22%. Total broker and legal costs associated with the issuance of $54,000 arebeing amortized over a 30 year period.

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**EMPLOYEES**

At December 31, 2006 the Northern CaliforniaBancorp, Inc. and its subsidiary Monterey County Bank employed a total of 53 fulltime equivalent persons.

**COMPETITION**

All phases of the Bank’s business have been, sinceinception, and will continue to be subject to significant competitiveforces.  Although the Bank has increasingrecognition in its primary service area and Monterey County, it neverthelesshas to compete with other independent local banking institutions, includingcommercial banks and savings and loan associations, as well as branch officesof regional commercial banks, some of which have assets, capital and lendinglimits substantially larger than the Bank, as well as wider geographic markets,more support services and larger media advertising capabilities.  The Bank will also compete with respect toits lending activities, as well as in attracting demand deposits, with savingsbanks, savings and loan associations, insurance companies, regulated small loancompanies and credit unions, as well as securities brokerage offices which canissue commercial paper and other securities (such as shares in money marketfunds).

Among the advantages such institutions have over theBank are their ability to finance wide ranging advertising campaigns and toallocate their investment assets to regions of highest yields and demand.  Many institutions offer certain services,such as trust services and international banking, which the Bank does notcurrently 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 individual customerbeing limited to a percentage of a bank’s total capital accounts).  These competitors may intensify theiradvertising and marketing activities to counter any efforts by the Bank tofurther 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.

Tocompete with the financial institutions in its primary service area, the Bankintends to use the flexibility, which its independent status will permit.  Its activities in this regard include anability and intention to respond quickly to changes in the interest rates paidon time and savings deposits and charged on loans, and to charges imposed ondepository accounts, so as to remain competitive in the market place.  It also will continue to emphasizespecialized services for the small business person and professional andpersonal contacts by the Bank’s officers, directors and employees.  If there are customers whose loan demandsexceed the Bank’s lending limits, the Bank has the ability to arrange for suchloans on a participation basis with other financial institutions.  No assurance can be given, however, that theBank’s efforts to compete with other financial institutions in its primaryservice area will be successful.

The Bank provides a range of competitive retail andcommercial banking services.  The depositservices offered include various types of personal and business checkingaccounts, savings accounts, money market investment accounts, certificates ofdeposit, and retirement accounts. Lending services include consumer loans, various type of mortgage loansfor residential and commercial real estate, personal lines of credit, homeequity loans, real estate construction, accounts receivable financing,commercial loans to small and medium size businesses and professionals.  The 

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Bank also provides drive-through facilities, at its Monterey and Carmeloffices, and night depository facilities for customer convenience.  The Bank offers safe deposit box facilities,cashiers’ checks, travelers’ checks, U.S. Savings Bonds, and wiretransfers.  The Bank does not providetrust services.

While the Bank has the authority to engage in a widerange of banking activities, and offers most of the types of banking servicesof a commercial bank, over the past three years it has derived much of itsprofitability and differentiated itself from its competitors through (i)commercial and real estate loans guaranteed by the Small BusinessAdministration (“SBA”); and (ii) credit card depository services for merchants.

The Bank entered into an agreement with GenesisFinancial Solutions, a purchaser of charged-off consumer credit card balances,to market a MasterCard credit card program. The Bank will be issuing the cards, but the credit card balances will be100 percent owned by Genesis Financial Solutions.  The program was implemented in the firstquarter of 2005 with the initial card solicitations being mailed in February2005 resulting in 14,741 active cards on file at December 31, 2005.  The Bank’s 2006 and 2005 fee revenue from theprogram were approximately $71,400 and $95,400, respectively.  Genesis Financial Solutions maintainsdeposits with the Bank equal to the sum of the total available credit of theportfolio plus the total of five (5) days average settlement activity for theprior month.  The average depositsmaintained during 2006 and 2005 were $648,400 and $275,800, respectively.

The Bank entered into an agreement in February 2006with GC Acquisitions, LLC (“GCA”), the owner of a portfolio of consumercredit card contracts and receivables, under which the Bank will offerMasterCard® credit cards to qualifying GCA credit card contract holders.  GCAwill, through its affiliates, agents and vendors, establish new credit cardaccounts with the Bank for certain of its existing credit card contractholders, service the credit card accounts and own the receivables generatedfrom the accounts.  A total ofapproximately 252,000 cards were issued during March and April 2006, as aresult 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 considerationthe Bank’s granting permission to transfer the accounts GCA paid one timetransfer fees totaling approximately $381,700. The Bank’s 2006 fee revenue from the program was approximately$1,209,400 including the on time transfer fees. GCA maintained average reservedeposits with the Bank of $7,488,400. The Bank’s future revenues from the program and reserve balancesmaintained will be diminished as result of 87,000 accounts transferred from theportfolio.

The Bank has implemented a pre-paid debit cardprogram.  The program is marketed bythird parties through employer payroll programs and check cashing facilities,through Internet websites for purchasers of the websites’ products andservices.  Holders of the pre-paid cardswill be able to have additional funds added to the card balance, make point ofsale purchases and 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.  Revenues from the program were $75,300,$13,800 and $8,300 in 2006, 2005 and 2004, respectively.

The Bank depends largely on rate differentials.  In general, the difference between theinterest rate paid by the Bank on its deposits and its other borrowings, andthe interest rate received by the Bank on loans extended to its customers andsecurities held in the Bank’s portfolio, comprise

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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 federalgovernment and the policies of regulatory agencies, particularly the FederalReserve Board, also impact on 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,by adjusting the required level of reserves for financial intermediariessubject to its reserve requirements and by varying the discount ratesapplicable to borrowings by depository institutions.  The actions of the Federal Reserve Board inthese areas influence the growth of bank loans, investments and deposits andalso affect interest rates charged on loans and paid on deposits.  The nature and impact of any future changesin monetary policies cannot be predicted.

**SUPERVISION AND REGULATION**

**The Corporation**

Future offers or sales of the stock of theCorporation will be subject to the registration require­ments of the SecuritiesAct of 1933, and qualification under the California Corporate Securities Act of1968, and possibly other state Blue Sky laws, (unless an exemption isavailable), although the Bank’s common stock is exempt from such requirements.

On December 29, 1995, after receipt of appropriateapprovals, and/or passage of notice periods without objection, from theCalifornia Superintendent of Banks, the Federal Deposit Insurance Corporation,the Board of Governors of the Federal Reserve System and the shareholders ofthe Bank, the Corporation acquired the Bank through a reverse triangular merger(the “Merger”).  As a result, by operationof law, each outstanding share of common stock of the Bank prior to the Mergerwas converted into a share of common stock of the Corporation, while theCorporation became the sole owner of the newly issued shares of common stock ofthe Bank.

The Bank Holding Company Act of 1956, as amended,places the Corporation under the supervision of the Board of Governors of theFederal Reserve System (the “FRB”). The Corporation must generally obtain theapproval of the FRB before acquiring all or substantially all of the assets ofany bank, or ownership or control of any voting securities of any bank if,after giving effect to such acquisition, the Corporation would own or controlmore than 5% of the voting shares of such bank.

A bank holding company is generally prohibited fromengaging in, or acquiring direct or indirect control of more than 5% of thevoting shares of any company engaged in non-banking activities unless the FRB,by order or regulation, has found such activities to be so closely related tobanking or managing or controlling banks as to be a proper incident thereto. Inmaking such determinations, the FRB considers whether the performance of suchactivities by a bank holding company would offer advantages to the public,which outweigh possible adverse effects.

The FRB’s Regulation “Y” sets out the non-bankingactivities that are permissible for bank holding companies under the law,subject to the FRB’s approval in individual cases.  Most of these 

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activities are now permitted for California banks that arewell-capitalized.   The Corporation andits subsidiaries will also be subject to certain restrictions with respect toengaging in the underwriting, 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 file reportswith the FRB and provide such additional information as the FRB may require.The FRB will also have the authority to examine the Corporation and each of itssubsidiaries 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.

The Corporation and its subsidiaries are prohibitedfrom engaging in certain tie-in arrangements in connection with any extensionof credit, sale or lease of property or furnishing of services.  For example, with certain exceptions, theBank may not condition an extension of credit on a customer’s obtaining otherservices provided by it, the Corporation or any other subsidiary, or on apromise from its customer not to obtain other services from a competitor.

**Sarbanes-Oxley Act**

The Sarbanes-Oxley Act of 2002 (the Act) was enactedinto law on July 30, 2002.  The Act wasin response to recent issues 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.

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·                  Enhanced criminal penalties for a board 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.

The effect of the Act upon corporations is uncertain; however, it islikely that compliance costs may increase as corporations modify procedures ifrequired to conform to the provisions of the Act.  The Company does not currently anticipatethat compliance with the Act will have a material effect upon its financialposition or results or its operations or its cash flows.

**Subsidiary Bank**

Both federal and state laws provide extensiveregulation of the banking business. State and federal statutes and regulations apply to many aspects of theBank’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 $100,000 perdepositor, 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-annualstatutory assessment and is subject to the rules and regulations of theFDIC.  Although the Bank is not a memberof the Federal Reserve System, certain regulations of the Federal Reserve Boardalso apply to its operations.

California law restricts the amount available forcash 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 banks withregard to transactions with affiliates, including any extensions of credit to,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 bymarketable obligations 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 certainrestrictions with respect to transactions involving other controlling personsof the Bank.

From time to time, legislation is enacted which hasthe effect of increasing the cost of doing business, limiting or expandingpermissible activities or affecting the competitive balance between banks andother financial intermediaries. Proposals to change the laws and regulations governing 

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the operations and taxation of banks, bank holding companies and otherfinancial intermediaries are frequently made in Congress, in the Californialegislature and before various bank regulatory and other professional agencies.The Bank cannot predict what, if any legislation or regulations will beenacted, or the impact thereof on its business and profitability.

**Capital Adequacy Standards**

Government agencies have traditionally regulatedbank capital through explicit and implicit guidelines and rules.  State law requires “adequate” capital,without objective definition.  Federallaw and regulations require minimum levels of risk-based and so-called “Leverage”capital.

FDIC guidelines implement the risk-based capitalrequirements. The guidelines establish a systematic analytical framework thatmakes regulatory capital requirements more sensitive to differences in riskprofiles (using the rough measures set forth therein) among bankingorganizations, take certain off-balance sheet items into account in assessingcapital adequacy and minimize disincentives to holding liquid, low-risk assets.Under these guidelines, assets and credit equivalent amounts of off-balancesheet items, such as letters of credit and outstanding loan commitments, areassigned to one of several risk categories, which range from 0% for risk-freeassets, such as cash and certain U.S. government securities, to 100% forrelatively high-risk assets, such as loans and investments in fixed assets,premises and other real estate owned. The aggregate dollar amount of eachcategory is then multiplied by the risk-weight associated with that category. Theresulting weighted values from each of the risk categories are then addedtogether to determine the total risk-weighted assets.

A banking organization’s risk-based capital ratiosare obtained by dividing its qualifying capital by its total risk adjusted assets,including dollar equivalents for certain off-balance sheet assets.

The guidelines require a minimum ratio of qualifyingtotal capital to risk-weighted assets of 8%, of which at least 4% must consistof Tier I capital.  Higher risk-basedratios are required to be considered “well capitalized” under prompt correctiveaction provisions.

A banking organization’s qualifying total capitalconsists of two components: Tier 1 capital (core capital) and Tier 2 capital(supplementary capital).  Tier 1 capital consistsprimarily of common stock, related surplus and retained earnings, qualifyingnoncumulative perpetual preferred stock and minority interests in the equityaccounts of consolidated subsidiaries. Trust preferred securities qualify asTier 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) the allowance forloan and lease losses in an amount up to 1.25% of risk-weighted assets; (ii)cumulative perpetual preferred stock and long-term preferred stock and relatedsurplus; (iii) hybrid capital instruments (instruments with characteristics ofboth debt and equity), perpetual debt and mandatory convertible debt securities;and (iv) eligible term subordinated debt and intermediate-term preferred stockwith an original maturity of five years or more, including related surplus, inan amount up to 50% of Tier 1 capital. The inclusion of the 

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foregoing elements of Tier 2 capital is subject to certain requirementsand limitations of the federal banking agencies.

The FDIC imposes a minimum leverage ratio of Tier Icapital to average total assets of 3% for the highest rated banks, and 4% forall other banks.  Institutions experiencingor anticipating significant growth or those with other than minimum riskprofiles are expected to maintain capital at least 100-200 basis points abovethe minimum level.

In addition, the Federal Reserve Board and the FDIChave issued or proposed rules to take account of interest rate risk,concentration of credit risk and the risks of nontraditional activities incalculating risk-based capital.

For capital adequacy purposes, deferred tax assetsthat can be realized from taxes paid in prior carry-back years, and from thefuture reversal of temporary differences, are generally unlimited.  However, deferred tax assets that can only berealized through future taxable earnings, including the implementation of a taxplanning strategy, count toward regulatory capital purposes only up to thelesser of (i) the amount that can be realized within one year of thequarter-end report date or (ii) 10% of Tier I capital.  The amount of deferred taxes in excess ofthis limit, if any, would be deducted from Tier I capital and total assets inregulatory capital calculations.

Effective January 17, 1995, the federal bankingagencies issued a final rule relating to capital standards and the risksarising from the concentration of credit and nontraditional activities.  Institutions which have significant amountsof their assets concentrated in high risk loans or nontraditional bankingactivities and who fail to adequately manage these risks, will be required toset aside capital in excess of the regulatory minimums.  The federal banking agencies have not imposedany quantitative assessment for determining when these risks are significant,but have identified these issues as important factors they will review inassessing 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.

In December 1993, the federal banking agenciesissued an interagency policy statement on the allowance for loan and leaselosses (the “ALLL”) which calls for the maintenance of the ALLL at a level atleast equal to the “estimated credit losses” in the bank’s loan portfolio.  “Estimated credit losses” are defined as “anestimate of the current amount of the loan and lease portfolio (net of unearnedincome) that is not likely to be collected; that is, net charge-offs thatare likely to be realized for a loan or pool of loans given facts andcircumstances as of the evaluation date.”  The policy statement also suggests that a test of reasonableness beapplied to the ALLL, which test is satisfied if the ALLL equals or exceeds thesum of (a) assets classified loss; (b) 50% of assets classified doubtful; (c)15% of assets classified substandard; and (d) estimated credit losses on otherassets over the upcoming twelve months. The Bank believes that its ALLL exceeds the amounts that would berequired under the terms of this policy statement and under such test ofreasonableness.  However, this is a verysubjective matter, and the Bank cannot assure that any bank examiner wouldagree with its evaluation, or that losses ultimately incurred from the Bank’sportfolio would not exceed the amounts so provided.

Future changes in regulations or practices couldfurther 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.

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**Prompt Corrective Action and OtherEnforcement Mechanisms**

Under Section 38 of the FDIA, as added by the Federal Deposit InsuranceCorporation Improvement Act of 1991 (“FDICIA”), each federal banking agency isrequired to implement a system of prompt corrective action for institutionswhich it regulates.  The federal bankingagencies have promulgated substantially similar regulations to implement thissystem of prompt corrective action. Under the 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 a Tier I risk-based capital ratio of 6.0% or more, has aTier I leverage capital ratio of 5.0% or more and is not subject tospecified requirements to meet and maintain a specific capital level for anycapital measure; (ii) ”adequately capitalized” if it has a total risk-basedcapital ratio of 8.0% or more, a Tier I risk-based capital ratio of4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0%under certain circumstances) and does not meet the definition of “wellcapitalized;” (iii) ”undercapitalized” if it has a total risk-basedcapital ratio that is less than 8.0%, a Tier I risk-based capital ratiothat is less than 4.0% or a Tier I leverage capital ratio that is lessthan 4.0% (3.0% under certain circumstances); (iv) ”significantlyundercapitalized” if it has a total risk-based capital ratio that is lessthan 6.0%, a Tier I risk-based capital ratio that is less than 3.0%or a Tier 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%.

Section 38 of the FDIA and the implementing regulations also providethat a federal banking agency may, after notice and an opportunity for ahearing, reclassify a well capitalized institution as adequately capitalizedand may require an adequately capitalized institution or an undercapitalizedinstitution to comply with supervisory actions as if it were in the next lowercategory if the institution is in an unsafe or unsound condition or engaging inan unsafe or unsound practice.  (The FDICmay not, however, reclassify a significantly undercapitalized institution ascritically undercapitalized.)

An institution generally must file a written capital restoration planwhich meets specified requirements, as well as a performance guaranty by eachcompany that controls the institution, with the appropriate federal bankingagency within 45 days of the date that the institution receives notice or isdeemed to have notice that it is undercapitalized, significantlyundercapitalized or critically undercapitalized.  Immediately upon becoming undercapitalized,an institution shall become subject to the provisions of Section 38 of theFDIA, which sets forth various mandatory and discretionary restrictions on itsoperations.

At December 31, 2006, the Bank met the tests to be categorized as “wellcapitalized” under the prompt corrective action 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) interest rate risk exposure; (v) asset growth; and(vi) compensation, fees and benefits. The federal banking agencies recently adopted final regulations andInteragency Guidelines Prescribing Standards for Safety and Soundness (“Guidelines”)to implement safety and soundness standards required by the FDIA.  The Guidelines set forth the safety andsoundness standards that the federal banking agencies use to identify andaddress problems at insured depository institutions before capital becomesimpaired.  

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Theagencies also proposed asset quality and earnings standards which, if adoptedin final, would be added to the Guidelines. Under the final regulations, if the FDIC determines that the Bank failsto meet any standard prescribed by the Guidelines, the agency may require theBank to submit to the agency an acceptable plan to achieve compliance with thestandard, as required by the FDIA.  Thefinal regulations establish deadlines for the submission and review of suchsafety and soundness compliance plans.

**Premiums for Deposit Insurance**

The FDIC adopted regulations implementing a risk-based premium systemrequired by federal law.  Under theregulations which cover the assessment periods commencing on and after January1, 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 depositinsurance and may change the base assessment rate (currently, 4 to 31 basispoints per year) by rulemaking with notice and comment.  Without notice or comment, the FDIC mayincrease or decrease the current rate schedule uniformly by as much as 5 basispoints, as deemed necessary to maintain the target designated reserve ratio1.25 percent (fund balance to estimated insured deposits).  The insured deposit rates for 2006 were $.00to $.27.

On February 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 changes toimplement deposit insurance reform, as well as a number of study and surveyrequirements.

The Reform Act provides for the following changes:

·                  Merging the Bank Insurance Fund (BIF) and theSavings Association Insurance Fund (SAIF) into a new fund, the DepositInsurance Fund (DIF). This change was made effective March 31, 2006.

·                  Increasing the coverage limit for retirementaccounts to $250,000 and indexing the coverage limit for retirement accounts toinflation as with the general deposit insurance coverage limit. This change wasmade effective April 1, 2006.

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

·                  Allowing the FDIC to manage the pace at whichthe reserve ratio varies within this range.

1.               If the reserve ratio falls below 1.15percent—or is expected to within 6 months—the FDIC must adopt a restorationplan that provides that the DIF will return to 1.15 percent generally within 5years.

2.               If the reserve ratio exceeds 1.35 percent,the FDIC must generally dividend to DIF members half of the amount above theamount necessary to maintain the DIF at 

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1.35 percent, unless the FDIC Board,considering statutory factors, suspends the dividends.

3.               If the reserve ratio exceeds 1.5 percent, theFDIC must generally dividend to DIF members all amounts above the amountnecessary to maintain the DIF at 1.5 percent.

·                  Eliminating the restrictions on premium ratesbased on the DRR and granting the FDIC Board the discretion to price depositinsurance according to risk for all insured institutions regardless of thelevel of the reserve ratio.

·                  Granting a one-time initial assessment credit(of approximately $4.7 billion) to recognize institutions’ past contributionsto the fund.

·                  The Federal Deposit Insurance ReformConforming Amendments Act of 2005 requires the FDIC to conduct studies of threeissues: (1) further potential changes to the deposit insurance system, (2) theappropriate deposit base in designating the reserve ratio, and (3) theCorporation’s contingent loss reserving methodology and accounting for losses.

·                  The 2005 act requires the Comptroller Generalto conduct studies of (1) federal bank regulators’ administration of the promptcorrective action program and recent changes to the FDIC deposit insurancesystem, and (2) the organizational structure of the FDIC.

The final ruleconsolidates the existing nine risk categories into four and names them RiskCategories I, II, III and IV. Risk Category I replaces the 1A risk category.

Within RiskCategory I, the final rule combines supervisory ratings with other riskmeasures to differentiate risk. For most institutions, the final rule combinesCAMELS component ratings with financial ratios to determine an institution’sassessment rate. For large institutions that have long-term debt issuerratings, the final rule differentiates risk by combining CAMELS componentratings with these ratings. For large institutions within Risk Category I,initial assessment rate determinations may be modified within limits uponreview of additional relevant information.

The final ruledefines a large institution as an institution that has $10 billion or more inassets. With certain exceptions, beginning in 2010, the final rule treats newinstitutions (those established for less than five years) in Risk Category Ithe same, regardless of size, and assesses them at the maximum rate applicableto Risk Category I institutions.

The final rulesets actual 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 theminimum or maximum rate vary between these rates.

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

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

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* Rates for institutions that do not pay theminimum or maximum rate vary between these rates.

The final rulecontinues to allow the FDIC Board to adjust rates uniformly from one quarter tothe next, except that no single adjustment can exceed three basis points. Inaddition, cumulative adjustments cannot exceed a maximum of three basis pointshigher or lower than the base rates without further notice-and-commentrulemaking.

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 initialassessment credit is estimated to be approximately $49,000, which will be usedto offset deposit insurance premiums; the assessment credit cannot be used tooffset FICO premiums.

The Financing Corporation (FICO), established by the CompetitiveEquality Banking Act of 1987, is a mixed-ownership government corporation whosesole purpose was to function as the financing vehicle for the Federal Savings& Loan Insurance Corporation (FSLIC). Effective December 12, 1991, as provided by the Resolution TrustCorporation Refinancing, Restructuring and Improvement Act of 1991, the FICO’sability to issue new debt was terminated. Outstanding FICO bonds, which are 30-year non-callable bonds with aprincipal amount of approximately $8.1 billion, mature in 2017 through 2019.

The FICO has assessment authority, separate from the FDIC’s authorityto assess risk-based premiums for deposit insurance, to collect funds fromFDIC-insured institutions 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.

The FICO assessment rate is adjusted quarterly to reflect changes inthe assessment basis of the respective funds based on the quarterly Call Reportand the Thrift Financial Report submissions. The FICO quarterly rates for 2006 were 1.32, 1.28, 1.26 and 1.24.  The FICO quarterly rate for the first quarterof 2007 is 1.22.

**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 which 

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the bank is located.  A state may limit the percentage of totaldeposits that may be held in that state by any one bank or bank holding companyif application of such limitation does not discriminate against out-of-statebanks.  An out-of-state bank holding companymay not acquire a state bank in existence for less than a minimum length oftime that may be prescribed by state law except that a state may not imposemore than a five year existence requirement.

The Interstate Actalso permitted 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 may adoptlegislation to prohibit interstate mergers after that date in that state or inother states by that state’s banks.  Thesame concentration limits discussed in the preceding paragraph apply.  The Interstate Act also permits a national orstate bank to establish branches in a state other than its home state ifpermitted by the laws of that state, subject to the same requirement andconditions as for a merger transaction.

The Interstate Actis likely 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.

On October 2,1995, the “California Interstate Banking and Branching Act of 1995” (the “1995Act”) became effective.  The 1995 Actgenerally allows out-of-state banks to enter California by merging with, orpurchasing, a California bank or industrial loan company which is at least fiveyears old.  Also, the 1995 Act repealsthe California Interstate (National) Banking Act of 1986, which previouslyregulated the acquisition of California banks by out-of-state bank holdingcompanies.  In addition, the 1995 Actpermits California state banks, with the approval of the Superintendent ofBanks, to establish agency relationships with FDIC-insured banks and savingsassociations.  Finally, the 1995 Actprovides for regulatory relief, including (i) authorization for theSuperintendent to exempt banks from the requirement of obtaining approvalbefore establishing or relocating a branch office or place of business, (ii)repeal of the requirement of directors’ oaths (Financial Code Section 682), and(iii) repeal of the aggregate limit on real estate loans (Financial CodeSection 1230).

**Community Reinvestment Act and Fair LendingDevelopments**

The Bank issubject to certain fair lending requirements, reporting obligations involvinghome mortgage 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 tosubstantial penalties and corrective measures that may be required for aviolation of certain fair lending laws, the federal banking agencies may takecompliance with such laws and CRA into account when regulating and supervisingother activities.

In May, 1995, thefederal banking agencies issued final regulations which change the manner inwhich they measure 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 Lending issueda 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 

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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 federalregulatory agencies have adopted regulations that implement Section 304 of FDICIAwhich requires federal banking agencies to adopt uniform regulationsprescribing standards for real estate lending. Each insured depository institution must adopt and maintain acomprehensive written real estate lending policy, developed in conformance withprescribed guidelines, and each agency has specified loan-to-value limits inguidelines concerning 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 equityinvestments, an insured state bank generally may not directly or indirectlyacquire or retain 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) acquiring orretaining a majority interest in a subsidiary, (ii) investing as a limited partnerin a partnership the sole purpose of which is direct or indirect investment inthe acquisition, rehabilitation or new construction of a qualified housingproject, provided that such limited partnership investments may not exceed 2%of the bank’s total assets, (iii) acquiring up to 10% of the voting stock of acompany that solely provides or reinsures directors’, trustees’ and officers’liability insurance coverage or bankers’ blanket bond group insurance coveragefor insured depository institutions, and (iv) acquiring or retaining the votingshares of a depository institution if certain requirements are met.

FDIC regulationsimplementing Section 24 of the FDIA provide that an insured state-charteredbank may not, directly, or indirectly through a subsidiary, engage as “principal”in any activity that is not permissible for a national bank unless the FDIC hasdetermined that such activities would pose no risk to the insurance fund ofwhich it is a member and the bank is in compliance with applicable regulatorycapital requirements.  Any insuredstate-chartered bank directly or indirectly engaged in any activity that is notpermitted for a national bank must cease the impermissible activity.

**Financial Modernization Act**

EffectiveMarch 11, 2000, the Gramm-Leach-Bliley Act eliminated most barriers toaffiliations among banks and securities firms, insurance companies, and otherfinancial service providers, and enabled full affiliations to occur betweensuch entities.  This new legislationpermits bank holding companies to become “financial holding companies” andthereby acquire securities firms and insurance companies and engage in otheractivities that are financial in nature. A bank holding company may become a financial holding company if each ofits subsidiary banks is well capitalized under the prompt corrective actionprovisions discussed above, is well managed, and has at least a satisfactoryrating under the Community Reinvestment Act by filing a declaration that thebank holding company wishes to become a financial holding company.  No regulatory approval will be required for afinancial holding company to acquire a company, other than a bank or savingsassociation, engaged in activities that are financial in nature or incidentalto activities that are financial in nature, as determined by the FederalReserve Board.  The Bank has no currentintention 

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of becoming a financialholding company, but may do so at some point in the future if deemedappropriate in view of opportunities or circumstances at the time.

TheGramm-Leach-Bliley Act defines “financial in nature” to include securitiesunderwriting, dealing and market making; sponsoring mutual funds and investmentcompanies; insurance underwriting and agencies; merchant banking activities;and activities that the Federal Reserve Board has determined to be closelyrelated to banking.  A national bank (andtherefore, a state bank as well) may also engage, subject to limitations oninvestment, in activities that are financial in nature, other than insurance underwriting,insurance company 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 financialsubsidiaries must continue to be well capitalized and well managed in order tocontinue to engage in activities that are financial in nature withoutregulatory actions or restrictions, which could include divestiture of thefinancial in nature subsidiary or subsidiaries. In addition, a financial holding company or a bank may not acquire acompany that is engaged in activities that are financial in nature unless eachof the subsidiary banks of the financial holding company or the bank has aCommunity Reinvestment Act rating of satisfactory or better.

TheGramm-Leach-Bliley Act also imposes significant new requirements on financialinstitutions with respect to the privacy of customer information, and modifiesother existing laws, including those related to community reinvestment.

**USA Patriot Act of 2001**

On October 26,2001, President Bush signed the USA Patriot Act of 2001.  Enacted in response to the terrorist attacksin New York, Pennsylvania and Washington, D.C. on September 11, 2001, theUSA Patriot Act is intended to strengthen U.S. law enforcement’s and theintelligence communities’ ability to work cohesively to combat terrorism on avariety of fronts.  The potential impactof the USA Patriot Act on financial institutions of all kinds is significantand wide ranging.  The USA Patriot Actcontains sweeping anti-money laundering and financial transparency laws andrequires various regulations applicable to financial institutions, including:

·                  duediligence requirements for financial institutions that administer, maintain, ormanage private bank accounts or correspondent accounts for non-U.S. persons;

·                  standardsfor verifying customer identification at account opening; and

·                  rulesto promote cooperation among financial institutions, regulators, and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering.

The Bankimplemented the requirements under the USA Patriot Act during 2001 and2002.  Compliance with such requirementshas all been accomplished with existing staff, so the financial impact on theBank has been negligible.

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**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 with theagency.  Enforcement actions may includethe imposition of a conservator or receiver, the issuance of a cease-and-desistorder that can be judicially enforced, the termination of insurance ofdeposits, the imposition of civil money penalties, the issuance of directivesto increase capital, the issuance of formal and informal agreements, theissuance 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 Changein Bank 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 of 1934,as amended (such as the Common stock), is generally presumed, subject torebuttal. to constitute the acquisition of control.

Under theCalifornia Financial Code, no person shall, directly or indirectly, acquirecontrol of a California licensed bank or a bank holding company unless theSuperintendent has approved such acquisition of control.  A person would be deemed to have acquiredcontrol of the Corporation under this state law if such person, directly orindirectly, has the power (i) to vote 25% or more of the voting power of theCorporation or (ii) to direct or cause the direction of the management andpolicies of the Corporation.  Forpurposes of this law, a person who directly or indirectly owns or controls 10%or more of the Common stock would be presumed to control the Corporation,subject to rebuttal.

In addition, any “company”would be required to obtain the approval of the Federal Reserve under the BankHolding Company Act of 1956, as amended (the “BHC Act”), before acquiring 25%(5% in the case of an acquirer that is, or is deemed to be, a bank holdingcompany) or more of the outstanding Common stock of, or such lesser number ofshares as constitute control over, the Bank or the Corporation.

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 upon 

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the filing of anyapplication to establish a domestic branch, to merge or to acquire the assetsor assume the liabilities of a bank.  Inthe case of a bank holding company, the CRA performance record of thesubsidiary bank(s) involved in the transaction is reviewed in connection withthe filing of an application to acquire ownership or control of shares or assetsof a bank or to merge with any other bank holding company.  An unsatisfactory record can substantiallydelay or block the transaction.

**RESEARCH**

Neither theCorporation nor the Bank makes any material expenditures for research anddevelopment.

**DEPENDENCE UPON A SINGLE CUSTOMER**

Neither theCorporation nor the Bank is dependent upon a single customer or very fewcustomers.  The Bank’s business isconcentrated in, and largely dependent upon the strength of the local economyin, the Monterey Peninsula area of Northern California.  The local economy is affected by bothnational trends and by local factors. Tourism and the activities at the former Fort Ord military base areamong the major contributors to the local economy.

**ITEM 2.PROPERTIES**

The main office ofthe Bank, which also serves as the principal office of the Corporation, islocated at 601 Munras Ave., Monterey, California 93940.  This facility contains a lobby, executive andcustomer service offices, teller stations, safe deposit boxes and relatednon-vault area, vault, operations area, lounge and miscellaneous areas.  A drive-through facility and adequate pavedparking are also on the premises.  Boththe land and all improvements thereto are owned by the Bank**.**  The Bank currently operates three branchoffices in Carmel-By-The-Sea, Carmel Valley and Pacific Grove, California, allwithin approximately 10 miles from the Bank’s main office.  The Bank also has a loan production officelocated in Monterey, California.  Theland and improvements dedicated to the Carmel-By-The-Sea, Carmel Valley andPacific Grove branch offices.  SeeFootnote 12 to the Corporation’s financial statements included herewith.  In March 2005 the Bank purchased a buildinglocated at 556 Abrego St., Monterey, CA 93940. This facility located within a city block of the Bank’s main office willbe utilized for additional office space, when renovations are completed.

Generally, neitherthe Bank nor the Corporation may invest in equity interests in real estate,except for the direct use of the Bank or the Corporation in theirbusiness.  The Bank makes and/orpurchases loans secured by real estate, subject to normal banking practices,its own policies and the restrictions described above under Item 1.

**ITEM 3.LEGAL PROCEEDINGS**

There are no known pending legal proceedings to which the Corporationor its subsidiary is a party, or to which any of their properties is subject,other than ordinary litigation arising in the normal course of businessactivities. Although the amount of any ultimate liability with respect to suchproceedings cannot be determined, in the opinion of management, any suchliability will not have a material effect on the consolidated financialposition of the Corporation and its subsidiary.

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

No matters weresubmitted to a vote of security holders during the fourth quarter.

**PART II**

**ITEM 5.MARKET FOR THE CORPORATION’SCOMMON STOCK AND RELATED     STOCKHOLDERMATTERS.**

The Corporation’s stock, which is held by approximately 530 persons,began trading on the NationalAssociation of Securities Dealers Automated Quotations (NASDAQ) systemin May 2005.   In addition to the limitedtrading on the NASDAQ, stock symbol NRLB; the Corporation also has knowledge ofa limited number of transactions conducted between individual shareholders.

The Corporation repurchased 3,795 shares of common stock at $4.00 pershare in 2005; no shares were repurchased in 2006 or 2004.

The following table sets forth, according to information known to theCorporation, the price paid per share in, and volume of, transactions in theCorporation’s stock during the quarters ended March 31, 2004 to December 31,2006.

| Quarter/Year         | ** ** | **Price**  | ** ** | **Volume (1)** | ** ** |
|----------------------|------------|------------|------------|---------------------|------------|
|                 |       |       |       |                |       |
| 1st quarter of  2004 |       | 3.00       |       | 1,438               |       |
| 2nd quarter of  2004 |       | 3.00-4.00  |       | 3,795               |       |
| 3rd quarter of  2004 |       | 3.00       |       | 166                 |       |
| 4th quarter of  2004 |       | —     |       | —              |       |
|                 |       |       |       |                |       |
| 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               |       |

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(1)             Forthe period presented, the information indicated might not include informationon shares which may have been traded directly by shareholders or throughdealers.

The principal source of cash flow of the Corporation, including cashflow to pay dividends on its stock or principal and interest on debt, isinterest and dividends on investments and tax benefit payments and dividendsfrom the Bank.  There are statutory andregulatory limitations on the payment of dividends by the Bank to theCorporation, as well as by the Corporation to its shareholders.

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If in the opinion of the applicable federal and/or state regulatoryauthority, a depository institution or holding company is engaged in or isabout to engage in an unsafe or unsound practice (which, depending on thefinancial condition of the depository institution or holding company, couldinclude the payment of dividends), such authority may require, after notice andhearing (except in the case of an emergency proceeding where there is in nonotice or hearing), that such institution or holding company cease and desistfrom such practice.  Moreover, theFederal Reserve and the FDIC have issued policy statements which provide thatbank holding companies and insured depository institutions generally shouldonly pay dividends out of current operating earnings.

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

The Bank’s payment of dividends, as a California chartered commercialbanking corporation, is regulated by the California Financial Code.  Under the California Financial Code, fundsavailable for cash dividend payments by the Bank are restricted to the lessor of:(i) retained earnings; or (ii) the Bank’s net income for its last three fiscalyears (less any distributions to the stockholders made during suchperiod).  As of December 31, 2006 theBank had $10,913,400 in retained earnings. The Bank’s net income for the last three fiscal years less distributionsto stockholders was $7,312,900.

In December 2006, 2005 and 2004 the Corporation paid cash dividends of$0.35, $0.20 and $0.165 per share, respectively.  The Bank paid cash dividends totaling$625,000 to the Corporation during 2006; no dividends were paid in 2004 or2005.

**ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATION**

**Statements Regarding Forward-Looking Information**

Except for historical information contained herein, the mattersdiscussed or incorporated by reference in this report contain forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, asamended (the “Securities Act”), and Section 21E of the Securities Exchange Actof 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’s otherreports 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 

22

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datehereof.  The Bank undertakes no obligation to publicly revise theseforward-looking statements to reflect events or circumstances that arise afterthe date thereof.

**OVERVIEW**

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

Net income for each of the last three years was $3,837,200 in 2006,$1,929,300 in 2005, and $1,065,200 in 2004. The primary net income per share for each of the last three years was$2.31, $1.20, and $.68 respectively.  Thediluted net income per share for the same time periods was $2.09, $1.00 and$.56, respectively.  Return on averageshareholders’ equity was 34.94%, 24.15% and 15.35% in 2006, 2005 and 2004,respectively.  Return on average assetswas 2.24%, 1.24%, and 0.88% in 2006, 2005 and 2004, respectively.

The increase in earnings in 2006 was due to increases of $1,283,800 innet interest income after provision for loan losses, $2,815,200 in non-interestincome, $814,300 in non-interest expense and $1,376,800 in income tax expense.

The increase in earnings in 2005 was due to increases of $2,134,500 innet interest income after provision for loan losses, $135,200 in non-interestincome, $696,800 in non-interest expense and $708,800 in income tax expense.

The increase inearnings in 2004 was due to increases of $1,240,700 in net interest incomeafter provision for loan losses; partially offset by a decrease of $181,500 innon-interest income and increases of $711,700 in non-interest expense and$122,100 in income tax expense.

23

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The following table provides a summary of the income statement, balancesheet, 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,** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2006**                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands except per share data)**         | ** ** |
| Summary of Operating  Results:                     |       |                                                                                   |       |   |   |   |   |   |   |   | ** ** |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   | ** ** |
| Total interest income                              |       | $                                                                                      | 13,760     |   | $ | 10,691 |   | $ | 7,355 |   | $ | 5,569 |   | $ | 4,876 | ** ** |
| Total interest expense                             |       | 5,197                                                                                  |       | 3,672 |   | 2,435 |   | 1,920 |   | 1,948 | ** ** |
| Net interest income                                |       | 8,563                                                                                  |       | 7,019 |   | 4,920 |   | 3,649 |   | 2,928 | ** ** |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   | ** ** |
| Provision for possible loan  losses                |       | 410                                                                                    |       | 150 |   | 185 |   | 155 |   | 117 | ** ** |
| Net interest income  after provision for loan loss |       | 8,153                                                                                  |       | 6,869 |   | 4,735 |   | 3,494 |   | 2,811 | ** ** |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   | ** ** |
| Total other income                                 |       | 7,177                                                                                  |       | 4,362 |   | 4,227 |   | 2,403 |   | 1,805 | ** ** |
| Total other expenses                               |       | 8,627                                                                                  |       | 7,813 |   | 7,116 |   | 4,399 |   | 3,754 | ** ** |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   | ** ** |
| Income before taxes                                |       | 6,703                                                                                  |       | 3,419 |   | 1,846 |   | 1,498 |   | 863 | ** ** |
| Provision for income  tax                          |       | 2,866                                                                                  |       | 1,489 |   | 781 |   | 659 |   | 354 | ** ** |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   | ** ** |
| Net income                                         |       | $                                                                                      | 3,837      |   | $ | 1,929 |   | $ | 1,065 |   | $ | 840 |   | $ | 509 | ** ** |
| ** **                                         | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Per Common Share Data:                             |       |                                                                                   |       |   |   |   |   |   |   |   |   |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Net income - Basic (1)                             |       | $                                                                                      | 2.313      |   | $ | 1.195 |   | $ | 0.676 |   | $ | 0.550 |   | $ | 0.343 |   |
| Net income - Diluted  (2)                          |       | $                                                                                      | 2.094      |   | $ | 1.003 |   | $ | 0.555 |   | $ | 0.480 |   | $ | 0.292 |   |
| Book value, end of  period (3)                     |       | 7.71                                                                                   |       | 5.55 |   | 4.55 |   | 4.09 |   | 3.77 |   |
| Avg shares outstanding  (4)                        |       | 1,658,675                                                                              |       | 1,614,196 |   | 1,576,589 |   | 1,528,268 |   | 1,483,493 |   |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Balance Sheet Data:                                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
|                                               |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Total loans, net of unearned  income (5)           |       | 130,050                                                                                |       | 107,300 |   | 95,036 |   | 76,908 |   | 60,257 |   |
| Total assets                                       |       | 190,570                                                                                |       | 162,645 |   | 134,039 |   | 107,872 |   | 86,279 |   |
| Total deposits                                     |       | 131,628                                                                                |       | 118,120 |   | 97,263 |   | 78,132 |   | 67,616 |   |
| Stockholders’ equity                          |       | 12,402                                                                                 |       | 8,931 |   | 7,321 |   | 6,411 |   | 5,639 |   |

 

24

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| ** **                                          | ** ** | **As of and for the Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Selected Financial Ratios (4):                      |       |                                           |       |   |   |   |   |   |   |   |   |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Return on average assets (5)                        |       | 2.24                                           | %          | 1.24 | % | 0.88 | % | 0.88 | % | 0.63 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Return on average stockholders’ equity (5)     |       | 34.94                                          | %          | 24.15 | % | 15.35 | % | 13.84 | % | 10.49 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Net interest spread                                 |       | 4.82                                           | %          | 4.68 | % | 4.02 | % | 3.92 | % | 3.22 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Net interest margin                                 |       | 5.58                                           | %          | 5.12 | % | 4.47 | % | 4.30 | % | 3.88 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Avg shareholders’ equity to average assets     |       | 6.40                                           | %          | 5.15 | % | 5.75 | % | 6.35 | % | 5.99 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Risked-Based capital ratios                         |       |                                           |       |   |   |   |   |   |   |   |   |
| Tier 1                                              |       | 9.50                                           | %          | 9.50 | % | 8.22 | % | 9.00 | % | 8.10 | % |
| Total                                               |       | 14.90                                          | %          | 14.90 | % | 14.83 | % | 17.30 | % | 9.10 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Total loans to total deposits at end of period      |       | 98.80                                          | %          | 90.84 | % | 97.71 | % | 98.43 | % | 89.12 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Allowance to total loans at end of period           |       | 1.07                                           | %          | 1.02 | % | 1.00 | % | 1.00 | % | 1.04 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Nonperforming loans to total Loans at end of period |       | 0.12                                           | %          | 0.00 | % | 0.04 | % | 0.04 | % | 0.06 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Net charge-offs to average loans                    |       | 0.09                                           | %          | 0.01 | % | 0.00 | % | 0.03 | % | 0.18 | % |

----

(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 1,658,675 for 2006, 1,614,196 for 2005, 1,576,589 for2004, 1,528,268 for 2003 and 1,483,493 for 2002.

(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 1,831,982, 1,923,532, 1,919,512, 1,796,859 and1,744,082 in 2006, 2005, 2004, 2003 and 2002, respectively.

(3)   Weighted average common shares.

(4)   Includes loans being held for sale.

(5)          Averages are of dailybalances.

**Critical Accounting Policies**

The preparation of financial statements in accordancewith accounting principles generally accepted in the United States of Americarequires management to make a number of judgments, estimates and assumptionsthat affect the reported amount of assets, liabilities, income and expenses

25

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inthe Bank’s financial statements and accompanying notes.  Managementbelieves that the judgments, estimates and assumptions used in preparation ofthe Bank’s financial statements are appropriate given the factual circumstancesas of December 31, 2006.

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.  Management has discussed the development and selection ofthis critical accounting policy with the Audit Committee of the Board ofDirectors.  Although Management believes the level of the allowance atDecember 31, 2006 is adequate to absorb losses inherent in the loan portfolio,a decline in the regional economy may result in increasing losses that cannotreasonably be predicted at this time.   For further informationregarding the allowance for loan losses see “Provision and Allowance for LoanLosses,” and Note 6 to the Bank’s audited financial statements includedelsewhere herein.

**Recently Issued AccountingStandards**

Refer to Note 1 to the Financial Statements — “Summary of SignificantAccounting Policies” for discussion of the recently issued accounting standards.

**NETINTEREST INCOME**

Net interestincome, the difference between (a) interest and fees earned on interest-earningassets and (b) interest paid on interest-bearing liabilities, is the mostsignificant component of the Bank’s earnings. Changes in net interest income from period to period result fromincreases or decreases in the average balances of interest earning assetsportfolio, the availability of particular sources of funds and changes inprevailing interest rates.

The following table summarizes the Corporation’snet interest income.
| ** **          | ** ** | **Years Ended**  | ** ** | **Increase (Decrease)**  | ** ** |
|---------------------|------------|-----------------------|------------|-------------------------------|------------|
| ** **          | ** ** | **December 31,** | ** ** | **From Prior Year** | ** ** |
| ** **          | ** ** | **2006**              | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2006/2005** | ** ** | **2005/2004** | ** ** |
| ** **          | ** ** | ** **            | ** ** | ** **                    | ** ** | ** ** | ** ** | **Amt** | ** ** | **%** | ** ** | **Amt** | ** ** | **%** | ** ** |
| ** **          | ** ** | ** **            | ** ** | ** **                    | ** ** | **(Dollars in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest Income     |       | $                     | 13,760     |                          | $          | 10,691 |   | $ | 7,355 |   | $ | 3,069 |   | 28.7 |   | $ | 3,336 |   | 45.4 |   |
| Interest Expense    |       | 5,197                 |       | 3,672                         |       | 2,435 |   | 1,525 |   | 41.6 |   | 1,237 |   | 50.8 |   |
| Net Interest Income |       | $                     | 8,563      |                          | $          | 7,019 |   | $ | 4,920 |   | $ | 1,543 |   | 22.0 |   | $ | 2,099 |   | 42.7 |   |

 

Net interest incomeincreased $1,543,800 or 22.0% from 2005 to 2006.  Average interest bearing assets increased10.61%, while the average rate earned increased 115 basis points, resulting inan increase of $3,069,200 in total interest income.  Interest expense increased $1,525,400 the

26

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result of a 6.56% increase in averageinterest bearing liabilities, while the average rate paid increased 100 basispoints.

Net interest incomeincreased $2,099,500 or 42.68% from 2004 to 2005.  Average interest bearing assets increased28.21%, while the average rate earned increased 72 basis points, resulting inan increase of $3,335,900 in total interest income.  Interest expense increased $1,236,400 theresult of a 29.72% increase in average interest bearing liabilities, while theaverage rate paid increased 43 basis points.

Thefollowing table shows the components of net interest income, setting forth, foreach of the three years ended December 31, 2006, 2005 and 2004 (i) averageassets, liabilities and investments, (ii) interest income earned oninterest-earning assets and interest expense paid on interest-bearingliabilities, (iii) average yields earned on interest-earning assets and averagerates paid on interest-bearing liabilities, (iv) the net interest spread (i.e.,the average yield earned on interest-earning assets less the average rate paidon interest-bearing liabilities) and (v) the net interest yield on averageinterest-earning assets (i.e., net interest income divided by averageinterest-earning assets).  Yields arecomputed on a tax-equivalent basis, resulting in adjustments to interest earnedon non-taxable securities of $148,700, $137,900 and $70,200 in 2006, 2005 and2004, respectively.  Non-accrual loansand overdrafts are included in average loan balances.  Average loans are presented net of unearnedincome.

27

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**INTERESTSPREAD ANALYSIS:**
| ** **                                                  | ** ** | **As of and for the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                  | ** ** | ** **                                                                             | ** ** | **Int** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Int** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Int** | ** ** | **Avg** | ** ** |
| ** **                                                  | ** ** | **Avg**                                                                                | ** ** | **Earn** | ** ** | **%** | ** ** | **Avg** | ** ** | **Earn** | ** ** | **%** | ** ** | **Avg** | ** ** | **Earn** | ** ** | **%** | ** ** |
| ** **                                                  | ** ** | **Bal**                                                                                | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Bal** | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Bal** | ** ** | **Paid** | ** ** | **Rate** | ** ** |
| ** **                                                  | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | **(Dollars in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Assets:                                                     |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Loans                                                       |       | $                                                                                      | 118,699    |   | $ | 11,954 |   | 10.07 |   | $ | 108,963 |   | $ | 9,561 |   | 8.77 |   | $ | 86,870 |   | $ | 6,756 |   | 7.78 | ** ** |
| Time deposits -  in other banks                             |       | 1,000                                                                                  |       | 50 |   | 4.97 |   | 1,000 |   | 29 |   | 2.92 |   | — |   | — |   | — | ** ** |
| Invest  securities - taxable                                |       | 15,145                                                                                 |       | 730 |   | 4.82 |   | 13,237 |   | 441 |   | 3.33 |   | 10,755 |   | 301 |   | 2.80 | ** ** |
| Invest  securities - nontaxable                             |       | 7,019                                                                                  |       | 480 |   | 6.83 |   | 7,026 |   | 445 |   | 6.33 |   | 3,456 |   | 226 |   | 6.55 | ** ** |
| Federal funds  sold                                         |       | 14,745                                                                                 |       | 721 |   | 4.89 |   | 10,481 |   | 352 |   | 3.36 |   | 10,479 |   | 141 |   | 1.35 | ** ** |
| Total  interest-earning assets                              |       | 156,607                                                                                |       | 13,933 |   | 8.90 |   | 140,707 |   | 10,828 |   | 7.75 |   | 111,561 |   | 7,425 |   | 6.66 | ** ** |
|                                                        |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Allowance for  credit losses                                |       | (1,162                                                                                 | )          |   |   |   |   | (1,023 | ) |   |   |   |   | (1,101 | ) |   |   |   | ** ** |
| Non-interest  bearing assets:                               |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Cash and due  from banks                                    |       | 5,187                                                                                  |       |   |   |   |   | 5,523 |   |   |   |   |   | 3,282 |   |   |   |   | ** ** |
| Premises and  equipment                                     |       | 4,441                                                                                  |       |   |   |   |   | 4,362 |   |   |   |   |   | 2,223 |   |   |   |   | ** ** |
| Accrued interest  receivable                                |       | 797                                                                                    |       |   |   |   |   | 699 |   |   |   |   |   | 422 |   |   |   |   | ** ** |
| Other assets                                                |       | 5,725                                                                                  |       |   |   |   |   | 5,822 |   |   |   |   |   | 4,314 |   |   |   |   | ** ** |
| Total average  assets                                       |       | 171,596                                                                                |       |   |   |   |   | 156,090 |   |   |   |   |   | 120,700 |   |   |   |   | ** ** |
|                                                        |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Liabilities and  Shareholders’ Equity:                 |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Interest Bearing  Liabilities:                              |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Interest-bearing  demand                                    |       | $                                                                                      | 13,243     |   | $ | 42 |   | 0.31 |   | $ | 12,584 |   | $ | 32 |   | 0.26 |   | $ | 13,099 |   | $ | 33 |   | 0.25 | ** ** |
| Money market  savings                                       |       | 3,589                                                                                  |       | 27 |   | 0.75 |   | 4,818 |   | 32 |   | 0.66 |   | 3,894 |   | 32 |   | 0.81 | ** ** |
| Savings deposits                                            |       | 7,355                                                                                  |       | 74 |   | 1.00 |   | 7,476 |   | 80 |   | 1.07 |   | 7,924 |   | 81 |   | 1.02 |   |
| Time deposits  >$100M                                    |       | 32,372                                                                                 |       | 1,479 |   | 4.57 |   | 29,908 |   | 990 |   | 3.31 |   | 18,795 |   | 562 |   | 2.99 |   |
| Time deposits  <$100M                                    |       | 33,174                                                                                 |       | 1,370 |   | 4.13 |   | 31,981 |   | 971 |   | 3.04 |   | 24,264 |   | 711 |   | 2.93 |   |
| Other Borrowing                                             |       | 37,894                                                                                 |       | 2,207 |   | 5.82 |   | 32,998 |   | 1,567 |   | 4.75 |   | 24,347 |   | 1,018 |   | 4.18 |   |
| Total  interest-bearing liabilities                         |       | 127,626                                                                                |       | 5,198 |   | 4.07 |   | 119,765 |   | 3,672 |   | 3.07 |   | 92,324 |   | 2,436 |   | 2.64 |   |
|                                                        |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing liabilities:                          |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing  checking                              |       | 30,155                                                                                 |       |   |   |   |   | 24,857 |   |   |   |   |   | 20,029 |   |   |   |   |   |
| Accrued interest  payable                                   |       | 995                                                                                    |       |   |   |   |   | 664 |   |   |   |   |   | 363 |   |   |   |   |   |
| Other  liabilities                                          |       | 1,838                                                                                  |       |   |   |   |   | 2,816 |   |   |   |   |   | 1,042 |   |   |   |   |   |
| Total  liabilities                                          |       | 160,614                                                                                |       |   |   |   |   | 148,102 |   |   |   |   |   | 113,758 |   |   |   |   |   |
| Total  shareholders equity                                  |       | 10,982                                                                                 |       |   |   |   |   | 7,988 |   |   |   |   |   | 6,941 |   |   |   |   |   |
| Total average  liabilities and shareholders equity          |       | $                                                                                 | 171,596    |   |   |   |   |   | $  | 156,090 |   |   |   |   |   | $  | 120,700 |   |   |   |   |   |
| Interest income  as a percentage of average earning assets  |       |                                                                                   |       |   |   | 8.90 |   |   |   |   |   | 7.75 |   |   |   |   |   | 6.66 |   |
| Interest expense  as a percentage of average earning assets |       |                                                                                   |       |   |   | 3.32 |   |   |   |   |   | 2.63 |   |   |   |   |   | 2.18 |   |
| Net yield on interest earning  assets                       |       |                                                                                   |       |   |   | 5.58 |   |   |   |   |   | 5.12 |   |   |   |   |   | 4.47 |   |

 

28

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**INTEREST SPREAD ANALYSIS (Continued):**

 
| ** **                                | ** ** | **Increase (decrease) in the twelve months ended**         | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **December 31, 2006 compared with December 31, 2005** | ** ** |
| ** **                                | ** ** | **Volume**                                                                               | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase  (decrease) in interest income:  |       |                                                                                     |       |   |   |   |   |
| Loans                                     |       | $                                                                                        | 854        |   | $ | 1,538 |   | $ | 2,392 |   |
| Time deposits -  in other banks           |       | —                                                                                   |       | 20 |   | 20 |   |
| Invest  securities - taxable              |       | 63                                                                                       |       | 225 |   | 289 |   |
| Invest securities  - nontaxable           |       | (0                                                                                       | )          | 35 |   | 35 |   |
| Federal funds  sold                       |       | 144                                                                                      |       | 225 |   | 369 |   |
| Total  interest-earning assets            |       | 1,061                                                                                    |       | 2,044 |   | 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       |       | 342                                                                                      |       | 1,183 |   | 1,525 |   |
| Increase in net  interest expense:        |       | $                                                                                        | 718        |   | $ | 861 |   | $ | 1,580 |   |

 

** **
| ** **                                | ** ** | **Increase (decrease) in the twelve months ended**         | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **December 31, 2005 compared with December 31, 2004** | ** ** |
| ** **                                | ** ** | **Volume**                                                                               | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase  (decrease) in interest income:  |       |                                                                                     |       |   |   |   |   |
| Loans                                     |       | $                                                                                        | 1,718      |   | $ | 1,087 |   | $ | 2,805 |   |
| Time deposits -  in other banks           |       | 29                                                                                       |       | — |   | 29 |   |
| Invest  securities - taxable              |       | 69                                                                                       |       | 70 |   | 140 |   |
| Invest  securities - nontaxable           |       | 234                                                                                      |       | (15 | ) | 218 |   |
| Federal funds  sold                       |       | 0                                                                                        |       | 211 |   | 211 |   |
| Total  interest-earning assets            |       | 2,051                                                                                    |       | 1,353 |   | 3,403 |   |
|                                      |       |                                                                                     |       |   |   |   |   |
| Increase  (decrease) in interest expense: |       |                                                                                     |       |   |   |   |   |
| Interest-bearing  demand                  |       | $                                                                                        | (1         | ) | $ | 1 |   | $ | (0 | ) |
| Money market  savings                     |       | 7                                                                                        |       | (7 | ) | 0 |   |
| Savings deposits                          |       | (5                                                                                       | )          | 5 |   | (0 | ) |
| Time deposits  >$100M                  |       | 332                                                                                      |       | 96 |   | 428 |   |
| Time deposits  <$100M                  |       | 226                                                                                      |       | 34 |   | 260 |   |
| Other borrowing                           |       | 362                                                                                      |       | 187 |   | 549 |   |
| Total  interest-bearing liabilities       |       | 922                                                                                      |       | 316 |   | 1,237 |   |
| Increase in net  interest expense:        |       | $                                                                                        | 1,129      |   | $ | 1,037 |   | $ | 2,166 |   |

 

29

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**Provisionand Allowance for Loan Losses**

The provision forloan losses is an expense charged against operating income and added to theallowance for loan losses.  The allowancefor loan losses represents amounts which have been set aside for the specificpurpose of absorbing losses which may occur in the Bank’s loan portfolio.

Theallowance for loan losses reflects management’s ongoing evaluation of the risksinherent in the loan portfolio both generally and with respect to specificloans, the state of the economy, and the level of net loan losses experiencedin the past.  Management and the Board ofDirectors review the results of the State Banking Department and FDICexaminations, independent accountants’ observations, and the Bank’s internalreview as additional indicators to determine if the amount in the allowance forloan losses is adequate to protect against estimated future losses.  It is the Bank’s current practice, whichcould change in accordance with the factors mentioned above, to maintain anallowance which is at least equal to the sum of the following percentage of loanbalances by loan category.

 

| 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 Etate –  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 |       | .10                | %          |
| Economic Risk  Factor                         |       | .20                | %          |
| SBA Loans –  Guaranteed portion          |       | 0.00               | %          |
| Cash Secured Loans                            |       | 0.00               | %          |

 

Althoughno assurance can be given that actual losses will not exceed the amountprovided for in the allowance, Management believes that the allowance isadequate to provide for all estimated credit losses in light of all knownrelevant factors.  At the end of 2006,2005 and 2004, the Bank’s allowance stood at 1.07%, 1.02%, and 1.00% of grossloans, respectively.  Provisions weremade to the allowance for loan losses in 2006, 2005 and 2004 of $410,000,$150,000, and $185,000, respectively. Loans charged off in 2006 and 2005 totaled $108,900 and $14,200,respectively; no loans were charged off in 2004.  Recoveries for these same periods were$7,100, $1,900, and $3,200, respectively.

30

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The Bank’snon-performing (delinquent 90 days or more and on non-accrual) loans as apercentage of total loans were 0.12 percent 0.00 percent and 0.04 percent as ofthe end of 2006, 2005 and 2004, respectively.

Basedupon statistics released by Federal and state banking authorities regardingbanks of similar size or otherwise located in California, Management believesthat the Bank’s ratios of delinquent and non performing loans to total loansare far better than average.  Prudentcollection efforts, and tighter lending controls, are responsible for the Bank’sstrong performance on these measures of credit quality.  However, no assurance can be given that theBank’s loan portfolio will continue to measure well against its peers on theseratios and quality measures, or that losses will not otherwise occur in thefuture.

**Non-InterestIncome**

The followingtable presents a summary of the Bank’s non-interest income:

|                                                         | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | **(Dollars in thousands)**        | ** ** |
| Service charges  on deposit accounts                    |       | $                                      | 547        |   | $  | 564 |   | $  | 517 |   |
|                                                    |       |                                        |       |   |   |   |   |
| Gain on sale of  Pacific Coast Bankers’ Bank Stock |       | 1,313                                       |       | — |   | — |   |
|                                                    |       |                                        |       |   |   |   |   |
| Other service  charges, commissions and  fees           |       | 4,627                                       |       | 2,807 |   | 2,994 |   |
|                                                    |       |                                        |       |   |   |   |   |
| Income from sales  and servicing of  SBA loans          |       | 690                                         |       | 991 |   | 716 |   |
|                                                    |       |                                        |       |   |   |   |   |
| Total non-interest  income                              |       | $                                           | 7,177      |   | $ | 4,362 |   | $ | 4,227 |   |

 

Totalnon-interest income increased $2,815,200 or 64.84% in 2006 when compared with2005.  The increase resulted from thegain on sale of the Bank’s investment in Pacific Coast Bankers’ Bank of$1,313,400, an increase in income from other service charges, commissions andfees of $1,819,900, and decreases of $301,700 in income from sales andservicing of Small Business Administration Loans and $16,400 in service chargeson deposit accounts.  The increase inother service charges, commissions and fees was due primarily to a $50,000 markto market gain on trading assets compared with a $427,300 mark to market lossin 2005, and increases of $1,099,800 in fee income from credit card programs,$271,700 in merchant discount fees and $29,800 from stored value card programs,while commercial banking origination fees decreased $287,200.

Totalnon-interest income increased $135,200 or 3.20% in 2005 when compared with2004.  Income from sales and servicing ofSBA loans increased $275,000 and service charges on deposit accounts increased$47,300; while other income decreased $187,100. The decrease in other income was due primarily to a mark to market lossof $427,300 in trading asset activities; partially offset by increases of$102,100 in credit card program fees and $138,100 in commercial bankingorigination fees.

31

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Total non-interestincome decreased $181,500 or 3.03% in 2004 when compared with 2003.  Income from sales and servicing of SBA loansincreased $55,800 and service charges on deposit accounts increased $10,800;while other income decreased $248,100. The decrease in other income was due primarily to decreases of $265,400in commercial banking origination fees.

The sale of SmallBusiness Administration (SBA) guaranteed loans is a significant contributor tothe Bank’s income.  SBA guaranteed loansyield up to 3 3/4% over the New York prime rate, and the guaranteed portionscan be sold at premiums which vary with market conditions.  SBA loans are guaranteed by the full faith ofthe United States Government up to 85 percent of the principal amount.  The guaranteed portion has risks comparablefor an investor to a U. S. Government security and can usually be sold in thesecondary financial market, either at a premium or at a yield which allows theBank to maintain a significant spread for itself.

There can be no assurancethat the gains on sale will continue at, or above, the levels realized in thepast three years.  The Small BusinessAdministration has recently 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 followingtable presents a summary of the activity in SBA loans for the years ended 2006,2005 and 2004:
| ** **           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|----------------------|------------|----------|------------|----------|------------|-----------|------------|
|                 |       |     |       |     |       |      |       |
| SBA loans authorized |       | $        | 3,645,000  |     | $          | 6,274,000 |       | $ | 15,844,000 |   |
| SBA loans sold       |       | $        | 4,428,400  |     | $          | 7,944,900 |       | $ | 4,669,100 |   |

 
| **Summary of Income from sales and Servicing of SBA Loans** | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from premium                                                                                      |       | $          | 349,800    |       | $          | 665,400    |       | $ | 412,400 |   |
| Income from servicing                                                                                    |       | 339,800    |       | 326,000    |       | 304,000    |       |
| Total income from sales and servicing of SBA loans                                                       |       | $          | 689,700    |       | $          | 991,400    |       | $ | 716,400 |   |

**Non-InterestExpense**

The followingtable presents a summary of the Bank’s other non-interest expense:
| ** **                       | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)**        | ** ** |
| Salaries and  benefits           |       | $                                           | 3,854      |   | $ | 3,282 |   | $ | 3,004 |   |
| Occupancy and  equipment expense |       | 790                                         |       | 664 |   | 597 |   |
| Professional  fees               |       | 149                                         |       | 141 |   | 113 |   |
| Data processing                  |       | 322                                         |       | 356 |   | 364 |   |
| Other expenses                   |       | 3,511                                       |       | 3,370 |   | 3,038 |   |
| Total other  expenses            |       | $                                           | 8,626      |   | $ | 7,813 |   | $ | 7,115 |   |

 

32

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Salary and benefits expense increased $572,000 in 2006as a result the addition of a Marketing Officer, Business Development Officerand a Credit Analyst, increased commission paid due to increased credit cardand stored value card program revenues, and merit increases and bonuspayments.  Salary and benefits expenseincreased $278,200 in 2005 as a result merit increases and bonus payments.  Salary and benefits expense increased$437,600 in 2004 as a result of the first full year of salary expense relatedto the hiring of an Executive Vice President/Chief Lending Officer during thefourth quarter of 2003, merit increases and bonus payments.

Occupancy and equipment expenses increased $125,700 in 2006, due toincreases of net merchant terminal expense $41,900, $16,000 in depreciationexpense, $11,100 in premises rent and $6,000 in property taxes; while subleaserental income decreased $45,100.  Occupancyand equipment expenses increased $67,800 in 2005, due to increases of $48,300in depreciation expense, $18,000 in property taxes, $11,100 in premises rent,$10,000 in premises other expense and $8,800 in janitorial expense; while netmerchant terminal decreased $30,800. Occupancy and equipment expenses increased $86,000 in 2004, due toincreases of $19,800 in depreciation expense, $22,700 in merchant terminalexpense, $14,100 in repairs and maintenance expense, $7,800 in janitorialexpense and $4,700 in premises rent.

Data processing expense decreased $33,400 in 2006, the result ofcontinued efforts to implement more cost effective programs.  Data processing expense decreased $8,100 in2005, the result of renegotiation of the data services contract during thefourth quarter of 2004.  Data processingexpense increased $6,800 in 2004.

In 2005, professional fees increased $8,700 due to increased legalfees.  In 2005, professional feesincreased $27,000 due to accounting/audit fees increasing $21,600 while legalfees increased $5,400.  In 2004,professional fees increased $24,400 due to accounting/audit fees increasing$19,500 while legal fees increased $4,900.

Other expenses for 2006 totaled $3,511,200 compared with $3,369,900 for2005, an increase of $141,300. Significant changes occurred in the following categories with increasesin merchant processing expense of $104,400, advertising of $82,900, operationallosses of $61,900, business development of $61,100, stationary/supplies of$42,400, loan expense of $36,500, travel expense of $22,800, bank fees of$20,700, dues and memberships of $13,000, and collection expense of $9,600;while decreases occurred in provision for debt securities losses of $229,400,provision for loss unfunded loan commitments of $71,000, director fees of$13,300, and meals of $10,400.

Other expenses for 2005 totaled $3,369,900 compared with $3,038,000 for2004, an increase of $331,900. Significant changes occurred in the following categories with therecording of the provision for debt securities losses of $119,500 and provisionfor loss unfunded loan commitments of $52,000; increases in director fees of$53,400, donations of $49,900, merchant processing expense of $44,500 telephoneexpense of $17,200, entertainment and meals of $16,100, bank fees of $15,200,stationary/supplies of $14,900, advertising of $13,600, insurance of $10,900,miscellaneous expense of $8,800, subscription/publication expense of $8,600,dues and memberships of $8,600; while decreases occurred in loan expense of$41,300, operational losses of 

33

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$30,600, collection expense of $21,300, postage expense of $9,100 andbusiness development of $9,000.

**IncomeTaxes**

In 2006, the Bank’sprovision for federal and state income taxes was $6.7 million, while theprovision was $3.4 million and $1.8 million for 2005 and 2004,respectively.  This represents 42.76% ofincome before taxes in 2006, 43.57% in 2005, and 42.30% in 2004.  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 increase in the tax provision from 2005to 2006 was due to an increase in volume of taxable 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 the cashsurrender value of life insurance, and certain other expenses that are notallowed as tax deductions.

**LOANS**

Loans, the largest component of earning assets,represented 76.28% of average earning assets, and 69.46% of average totalassets during 2006, compared with 77.46% and 70.53%, respectively during2005.  In 2006, average loans increased8.94% from $108,962,800 in 2005 to $118,699,100.  Average real estate loans increased $10,892,600or 15.72%, average construction loans increased $2,062,900 or 20.73% whileaverage commercial loans decreased $3,210,100 or 11.12%, and averageinstallment loans decreased $9,100 or 1.06%.

Loan policies and procedures provide the overall direction to theadministration of the loan portfolio. The Bank’s loan underwriting process is intended to encourage sound andconsistent credit decisions are made. Emphasis is placed upon credit quality, the borrower’s ability to repaythrough cash flow, secondary and (occasionally tertiary) repayment sources, andthe value of collateral.

The Bank’s commercial and industrial loans are generally made for thepurpose of providing working capital, financing the purchase of equipment orinventory, and other business purposes. Such loans generally have maturitiesranging from one year to several years. Short-term business loans are generally intended to finance currenttransactions and typically provide for monthly interest payments with principalbeing payable at maturity or at 90-day intervals. Term loans (usually for aterm of two to five years) normally provide for monthly installments ofprincipal and interest.  The Bank fromtime to time utilizes accounts receivable and inventory as security for loans.

The Bank is therecognized leader for Small Business Administration lending in Monterey County,and holds SBA’s coveted Preferred Lender Status.  Generally, SBA loans are guaranteed by theSBA for up to 85 percent of their principal amount, which can be retained inportfolio or sold to investors.  Suchloans are made at floating interest rates, but generally for longer terms (upto 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 conventional commercialloans because they may be based upon credit standards the Bank would nototherwise apply, such as lower cash flow coverage, or longer repayment terms.

34

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The Bank’s realestate loan portfolio consists both of real estate construction loans and realestate mortgage loans.  The Bank hasinitiated a program to generate more commercial and industrial real estateloans, which generally yield higher returns than normal commercial loans.  The Bank has also developed a broker programfor generating residential real estate loans. The Bank does not make real estate development loans.  Real estateconstruction loans are made for a much shorter term, and often at higherinterest rates, than conventional single-family residential real estateloans.  The cost of administering suchloans is often higher than for other real estate loans, as principal is drawnon periodically as construction progresses.

The Bank alsomakes real estate loans secured by a first deed of trust on single familyresidential properties and commercial and industrial real estate.  California commercial banks are permitted,depending on the type and maturity of the loan, to lend up to 90 percent of thefair market value of real property (or more if the loan is insured either byprivate 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.

Consumerloans are made for the purpose of financing the purchase of various types ofconsumer goods, home improvement loans, auto loans and other personalloans.  Consumer installment loansgenerally provide for monthly payments of principal and interest, at a fixedrate.  Most of the Bank’s consumerinstallment loans are generally secured by the personal property beingpurchased.  The Bank generally makesconsumer loans to those customers with a prior banking relationship with theBank.

The followingtable presents the composition of the loan portfolio, including loans held forsale, at December 31 for the last five years.
| ** **                              | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)**        | ** ** |
| Commercial and  industrial              |       | $                                           | 27,543     |   | $ | 26,236 |   | $ | 23,854 |   | $ | 18,607 |   | $ | 14,432 |   |
| Real estate,  construction              |       | 17,326                                      |       | 10,456 |   | 7,373 |   | 5,934 |   | 4,066 |   |
| Real estate,  mortgage                  |       | 86,207                                      |       | 71,006 |   | 64,339 |   | 52,698 |   | 42,000 |   |
| Installment                             |       | 694                                         |       | 942 |   | 622 |   | 580 |   | 462 |   |
| Government  guaranteed loans  purchased |       | 39                                          |       | 45 |   | 51 |   | 57 |   | 63 |   |
|                                    |       | 131,809                                     |       | 108,685 |   | 96,239 |   | 77,876 |   | 61,024 |   |
| Less:                                   |       |                                        |       |   |   |   |   |   |   |   |   |
| Allowance for possible loan losses      |       | (1,409                                      | )          | (1,101 | ) | (963 | ) | (775 | ) | (637 | ) |
| Deferred origination fees, net          |       | (350                                        | )          | (284 | ) | (240 | ) | (193 | ) | (130 | ) |
| Net loans                               |       | $                                           | 130,050    |   | $ | 107,300 |   | $ | 95,036 |   | $ | 76,908 |   | $ | 60,257 |   |

The followingtable shows the maturity distribution and repricing intervals of the Bank’soutstanding loans at December 31, 2006. 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.

35

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| ** **                                       | ** ** | **Loan Maturities and Repricing Schedule** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Within One Year**                                  | ** ** | **After One   But Within   Five Years** | ** ** | **After Five   Years** | ** ** | **Total** | ** ** |
| ** **                                       | ** ** | **($ in thousands)**                                 | ** ** |
| Construction                                     |       | $                                                              | 16,525     |   | $ | 801 |   | $ | — |   | $ | 17,326 |   |
| Commercial                                       |       | 24,081                                                         |       | 2,501 |   | 1,000 |   | 27,582 |   |
| Real estate                                      |       | 40,819                                                         |       | 27,999 |   | 17,389 |   | 86,207 |   |
| Installment                                      |       | 429                                                            |       | 168 |   | 97 |   | 694 |   |
| Total gross  loans                               |       | $                                                              | 81,854     |   | $ | 31,469 |   | $ | 18,488 |   | $ | 131,809 |   |
| Loans with  variable (floating) interest rates   |       | $                                                              | 78,030     |   | $ | 7,203 |   | $ | — |   | $ | 85,233 |   |
| Loans with  predetermined (fixed) interest rates |       | $                                                              | 3,824      |   | $ | 24,266 |   | $ | 18,488 |   | $ | 46,576 |   |

**Non-performingand Non-accrual Loans**

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

36

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Thefollowing table presents information with respect to loans which, as of thedates indicated, were past due 90 days or more or were placed on non-accrualstatus (referred to collectively as “non-performing loans”):
| ** **                                                                  | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                  | ** ** | **(Dollars in thousands)**  | ** ** |
| Accruing, past due 90 days or more:                                         |       |                                  |       |   |   |   |   |   |   |   |   |
|                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Real estate                                                                 |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial                                                                  |       | —                                |       | — |   | — |   | — |   | — |   |
| Installment                                                                 |       | —                                |       | — |   | — |   | — |   | — |   |
| Total accruing                                                              |       | —                                |       | — |   | — |   | — |   | — |   |
|                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Nonaccrual Loans:                                                           |       |                                  |       |   |   |   |   |   |   |   |   |
|                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Real estate                                                                 |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial                                                                  |       | 155                                   |       | — |   | 43 |   | 28 |   | 24 |   |
| Installment                                                                 |       | —                                |       | — |   | — |   | — |   | 10 |   |
| Total nonaccrual                                                            |       | 155                                   |       | — |   | 43 |   | 28 |   | 34 |   |
|                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Total  nonperforming                                                        |       | $                                     | 155        |   | $ | — |   | $ | 43 |   | $ | 28 |   | $ | 34 |   |
|                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Total loans end of  period                                                  |       | $                                     | 131,809    |   | $ | 108,685 |   | $ | 96,239 |   | $ | 77,876 |   | $ | 61,024 |   |
|                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Ratio of nonperforming  loans to total loans at end of period               |       | 0.12                                  | %          | 0.00 | % | 0.04 | % | 0.04 | % | 0.06 | % |
|                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Ratio of nonperforming loans to allowance for loan losses at end of  period |       | 909.37                                | %          | N/A |   | 2259.14 | % | 4421.35 | % | 1862.78 | % |

 

The low level of non-performing loans is theresult of underwriting criteria intended to be conservative, frequent review ofnew and delinquent loans and a firm collection policy (with the assistance ofoutside legal counsel).  The Bank doesnot have any foreign loans or loans for highly leveraged transactions.

37

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**Summary of Loan Loss Experience**
| ** **                                                                     | ** ** | **For the Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                                      | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)**                          | ** ** |
| Average loans outstanding                                                      |       | $                                                             | 118,699    |   | $ | 108,963 |   | $ | 86,870 |   | $ | 67,949 |   | $ | 11,192 |   |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Allowance, beginning of period                                                 |       | $                                                             | 1,101      |   | $ | 963 |   | $ | 775 |   | $ | 637 |   | $ | 566 |   |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Loans charged off during period:                                               |       |                                                          |       |   |   |   |   |   |   |   |   |
| Real estate                                                                    |       | 0                                                             |       | 0 |   | 0 |   | 0 |   | 58 |   |
| Commercial                                                                     |       | 109                                                           |       | 14 |   | 0 |   | 18 |   | 1 |   |
| Installment                                                                    |       | 0                                                             |       | 0 |   | 0 |   | 0 |   | 1 |   |
| Other                                                                          |       | 0                                                             |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total charge offs                                                              |       | 109                                                           |       | 14 |   | 0 |   | 18 |   | 60 |   |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Recoveries during period:                                                      |       |                                                          |       |   |   |   |   |   |   |   |   |
| Real estate                                                                    |       | 0                                                             |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Commercial                                                                     |       | 7                                                             |       | 2 |   | 3 |   | 1 |   | 13 |   |
| Installment                                                                    |       | 0                                                             |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Other                                                                          |       | 0                                                             |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total recoveries                                                               |       | 7                                                             |       | 2 |   | 3 |   | 1 |   | 13 |   |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Net loans charged off during the period                                        |       | 102                                                           |       | 12 |   | (3 | ) | 17 |   | 47 |   |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Additions to allowance for possible loan losses                                |       | 410                                                           |       | 150 |   | 185 |   | 155 |   | 117 |   |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Allowance, end of period                                                       |       | $                                                             | 1,409      |   | $ | 1,101 |   | $ | 963 |   | $ | 775 |   | $ | 637 |   |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Ratio of net loans charged off to average loans outstanding during  the period |       | 0.09                                                          | %          | 0.01 | % | 0.00 | % | 0.03 | % | 0.42 | % |
|                                                                           |       |                                                          |       |   |   |   |   |   |   |   |   |
| Ratio of allowance to total loans at end of period                             |       | 1.07                                                          | %          | 1.02 | % | 1.00 | % | 1.00 | % | 1.04 | % |

 

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FundingSources

Average deposits increased 8.30% to $119,887,300 in2006 from $110,699,800 in 2005.  In 2006average demand deposits increased 26.00% and average certificates of deposit increased5.91% while average interest checking, money market and savings accounts as agroup decreased 2.78%.  Averagecertificates of deposit represented 54.54% of average deposits in 2006 comparedwith 55.91% in 2005.  Average interestchecking, money market and savings accounts as a group were 20.13% of averagedeposits in 2006 compared with 22.47% in 2005. Average demand deposits represented 25.09% of average deposits in 2006compared with 21.62% in 2005.

The following table summarizes the distribution ofaverage daily deposits and the average daily rates paid for the years endedDecember 31, 2006, 2005, 2004, respectively.
| ** **                                                      | ** ** | **Average deposits**             | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                      | ** ** | **For the year ended** | ** ** | **For the year ended** | ** ** | **For the year ended** | ** ** |
| ** **                                                      | ** ** | **December 31, 2006**       | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
| ** **                                                      | ** ** | **($ in thousands)**        | ** ** |
| ** **                                                      | ** ** | **Average  Balance**                  | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Average  Rate** | ** ** |
| Non-interest-bearing  checking                                  |       | $                                     | 30,155     |   | — |   | $ | 24,857 |   | — |   | $ | 20,029 |   | — |   |
|                                                            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  demand                                        |       | 13,243                                |       | 0.31 | % | 12,584 |   | 0.26 | % | 13,099 |   | 0.25 | % |
|                                                            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Money market  savings                                           |       | 3,589                                 |       | 0.75 | % | 4,818 |   | 0.66 | % | 3,894 |   | 0.81 | % |
|                                                            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Savings deposits                                                |       | 7,355                                 |       | 1.00 | % | 7,476 |   | 1.07 | % | 7,924 |   | 1.02 | % |
|                                                            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Time certificate  deposits in denominations of $100,000 or more |       | 32,372                                |       | 4.57 | % | 29,908 |   | 3.31 | % | 18,795 |   | 2.99 | % |
|                                                            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Other time  deposits                                            |       | 33,174                                |       | 4.13 | % | 31,981 |   | 3.04 | % | 24,264 |   | 2.93 | % |
| Total Deposits                                                  |       | $                                     | 119,887    |   | 2.50 | % | $ | 111,624 |   | 1.89 | % | $ | 88,006 |   | 1.61 | % |

 

The following table setsforth the scheduled maturities of the Company’s time deposits in denominationsof $100,000 or greater which amounted to $35,825,800 at December 31, 2006:

| Maturities of Time Deposits of $100,000 or more | ** ** |
|------------------------------------------------------------------------------------|------------|
| **At December 31, 2006**                                            | ** ** |
| **($ in thousands)**                                                     | ** ** |
| Three months or  less                                                              |       | $ | 9,750 |   |
| Over three  months through six months                                              |       | 7,922 |   |
| Over six months  through twelve months                                             |       | 13,019 |   |
| Over twelve  months                                                                |       | 5,135 |   |
|                                                                               |       | $ | 35,826 |   |

 

The Bank has lines of credit from theFederal Home Loan Bank (FHLB) of San Francisco, Bank of the West, Pacific CoastBankers’ Bank and The Independent Bank with remaining available borrowingcapacity on December 31, 2006 of $1,065,800 (based on pledged collateral),$4,500,000, $6,000,000 and $5,000,000, respectively.  The Federal Home Loan Bank line of credit hasa 

39

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maximumborrowing capacity of twenty five percent (25%) of the Bank’s total assets,adjusted quarterly.  The Federal HomeLoan Bank line of credit is secured by a portion of the Bank’s real estatesecured loans and securities at December 31, 2006.  The total principal balance of pledged loanswas $33,463,500 and securities of $15,364,900. The following table provides information on thirteen FHLB advancestotaling $34,750,000 and outstanding at December 31, 2006.

| Advance    | ** ** | **Fixed Interest** | ** ** | **Funding** | ** ** | **Maturity** |
|------------|------------|-------------------------|------------|-------------|------------|--------------|
| **Amount** | ** ** | **Rate**                | ** ** | **Date**    | ** ** | **Date**     |
| $          | 2,750,000  |                    | 3.44       | %           | 09/27/02   |         | 09/27/07 |
| 3,000,000  |       | 4.30                    | %          | 06/17/05    |       | 06/17/10     |
| 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     |
| 1,000,000  |       | 7.72                    | %          | 06/01/00    |       | 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     |
| $          | 34,750,000 |                    |       |        |       |         |   |

 

The Bankof the West, Pacific Coast Bankers’ Bank and The Independent Bank lines of credit are unsecured.  The Bank did not utilize any overnightborrowings in 2006, 2005 or 2004.

The Bank has a $330,000 letter of credit issued by theFederal Home Loan Bank of San Francisco to secure the uninsured portion oflocal agency deposits maintained with the Bank. The letter of credit matures April 17, 2011.

**Capital Resources**

The Corporation maintains capital to comply with legalrequirements, to provide a margin of safety for its depositors andstockholders, and to provide for future growth and the ability to paydividends.  At December 31, 2006,stockholders’ equity was $12,401,900 versus $8,930,900 at December 31,2005.  The Corporation paid cashdividends of $0.35, $0.20 and $0.165 per share in 2006, 2005 and 2004,respectively.  The Bank paid cashdividends totaling $625,000 to the Corporation in 2005, no cash dividends werepaid in 2005 and 2004.

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.

40

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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 risk associatedwith each asset.  Each asset is assignedto one of four risk-weighted categories. For example, 0 percent for cash and unconditionally guaranteedgovernment securities; 20 percent for deposits with other banks and fed funds;50 percent for state bonds and certain residential real estate loans; and 100percent for commercial loans and other assets. Capital is categorized as either Tier 1 capital, consisting of commonstock and retained earnings (or deficit), or Tier 2 capital, which includeslimited-life preferred stock and allowance for loan losses (subject to certainlimitations).  The guidelines also defineand set minimum capital requirements (risk-based capital ratios), whichincreased over a transition period, ended December 31, 1992.  Under the final 1992 rules, all banks wererequired to maintain Tier 1 capital of at least 4 percent and total capital of8.0% of risk-adjusted assets. The Bank had a Tier 1 capital ratio of 12.40% and12.07% at December 31, 2006 and 2005, respectively.  The Bank’s Tier 1 capital exceeds the minimumregulatory requirement by $12,291,000. The Bank had a Total Risk-Based capital ratio of 13.40% and 12.48% atDecember 31, 2006 and 2005, respectively. The Bank’s Total Risk-Based capital exceeds the minimum regulatory requirementby $7,907,000.

The Tier 1leverage capital ratio guidelines require a minimum leverage capital ratio of3% of Tier 1 capital to total assets less goodwill.  The Bank had a leverage capital ratio of10.20% and 9.60% at December 31, 2006 and 2005, respectively.  The Bank’s Tier 1 leverage capital exceedsthe minimum regulatory requirement by $10,980,000.

The significantincrease in each of the Bank’s risk-based capital ratios from December 31, 2002to December 31, 2003 was the result of $4,000,000 in capital contributions fromthe Corporation.  The Corporationutilized a portion of the proceeds from two trust preferred security issuancesto make the capital contributions.

Asof the end of 2006, the Bank was considered to be “well capitalized” by regulatorystandards.  We do not foresee anycircumstances that would cause either the Corporation or the Bank to be lessthan “well capitalized”, although no assurance can be given that this will notoccur.

On March 27, 2003, the Company’s wholly owned special-purpose trustsubsidiary, Northern California Bancorp, Inc. Trust I (“Trust I”) issued $3million in cumulative Trust Preferred Securities.  The securities beara floating rate of interest of 3.25% over the three month LIBOR rate, payablequarterly.  The effective rate atDecember 31, 2006 was 8.62%. Concurrent with the issuance of the TrustPreferred Securities, Trust I used the proceeds from the Trust PreferredSecurities offering to purchase a like amount of Junior Subordinated Debenturesof the Company.  The SubordinatedDebentures are the sole assets of Trust I and are eliminated, along withthe related income statement effects, in the consolidated financialstatements.  The Company will payinterest on the Junior Subordinated Debentures to Trust I, which represents thesole revenue and sole source of dividend distributions to the holders of theTrust Preferred Securities.  The Companyhas 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 TrustPreferred Securities will mature on April 7, 2033, but can be redeemed undercertain circumstances at a premium prior to April 7, 2008, and can be redeemed,in whole or in part, on any January 7, April 7, July 7 or October 7 on or afterApril 7, 2008 at par.  The Company fullyand unconditionally guarantees the obligations Trust I, on a subordinatedbasis.

41

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

On November 13, 2003, the Company’s wholly owned special-purpose trustsubsidiary, Northern California Bancorp, Inc. Trust II (“Trust II”) issued $5million 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, 2006 was 8.22%.  Concurrent with the issuance ofthe Trust Preferred Securities, Trust II used the proceeds from the TrustPreferred Securities offering to purchase a like amount of Junior SubordinatedDebentures of the Company.  TheSubordinated Debentures are the sole assets of Trust II and are eliminated,along with the related income statement effects, in the consolidated financialstatements.  The Company will payinterest on the Junior Subordinated Debentures to Trust II, which representsthe sole revenue and sole source of dividend distributions to the holders ofthe Trust Preferred Securities.  TheCompany has the right, assuming no default has occurred, to defer payments ofinterest on the Junior Subordinated Debentures at any time for a period not toexceed 20 consecutive quarters.  TheTrust Preferred Securities will mature on August 8, 2033, but can be redeemedunder certain circumstances at a premium prior to August 8, 2008, and can beredeemed, in whole or in part, on any February 8, May 8, August 8 or November 8on or after August 8, 2008 at par.  TheCompany fully and unconditionally guarantees the obligations of Trust II, on asubordinated basis.

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

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 $46,174,500, 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 lineof credit is subject to pledging of acceptable collateral.  Additionally the Bank has unsecured federalfunds lines of credit with Bankof the West $4,500,000, Pacific Coast Bankers’ Bank $6,000,000 and TheIndependent Bank $5,000,000 to meet temporary liquidityrequirements.  Available borrowing capacities on December 31, 2006 were $1,065,800,$4,500,000, $6,000,000 and $5,000,000, respectively.

As amatter of policy, the Bank seeks to maintain a level of liquid assets,including marketable investment securities, equal to a least 15 percent oftotal assets (“primary liquidity”), while maintaining sources of secondaryliquidity (borrowing lines from other institutions) equal to at least anadditional 10 percent of assets.  Inaddition, it seeks to generally limit loans to not more 

42

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than 90 percent ofdeposits.  Within these ratios, the Bank generally has excess fundsavailable to sell as federal funds on a daily basis, and is able to fund itsown liquidity needs without the need of short-term borrowing.  The Bank’s total liquidity at December 31,2006, 2005 and 2004 was 24.31%, 27.09%, and 22.70%, respectively, while itsaverage loan to deposit ratio for such years was 99.76%, 90.84% and 97.71%,respectively.

Brokered depositsare deposit 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’s brokered deposits totaled approximately $5,046,000 or 3.83%at December 31, 2006, $12,849,300 or 10.82% at December 31, 2005 and$14,385,800 or 14.54% of total deposits at December 31, 2004. 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 monitorsits interest 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, 2006.

43

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| Rate Shock Increase(Decrease)  in Basis Points | ** ** | **Percent Increase(Decrease) in  Net Interest Income** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| 100                                                                |       | 8.0                                                                        | %          |
| (100)                                                              |       | (8.4                                                                       | %)         |
| 200                                                                |       | 16.1                                                                       | %          |
| (200)                                                              |       | (16.9                                                                      | %)         |

The Corporation’s sources of revenues and liquidityare the dividends, tax equalization payments or management fees from the Bankand gains on securities held in a trading account and other investments.  The ability of the Bank to pay such items tothe Corporation is subject to limitations under state and Federal law.

**InvestmentSecurities**

The Corporation maintains a trading account, at fair value, consistingof marketable securities.  At December31, 2006 and 2005 the account value was $1,762,300 and $1,027,500,respectively.  The Corporation hasinvestments of $20,100 in AT Service LLC, which provides title insuranceservices for commercial, industrial and residential properties, as well asother real estate related financial and informational services, includingescrow, real estate information, trustee sale guarantees and real estate tax exchanges,and $10,000 in Metrocities Mortgage, LLC. In addition the Corporation has investments in Northern CaliforniaBancorp Trust I ($93,000) and Northern California Bancorp Trust II ($155,000),these are special-purpose trust subsidiaries which were formed to facilitatethe issuance of trust preferred securities.

44

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The followingtable sets forth the book and market value of the Bank’s investment securitiesas of December 31, 2006 and 2005:

|                                                | ** ** | **INVESTMENT PORTFOLIO MIX** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **Book**                               | ** ** | **Market** | ** ** | **Book** | ** ** | **Market** | ** ** |
| ** **                                     | ** ** | **value**                              | ** ** | **value** | ** ** | **value** | ** ** | **value** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)**   | ** ** |
| Available for  sale:                           |       |                                   |       |   |   |   |   |   |   |
| Corporate Debt  Securities                     |       | $                                      | —     |   | $ | — |   | $ | 631 |   | $ | 631 |   |
| Government  National Mortgage Association      |       | 641                                    |       | 626 |   | 857 |   | 837 |   |
| U.S. Government  Agencies                      |       | 14,724                                 |       | 14,660 |   | 9,714 |   | 9,597 |   |
| Total                                          |       | 15,365                                 |       | 15,286 |   | 11,202 |   | 11,065 |   |
|                                           |       |                                   |       |   |   |   |   |   |   |
| Held to  maturity:                             |       |                                   |       |   |   |   |   |   |   |
| State/Local  Agency Securities                 |       | $                                      | 7,012      |   | $ | 7,281 |   | $ | 7,025 |   | $ | 7,162 |   |
|                                           |       |                                   |       |   |   |   |   |   |   |
| Other  Securities:                             |       |                                   |       |   |   |   |   |   |   |
| Federal Home  Loan Bank Stock                  |       | $                                      | 1,633      |   | $ | 1,633 |   | $ | 1,183 |   | $ | 1,183 |   |
| Pacific Coast  Bankers’ Bank Stock        |       | —                                 |       | — |   | 440 |   | 1,757 |   |
| AT Services, LLC                               |       | 20                                     |       | 20 |   | 40 |   | 40 |   |
| Metrocities  Mortgage, LLC                     |       | 10                                     |       | 10 |   | 10 |   | 10 |   |
| Pan Pacific Bank                               |       | —                                 |       | — |   | 100 |   | 100 |   |
| The Independent  Bankers’ Financial Corp. |       | 50                                     |       | 50 |   | — |   | — |   |
| MasterCard Inc  Class “B” Stock      |       | 5                                      |       | 5 |   | — |   | — |   |
| Northern  California Bancorp, Inc. Trust I     |       | 93                                     |       | 93 |   | 93 |   | 93 |   |
| Northern  California Bancorp, Inc. Trust II    |       | 155                                    |       | 155 |   | 155 |   | 155 |   |
| Total                                          |       | $                                      | 1,967      |   | $ | 1,967 |   | $ | 2,021 |   | $ | 3,338 |   |

The followingtables summarize the maturity of the Bank’s investment securities at December31, 2006:

|                                    | ** ** | **INVESTMENT PORTFOLIO MATURITIES** | ** ** |
|------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **Available for Sale**              | ** ** |
| ** **                         | ** ** | **Amortized**                                 | ** ** | **Fair** | ** ** |
| ** **                         | ** ** | **Cost**                                      | ** ** | **Value** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)**          | ** ** |
| Due within one  year               |       | $                                             | 3,741,700  |   | $ | 3,713,400 |   |
| Due between one  and five years    |       | 993,700                                       |       | 978,800 |   |
| Due between five  and ten years    |       | 9,988,900                                     |       | 9,968,100 |   |
| GNMA - Mortgage  Backed Securities |       | 640,600                                       |       | 625,600 |   |
|                               |       | $                                             | 15,364,900 |   | $ | 15,285,900 |   |

 

45

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|                        | ** ** | **Held to Maturity** | ** ** |
|------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **Amortized**                  | ** ** | **Fair** | ** ** |
| ** **             | ** ** | **Cost**                       | ** ** | **Value** | ** ** |
| Due in over ten  years |       | $                              | 7,012,300  |   | $ | 7,280,700 |   |
|                        |            |                                |            |  |  |  |  |

**ITEM 7.FINANCIAL STATEMENTS**

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

| Independent Auditors’ Report  on the Financial Statements                                                                     |   | 1      |
|------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                               |   |   |
| Consolidated Balance Sheets at December 31, 2006 and  2005                                                                         |   | 2      |
|                                                                                                                               |   |   |
| Consolidated Statements of Income for each of the  three years in the period ended December 31, 2006                               |   | 3      |
|                                                                                                                               |   |   |
| Consolidated Statements of Changes in Stockholders’  Equity for each of the three years in the period ended December 31, 2006 |   | 4      |
|                                                                                                                               |   |   |
| Consolidated Statements of Cash Flows for each of  the three years in the period ended December 31, 2006                           |   | 5-6    |
|                                                                                                                               |   |   |
| Notes to Consolidated Financial Statements                                                                                         |   | 7-48   |

**ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ANDFINANCIAL DISCLOSURE**

The Company had nodisagreements with its independent accountants on any matter of accountingprinciples, practices or financial statement disclosure during 2006, 2005 or2004.

**ITEM8A.  CONTROLS AND PROCEDURES**

(a)           **Evaluation of DisclosureControls and Procedures**

Northern CaliforniaBancorp, Inc.’s Chief Executive Officer and its Chief Financial Officer, afterevaluating the effectiveness of Northern California Bancorp, Inc.’s disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14(c) and15-d-14(c) as of a date within 90 days of the filing date of this annual report(the “Evaluation Date”) have concluded that as of the Evaluation Date, NorthernCalifornia Bancorp, Inc.’s disclosure controls and procedures were adequate andeffective to ensure that material information relating to Northern CaliforniaBancorp, Inc. and its consolidated subsidiaries would be made known to them byothers within those entities, particularly during the period in which thisannual report was being prepared.

46

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Disclosurecontrols and procedures are designed to ensure that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. Disclosurecontrols and procedures include, without limitation, controls and proceduresdesigned to ensure that information required to be disclosed by us in thereports that we file under the Exchange Act is accumulated and communicated toour management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

(b)           **Changes in InternalControls**

There were nosignificant changes in Northern California Bancorp, Inc.’s internal controls orin other factors that could significantly affect Northern California Bancorp,Inc.’s internal controls subsequent to the Evaluation Date, nor any significantdeficiencies or material weaknesses in such controls requiring correctiveactions.  As a result, no correctiveactions were taken.

**ITEM8B.  OTHER INFORMATION**

Not Applicable

#  

47

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**PART III**

**ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERSAND CONTROL PERSONS; 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 ofDecember 31, 2006, 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 |       | 65      |       | Chairman of the Board & Chief Executive Officer   Monterey County Bank since 3/87                                                                                                          |
|                                                                                                     |       |    |       |                                                                                                                                                                                           |
| Sandra G. Chrietzberg

Director, 1988 to 1994  and

since 1995                                           |       | 63      |       | Formerly President and CEO Queen of Chardonnay,  Inc., 

dba La Reina Winery 8/84-12/93                                                                                                        |
|                                                                                                     |       |    |       |                                                                                                                                                                                           |
| Peter J. Coniglio, Esq.

Director since 1976                                                             |       | 77      |       | Partner - Hudson, Martin, Ferrante & Street,  Monterey, CA                                                                                                                                 |
|                                                                                                     |       |    |       |                                                                                                                                                                                           |
| Carla S. Hudson, CPA

Director since 1994                                                                |       | 53      |       | Partner — Bianchi, Lorinez, Huey, Hudson and  Company, LLP                                                                                                                                |
|                                                                                                     |       |    |       |                                                                                                                                                                                           |
| John M. Lotz 

Director since 1991                                                                       |       | 65      |       | 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                                                                      |       | 59      |       | 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                                                                    |       | 28      |       | Chief Executive Officer & President, Pacific  Tweed, Inc. 

Carmel, CA                                                                                                                     |
|                                                                                                     |       |    |       |                                                                                                                                                                                           |
| Timothy M. Leveque

Executive Vice President

Chief Lending Officer                                      |       | 63      |       | 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 |

48

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| Bruce N. Warner

Executive Vice  President,

Chief Financial Officer

and Chief Operating  Officer |   | 59     |   | 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                                                          |   | 68     |   | Senior Vice President, Loan Administration, Monterey  County 

Bank Since 10/98.                                                                                                                                                                |
|                                                                                               |   |   |   |                                                                                                                                                                                                                                            |
| Andre G. Herrera

Senior Vice President                                                            |   | 41     |   | 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                               |   | 46     |   | Senior Vice President, Senior Operations Manager  12/04, Vice

President, Operations Manager 6/97.                                                                                                                                              |

 

Directors of the Corporation serve in similarcapacities with the Bank.  The Chairmanof the Board, Chief Executive Officer and Executive Vice President, ChiefFinancial Officer of the Corporation serve in similar capacities with the Bank,although the limited operations of the Corporation do not require significantamounts of their time.  There is nofamily relationships among the persons listed above, except that Mr. and Mrs.Chrietzberg are spouses.

Based solely upon a review of the relevant formsfurnished to the Bank and the Corporation, except as disclosed below, theCorporation believes that all officers, directors and principal shareholdersfiled appropriate forms as required by Section 16(a) of the Exchange Act, andrelated regulations, during 2006.  Thefollowing late reports on Form 3 were filed; Messrs. Bernahl and Briant, onereport.

49

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**ITEM 10. EXECUTIVE COMPENSATION**

The following table setsforth certain information regarding the compensation paid to the ChiefExecutive Officer, Executive Officers and the next two highest compensatedofficer of the Corporation/Bank whose total compensation exceeded $100,000 for2006.
| **Name & Principal Position**                                                                      | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)** | ** ** | **Stock  Awards  ($)** | ** ** | **Non-Equity  Incentive Plan  Compensation  ($)** | ** ** | **Nonquailified  Deferred  Compensation  Earnings  ($)** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|-----------------|------------|----------------|------------|------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------|------------|----------------|------------|
| Charles  T. Chrietzberg, Jr. 

Chairman,  President & CEO                                                         |       | 2006     |       | 307,730         |       | 300,000        |       | None                   |       | None                                                   |       | None                                                     |       | 56,054                           | (1)        | 663,784        |       |
|                                                                                                                  |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Timothy  M. Leveque  

Executive  Vice President,  

Chief  Lending Officer                                 |       | 2006     |       | 173,287         |       | 75,000         |       | None                   |       | None                                                   |       | None                                                     |       | 27,577                           | (2)        | 275,864        |       |
|                                                                                                                  |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Bruce  N. Warner  

Executive  Vice President,  

Chief  Financial Officer  

Chief  Operating Officer |       | 2006     |       | 152,515         |       | 75,000         |       | None                   |       | None                                                   |       | None                                                     |       | 13,831                           | (3)        | 241,346        |       |
|                                                                                                                  |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Andre  G. Herrera  

Senior  Vice President, 

Chief  Information Officer 

Manager  BankCard Services           |       | 2006     |       | 218,970         |       | None           |       | None                   |       | None                                                   |       | None                                                     |       | 13,518                           | (4)        | 232,488        |       |
|                                                                                                                  |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Patricia D. Weber  

Senior Vice President, 

Senior Operations Manager                                          |       | 2006     |       | 98,058          |       | 30,000         |       | None                   |       | None                                                   |       | None                                                     |       | 7,796                            | (5)        | 135,854        |       |

----

(1)                                  Includes$28,896 in expense accrued in the Salary Continuation Plan net of earnings onlife insurance policies as more fully described in the Long Term Incentive PlanTable, $15,000 in matching 401K plan contributions, health insurance premiums$6,510, $4,088 personal use of a Bank owned automobile and $1,560 in lifeinsurance premiums.

(2)                                  Includes$11,180 in matching 401K plan contributions, health insurance premiums $9,134,$6,000 automobile and $1,263 in life insurance premiums.

(3)                                  Includes$12,271 in matching 401K plan contributions and $1,560 in life insurancepremiums.

(4)                                  Includes$12,488 in matching 401K plan contributions and $1,030 in life insurancepremiums.

(5)                                  Includes$6,788 in matching 401K plan contributions and $1,008 in life insurancepremiums.

The Bank furnishes, on anon-discriminatory basis, to the employees: (i) insurance benefits; and (ii)other benefits.  The value of thesebenefits for the respective persons is included in the table if the aggregateof value of the benefits exceeded $10,000.

The Board of Directorsauthorized the Bank to enter into a three year employment contract with Mr.Chrietzberg, effective January 1, 2005. It provides for a base salary of $240,000 per year, a Bank furnishedautomobile or automobile allowance, and a bonus based on profits.  The bonus, not to exceed $250,000 annually,will equal $10,000 for each 0.1 percent that the Bank’s profits exceed 1.0percent return on average assets plus $10,000 for each 1 percent that the Bank’sreturn on equity exceeds 10.0 percent. Under the terms of the contract, if Mr. Chrietzberg is terminated otherthan for cause (as defined in the contract), he is entitled to severancecompensation for his monthly salary plus a pro rated incentive bonus for thegreater of 24 months or the remaining term of his 

50

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contract (which ends in December, 2008); however, if the terminationfollows within twelve (12) months after a change in control transaction (asdefined in the contract), he is entitled to such severance compensation for thegreater of 24 months or the remainder of the term of the contract.

The Board of Directorsauthorized the Bank to execute Addendum 1 to the three year employment contractwith Mr. Chrietzberg effective January 1, 2006.   Addendum 1 provides for a base salary of$300,000 and a bonus not to exceed $300,000. All other terms of the employment contract remain the same.

The following table setsforth certain information regarding the long term incentive plan provided forMr. Chrietzberg.
| ** **                 | ** ** | ** **                       | ** ** | **Performance or**                                                                | ** ** | **Estimated Future Payouts under** |
|----------------------------|------------|----------------------------------|------------|-----------------------------------------------------------------------------------|------------|------------------------------------|
| ** **                 | ** ** | **Number of**                    | ** ** | **Other Period**                                                                  | ** ** | **Non-Stock Price-Based Plans**    |
| ** **                 | ** ** | **Shares, Units**                | ** ** | **Until**                                                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **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 Directorsapproved a Salary Continuation Agreement for the benefit of Mr. Chrietzbergthat provided for payments of $75,000 per year, for 15 years, if he remainswith the Bank until 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 provides forlesser payments in the event of early retirement, generally designated tocoincide with increases in the anticipated surrender value for the lifeinsurance policies described below.

InAugust, 2001, the Board of Directors amended the Salary Continuation Agreementfor the benefit 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, forMr. Chrietzberg’s lifetime.  The amendedSalary Continuation Agreement provides the following with regard to thedivision of death proceeds should Mr. Chrietzberg die before his sixty-fifth(65th) birthday; his beneficiary(ies) shall beentitled to an amount equal to $2,940,000 or the net at risk insurance portionof the proceeds, whichever amount is less. The net at risk insurance portion is the total proceeds less the cashvalue of the policy.  Should Mr.Chrietzberg die on or subsequent to his sixty-fifth (65th)birthday, his beneficiary(ies) shall be entitled to an amount equal to$1,000,000 plus the present value of the remaining retirement benefits due toMr. Chrietzberg or the net at risk insurance portion of the proceeds, whicheveris less, and the Bank shall be entitled to the remainder of such proceeds.

TheBank’s obligations under the Salary Continuation Agreement are not secured byany segregated amounts, but are informally funded by the purchase ofsingle-premium life insurance policies. The salary continuation expense accrued net of earnings on lifeinsurance policies in 2006,

51

----

2005 and 2004 was $28,900, $47,200, and $76,800, respectively.  Based upon the current projected earnings ofthe insurance used to informally fund the Bank’s obligations under theAgreement, and the anticipated salary continuation expense to be booked, net oftax benefits, the Bank anticipates (based upon current tax laws and assumptionsregarding the yield on alternative investment(s)) that the cost of the benefitsto be provided under the agreement will not have a material adverse impact onthe Bank’s net income after taxes in the future, although no assurance can begiven in this regard.  The SurvivingIncome Agreement was terminated upon adoption of the amended SalaryContinuation Agreement.

The Corporation did not grant any stock options under the Corporation’s1998 Amended Stock Option Plan during the year ended December 31, 2006.

Thefollowing table 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, 2006 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 (#)  Exercisable** | ** ** | **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. |       | 30,000                                                                                 | (1)        | NONE                                                                                   |       | NONE |   | 99,000 |   | 3/20/08 |   | NONE |   | NONE |   | NONE |   | NONE |   |
|                             |       | 25,000                                                                                 | (1)        | NONE                                                                                   |       | NONE |   | 110,000 |   | 2/2/09 |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Timothy  Leveque            |       | 60,000                                                                                 | (2)        | NONE                                                                                   |       | NONE |   | 240,000 |   | 2/2/09 |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Bruce N. Warner             |       | 10,000                                                                                 | (3)        | NONE                                                                                   |       | NONE |   | 40,000 |   | 6/16/10 |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Andre  G. Herrera           |       | —                                                                                 |       | NONE                                                                                   |       | NONE |   | N/A |   | N/A |   | NONE |   | NONE |   | NONE |   | NONE |   |
| Patricia D. Weber           |       | 2,200                                                                                  | (4)        | NONE                                                                                   |       | NONE |   | 6,000 |   | 2/23/07 |   | NONE |   | NONE |   | NONE |   | NONE |   |
|                             |       | 1,500                                                                                  | (4)        | NONE                                                                                   |       | NONE |   | 4,500 |   | 3/20/08 |   | NONE |   | NONE |   | NONE |   | NONE |   |
|                             |       | 2,500                                                                                  | (4)        | NONE                                                                                   |       | NONE |   | 10,000 |   | 2/2/09 |   | NONE |   | NONE |   | NONE |   | NONE |   |

----

(1)          The vesting dates forMr. Chrietzberg’s options were March 20, 2003 and February 2, 2004.

(2)          The vesting dates forMr. Leveque’s options were 20,000 options on February 2, 2004, 20,000 onJanuary 1, 2005 and 20,000 on January 1, 2006.

(3)          The vesting date for Mr.Warner’s options was June 16, 2005.

(4)          Thevesting dates for Ms. Weber’s options were February 23, 2002, March 20, 2003and February 2, 2004.

52

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The following table sets forth certaininformation regarding the compensation paid to each director during 2006.
| **Name**                     | ** ** | **Fees  Earned  or Paid  in Cash  ($)** | ** ** | **Stock  Awards  ($)** | ** ** | **Option  Awards  ($)** | ** ** | **Non-Equity  Incentive Plan  Compensation  ($)** | ** ** | **Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation  ($)** | ** ** |
|------------------------------|------------|---------------------------------------------------|------------|------------------------|------------|-------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------|------------|
| Charles T.  Chrietzberg, Jr. |       | 16,875                                            | (1)        | None                   |       | None                    |       | None                                                   |       | None                                               |       | None                                  |       |
| Sandra G.  Chrietzberg       |       | 16,875                                            | (2)        | None                   |       | None                    |       | None                                                   |       | None                                               |       | None                                  |       |
| Peter J.  Coniglio           |       | 17,325                                            | (3)        | None                   |       | None                    |       | None                                                   |       | None                                               |       | None                                  |       |
| Carla S. Hudson              |       | 18,075                                            | (4)        | None                   |       | None                    |       | None                                                   |       | None                                               |       | None                                  |       |
| John M. Lotz                 |       | 17,475                                            | (5)        | None                   |       | None                    |       | None                                                   |       | None                                               |       | None                                  |       |
| Mark A. Briant               |       | 4,375                                             | (6)        | None                   |       | None                    |       | None                                                   |       | None                                               |       | None                                  |       |

----

1.               Includes a retainerof $10,000 and $6,875 in fees for monthly Board of Director meetings.

2.               Includes a retainerof $10,000 and $6,875 in fees for monthly Board of Director meetings.

3.               Includes a retainerof $10,000, $6,875 in fees for monthly Board of Director meetings and $450 inmeeting fees for attendance as a member of the Audit Committee.

4.               Includes a retainerof $10,000, $6,875 in fees for monthly Board of Director meetings and $1,200 inmeeting fees for attendance as chair of the Audit Committee.

5.               Includes a retainerof $10,000, $6,875 in fees for monthly Board of Director meetings and $600 inmeeting fees for attendance as a member of the Audit Committee.

6.               Includesa retainer of $2,500 (elected to the Board in October 2006) and $1,875 in feesfor monthly Board of Director meetings.

**ITEM 11.****              SECURITY OWNERSHIPOF CERTAIN 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.   P.O. Box 1344  Carmel, CA 93921    |       | 768,874                                 | (1)        | 44.72               |       |
|                                                             |       |                                    |       |                |       |
| David S. Lewis  Trust 

30500 Aurora del  Mar 

Carmel, CA 93923 |       | 153,863                                 |       | 8.94                |       |
|                                                             |       |                                    |       |                |       |
| Bruce N. Warner 

601 Munras Ave. 

Monterey, CA 93940           |       | 114,530                                 | (2)        | 6.61                |       |

----

(1)          Includes 55,000 sharessubject to employee stock options and 18,414 shares held beneficially for Mr.Chrietzberg and Mrs. Chrietzberg in Individual Retirement Accounts where votingpower is shared with the custodian of the account.  400,000 shares of the Common stock owned byMr. Chrietzberg are pledged to secure a loan from an unaffiliated bank.

(2)          Includes 10,000 sharessubject to employee stock options.

53

----

Thefollowing table sets forth similar information regarding the beneficialownership, both by numerical holding and percentage interest of each of theCompany’s directors and all of its directors and executive officers as agroup.  All addresses are in care of theCorporation at 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.                      |       | 768,874             | (1) (2) (3) | 43.28               | %          | 55,000              |       | 41.46                  | %          |
| Sandra G.  Chrietzberg                            |       | 768,874             | (2) (3)     | 43.28               | %          | 55,000              |       | 41.46                  | %          |
| Peter J.  Coniglio                                |       | 80,354              | (4) (5)     | 4.61                | %          | 21,213              |       | 3.44                   | %          |
| Carla S. Hudson                                   |       | 39,899              | (6)         | 2.31                | %          | 2,500               |       | 2.17                   | %          |
| John M. Lotz                                      |       | 11,395              |        | 0.66                | %          | 10,500              |       | 0.05                   | %          |
| Mark A. Briant                                    |       | 2,534               | (7)         | 0.15                | %          | —              |       | 0.15                   | %          |
| All Directors and  Executive  Officers as a group |       | 1,079,597      | (8)         | 57.40               | %          | 159,213             |       | 53.46                  | %          |

----

(1)                      Includes88,000 shares subject to his employee stock options.  400,000 shares of the Common stock owned byMr. Chrietzberg are pledged to secure a loan from an unaffiliated bank. Shouldhe default under such credit, the shares could be acquired by the lender, orsold pursuant to applicable terms of the Uniform Commercial Code, in atransaction that could result in a change of control of the Corporation.  Such transaction may require approval underprovisions of Federal and California change in bank control laws.

(2)                      Theshares include an aggregate of 18,414 shares held beneficially by Mr.Chrietzberg and Mrs. Chrietzberg in Individual Retirement Accounts, wherevoting power is also shared with the custodian of the account.

(3)       Includes shares of spouse pursuant toCalifornia’s community property laws.

(4)       Sole voting power.

(5)                      Includes21,213 shares subject to the respective director’s stock options.  Of the remaining shares, 24,158 are held byMr. Coniglio, 26,530 are held in a family trust controlled by Mr. Coniglio, asto which he has sole voting and investment power, while 8,453 shares are heldby Hudson, Martin, Ferrante & Street, a partnership of which Mr. Conigliois the managing partner, with voting and investment power.

(6)                      Includes 2,500shares subject to the respective director’s stock options.  The remaining shares are held jointly withfamily members, other than 1,610 shares held in a corporate pension, as towhich Ms. Hudson has voting and investment power.

(7)                      Shares areheld in a profit sharing plan, as to which Mr. Briant has voting and investmentpower.

(8)                      Includes176,541 shares held by executive officers who are not also directors, 70,000shares are subject to employee stock options.

**ITEM 12. CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS**

TheBank has had, and expects to have in the future, banking transactions in theordinary course of its business with directors, officers, principalshareholders and their associates. Management of the Bank believes that these transactions have been (andthose in the future are intended to be) on substantially the same terms,including interest rates, collateral and repayment terms on extensions ofcredit, as those prevailing at the same time for comparable transactions withothers and did not involve more than the normal risk of collectibility orpresent other unfavorable features. Management does not believe that any such loans are outside the ordinarycourse of 

54

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business.  The following table sets forth information onextensions of credit to directors and to directors, principal shareholders andofficers.
| ** **                                                                    | ** ** | ** **  | ** ** | ** **                      | ** ** | **Outstanding as of** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                    | ** ** | **Maximum** | ** ** | **December 31, 2006** | ** ** |
| ** **                                                                    | ** ** | ** **  | ** ** | **Percent of**             | ** ** | ** **                      | ** ** | **Percent of** | ** ** |
| ** **                                                                    | ** ** | ** **  | ** ** | **Equity**                      | ** ** | ** **                      | ** ** | **Equity** | ** ** |
| **Name**                                                                      | ** ** | **Amount**  | ** ** | **Capital**                     | ** ** | **Amount**                      | ** ** | **Capital** | ** ** |
| Peter J. Coniglio                                                             |       | $      | 1,160,700  | (1)                             | 11.78      | %                               | $          | 1,128,900 |   | 9.10 | % |
| Carla S. Hudson                                                               |       | 105,600     | (2)        | 1.07                            | %          | —                          |       | — |   |
| John M. Lotz                                                                  |       | 2,500       |       | 0.03                            | %          | 2,500                           |       | 0.02 | % |
| Mark A. Briant                                                                |       | 538,700     |       | 5.47                            | %          | 497,100                         |       | 4.01 | % |
|                                                                          |       |        |       |                            |       |                            |       |   |   |
| Directors, Principal 

Shareholder, and  Officers 

as a Group (7 in  number) |       | $      | 1,807,500  |                            | 18.34      | %                               | $     | 1,628,500 |   | 22.65 | % |

----

(1)          Included in theextensions of credit to Mr. Coniglio is a loan to the Coniglio FamilyPartnership, which had an outstanding balance of $1,024,800 on December 31,2006.

(2)          The extension of creditto Ms. Hudson is a loan to a corporation which is a related party.

55

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**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 to Employment 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                                                         |
|      |       | (11) First Amendment to the Monterey County Bank  Supplemental Life Insurance Agreement                                                         |
|      |       | Dated October 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 to Section 302 of the  Sarbannes-Oxley Act of 2002. |

 

56

----

 
| 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.       |

 

B.            REPORTS

None

**ITEM 14.  PRINCIPALACCOUNTANT FEES AND SERVICES**

**Fees**

**Audit Fees.**Aggregate fees billedby Hutchinson and Bloodgood for professional services rendered in connectionwith the audit of the Bank’s annual financial statements for the fiscal yearended December 31, 2006 and for the required review of the Bank’s financialstatements included in its Form 10-QSB’s for that same year totaled$71,700.

**FinancialInformation System Design and Implementation Fees.**No fees were paid to Hutchinson and Bloodgoodfor financial information system design and implementation services renderedfor the 2006 fiscal year.

**All OtherFees.**$2,800 was paidto Hutchinson & Bloodgood for all tax services rendered for the 2006 fiscalyear.

57

----

**SIGNATURES**

In accordance withSection 13 or 15(d) of the Exchange Act, the registrant caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.
|                                       |   | NORTHERN CALIFORNIA BANCORP, INC. |
|---------------------------------------|--------|-----------------------------------|
|                                  |   |                              |   |
| Date:   March 22, 2007 |   | By:                               | /s/ Charles T. Chrietzberg, Jr. |   |
|                                  |   |                              | Charles T.  Chrietzberg, Jr. |
|                                  |   |                              | Chief Executive  Officer |
|                                  |   |                              | and President |
|                                  |   |                              |   |
| Date:   March 22, 2007 |   | 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 22, 2007 |
| Charles T. Chrietzberg, Jr.     |       | Director     |       |           |
|                            |       |         |       |           |
| /s/ Sandra G. Chrietzberg       |       |         |       | March 22, 2007 |
| Sandra G. Chrietzberg           |       | Director     |       |           |
|                            |       |         |       |           |
| /s/ Peter J. Coniglio           |       |         |       | March 22, 2007 |
| Peter J. Coniglio               |       | Director     |       |           |
|                            |       |         |       |           |
| /s/ Carls S. Hudson             |       |         |       | March 22, 2007 |
| Carla S. Hudson                 |       | Director     |       |           |
|                            |       |         |       |           |
| /s/ John M. Lotz                |       |         |       | March 22, 2007 |
| John M. Lotz                    |       | Director     |       |           |
|                            |       |         |       |           |
| /s/ Mark A. Briant              |       |         |       | March 22, 2007 |
| Mark A. Briant                  |       | Director     |       |           |
|                            |       |         |       |           |
| /s/ David Bernahl               |       |         |       | March 22, 2007 |
| David Bernahl                   |       | Director     |       |           |
|                            |       |         |       |           |
| /s/ Stephanie G. Chrietzberg    |       |         |       | March 22, 2007 |
| Stephanie G. Chrietzberg        |       | Director     |       |           |

 

58

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**NORTHERN CALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

**CONSOLIDATEDFINANCIAL REPORT**

**YearsEnded December 31, 2006 and 2005**

----

**TABLE OFCONTENTS**
|                                                                           | ** ** | **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                               |       | 7-48     |

 

----

**Independent Auditors’ Report**

To the Board of DirectorsNorthern California Bancorp, Inc.Monterey, California

We have audited the accompanying consolidated balance sheetsof Northern California Bancorp, Inc. and its wholly owned subsidiary, MontereyCounty Bank, as of December 31, 2006 and 2005 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, 2006. 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.

We conducted our audits in accordance with standards of thePublic Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Northern California Bancorp, Inc. and its wholly owned subsidiary, asof December 31, 2006 and 2005, and the results of their operations and theircash flows for each of the years in the three-year period ended December 31,2006 in conformity with accounting principles generally accepted in the UnitedStates of America.

Watsonville, CaliforniaFebruary 14, 2007

1

----

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

**CONSOLIDATEDBALANCE SHEETS**

**December31, 2006 and 2005**
| **ASSETS**                                                                                                                                                            | ** ** | **2006**    | ** **  | **2005**    | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| Cash and due  from banks                                                                                                                                              |       | $           | 4,979,200   |        | $          | 5,830,600 |   |
| Federal funds  sold                                                                                                                                                   |       | 17,455,000  |        | 18,300,000  |       |
| Total cash and cash equivalents                                                                                                                                       |       | 22,434,200  |        | 24,130,600  |       |
| Time deposits  with other financial institutions                                                                                                                      |       | 1,000,000   |        | 1,000,000   |       |
| Trading assets                                                                                                                                                        |       | 1,762,300   |        | 1,027,500   |       |
| Investment  securities available for sale                                                                                                                             |       | 15,285,900  |        | 11,065,300  |       |
| Investment  securities held to maturity, at cost (fair value approximates $7,281,000 in  2006; $7,161,900 in 2005)                                                    |       | 7,012,300   |        | 7,025,000   |       |
| Other  investments                                                                                                                                                    |       | 1,966,800   |        | 2,020,500   |       |
| Loans held for  sale                                                                                                                                                  |       | 1,182,100   |        | 5,315,000   |       |
| Loans, net of  allowance for loan losses of $1,408,800 in 2006; $1,100,700 in 2005                                                                                    |       | 128,867,600 |        | 101,985,000 |       |
| Premises and  equipment, net                                                                                                                                          |       | 4,613,000   |        | 4,362,300   |       |
| Cash surrender  value of life insurance                                                                                                                               |       | 3,671,000   |        | 2,466,700   |       |
| Interest  receivable and other assets                                                                                                                                 |       | 2,774,700   |        | 2,247,200   |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Total assets                                                                                                                                                          |       | $           | 190,569,900 |        | $          | 162,645,100 |   |
|                                                                                                                                                                  |       |        |        |        |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                         |       |        |        |        |       |
| Deposits:                                                                                                                                                             |       |        |        |        |       |
| Non interest-bearing demand                                                                                                                                           |       | $           | 30,079,100  |        | $          | 30,814,900 |   |
| Interest-bearing demand                                                                                                                                               |       | 17,261,800  |        | 17,824,500  |       |
| Savings                                                                                                                                                               |       | 5,326,400   |        | 7,659,300   |       |
| Time less than $100,000                                                                                                                                               |       | 43,134,600  |        | 32,143,200  |       |
| Time in denominations of $100,000 or more                                                                                                                             |       | 35,825,800  |        | 29,678,200  |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Total deposits                                                                                                                                                        |       | 131,627,700 |        | 118,120,100 |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Federal Home  Loan Bank borrowed funds                                                                                                                                |       | 34,750,000  |        | 24,750,000  |       |
| Junior  subordinated debt securities                                                                                                                                  |       | 8,248,000   |        | 8,248,000   |       |
| Interest payable  and other liabilities                                                                                                                               |       | 3,542,300   |        | 2,596,100   |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Total liabilities                                                                                                                                                     |       | 178,168,000 |        | 153,714,200 |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Commitments  (Note 12)                                                                                                                                                |       |        |        |        |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Shareholders’  equity                                                                                                                                            |       |        |        |        |       |
| Common stock, no stated par value, authorized:  2,500,000 shares, issued and outstanding: 1,721,715 and 1,631,439 shares at  December 31, 2006 and 2005, respectively |       | 5,059,700   |        | 4,771,800   |       |
| Retained earnings                                                                                                                                                     |       | 7,363,100   |        | 4,128,600   |       |
| Accumulated other comprehensive income (loss)                                                                                                                         |       | (20,900     | )           | 30,500      |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Total shareholders’ equity                                                                                                                                       |       | 12,401,900  |        | 8,930,900   |       |
|                                                                                                                                                                  |       |        |        |        |       |
| Total  liabilities and shareholders’ equity                                                                                                                      |       | $           | 190,569,900 |        | $          | 162,645,100 |   |

 

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

2

----

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**YearsEnded December 31, 2006, 2005, and 2004**
| ** **                                                              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**  | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|------------|------------|-----------|------------|
| Interest income                                                         |       |       |       |       |       |      |       |
| Loans                                                                   |       | $          | 11,953,600 |       | $          | 9,561,100 |       | $ | 6,756,100 |   |
| Time deposits with other financial institutions                         |       | 49,700     |       | 29,200     |       | —    |       |
| Investment securities                                                   |       | 1,035,800  |       | 748,100    |       | 457,500   |       |
| Federal funds sold                                                      |       | 720,900    |       | 352,400    |       | 141,300   |       |
| Total interest income                                                   |       | 13,760,000 |       | 10,690,800 |       | 7,354,900 |       |
|                                                                    |       |       |       |       |       |      |       |
| Interest expense                                                        |       |       |       |       |       |      |       |
| Interest-bearing transaction accounts                                   |       | 68,300     |       | 64,400     |       | 64,400    |       |
| Savings and time deposit accounts                                       |       | 1,442,800  |       | 1,050,500  |       | 791,300   |       |
| Time deposits in denominations of $100,000 or more                      |       | 1,478,700  |       | 989,900    |       | 561,600   |       |
| Notes payable and other borrowings                                      |       | 2,207,200  |       | 1,566,800  |       | 1,017,900 |       |
| Total interest expense                                                  |       | 5,197,000  |       | 3,671,600  |       | 2,435,200 |       |
|                                                                    |       |       |       |       |       |      |       |
| Net interest income                                                     |       | 8,563,000  |       | 7,019,200  |       | 4,919,700 |       |
| Provision for  loan losses                                              |       | 410,000    |       | 150,000    |       | 185,000   |       |
| Net interest income, after provision for loan losses                    |       | 8,153,000  |       | 6,869,200  |       | 4,734,700 |       |
|                                                                    |       |       |       |       |       |      |       |
| Non-interest  income                                                    |       |       |       |       |       |      |       |
| Service charges on deposit accounts                                     |       | 547,400    |       | 563,800    |       | 516,500   |       |
| Income from sales and servicing of Small Business  Administration loans |       | 689,700    |       | 991,400    |       | 716,400   |       |
| Gain on sale of Pacific Coast Bankers’ Bank Stock                  |       | 1,313,400  |       | —     |       | —    |       |
| Other income                                                            |       | 4,626,700  |       | 2,806,800  |       | 2,993,900 |       |
| Total non-interest income                                               |       | 7,177,200  |       | 4,362,000  |       | 4,226,800 |       |
|                                                                    |       |       |       |       |       |      |       |
| Non-interest  expenses                                                  |       |       |       |       |       |      |       |
| Salaries and employee benefits                                          |       | 3,853,800  |       | 3,281,800  |       | 3,003,600 |       |
| Occupancy and equipment expense                                         |       | 790,200    |       | 664,500    |       | 596,700   |       |
| Professional fees                                                       |       | 149,200    |       | 140,500    |       | 113,500   |       |
| Data processing                                                         |       | 322,400    |       | 355,800    |       | 363,900   |       |
| Other general and administrative                                        |       | 3,511,200  |       | 3,369,900  |       | 3,038,000 |       |
| Total non-interest expenses                                             |       | 8,626,800  |       | 7,812,500  |       | 7,115,700 |       |
|                                                                    |       |       |       |       |       |      |       |
| Income before  tax provision                                            |       | 6,703,400  |       | 3,418,700  |       | 1,845,800 |       |
| Income tax provision                                                    |       | 2,866,200  |       | 1,489,400  |       | 780,600   |       |
|                                                                    |       |       |       |       |       |      |       |
| Net income                                                              |       | $          | 3,837,200  |       | $          | 1,929,300 |       | $ | 1,065,200 |   |
|                                                                    |       |       |       |       |       |      |       |
| Earnings per  common share                                              |       |       |       |       |       |      |       |
|                                                                    |       |       |       |       |       |      |       |
| Basic                                                                   |       | $          | 2.31       |       | $          | 1.20      |       | $ | 0.68 |   |
|                                                                    |       |       |       |       |       |      |       |
| Diluted                                                                 |       | $          | 2.09       |       | $          | 1.00      |       | $ | 0.56 |   |

 

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

3

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**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**

**YearsEnded December 31, 2006, 2005, and 2004**
| ** **                                                                       | ** ** | ** **         | ** ** | ** ** | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------|------------|------------|------------|--------------|------------|------------------------|------------|------------|------------|
| ** **                                                                       | ** ** | ** **         | ** ** | ** ** | ** ** | ** **   | ** ** | **Other**              | ** ** | ** ** | ** ** |
| ** **                                                                       | ** ** | **Number of** | ** ** | **Common** | ** ** | **Retained** | ** ** | **Comprehensive**      | ** ** | ** ** | ** ** |
| ** **                                                                       | ** ** | **Shares**         | ** ** | **Stock**  | ** ** | **Earnings** | ** ** | **Income (loss)** | ** ** | **Total**  | ** ** |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| Balance at  December 31, 2003                                                    |       | 1,566,658          |       | $          | 4,630,900  |         | $          | 1,725,700              |       | $          | 53,900     |   | $ | 6,410,500 |   |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| Comprehensive income:                                                            |       |               |       |       |       |         |       |                   |       |       |       |
| Net income for the year                                                          |       | —             |       | —     |       | 1,065,200    |       | —                 |       | 1,065,200  |       |
| Change in net unrealized gain on securities and  other assets, net of tax effect |       | —             |       | —     |       | —       |       | 21,700                 |       | 21,700     |       |
| Total comprehensive income                                                       |       |               |       |       |       |         |       |                   |       | 1,086,900  |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| $.165 per share cash dividend                                                    |       | —             |       | —     |       | (265,300     | )          | —                 |       | (265,300   | )          |
| Exercise of stock options                                                        |       | 41,361             |       | 89,000     |       | —       |       | —                 |       | 89,000     |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| Balance at  December 31, 2004                                                    |       | 1,608,019          |       | 4,719,900  |       | 2,525,600    |       | 75,600                 |       | 7,321,100  |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| Comprehensive income:                                                            |       |               |       |       |       |         |       |                   |       |       |       |
| Net income for the year                                                          |       | —             |       | —     |       | 1,929,300    |       | —                 |       | 1,929,300  |       |
| Change in net unrealized gain on securities and  other assets, net of tax effect |       | —             |       | —     |       | —       |       | (45,100                | )          | (45,100    | )          |
| Total comprehensive income                                                       |       |               |       |       |       |         |       |                   |       | 1,884,200  |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| $.20 per share cash dividend                                                     |       | —             |       | —     |       | (326,300     | )          | —                 |       | (326,300   | )          |
| Repurchase of stock options                                                      |       | (3,795             | )          | (15,200    | )          | —       |       | —                 |       | (15,200    | )          |
| Exercise of stock options                                                        |       | 27,215             |       | 67,100     |       | —       |       | —                 |       | 67,100     |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| Balance at  December 31, 2005                                                    |       | 1,631,439          |       | 4,771,800  |       | 4,128,600    |       | 30,500                 |       | 8,930,900  |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| Comprehensive income:                                                            |       |               |       |       |       |         |       |                   |       |       |       |
| Net income for the year                                                          |       | —             |       | —     |       | 3,837,200    |       | —                 |       | 3,837,200  |       |
| Change in net unrealized gain on securities and  other assets, net of tax effect |       | —             |       | —     |       | —       |       | (51,400                | )          | (51,400    | )          |
| Total comprehensive income                                                       |       |               |       |       |       |         |       |                   |       | 3,785,800  |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| $.35 per share cash dividend                                                     |       | —             |       | —     |       | (602,700     | )          | —                 |       | (602,700   | )          |
| Stock based compensation                                                         |       | —             |       | 17,800     |       | —       |       | —                 |       | 17,800     |       |
| Exercise of stock options                                                        |       | 90,276             |       | 270,100    |       | —       |       | —                 |       | 270,100    |       |
|                                                                             |       |               |       |       |       |         |       |                   |       |       |       |
| Balance at December 31,  2006                                                    |       | 1,721,715          |       | $          | 5,059,700  |         | $          | 7,363,100              |       | $          | (20,900    | ) | $ | 12,401,900 |   |

 

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, 2006, 2005, and 2004**
| ** **                                                                                | ** ** | **2006**    | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                 |       |        |       |        |       |        |       |
| Net income                                                                                |       | $           | 3,837,200  |        | $          | 1,929,300   |       | $ | 1,065,200 |   |
| Adjustments to reconcile net income to net cash provided  (used) by operating activities: |       |        |       |        |       |        |       |
| Depreciation and amortization expense                                                     |       | 276,900     |       | 240,700     |       | 208,500     |       |
| Provision for loan losses                                                                 |       | 410,000     |       | 150,000     |       | 185,000     |       |
| Realized (gain) loss on sales of available for sale  securities, net                      |       | (1,311,700  | )          | 91,800      |       | (50,600     | )          |
| Amortization of deferred loan costs                                                       |       | 333,800     |       | 224,000     |       | 126,300     |       |
| Net amortization (accretion) of securities                                                |       | (3,000      | )          | 7,300       |       | 28,100      |       |
| Stock based compensation                                                                  |       | 17,800      |       | —      |       | —      |       |
| (Gain) loss on sale of equipment                                                          |       | 11,900      |       | (800        | )          | (2,100      | )          |
| Increase in deferred tax asset                                                            |       | (74,300     | )          | (178,800    | )          | (75,900     | )          |
| Increase in trading assets                                                                |       | (734,800    | )          | (223,800    | )          | (640,400    | )          |
| (Increase) decrease in loans held for sale                                                |       | 4,132,900   |       | (775,500    | )          | (2,191,700  | )          |
| Increase in interest receivable                                                           |       | (186,700    | )          | (209,700    | )          | (175,300    | )          |
| (Increase) decrease in other assets                                                       |       | (1,626,500  | )          | 9,200       |       | (388,600    | )          |
| Increase in interest payable                                                              |       | 589,300     |       | 376,000     |       | 24,100      |       |
| Increase in other liabilities                                                             |       | 356,900     |       | 663,100     |       | 201,800     |       |
| Net cash provided (used) by operating activities                                          |       | 6,029,700   |       | 2,302,800   |       | (1,685,600  | )          |
|                                                                                      |       |        |       |        |       |        |       |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                                 |       |        |       |        |       |        |       |
| Net change in time deposits with other financial  institutions                            |       | —      |       | (1,000,000  | )          | —      |       |
| Proceeds from maturity of investment securities                                           |       | 5,830,700   |       | 597,300     |       | 8,557,800   |       |
| Purchase of investments                                                                   |       | (8,570,500  | )          | (6,020,000  | )          | (15,643,400 | )          |
| Net increase in loans                                                                     |       | (43,118,300 | )          | (60,466,800 | )          | (35,517,000 | )          |
| Loan purchases                                                                            |       | (19,150,000 | )          | (13,448,200 | )          | (11,043,300 | )          |
| Proceeds from loan sales                                                                  |       | 34,641,900  |       | 62,052,300  |       | 30,313,300  |       |
| Proceeds from sale of equipment                                                           |       | 48,600      |       | 500         |       | 3,200       |       |
| Additions to bank premises and equipment                                                  |       | (583,500    | )          | (2,378,800  | )          | (223,600    | )          |
| Net cash used by investing activities                                                     |       | (30,901,100 | )          | (20,663,700 | )          | (23,553,000 | )          |
|                                                                                      |       |        |       |        |       |        |       |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                                                 |       |        |       |        |       |        |       |
| Net increase in deposits                                                                  |       | 13,507,600  |       | 20,856,900  |       | 19,130,800  |       |
| Proceeds from FHLB borrowings                                                             |       | 12,000,000  |       | 10,000,000  |       | 13,900,000  |       |
| Repayments of FHLB borrowings                                                             |       | (2,000,000  | )          | (4,900,000  | )          | (8,000,000  | )          |
| Proceeds from exercise of stock options                                                   |       | 270,100     |       | 67,100      |       | 89,000      |       |
| Repurchase of common stock and stock options                                              |       | —      |       | (15,200     | )          | —      |       |
| Cash dividends paid on common stock                                                       |       | (602,700    | )          | (326,300    | )          | (265,300    | )          |
| Net cash provided by financing activities                                                 |       | 23,175,000  |       | 25,682,500  |       | 24,854,500  |       |
|                                                                                      |       |        |       |        |       |        |       |
| Net increase (decrease) in cash and cash equivalents                                      |       | (1,696,400  | )          | 7,321,600   |       | (384,100    | )          |
|                                                                                      |       |        |       |        |       |        |       |
| **CASH  AND CASH EQUIVALENTS, BEGINNING**                                                 |       | 24,130,600  |       | 16,809,000  |       | 17,193,100  |       |
|                                                                                      |       |        |       |        |       |        |       |
| **CASH AND CASH EQUIVALENTS,  ENDING**                                                    |       | $           | 22,434,200 |        | $          | 24,130,600  |       | $ | 16,809,000 |   |

 

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

5

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**NORTHERN CALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2006, 2005, and 2004**
| ** **                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| **OTHER  CASH FLOW INFORMATION** |       |     |       |     |       |      |       |
|                             |       |     |       |     |       |      |       |
| Interest paid                    |       | $        | 4,607,700  |     | $          | 3,295,600 |       | $ | 2,411,500 |   |
|                             |       |     |       |     |       |      |       |
| Income taxes  paid               |       | $        | 3,090,400  |     | $          | 1,519,500 |       | $ | 815,400 |   |

 

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

6

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**NORTHERN CALIFORNIA BANCORP, INC. ANDSUBSIDIARY**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2006 and 2005**

**Note1.****                             SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

***Nature of Business***

TheBank provides a variety of financial services to individuals and smallbusinesses through its four offices on the Monterey Peninsula.  Its primary deposit products are demand andterm certificate accounts.  Its primarylending products are residential, commercial, and Small Business Administration(SBA) loans.

***Basis of Presentation and Consolidation***

Theconsolidated financial statements include the accounts of Northern CaliforniaBancorp, Inc. (the “Corporation”) and its wholly owned subsidiary, MontereyCounty Bank (the “Bank”).  All****significant inter-company balances andtransactions have been eliminated in consolidation.

TheCorporation determines whether it has a controlling financial interest in anentity by first evaluating whether the entity is a voting interest entity or avariable interest entity under accounting principles generally accepted in theUnited States of America. Voting interest entities are entities in which thetotal equity investment at risk is sufficient to enable the entity to financeitself independently and provides the equity holders with the obligation toabsorb losses, the right to receive residual returns and the right to makedecisions about the entity’s activities. The Corporation consolidates votinginterest entities in which it has all, or at least a majority of, the voting interest.  As defined in applicable accountingstandards, variable interest entities (VIEs) are entities that lack one or moreof 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 Northern CaliforniaBancorp, Inc. Trust II, are VIEs for which the Corporation is not the primarybeneficiary.  Accordingly, the accountsof these entities are not included in the Corporation’s consolidated financialstatements at December 31, 2006 and 2005.

7

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***Use of Estimates***

Inpreparing consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America, management isrequired to make estimates and assumptions that affect the reported amounts ofassets and liabilities as of the date of the balance sheet and reported amountsof revenues and expenses during the reporting period. Actual results coulddiffer from those estimates.  Materialestimates that are particularly susceptible to significant change in the nearterm relate to the determination of the allowance for loan losses, and thevaluation of deferred tax assets.

***Cash and Cash Equivalents***

For purposes ofreporting cash flows, cash and cash equivalents include cash, amounts due frombanks and Federal funds sold on a daily basis, all of which mature withinninety days.

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

Interest-bearingdeposits in banks mature within one year and are carried at cost.

***Trading Activities***

TheCorporation engages in trading activities consisting of securities that areheld principally for resale in the near term. The securities are recorded in the trading assets account at fair valuewith changes in fair value recorded in earnings.  Interest and dividends are included in netinterest income.

Quotedmarket prices, when available, are used to determine the fair value of tradinginstruments.  If quoted market prices arenot available, then the fair values are estimated using pricing models, quotedprices of instruments with similar characteristics, or discounted cash flows.

8

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***Investment Securities***

Investmentsin debt securities that management has the positive intent and ability to holdto maturity are classified as “held to maturity” and reflected at cost,adjusted for amortization of premiums and accretion of discounts, which arerecognized as adjustments to interest income. Other marketable securities are classified as “available for sale” andare reflected at fair value, with unrealized gains and losses excluded fromearnings and reported in other comprehensive income.

Purchasepremiums and discounts are recognized in interest income using the interestmethod over the terms of the securities. Declines in the fair value ofheld-to-maturity and available for sale securities below their cost that aredeemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairmentlosses, management considers (1) the length of time and the extent to which thefair value has been less than cost, (2) the financial condition and near-termprospects of the issuer, and (3) the intent and ability of the Bank to retainits investment in the issuer for a period of time sufficient to allow for anyanticipated recovery in fair value. Gains and losses on disposition are generally recognized on the tradedate, based on the net proceeds and the adjusted carrying amount of thesecurities sold using the specific identification method.

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

TheBank originates loans to customers under the Small Business Administration(SBA) program that generally provides for SBA guarantees of 70% to 85% of eachloan.  The Bank generally sells theguaranteed portion of each loan to a third party and retains only thenon-guaranteed portion in its own portfolio. A gain is recognized on these loans through collection on sale of apremium over the adjusted carrying value, or through retention of an ongoingrate differential, less a normal service fee between the rate paid by theborrower to the Bank and the rate paid by the Bank to the purchaser (excessservicing fee).  In calculating the gain,the Bank assumes that the loans sold will be outstanding for one-half of theircontractual lives.

9

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TheBank’s investment in an SBA loan is allocated among the retained portion of theloan, excess servicing retained, and the sold portion of the loan, based on therelative fair market value of each portion at the time of loan origination,adjusted for payments and other activities. Since the portion retained does not carry an SBA guarantee, part of thegain recognized on the sold portion of the loan is deferred and amortized as ayield enhancement on the retained portion of the loan.  Excess servicing fees are reflected as anasset which is amortized over an assumed half life; in the event futureprepayments are significant and future expected cash flows are inadequate tocover the unamortized excess servicing asset, additional amortization isrecognized.

***Loans Held for Sale***

Loansheld for sale consist of the portion of loans that are guaranteed by the SBAand are carried at the lower of cost or market. Market value for loans guaranteed by the SBA is generally determinedbased on the price at which the loans were committed to be sold on the tradedate.  Direct loan origination costs arerecorded at settlement as an adjustment to gain or loss on sale.

***Loans and Loan Fees***

TheBank grants mortgage, commercial, construction, and consumer loans tocustomers.  A substantial portion of theloan portfolio is represented by****mortgageloans on the Monterey Peninsula.  Theability of the Bank’s debtors to honor their contracts is dependent upon thereal estate and general economic conditions in the area.

Loans, asreported, have been reduced by****undisbursedloan funds, net deferred loan fees, and the allowance for loan losses.

Loansthat management has the intent and ability to hold for the foreseeable futureor until maturity or pay-off generally are reported at their outstanding unpaidprincipal balances adjusted for charge-offs, the allowance for loan losses, andany deferred fees or cost on originated loans. Interest income 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

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Theaccrual of interest on mortgage and commercial loans is discontinued at thetime the loan is 90 days past due unless the credit is well-secured and inprocess of collection.  Credit card loansand other personal loans are typically charged off no later than 180 days pastdue.  Past due status is based oncontractual terms of the loan.  In allcases, loans are placed on nonaccrual or charged-off at an earlier date ifcollection of principal or interest is considered doubtful.

Allinterest accrued but not collected for loans that are placed on nonaccrual orcharged off is reversed against interest income.  The interest on these loans is accounted foron the cash-basis or cost-recovery method, until qualifying for return toaccrual.  Loans are returned to accrualstatus when all the principal and interest amounts contractually due arebrought current and future payments are reasonably assured.

***Allowance for Loan Losses***

Theallowance for loan losses is established through a provision for loan lossescharged to earnings and is maintained at a level considered adequate to providefor reasonably foreseeable loan losses.

Theprovision and the level of the allowance are evaluated on a regular basis bymanagement and are based upon management’s periodic review of thecollectibility of the loans in light of historical experience, known andinherent risks in the nature and volume of the loan portfolio, adversesituations that may affect the borrower’s ability to repay, estimated value ofany underlying collateral, and prevailing economic conditions.  This evaluation is inherently subjective asit requires estimates that are susceptible to significant change.  In addition, various regulatory agencies, asan integral part of their examination process, periodically review the Bank’sallowance for losses on loans and other real estate owned. Such agencies mayrequire the Bank to recognize additions to the allowance based on theirjudgment of information available to them at the time of theirexamination.  Ultimately, losses may varyfrom current estimates and future additions to the allowance may be necessary.

Loan losses arecharged against the allowance when management believes the collectibility ofthe loan balance is unlikely.  Subsequentrecoveries, if any, are credited to the allowance.

11

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Theallowance consists of specific, general and unallocated components.  The specific component relates to loans thatare classified as either doubtful, substandard or special mention.  For such loans that are also classified asimpaired, an allowance is established when the discounted cash flows (orcollateral value or observable market price) of the impaired loan is lower thanthat of the carrying value of that loan. The general component covers non-classified loans and is based onhistorical loss experience adjusted for qualitative factors.  An unallocated component is maintained tocover uncertainties that could affect management’s estimate of probablelosses.  The unallocated component of theallowance reflects the margin of imprecision inherent in the underlyingassumptions used in the methodologies for estimating specific and generallosses in the portfolio.

A loanis considered impaired when, based on current information and events, it isprobable that a creditor will be unable to collect the scheduled payments ofprincipal or interest when due according to the contractual terms of the loanagreement.  Factors considered bymanagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loanbasis by either the present value of expected future cash flows discounted atthe loan’s effective interest rate, the loan’s obtainable market price, or thefair value of the collateral if the loan is collateral dependent.  Substantially, all of the Bank’s loans thathave been identified as impaired have been measured by the fair value ofexisting collateral.

Largegroups of smaller balance homogeneous loans are collectively evaluated forimpairment.  Accordingly, the Bank doesnot separately identify individual consumer loans for impairment disclosures.

***Loan Servicing***

Rightsto service loans for others are capitalized as separate assets, whetheracquired through purchase or origination, if such loans are sold or securitizedwith servicing rights retained. Accordingly, the total cost of the loan is allocated to the relatedservicing right and to the loan based on the relative fair values if it ispracticable to estimate those fair values.

12

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The Bank estimates fair value based on the presentvalue of estimated expected future cash flows using prepayment speeds anddiscount rates commensurate with the risks involved, and servicing costsdetermined on an incremental cost basis.

 

Capitalized mortgage servicing rights are reported inother assets and amortized to servicing revenue in proportion to, and over theperiod of, estimated net servicing revenues. Impairment of mortgage servicingrights is assessed based on the fair value of those rights. For purposes of measuringimpairment, the rights are stratified based on the following predominant risk characteristicsof the underlying loans: loan type, size, note rate, date of origination, term,and geographic location. Impairment is recognized through a valuation allowancefor an individual stratum, to the extent that fair value is less than thecapitalized amount for the stratum.

 

***Premises and Equipment***

The Banks premises and equipment are stated at costless accumulated depreciation and amortization. Depreciation is provided for inamounts sufficient to relate the cost of depreciable assets to operations overtheir estimated service lives. Leasehold improvements are amortized over theterm of the lease or the service lives of the improvements, whichever isshorter. The straight-line method of depreciation is followed for financialreporting purposes, while both accelerated and straight-line methods arefollowed for income tax purposes. It is general practice to charge the cost ofmaintenance and repairs to earnings when incurred; major expenditures forbetterments are capitalized and depreciated.

 

***Income Taxes***

Deferred income taxes are recognized for estimatedfuture tax effects attributable to income tax carry forwards as well astemporary differences between income tax and financial reporting purposes. Valuationallowances are established when necessary to reduce the deferred tax asset tothe 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

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***Transfers of Financial Assets***

Transfersof financial assets are accounted for as sales when control over the assets hassurrendered. Control over transferred assets is deemed to be surrendered when1) the assets been isolated from the Bank, 2) the transferee (buyer) obtainsthe right to pledge or exchange transferred assets, free of conditions thatwould constrain it from taking advantage of that and 3) the Bank does notmaintain effective control over the transferred assets through agreement torepurchase them before their maturity.

***Stock Option Plan***

Underthe Corporation’s Stock Option Plan, the Bank may grant incentive stock optionsnon-qualified stock options to directors, officers, and employees of theCorporation and subsidiary, so long as the Corporation owns a majority of theequity interest of such subsidiary Incentive Stock Options are granted at fairvalue of the common stock on the date of grant However, an incentive stockoption granted to an individual owning 10% or more of Corporation’s stock aftersuch grant must have an exercise price of at least 110%****of such 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 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 the211,081 shares of common stock have been reserved for the granting of these options.  December 31, 2006, 202,864 options wereoutstanding.  During 2006, no optionswere granted, and 90,276 options were exercised by officers, employees, andboard members.  As of December 31, 2006,all options have been vested.

14

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InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement No. 123 (revised 2004), *Share-BasedPayment.*SFAS No. 123(R) requires that the compensation costrelating to share-based payment transactions be recognized in financialstatements. That cost will be measured based on the fair value of the equity orliability instruments issued. SFAS No. 123(R) covers a wide range ofshare-based compensation arrangements including stock options, restricted shareplans, performance-based awards, share appreciation rights, and employee sharepurchase plans. SFAS No. 123(R) is a replacement of SFAS No. 123, *Accounting for Stock-Based Compensation,*andsupersedes APB Opinion No. *25, Accountingfor Stock Issued to Employees,*and its related interpretiveguidance. The effect of the Statement will be to require entities to measurethe cost of employee services received in exchange for stock options based onthe grant-date fair value of the award, and to recognize the cost over theperiod the employee is required to provide services for the award. SFAS No. 123(R)permits entities to use any option-pricing model that meets the fair valueobjective in the Statement.

TheCorporation elected to adopt SFAS No. 123(R) on January 1, 2006 under themodified prospective method. Compensation cost has been measured using the fairvalue of an award on the grant dates and is recognized over the service period,which is usually the vesting period. Compensation cost related to thenon-vested portion of awards outstanding as of that date was based on thegrant-date fair value of those awards as calculated under the originalprovisions of SFAS No. 123; that is, the Corporation was not required tore-measure the grant-date fair value estimate of the unvested portion of awardsgranted prior to the effective date of SFAS No. 123(R).

TheCorporation had applied Accounting Principles Board Opinion No. 25 and relatedInterpretations, in accounting for the stock option plan prior to January 1,2006. Under APB Opinion No. 25, stock options issued under the Corporation’sstock option plan have no intrinsic value at the grant date, and therefore, nocompensation cost is recognized for them.

Thefollowing table illustrates the effect on the Corporation’s reported net incomeand earnings per share if the Company had applied the fair value recognitionprovision of SFAS No. 123 to stock-based employee compensation prior to theadoption date:

15

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|                                                              | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Reported net  earnings                                       |       | $                                           | 1,929,300  |   | $ | 1,065,200 |   |
| Additional  expense had the Corporation adopted SFAS No. 123 |       | (52,400                                     | )          | (60,300 | ) |
| Related income tax benefit                                   |       | 22,000                                      |       | — |   |
| Pro forma net  earnings                                      |       | $                                           | 1,898,900  |   | $ | 1,004,900 |   |
|                                                         |       |                                        |       |   |   |
| Earnings per  share as reported:                             |       |                                        |       |   |   |
| Basic                                                        |       | $                                           | 1.20       |   | $ | 0.68 |   |
| Diluted                                                      |       | $                                           | 1.00       |   | $ | 0.56 |   |
| Pro forma  earnings per share:                               |       |                                        |       |   |   |
| Basic                                                        |       | $                                           | 1.18       |   | $ | 0.64 |   |
| Diluted                                                      |       | $                                           | 1.11       |   | $ | 0.64 |   |

 

Thefair value of these options was estimated at the grant date using theBlack-Scholes option pricing model with the following weighted-averageassumptions for 2005 and 2004: risk-free interest rate of 4.6% and 4.8%,respectively; dividend yield of 1.3% and 1.0%, respectively; expected optionlife of 4 years and 8 years, respectively; and volatility of 20% for bothyears.

Theexpected volatility is based on historical volatility. The risk-free interestrates for periods within the contractual life of the awards are based on theU.S. Treasury yield curve in effect at the time of the grant. The expected lifeis based on historical exercise experience. The dividend yield assumption isbased on the Company’s history and expectation of dividend payouts.

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***Earnings per share***

Basic earnings per share represents income availableto common shareholders divided by the weighted-average number of common sharesoutstanding during the period. Diluted earnings per share reflects 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. Potential common shares that may be issued by theCorporation relate solely to outstanding stock options, and are determinedusing the treasury stock method. The weighted average number of shares used inthe computation of basic earnings per share was 1,658,675 for 2006, 1,614,196for 2005, and 1,576,589 for 2004. The weighted average number of shares used inthe computation of earnings per share assuming dilution of stock options was1,831,892 for 2006, 1,923,532 for 2005, and 1,919,512 for 2004. The Corporationpaid cash dividends of $.35, $.20, and $.165 per share in 2006, 2005 and 2004,respectively.

*** ***

***Recent AccountingPronouncements***

 

In March of 2006, the FASB published SFAS No. 156, *Accounting for Servicing of Financial Assets*,which amends SFAS No. 140, *Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities,*with respect to the accounting for servicing of financial assets. SFASNo. 156 requires that all separately recognized servicing rights be initiallymeasured at fair value, if practicable. For each class of separately recognizedservicing assets and liabilities, SFAS No. 156 permits an entity to chooseeither of the following 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 reporting ofservicing 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 all separatelyrecognized servicing rights. Early adoption is permitted as of the beginning ofan entity's fiscal year, provided the entity has not yet issued financialstatements, including interim financial statements, for any period of thatfiscal year. SFAS No. 156 is effective the earlier of the date an entity adoptsthe requirements of SFAS No. 156, or as of the beginning of its first fiscalyear beginning after September 15, 2006. An entity should apply the Requirementsfor recognition and initial measurement of servicing assets and servicingliabilities prospectively to all transactions after the effective date of SFASNo. 156. The Bank is currently evaluating the impact of the adoption of thisstandard.

 

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InSeptember 2006, the FASB issued Interpretation No. 48 (“FIN 48”), *“Accounting for Uncertainty in Income Taxes*,an interpretation of FASB Statement No. 109, *Accountingfor Income Taxes*,” effective for the Company beginning afterDecember 15, 2006 with earlier adoption encouraged. FIN 48 clarifies theaccounting for income taxes by prescribing the minimum recognition threshold atax position is required to meet before being recognized in the financialstatements. FIN 48 also provides guidance on derecognition, measurement,classification, interest and penalties, accounting in interim periods,disclosure and transition. The Bank is currently assessing the impact of thisguidance on its financial statements.

InSeptember 2006, the FASB issued Statement of Financial Accounting Standards No.157 (“SFAS 157”), *“Fair Value Measurements”*,effective for the Company beginning on January 1, 2008, with earlier adoptionpermitted. This Statement defines fair value, establishes a framework formeasuring fair value, and expands disclosures about fair value measurements.

Thisstatement establishes a fair value hierarchy that distinguishes betweenvaluations obtained from sources independent of the entity and those from theentity’s own unobservable inputs that are not corroborated by observable marketdata. SFAS 157 expands disclosures about the use of fair value to measureassets and liabilities in interim and annual periods subsequent to initialrecognition.  The disclosures focus onthe inputs used to measure fair value and for recurring fair value measurementsusing significant unobservable inputs, the effect of the measurements onearnings or changes in net assets for the period. This statement encourages anentity to combine the fair value information disclosed under this statementwith the fair value information disclosed under other accountingpronouncements, including SFAS 107, “Disclosures about Fair Value of FinancialInstruments”, where practicable. The Bank is currently assessing the impact ofthis guidance on its financial statements.

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In September 2006,the EITF reached a consensus on EITF Issue 06-5, Accounting for Purchases ofLife Insurance-Determining the Amount That Could Be Realized in Accordance withFASB Technical Bulletin No. 85-4 (“EITF 06-5”). EITF 06-5 requires that apolicyholder should consider any additional amounts included in the contractualterms of the policy in determining the amount that could be realized under theinsurance contract on a policy by policy basis. EITF 06-5 is effective forfiscal years beginning after December 15, 2006 and it requires that recognitionof the effects of adoption should be either by (a) a change in accountingprinciple through a cumulative-effect adjustment to retained earnings as of thebeginning of the year of adoption or (b) a change in accounting principlethrough retrospective application to all prior periods. The Bank is currentlyevaluating what effect, if any, adoption of EITF 06-5 will have on itsFinancial Statements.

***ComprehensiveIncome (Loss)***

Accountingprinciples generally require that recognized revenue, expenses, gains, andlosses be included in net income. Although certain changes in assets and liabilities, such as unrealizedgains and losses on available-for-sale securities, are reported as a separatecomponent of the equity section of the balance sheet, such items, along withnet income, are components of comprehensive income.

The components ofother comprehensive income (loss) and related tax effects for the years endedDecember 31, are as follows:

 

|                                                                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unrealized holding  gains (losses) on available for sale securities and other assets, net |       | $   | (93,500    | )        | $     | (81,900  | )          | $  | 39,300 |   |
| Tax effect                                                                                |       | 42,100   |       | 36,800   |       | (17,600  | )          |
|                                                                                      |       |     |       |     |       |     |       |
| Net-of-tax amount                                                                         |       | $        | (51,400    | )        | $          | (45,100  | )          | $ | 21,700 |   |

 

19

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The components ofaccumulated other comprehensive income (loss) and related tax effects for theyears ended December 31, 2006 and 2005 are as follows:

 

|                                                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Unrealized  holding losses on available for sale securities            |       | $        | (79,000    | )        | $          | (136,600 | ) |
| Unrealized  holding gains on available for sale asset strip receivable |       | 40,900   |       | 192,000  |       |
| Tax effect                                                             |       | 17,200   |       | (24,900  | )          |
|                                                                   |       |     |       |     |       |
| Net-of-tax amount                                                      |       | $        | (20,900    | )        | $          | 30,500 |   |

*** ***

***AdvertisingCosts***

Advertising costsare charged to operations when incurred. The amount expensed for advertising as of December 31, 2006, 2005, and2004 was $223,800, $140,900, and $127,300, respectively.

***Reclassification***

Certain amountshave been reclassified in the 2005 and 2004 financial statements to conform tothe 2006 presentation.

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

The Corporation isrequired to maintain aggregate reserves (in the form of cash and deposits withthe Federal Reserve Bank) to satisfy federal regulatory requirements.  At December 2006 and 2005, these reservebalances amounted to $1,184,000 and $800,000, respectively.

**Note 3. TRADING ASSETS**

At December 31,2006 and 2005, the Corporation’s trading assets consisted of marketable equitysecurities in the amount of $1,762,300 and $1,027,500, respectively.

20

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**Note 4. INVESTMENT SECURITIES ANDOTHER INVESTMENTS**

The amortized costand fair value of investment securities, with gross unrealized gains andlosses, follows:
| ** **                                          | ** ** | ** **    | ** ** | **Gross**                       | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|---------------|------------|---------------------------------|------------|----------------|------------|------------|------------|
| ** **                                          | ** ** | ** **    | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | **Amortized** | ** ** | **Gains**                       | ** ** | **Losses**     | ** ** | **Fair**   | ** ** |
| ** **                                          | ** ** | **Cost**      | ** ** | **December 31, 2006** | ** ** | **Value**      | ** ** |
| **Securities  Available for Sale**                  |       |          |       |                            |       |           |       |       |       |
| GNMA - Mortgage Backed Securities                   |       | $             | 640,600    |                            | $          | —         |       | $          | (15,000    | ) | $ | 625,600 |   |
| Government Agency Securities                        |       | 14,724,300    |       | 1,800                           |       | (65,800        | )          | 14,660,300 |       |
|                                                |       |          |       |                            |       |           |       |       |       |
| Total securities available for sale                 |       | $             | 15,364,900 |                            | $          | 1,800          |       | $          | (80,800    | ) | $ | 15,285,900 |   |
|                                                |       |          |       |                            |       |           |       |       |       |
| **Securities  Held to Maturity**                    |       |          |       |                            |       |           |       |       |       |
| State/Local Agency Securities                       |       | $             | 7,012,300  |                            | $          | 268,400        |       | $          | —     |   | $ | 7,280,700 |   |
|                                                |       |          |       |                            |       |           |       |       |       |
| **Other  Investments, at cost**                     |       |          |       |                            |       |           |       |       |       |
| AT Services LLC                                     |       | $             | 20,100     |                            | $          | —         |       | $          | —     |   | $ | 20,100 |   |
| Federal Home Loan Bank stock, restricted            |       | 1,633,300     |       | —                          |       | —         |       | 1,633,300  |       |
| Metrocities Mortgage, LLC                           |       | 10,000        |       | —                          |       | —         |       | 10,000     |       |
| Northern California Bancorp, Inc. Trust I           |       | 93,000        |       | —                          |       | —         |       | 93,000     |       |
| Northern California Bancorp, Inc. Trust II          |       | 155,000       |       | —                          |       | —         |       | 155,000    |       |
| The Independent Bankers’ Financial Corporation |       | 50,000        |       | —                          |       | —         |       | 50,000     |       |
| MasterCard Inc. Class “B” Stock           |       | 5,400         |       | —                          |       | —         |       | 5,400      |       |
|                                                |       |          |       |                            |       |           |       |       |       |
| Total other  investments                            |       | $             | 1,966,800  |                            | $          | —         |       | $          | —     |   | $ | 1,966,800 |   |

 

21

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| ** **                                 | ** ** | ** **    | ** ** | **Gross**                       | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|---------------|------------|---------------------------------|------------|----------------|------------|------------|------------|
| ** **                                 | ** ** | ** **    | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Amortized** | ** ** | **Gains**                       | ** ** | **Losses**     | ** ** | **Fair**   | ** ** |
| ** **                                 | ** ** | **Cost**      | ** ** | **December 31, 2005** | ** ** | **Value**      | ** ** |
| **Securities  Available for Sale**         |       |          |       |                            |       |           |       |       |       |
| GNMA - Mortgage Backed Securities          |       | $             | 857,300    |                            | $          | —         |       | $          | (19,500    | ) | $ | 837,800 |   |
| Government Agency Securities               |       | 9,714,100     |       | —                          |       | (117,100       | )          | 9,597,000  |       |
| Corporate Debt Securities                  |       | 630,500       |       | —                          |       | —         |       | 630,500    |       |
|                                       |       |          |       |                            |       |           |       |       |       |
| Total securities available for sale        |       | $             | 11,201,900 |                            | $          | —         |       | $          | (136,600   | ) | $ | 11,065,300 |   |
|                                       |       |          |       |                            |       |           |       |       |       |
| **Securities  Held to Maturity**           |       |          |       |                            |       |           |       |       |       |
| State/Local Agency Securities              |       | $             | 7,025,000  |                            | $          | 151,500        |       | $          | (14,600    | ) | $ | 7,161,900 |   |
|                                       |       |          |       |                            |       |           |       |       |       |
| **Other  Investments, at cost**            |       |          |       |                            |       |           |       |       |       |
| AT Services LLC                            |       | $             | 40,000     |                            | $          | —         |       | $          | —     |   | $ | 40,000 |   |
| Federal Home Loan Bank stock, restricted   |       | 1,182,600     |       | —                          |       | —         |       | 1,182,600  |       |
| Metrocities Mortgage, LLC                  |       | 10,000        |       | —                          |       | —         |       | 10,000     |       |
| Northern California Bancorp, Inc. Trust I  |       | 93,000        |       | —                          |       | —         |       | 93,000     |       |
| Northern California Bancorp, Inc. Trust II |       | 155,000       |       | —                          |       | —         |       | 155,000    |       |
| Pacific Coast Banker’s Bank Stock     |       | 439,900       |       | 1,317,100                       |       | —         |       | 1,757,000  |       |
| Pan Pacific Bank                           |       | 100,000       |       | —                          |       | —         |       | 100,000    |       |
|                                       |       |          |       |                            |       |           |       |       |       |
| Total other investments                    |       | $             | 2,020,500  |                            | $          | 1,317,100      |       | $          | —     |   | $ | 3,337,600 |   |

 

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The amortized costand fair value of debt securities by contractual maturity date at December 31,2006 follows:

 

|                                         | ** ** | **Available for Sale** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **Amortized**                    | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **Cost**                         | ** ** | **Value** | ** ** |
| Due within one  year                    |       | $                                | 3,741,700  |   | 3,713,400 |   |
| Due after one  year through five years  |       | 993,700                          |       | 978,800 |   |
| Due after five  years through ten years |       | 9,988,900                        |       | 9,968,100 |   |
| GNMA - Mortgage  Backed Securities      |       | 640,600                          |       | 625,600 |   |
|                                    |       |                             |       |   |   |
|                                    |       | $                                | 15,364,900 |   | $ | 15,285,900 |   |
|                                         |            |                                  |            |  |  |  |  |

 

|                      | ** ** | **Held to Maturity** | ** ** |
|----------------------|------------|--------------------------------|------------|
| ** **           | ** ** | **Amortized**                  | ** ** | **Fair** | ** ** |
| ** **           | ** ** | **Cost**                       | ** ** | **Value** | ** ** |
| Due after ten  years |       | $                              | 7,012,300  |   | $ | 7,280,700 |   |
|                      |            |                                |            |  |  |  |  |

 

Proceeds frommaturity and sales of investment securities for the years ended December 31,2006, 2005, and 2004 were $5,830,700, $597,300, and $8,557,800,respectively.  Realized gains (losses)for the years ended December 31, 2006, 2005, and 2004 were $1,311,700,$(91,800), and $50,600, respectively.

On January 31,2006, Monterey County Bank, a wholly owned subsidiary of Northern CaliforniaBancorp, Inc., sold its shares of common stock in Pacific Coast Banker’sBancshares (“PCBB”).  The gross salesproceeds were $1,757,025. After subtracting the book value of $439,900, theresulting pretax gain was $1,313,426. The after tax gain will approximate$790,000. Monterey County Bank owned 3,699 shares of PCBB that sold for $475.00per share less a $3,699 sales charge.

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As a member of theFederal Home Loan Bank (FHLB) system, the Bank is required to maintain aninvestment in FHLB stock in an amount equal to the greater of 1% of itsoutstanding mortgage loans or 5% of advances from the FHLB. As of December 31,2006 and 2005, the Bank had advances from the FHLB totaling $34,750,000 and$24,750,000, respectively. No ready market exists for FHLB stock, and it has noquoted market value. FHLB stock is evaluated for impairment based on anestimate of the ultimate recoverability of par value.

At December 31,2006 and 2005, U.S. Government obligations with a carrying value of $15,364,900and $11,201,900, respectively, were pledged to secure advances from the FHLB.

Informationpertaining to securities with gross unrealized losses at December 31, 2006,aggregated by investment category and length of time that individual securitieshave been in a continuous loss position follows:

 
| ** **                       | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**    | ** ** |
|----------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|--------------|------------|
| ** **                       | ** ** | **Carrying**                           | ** ** | **Unrealized**                       | ** ** | **Carrying** | ** ** | **Unrealized** | ** ** | **Carrying** | ** ** | **Unrealized** | ** ** |
| ** **                       | ** ** | **Amount**                             | ** ** | **Loss**                             | ** ** | **Amount**   | ** ** | **Loss** | ** ** | **Amount** | ** ** | **Loss** | ** ** |
| Securities  Available for Sale:  |       |                                   |       |                                 |       |         |       |   |   |   |   |   |   |
| Government Agencies              |       | $                                 | 5,988,900  |                                 | $     | (5,500       | )          | $  | 5,735,400 |   | $  | (60,300 | ) | $  | 11,724,300 |   | $  | (65,800 | ) |
| GNMA - Mortgage Backed  Security |       | 640,200                                |       | (15,000                              | )          | —       |       | — |   | 640,200 |   | (15,000 | ) |
|                             |       |                                   |       |                                 |       |         |       |   |   |   |   |   |   |
| Total                            |       | $                                      | 6,629,100  |                                 | $          | (20,500      | )          | $ | 5,735,400 |   | $ | (60,300 | ) | $ | 12,364,500 |   | $ | (80,800 | ) |

 

There were nounrealized losses at December 31, 2006 pertaining to securities held tomaturity.

 

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Informationpertaining to securities with gross unrealized losses at December 31, 2005,aggregated by investment category and length of time that individual securitieshave been in a continuous loss position follows:

|                                  | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**    | ** ** |
|----------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|--------------|------------|
| ** **                       | ** ** | **Carrying**                           | ** ** | **Unrealized**                       | ** ** | **Carrying** | ** ** | **Unrealized** | ** ** | **Carrying** | ** ** | **Unrealized** | ** ** |
| ** **                       | ** ** | **Amount**                             | ** ** | **Loss**                             | ** ** | **Amount**   | ** ** | **Loss** | ** ** | **Amount** | ** ** | **Loss** | ** ** |
| Securities Available  for Sale:  |       |                                   |       |                                 |       |         |       |   |   |   |   |   |   |
| Government Agencies              |       | $                                      | 8,715,000  |                                 | $          | (95,800      | )          | $ | 999,100 |   | $ | (21,300 | ) | $ | 9,714,100 |   | $ | (117,100 | ) |
| GNMA - Mortgage Backed  Security |       | 857,300                                |       | (19,500                              | )          | —       |       | — |   | 857,300 |   | (19,500 | ) |
|                             |       |                                   |       |                                 |       |         |       |   |   |   |   |   |   |
| Total                            |       | $                                      | 9,572,300  |                                 | $          | (115,300     | )          | $ | 999,100 |   | $ | (21,300 | ) | $ | 10,571,400 |   | $ | (136,600 | ) |
|                             |       |                                   |       |                                 |       |         |       |   |   |   |   |   |   |
| Securities Held to  Maturity:    |       |                                   |       |                                 |       |         |       |   |   |   |   |   |   |
| State/Local Agency Securities    |       | $                                      | 604,700    |                                 | $          | (14,600      | )          | $ | — |   | $ | — |   | $ | 604,700 |   | $ | (14,600 | ) |

Managementevaluates securities for other-than-temporary impairment at least on aquarterly basis, and more frequently when economic or market concerns warrantsuch evaluation. Consideration is given to (1) the length of time and theextent to which the fair value has been less than cost, (2) the financialcondition and near-term prospects of the issuer, and (3) the intent and abilityof the Bank to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in fair value.

On December 31,2006, 7 securities have an unrealized loss with aggregate depreciation of 0.65%from the Bank’s amortized cost basis. The unrealized losses relate to amortgage backed security issued by federally sponsored agencies, which arefully secured by conforming residential loans and securities issued by agenciesof the United States.  Since the Bank hasthe ability to hold these securities until estimated maturity, no decline isdeemed to be other than temporary.

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

A summary of theactivity of SBA loans follows:

|                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|----------------------|------------|----------|------------|----------|------------|-----------|------------|
| SBA loans originated |       | $        | 3,645,000  |     | $          | 6,274,000 |       | $ | 15,844,000 |   |
| SBA loans sold       |       | $        | 4,428,400  |     | $          | 7,944,900 |       | $ | 4,669,100 |   |

A summary ofincome from SBA loans sold is as follows:

|                                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income from premiums                  |       | $        | 349,800    |     | $          | 665,400  |       | $ | 412,400 |   |
| Income from servicing                 |       | 339,900  |       | 326,000  |       | 304,000  |       |
| Total SBA sales and  servicing income |       | $        | 689,700    |     | $          | 991,400  |       | $ | 716,400 |   |

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

A summary of loanbalances follows:

|                                        | ** ** | **2006**    | ** **  | **2005**    | ** ** |
|----------------------------------------|------------|-------------|-------------|-------------|------------|
| Commercial and  industrial             |       | $           | 26,361,000  |        | $          | 20,920,900 |   |
| Construction                           |       | 17,325,900  |        | 10,455,900  |       |
| Real estate, mortgage                  |       | 86,207,200  |        | 71,005,800  |       |
| Installment                            |       | 693,900     |        | 942,300     |       |
| Government guaranteed  loans purchased |       | 38,900      |        | 45,300      |       |
|                                   |       | 130,626,900 |        | 103,370,200 |       |
| Allowance for loan  losses             |       | (1,408,800  | )           | (1,100,700  | )          |
| Deferred origination  fees, net        |       | (350,500    | )           | (284,500    | )          |
| Loans, net                             |       | $           | 128,867,600 |        | $          | 101,985,000 |   |

An analysis of theallowance for loan losses follows:

|                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|----------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Beginning balance          |       | $        | 1,100,700  |     | $          | 963,000   |       | $ | 774,800 |   |
| Recoveries                 |       | 7,000    |       | 1,900    |       | 3,200     |       |
| Loans charged off          |       | (108,900 | )          | (14,200  | )          | —    |       |
| Provision for loan  losses |       | 410,000  |       | 150,000  |       | 185,000   |       |
| Ending balance             |       | $        | 1,408,800  |     | $          | 1,100,700 |       | $ | 963,000 |   |

 

27

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As of December 31,2006 there were $154,900 in impaired loans; at December 31, 2005 there were noimpaired loans.  No additional amountsare committed to be advanced in connection with impaired loans.

During the yearsended December 31, 2006, 2005, and 2004 the average recorded investment in impairedloans amounted to approximately $142,200, $82,400, and $617,100,respectively.  At December 31, 2006 therewas $154,900 in impaired loans with an allowance of $31,000. If interest onnon-accrual loans had been accrued, such income would have approximated $10,700and $8,200 for 2006 and 2004, respectively. There were no non-accrual loans at December 31, 2005.

As of December 31,2006 and 2005, there were no loans past due ninety days or more and stillaccruing interest.

Loans serviced forothers are not included in the accompanying balance sheets.  The unpaid principal balance of loansserviced for others was $101,138,400 and $85,033,900 at December 31, 2006 and2005, respectively.

**Note 7. PREMISES AND EQUIPMENT**

A summary of thecost and accumulated depreciation of banking premises and equipment and theirestimated useful lives follows:

|                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Estimated**         | ** ** |
|---------------------------|------------|------------|------------|------------|------------|-----------------------|------------|
| ** **                | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Useful Lives** | ** ** |
| Land                      |       | $          | 1,173,700  |       | $          | 1,173,700             |       |   |   |
| Building                  |       | 1,807,800  |       | 1,807,800  |       | 40 years              |       |
| Building improvements     |       | 897,100    |       | 484,500    |       | 40 years              |       |
| Leasehold improvements    |       | 833,500    |       | 877,300    |       | Lease term            |       |
| Furniture and equipment   |       | 1,932,000  |       | 1,787,700  |       | 3-8 years             |       |
|                      |       | 6,644,100  |       | 6,131,000  |       |                  |       |
| Accumulated  depreciation |       | (2,031,100 | )          | (1,768,700 | )          |                  |       |
|                      |       | $          | 4,613,000  |       | $          | 4,362,300             |       |   |   |

 

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Depreciation andamortization expense for the years ending December 31, 2006, 2005, and 2004amounted to $276,900, $240,700, and $208,500, respectively.

Included inbuilding improvements is $241,000 in costs related to remodeling of a buildingthat was purchased in March 2005.  Theestimated total cost of the remodeling is $400,000.  The project is expected to be completed inApril 2007.

**Note 8. DEPOSITS**

At December 31,2006, the scheduled maturities of time deposits are as follows:

| 2007       |   | $          | 60,855,900 |   |
|------------|--------|------------|------------|--------|
| 2008       |   | 5,502,500  |       |
| 2009       |   | 10,917,300 |       |
| 2010       |   | 529,900    |       |
| 2011       |   | 1,080,300  |       |
| Thereafter |   | 74,500     |       |
|       |   |       |       |
|       |   | $          | 78,960,400 |   |

**Note 9. JUNIOR SUBORDINATED DEBTSECURITIES**

On March 27, 2003,the Company’s wholly owned special-purpose trust subsidiary, NorthernCalifornia Bancorp, Inc. Trust I (“Trust I”) issued $3 million in cumulativeTrust Preferred Securities.  Thesecurities bear a floating rate of interest of 3.25% over the three month LIBORrate, payable quarterly.  The effectiverate at December 31, 2006 was 8.62%. Concurrent with the issuance of the Trust Preferred Securities, Trust Iused the proceeds from the Trust Preferred Securities offering to purchase alike amount of Junior Subordinated Debentures of the Company. The Company willpay interest on the Junior Subordinated Debentures to Trust I, which representsthe sole revenue and sole source of dividend distributions to the holders ofthe Trust Preferred Securities.  TheCompany has the right, assuming no default has occurred, to defer payments ofinterest on the Junior Subordinated Debentures at any time for a period not toexceed 20 consecutive quarters.

29

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The TrustPreferred Securities will mature on April 7, 2033, but can be redeemed undercertain circumstances at a premium prior to April 7, 2008, and can be redeemed,in whole or in part, on any January 7, April 7, July 7 or October 7 occurringafter April 7, 2008 at par.  The Companyfully and unconditionally guarantees the obligations of Trust I, on asubordinated basis.

The Companyreceived $2.91 million from Trust I upon issuance of the Junior SubordinatedDebentures, of which $1 million was contributed by the Company to the Bank toincrease its capital, $1.14 million was used to retire existing Company debtand the remainder 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 IICapital.

On November 13,2003, the Company’s wholly owned special-purpose trust subsidiary, NorthernCalifornia Bancorp, Inc. Trust II (“Trust II”) issued $5 million in cumulativeTrust Preferred Securities.  The securitiesbear a floating rate of interest of 2.85% over the three month LIBOR rate,payable quarterly.  The effective rate atDecember 31, 2006 was 8.22%. 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 Company. The Company will pay interest on the Junior SubordinatedDebentures to Trust II, which represents the sole revenue and sole source ofdividend distributions to the holders of the Trust Preferred Securities.  The Company 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 a premiumprior to November 8, 2008, and can be redeemed, in whole or in part, on anyFebruary 8, May 8, August 8 or November 8 occurring after November 8, 2008 atpar.  The Company fully andunconditionally guarantees the obligations of Trust II, on a subordinatedbasis.

The Companyreceived $4.96 million from Trust II upon issuance of the Junior SubordinatedDebentures, of which $2.5 million was contributed by the Company to the Bank toincrease its capital and the remainder held as working capital.

Issuance costs of$115,800 and $54,000 related to Trust I and Trust II, respectively have beendeferred and will be amortized over the 30-year life of the securities.

During the yearsended December 31, 2006, 2005 and 2004 interest expense on Junior SubordinatedDebentures totaled $675,600, $526,200, and $372,500, respectively.  The amortization of the issuance cost totaled$5,700 for each year ended December 31, 2006, 2005 and 2004, respectively.

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**Note 10. FUNDING SOURCES**

The Bank has linesof credit from the Federal Home Loan Bank (FHLB) of San Francisco, Bank of theWest, Pacific Coast Bankers’ Bank and The Independent Bank with remainingavailable borrowing capacity on December 31, 2006 of $1,065,800, $4,500,000,$6,000,000 and $5,000,000, respectively. The Federal Home Loan Bank line of credit has a maximum borrowingcapacity of twenty five percent (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 atDecember 31, 2006.  The total principalbalance of pledged loans was $33,463,500 and securities of $15,364,900.  The following table provides information onthirteen FHLB advances outstanding at December 31, 2006.

|                      | ** ** | **Fixed**    | ** ** | ** **  | ** ** | ** **   | ** ** |
|----------------------|------------|--------------|------------|-------------|------------|--------------|------------|
| **Advance**          | ** ** | **Interest** | ** ** | **Funding** | ** ** | **Maturity** | ** ** |
| **Amount**           | ** ** | **Rate**     | ** ** | **Date**    | ** ** | **Date**     | ** ** |
| $** **2,750,000 |       | 3.44         | %          | 09/27/02    |       | 09/27/07     |       |
| 3,000,000            |       | 4.30         | %          | 06/17/05    |       | 06/17/10     |       |
| 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     |       |
| 1,000,000            |       | 7.72         | %          | 06/01/00    |       | 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     |       |
| $34,750,000          |       |         |       |        |       |         |       |

The Bank of theWest, Pacific Coast Bankers’ Bank and The Independent Bank lines of credit areunsecured.  The Bank did not utilize anyovernight borrowings in 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 April17, 2011.

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**Note 11. INCOME TAXES**

Allocation offederal and California income taxes between current and deferred portions is asfollows:

|                                    | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Current tax  provision:            |       |      |       |      |       |      |       |
| Federal                            |       | $         | 2,129,700  |      | $          | 1,218,100 |       | $ | 619,800 |   |
| California                         |       | 768,300   |       | 450,100   |       | 236,700   |       |
|                               |       | 2,898,000 |       | 1,668,200 |       | 856,500   |       |
| Deferred tax  provision (benefit): |       |      |       |      |       |      |       |
| Federal                            |       | (116,900  | )          | (212,800  | )          | (146,700  | )          |
| California                         |       | (49,900   | )          | (41,000   | )          | (36,200   | )          |
| Increase in valuation allowance    |       | 135,000   |       | 75,000    |       | 107,000   |       |
|                               |       | (31,800   | )          | (178,800  | )          | (75,900   | )          |
|                               |       | $         | 2,866,200  |      | $          | 1,489,400 |       | $ | 780,600 |   |

The differencesbetween the statutory federal income tax rate and the effective tax rates aresummarized as follows:

|                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| 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                                    |       | 1.56     |       | 2.37     |       | 1.10     |       |
| Effective tax  rates                          |       | 42.76    | %          | 43.57    | %          | 42.30    | %          |

 

32

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The components ofthe net deferred tax asset, included in other assets, are as follows:

|                           | ** ** | **2006**  | ** ** | **2005** | ** ** |
|---------------------------|------------|-----------|------------|----------|------------|
| Deferred tax  asset       |       |      |       |     |       |
| Federal                   |       | $         | 842,400    |     | $          | 692,900 |   |
| California                |       | 232,000   |       | 172,200  |       |
|                      |       |      |       |     |       |
| Total deferred  tax asset |       | 1,074,400 |       | 865,100  |       |
| Valuation  allowance      |       | (545,000  | )          | (410,000 | )          |
|                      |       |      |       |     |       |
| Net deferred tax asset    |       | $         | 529,400    |     | $          | 455,100 |   |

The tax effects ofeach type of income and expense item that give rise to deferred taxes are asfollows:

|                                          | ** ** | **2006**  | ** ** | **2005** | ** ** |
|------------------------------------------|------------|-----------|------------|----------|------------|
| Deferred tax  assets (liabilities)       |       |      |       |     |       |
| Net unrealized gain (loss) on securities |       | $         | 7,900      |     | $          | (27,800 | ) |
| California franchise tax                 |       | 182,400   |       | 211,600  |       |
| Allowance for loan losses                |       | 600,500   |       | 465,800  |       |
| Accrued salary continuation liability    |       | 383,300   |       | 323,000  |       |
| Depreciation                             |       | (99,700   | )          | (107,500 | )          |
|                                     |       |      |       |     |       |
| Total deferred  tax asset                |       | 1,074,400 |       | 865,100  |       |
| Valuation  allowance                     |       | (545,000  | )          | (410,000 | )          |
|                                     |       |      |       |     |       |
| Net deferred tax asset                   |       | $         | 529,400    |     | $          | 455,100 |   |

The Bankestablishes a valuation allowance if, based on the weight of evidence, it ismore likely than not that some portion or all of the deferred tax assets willnot be realized.

33

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**Note 12. COMMITMENTS**

In the normalcourse of business, there are outstanding commitments that are not reflected inthe consolidated financial statements.

***Operating lease commitments***

The Bank leasesits branch offices in Carmel By-The-Sea, Carmel Valley, and Pacific Grove.  The Carmel By-The-Sea office has a five andone half year lease with four, five year options and commenced in April2002.  The Carmel Valley building has atwenty-five year lease which commenced in March 1981 and an addendum to thelease executed in 2005 provides for two options to renew the lease for anadditional 10 years each, and may be adjusted annually for changes in theConsumer Price Index.  The Pacific Grovebuilding has a five-year lease with five, five-year options and commenced inApril 1997.  The Bank leases approximately1,000 square feet at 321 Webster Street, Monterey, CA.  The 321 Webster Street lease has a term ofthree years commencing September 2000, with a three-year option.  An addendum to the lease was executed in 2004and provided for two, five year options to extend the lease, which commenced inSeptember 2006.  The Bank also leasescertain equipment used in the normal course of business.

Rent expense foroperating leases is included in occupancy and equipment expense and amounted toapproximately $275,200, $286,400, and $275,200 in 2006, 2005, and 2004,respectively.

Effective April 1,2000, the Bank entered into a 5 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 years ending2005 and 2004 was approximately $26,500 and $37,400, respectively.

Effective July 1,2002, the Bank entered into a 5 year and 3 months sublease agreement to rentone of the units in the Carmel-By-The-Sea branch.  The sublease was terminated in 2006 due to defaultfor non-payment of rent.  Sublease rentalincome for the yeas ending 2006, 2005, and 2004 was approximately $24,100,$40,200, and $37,200, respectively.  TheBank has decided to retain the subleased portion of the facility for its ownuse.

34

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Future minimumlease commitments for all non-cancelable operating leases are as follows:

| Year Ending     | ** ** | **Minimum Lease** | ** ** |
|----------------------|------------|------------------------|------------|
| **December 31** | ** ** | **Commitments**        | ** ** |
| 2007                 |       | $                      | 270,700    |   |
| 2008                 |       | 270,700                |       |
| 2009                 |       | 270,700                |       |
| 2010                 |       | 270,700                |       |
| 2011                 |       | 156,200                |       |
| Thereafter           |       | 475,700                |       |
|                 |       | $                      | 1,714,700  |   |

***Loan commitments***

The Bank is aparty to financial instruments with off-balance-sheet risk in the normal courseof business 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’sexposure to credit 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 31,2006 and 2005, such commitments to extend credit were $35,368,500 and$25,950,100, respectively, of undisbursed lines of credit, undisbursed loans inprocess, and commitment letters.

35

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**Note 13. CONCENTRATION OF RISK**

The Bank grantscommercial, construction, real estate and installment loans to businesses andindividuals primarily in the Monterey Peninsula area of Northern California.  Most loans are secured by business assets,and commercial and residential real estate. Real estate and construction loansheld for investment represented 79% of total loans held for investment atDecember 31, 2006 and 2005.  The Bank hasno 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 35.65% and 31.13% of total loans held for investmentat December 31, 2006 and 2005, respectively. Loans held for investment in the accommodation and food servicesindustry represented 16.58% and 20.57% of total loans held for investment atDecember 31, 2006 and 2005, respectively.

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

Other income forthe years ended December 31, 2006, 2005, and 2004 totaled $4,626,700,$2,806,800, and $2,993,900, respectively. Significant categories comprising other income in the years endingDecember 31, 2006, 2005, and 2004 were net merchant discount fees of$2,614,300, $2,342,600, and $2,343,400, commercial banking broker fees of$125,000, $412,200, and $274,000, life insurance cash surrender value earningsof $108,200, $79,900, and $65,200, credit card marketing program income of$1,308,300, $222,100 and $120,000, and trading asset activities of $283,100,($392,400) and $53,200, respectively.

Other general andadministrative expenses for the years ended December 31, 2006, 2005, and 2004totaled $3,511,200, $3,369,900, and $3,038,000, respectively.

Significantcategories comprising other general and administrative expenses in the yearsending December 31, 2006, 2005, and 2004 were merchant credit processingexpense of $2,153,900, $2,049,500, and $2,005,000, advertising of $223,800,$140,900, and $127,300, business development of $124,200, $63,100 and 72,100,insurance of $110,700, $117,300, and $106,400 and stationary and supplies of$123,100, $80,700 and $80,700, respectively.

36

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**Note 15. MINIMUM REGULATORY CAPITALREQUIREMENTS**

The Corporation(on a consolidated basis) and the Bank are subject to various regulatorycapital requirements 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 capitaladequacy guidelines and the regulatory framework for prompt corrective action,the Corporation 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 the remainderas Tier II Capital.   Prompt correctiveaction provisions are not applicable to bank holding companies.

Quantitativemeasures established by regulation to ensure capital adequacy require theCorporation and the Bank to maintain minimum amounts and ratios (set forth inthe following table) of total and Tier 1 capital (as defined in theregulations) to risk-weighted assets (as defined) and of Tier 1 capital (asdefined) to average assets (as defined). Management believes, as of December 31, 2006 and 2005, that theCorporation and the Bank met all capital adequacy requirements to which theyare subject.

As of December 31,2006, 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 December31, 2006 and 2005 are also presented in the tables.

37

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**December31, 2006**

|                                          | ** ** | ** **                                    | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | **Well Capitalized** | ** ** |
|------------------------------------------|------------|-----------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|---------------------------|------------|
| ** **                               | ** ** | ** **                                    | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | **Under Prompt**     | ** ** |
| ** **                               | ** ** | ** **                                    | ** ** | ** **      | ** ** | **Minimum**    | ** ** | **Corrective** | ** ** |
| ** **                               | ** ** | ** **                                    | ** ** | ** **      | ** ** | **Capital**    | ** ** | **Action**     | ** ** |
| ** **                               | ** ** | **Actual**                                    | ** ** | **Requirement** | ** ** | **Provisions** | ** ** |
| ** **                               | ** ** | **Amount**                                    | ** ** | **Ratio**       | ** ** | **Amount**     | ** ** | **Ratio**      | ** ** | **Amount**                | ** ** | **Ratio** | ** ** |
| ** **                               | ** ** | **(All 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 | % |

 

38

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**December31, 2005**

|                                          | ** ** | ** **                                    | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | **Well Capitalized** | ** **   |
|------------------------------------------|------------|-----------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|---------------------------|--------------|
| ** **                               | ** ** | ** **                                    | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | **Under Prompt**     | ** **   |
| ** **                               | ** ** | ** **                                    | ** ** | ** **      | ** ** | **Minimum**    | ** ** | **Corrective** | ** ** |
| ** **                               | ** ** | ** **                                    | ** ** | ** **      | ** ** | **Capital**    | ** ** | **Action**     | ** ** |
| ** **                               | ** ** | **Actual**                                    | ** ** | **Requirement** | ** ** | **Provisions** | ** ** |
| ** **                               | ** ** | **Amount**                                    | ** ** | **Ratio**       | ** ** | **Amount**     | ** ** | **Ratio**      | ** ** | **Amount**                | ** **   | **Ratio** | ** ** |
| ** **                               | ** ** | **(All dollars in thousands)** | ** ** |
| Total Capital to  Risk Weighted Assets:  |       |                                          |       |            |       |           |       |           |       |                      |         |   |   |
| Consolidated                             |       | $                                             | 17,751     |            | 14.3       | %              | $9,899     |           | 8.0        | %                         | N/A          |   | N/A |   |
| Monterey County Bank                     |       | $                                             | 15,958     |            | 13.1       | %              | $9,772     |           | 8.0        | %                         | $12,215      |   | 10.0 | % |
| Tier 1 Capital  to Risk Weighted Assets: |       |                                          |       |            |       |           |       |           |       |                      |         |   |   |
| Consolidated                             |       | $                                             | 10,763     |            | 8.7        | %              | $4,949     |           | 4.0        | %                         | N/A          |   | N/A |   |
| Monterey County Bank                     |       | $                                             | 14,738     |            | 12.1       | %              | $4,886     |           | 4.0        | %                         | $ 7,329 |   | 6.0 | % |
| Tier 1 Capital  to Average Assets:       |       |                                          |       |            |       |           |       |           |       |                      |         |   |   |
| Consolidated                             |       | $                                             | 10,763     |            | 6.9        | %              | $6,224     |           | 4.0        | %                         | N/A          |   | N/A |   |
| Monterey County  Bank                    |       | $                                             | 14,738     |            | 9.6        | %              | $6,139     |           | 4.0        | %                         | $ 7,674 |   | 5.0 | % |

**Note16. OTHER REGULATORY MATTERS**

TheCorporation is subject to regulation by the Board of Governors of the FederalReserve System under the Bank Holding Corporation Act.  The Bank is subject to regulation,supervision, and regular examination by the California Department of Financial Institutionsand the Federal Deposit Insurance Corporation. The regulations of these agencies affect most aspects of the Corporation’sbusiness and prescribe permissible types of loans and investments, the amountof required reserves, requirements for branch offices, the permissible scope ofthe Corporation’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).

39

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

 

At December 31,2006, options for the purchase of 202,864 shares of the Corporation’s commonstock were outstanding and exercisable at prices ranging from $1.86 - $4.40.  The status of all stock options isas follows:

|                                   | ** ** | ** ** | ** ** | ** **                         | ** **   | **Weighted Average** | ** ** |
|-----------------------------------|------------|------------|------------|------------------------------------|--------------|---------------------------|------------|
| ** **                        | ** ** | ** ** | ** ** | ** **                         | ** **   | **Remaining**             | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Exercise Price Range** | ** **   | **Contractual Life** | ** ** |
| Outstanding at December  31, 2004 |       | 318,717    |       | $                                  | 2.75 - $4.40 |                      | 5.1 Years  |   |
|                              |       |       |       |                               |         |                      |       |
| Granted                           |       | 10,000     |       | $                                  | 4.00         |                      |       |   |
| Exercised                         |       | (27,215    | )          | $                                  | 1.86 - $3.00 |                      |       |   |
| Cancelled                         |       | (8,362     | )          | $                                  | 2.25 - $4.00 |                      |       |   |
|                              |       |       |       |                               |         |                      |       |
| 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  |   |

 

The weightedaverage exercise price was $3.19, $2.47, and $2.15 for the years endingDecember 31, 2006, 2005, and 2004, respectively.  No options were granted in 2006, the weightedaverage fair value of options granted during the years ending December 31, 2005and 2004 were $4.00 and $2.89, respectively. All of the options are exercisable as of December 31, 2006.

40

----

Informationpertaining to options outstanding at December 31, 2006 is as follows:

|                                        | ** ** | ** **         | ** ** | **Weighted Average**     | ** ** |
|----------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **Number**         | ** ** | **Grant Date Fair** | ** ** |
| ** **                             | ** ** | **of Shares** | ** ** | **Value**                     | ** ** |
| Non-vested options,  December 31, 2005 |       | 20,000             |       | $                             | 0.89       |   |
| Vested                                 |       | (20,000            | )          | 0.89                          |       |
|                                   |       |               |       |                          |       |
| Non-vested options, December 31, 2006  |       | —             |       |                          |       |
|                                        |            |                    |            |                               |            |  |

 
| **Note 18.** | **RELATED PARTY TRANSACTIONS** |
|--------------|--------------------------------|

 

The Corporationhas, and expects to have in the future, banking transactions in the ordinarycourse of its business with directors, officers, principal shareholders, andtheir associates.  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 loantransactions with related parties are approximately as follows:

| Balance as of December 31,  2004 |   | $         | 1,207,900 |   |
|----------------------------------|--------|-----------|-----------|--------|
| Advances on  lines of credit     |   | 11,700    |      |
| Repayments                       |   | (43,400   | )         |
|                             |   |      |      |
| Balance as of December 31,  2005 |   | 1,176,200 |      |
| New Director  loans              |   | 497,100   |      |
| Advances on  lines of credit     |   | 70,600    |      |
| Repayments                       |   | (115,400  | )         |
|                             |   |      |      |
| Balance as of December 31, 2006  |   | $         | 1,628,500 |   |

 

Related partydeposits totaled $258,800 and $167,700 at December 31, 2006 and 2005, respectively.

41

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| **Note 19.** | **EMPLOYEE BENEFIT PLANS** |
|--------------|----------------------------|

 

During 1995, theCorporation established an employee stock ownership plan (ESOP) to invest inthe Corporation’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 2006, 2005, or 2004.  Therewere no shares in the plan as of December 31, 2006.

The Bank has asalary reduction plan under Section 401(k) of the Internal Revenue Code.  The plan covers substantially all full-timeemployees 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 2006,2005, and 2004 totaled $128,500, $107,200, and $87,200, respectively.
| **Note 20.** | **RESTRICTION ON DIVIDENDS, LOANS AND ADVANCES** |
|--------------|--------------------------------------------------|

 

Federal and statebanking regulations place certain restrictions on dividends paid and loans oradvances made by the Bank to the Corporation. The total amount of dividends which may be paid at any date is generallylimited to the lesser of: (i) retained earnings; or (ii) the Bank’s net incomefor its last three fiscal years (less any distributions to the stockholdersmade during such period), and loans or advances are limited to 25% of the Bank’sprimary capital plus the allowance for loan losses on a secured basis and 15%on an unsecured basis.
| **Note 21.** | **SALARY CONTINUATION PLANS** |
|--------------|-------------------------------|

 

The Corporationhas established salary continuation plans, which provide for payments to acertain officer at retirement.  Includedin other liabilities at December 31, 2006 and 2005, respectively, is $854,700and $720,300 of deferred compensation related to the continuation plans.  The plans are funded through life insurancepolicies that generate value to fund the future benefits.

42

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

 

The Bank had anon-cash transaction relating to the trade in of a vehicle of $12,700 and $0for the years ended December 31, 2006 and 2005, respectively.
| **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 certain financialinstruments 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:*** Thecarrying amounts of cash and short-term instruments approximate fair values.

***Investment securities:***Fair values for investment securities, excluding Federal Home Loan Bank stockand Pacific Coast Banker’s Bank stock, are based on quoted market prices.  The carrying value of Federal Home Loan Bankstock approximates fair value based on the redemption provisions of the FederalHome 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.

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***Commitments to Extend Credit and StandbyLetters 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 disclosed for demand deposits (e.g., interest and non-interestchecking, savings, and certain types of money market accounts) are, bydefinition, equal to the amount payable on demand at the reporting date (i.e.,their carrying amounts).  Fair values forfixed-rate certificates of deposit are estimated using a discounted cash flowcalculation that applies interest rates currently being offered on certificatesto a schedule of aggregated expected monthly maturities on time deposits.

***Accrued interest:***The carrying amounts of accrued 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 of federal funds purchased, borrowings under repurchaseagreements, and other short-term borrowings maturing within ninety days approximatetheir fair values.  Fair values of otherborrowings are estimated using discounted cash flow analyses based on theCorporation’s current incremental borrowing rates for similar types ofborrowing arrangements.

***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

44

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The estimated fairvalues, and related carrying amounts, of the Corporation’s financialinstruments as of December 31, 2006 and 2005 are as follows:
| ** **                                       | ** ** | **2006**     | ** ** | **2005**    | ** ** |
|--------------------------------------------------|------------|--------------|------------|-------------|------------|
| ** **                                       | ** ** | **Carrying** | ** ** | **Fair**    | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                       | ** ** | **Amount**   | ** ** | **Value**   | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial Assets:                                |       |         |       |        |       |   |   |   |   |
| Cash and cash  equivalents                       |       | $            | 22,434,200 |        | $          | 22,434,200 |   | $ | 24,130,600 |   | $ | 24,130,600 |   |
| Time deposits  with other financial institutions |       | 1,000,000    |       | 1,000,000   |       | 1,000,000 |   | 1,000,000 |   |
| Trading assets                                   |       | 1,762,300    |       | 1,762,300   |       | 1,027,500 |   | 1,027,500 |   |
| Securities,  available for sale                  |       | 15,285,900   |       | 15,285,900  |       | 11,065,300 |   | 11,065,300 |   |
| Securities, held  to maturity                    |       | 7,012,300    |       | 7,280,700   |       | 7,025,000 |   | 7,161,900 |   |
| Other  investments                               |       | 1,966,800    |       | 1,966,800   |       | 2,020,500 |   | 3,337,600 |   |
| Loans, held for  sale                            |       | 1,182,100    |       | 1,182,100   |       | 5,315,000 |   | 5,315,000 |   |
| Loans, net                                       |       | 128,867,600  |       | 122,346,000 |       | 101,985,000 |   | 98,569,000 |   |
| Accrued interest  receivable                     |       | 963,800      |       | 963,800     |       | 773,900 |   | 773,900 |   |
|                                             |       |         |       |        |       |   |   |   |   |
| Financial Liabilities:                           |       |         |       |        |       |   |   |   |   |
| Deposits                                         |       | 131,627,700  |       | 131,436,800 |       | 118,120,200 |   | 117,890,600 |   |
| Long-term debt                                   |       | 42,998,000   |       | 43,463,600  |       | 32,998,000 |   | 32,460,800 |   |
| Accrued interest  payable                        |       | 1,346,100    |       | 1,346,100   |       | 649,400 |   | 649,400 |   |
|                                                  |            |              |            |             |            |  |  |  |  |  |  |  |  |

 

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

 

The following arethe financial statements of Northern California Bancorp, Inc. (ParentCorporation only) as of December 31, 2006 and 2005:

| Balance Sheets                                 | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|
| Assets                                              |       |       |       |       |       |
| Cash and due  from banks                            |       | $          | 143,200    |       | $          | 581,100 |   |
| Investment in  common stock of Monterey County Bank |       | 18,522,100 |       | 15,139,000 |       |
| Investment  securities - trading account            |       | 1,762,300  |       | 1,027,500  |       |
| Investment in  Metrocities Mortgage, LLC Stock      |       | 10,000     |       | 10,000     |       |
| Investment in  Pan Pacific Bank Stock               |       | —     |       | 100,000    |       |
| Investment in AT  Services LLC Acquisition Corp.    |       | 20,100     |       | 40,000     |       |
| Northern  California Bancorp, Inc. Trust I          |       | 93,000     |       | 93,000     |       |
| Northern  California Bancorp, Inc. Trust II         |       | 155,000    |       | 155,000    |       |
| Debt issue  costs, net                              |       | 149,900    |       | 155,600    |       |
| Accounts  receivable                                |       | 3,800      |       | 5,000      |       |
|                                                |       | $          | 20,859,400 |       | $          | 17,306,200 |   |
| Liabilities and  Shareholders’ Equity          |       |       |       |       |       |
| Accounts payable  and accrued expenses              |       | $          | 125,300    |       | $          | 107,900 |   |
| Dividend payable                                    |       | 74,600     |       | 16,600     |       |
| Deferred tax  liability                             |       | 9,600      |       | 2,800      |       |
| Junior  subordinated debt securities                |       | 8,248,000  |       | 8,248,000  |       |
| Total  liabilities                                  |       | 8,457,500  |       | 8,375,300  |       |
| Shareholders’  equity                          |       | 12,401,900 |       | 8,930,900  |       |
|                                                |       | $          | 20,859,400 |       | $          | 17,306,200 |   |

 

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| Statements of Income                   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
|                                             |       |     |       |     |       |      |       |
| Equity in income of  subsidiary                  |       | $        | 4,059,600  |     | $          | 2,588,300 |       | $ | 1,290,100 |   |
| Investment income from AT  Services LLC          |       | —   |       | 100      |       | —    |       |
| Gain on sale of  securities                      |       | 233,100  |       | 34,900   |       | 27,400    |       |
| Gain (loss) on trading  asset                    |       | 50,000   |       | (427,300 | )          | 25,900    |       |
| Dividend income                                  |       | 26,100   |       | 24,000   |       | 13,200    |       |
| Interest & Fees on  Loans                    |       | —   |       | 23,700   |       | —    |       |
| Miscellaneous income                             |       | 600      |       | 300      |       | 100       |       |
| Investment income from Metrocities  Mortgage LLC |       | 31,000   |       | 59,000   |       | —    |       |
| Operating expenses                               |       | (738,200 | )          | (579,000 | )          | (421,200  | )          |
| Applicable tax benefit                           |       | 175,000  |       | 205,300  |       | 129,700   |       |
|                                             |       |     |       |     |       |      |       |
| Net income                                       |       | $        | 3,837,200  |     | $          | 1,929,300 |       | $ | 1,065,200 |   |

 

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| Statements of Cash Flows                                        | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Cash flows from  operating activities:                                         |       |       |       |       |       |       |       |
| Net income                                                                     |       | $          | 3,837,200  |       | $          | 1,929,300  |       | $ | 1,065,200 |   |
| Adjustments to  reconcile net income to net cash used by operating activities: |       |       |       |       |       |       |       |
| Equity in  undistributed income of Monterey County Bank                        |       | (4,059,500 | )          | (2,588,300 | )          | (1,290,100 | )          |
| Increase in  trading securities                                                |       | (734,800   | )          | (223,800   | )          | (640,400   | )          |
| Decrease in  other assets                                                      |       | 6,900      |       | 2,700      |       | 18,000     |       |
| Increase in  accrued expenses                                                  |       | 17,500     |       | 30,500     |       | 18,700     |       |
| Increase  (decrease) in other liabilities                                      |       | 64,700     |       | (4,800     | )          | 9,400      |       |
| Net cash used by  operating activities                                         |       | (868,000   | )          | (854,400   | )          | (819,200   | )          |
| Cash flows from  investing activities:                                         |       |       |       |       |       |       |       |
| Cash dividends  received from subsidiary                                       |       | 625,000    |       | —     |       | —     |       |
| Decrease in  investments                                                       |       | 119,900    |       | 52,100     |       | 25,000     |       |
| Net cash  provided by investing activities                                     |       | 744,900    |       | 52,100     |       | 25,000     |       |
| Cash flows from  financing activities:                                         |       |       |       |       |       |       |       |
| Cash dividends  paid on common stock                                           |       | (602,700   | )          | (326,300   | )          | (265,300   | )          |
| Exercise of  stock options                                                     |       | 287,900    |       | 67,100     |       | 89,000     |       |
| Stock repurchase                                                               |       | —     |       | (15,200    | )          | —     |       |
| Net cash used by  financing activities                                         |       | (314,800   | )          | (274,400   | )          | (176,300   | )          |
|                                                                           |       |       |       |       |       |       |       |
| Net decrease in cash  and cash equivalents                                     |       | (437,900   | )          | (1,076,700 | )          | (970,500   | )          |
| Cash and cash  equivalents, beginning of year                                  |       | 581,100    |       | 1,657,800  |       | 2,628,300  |       |
| Cash and cash equivalents, end of year                                         |       | $          | 143,200    |       | $          | 581,100    |       | $ | 1,657,800 |   |

 

 

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