** **

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

**WashingtonD.C. 20549**

 

**FORM 10-KSB/A**

**(Amendment No. 1)**

 

| **x**  | ** ** | **Annual report under Section 13  or 15(d) of the Securities Exchange Act of 1934 (Fee required)for fiscal year ended December 31, 2006**                                                                                       |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                                                                                            |
| **o**  | ** ** | **Transition report under Section  13 or 15(d) of the Securities Exchange Act of 1934 (No fee required)for the period  from                to** |

 

**CommissionFile Number 0-27666**

 

**NORTHERN CALIFORNIA BANCORP, INC.**

(Name of SmallBusiness Issuer in its Charter)

 

**Incorporatedin the State of California**

**IRSEmployer Identification Number 77-0421107**

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

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

 

|   | Securities registered  under Section 12(b) of the Exchange Act: |   | **None**         |
|--------|-----------------------------------------------------------------|--------|------------------|
|   | Securities registered  under Section 12(g) of the Exchange Act: |   | **Common stock** |

 

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

 

Check if there is 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 aggregatemarket value of voting stock held by non-affiliates of the Corporation was$11,809,600, based on the most recent 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/A:

 

1.   Portionsof the Independent Auditor’s Report for the fiscal year ended December 31, 2006are incorporated by reference in Part II Item 7.

 

 

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EXPLANATORY NOTE

 

On March 26, 2007Northern California Bancorp, Inc., timely filed our original Annual Report on Form10-KSB for the fiscal year ended December 31, 2006. This Form 10-KSB/A is beingfiled solely to include revised Item 8A(a) Evaluation of Disclosure Controlsand Procedures and revised certifications pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

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                                                                                | 20         |
|         |                                                                                                                                |       |
| **PART II**  | ** **                                                                                                                          | ** ** |
| ITEM 5       | Market for the Corporation’s  Common stock and Related Stockholder Matters                                                     | 20         |
| ITEM 6       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                         | 22         |
| ITEM 7       | Financial  Statements and Supplementary Data                                                                                        | 45         |
|         | 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                                                             | 45         |
| ITEM 8A      | Controls and  Procedures                                                                                                            | 45         |
| ITEM 8B      | Other Information                                                                                                                   | 46         |
|         |                                                                                                                                |       |
| **PART III** | ** **                                                                                                                          | ** ** |
| ITEM 9       | Directors,  Executive Officers, Promoters and Control Persons: Compliance with Section  16(a) of the Exchange Act                   | 47         |
| ITEM 10      | Executive and  Director Compensation                                                                                                | 49         |
| ITEM 11      | Security  Ownership of Certain Beneficial Owners and Management, and Related  Stockholder Matters                                   | 52         |
| ITEM 12      | Certain  Relationships and Related Transactions                                                                                     | 53         |
| ITEM 13      | Exhibits and  Reports                                                                                                               | 54         |
| ITEM 14      | Principal  Accountant Fees and Services                                                                                             | 55         |
|         | Signatures                                                                                                                          | 56         |

 

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**PART I**

 

Certain matters discussedor incorporated by reference in this Annual Report of Form 10-KSB/A including,but not limited to, those described in “Item 6 - Management’s Discussion andAnalysis of Financial Condition and Results of Operations”, are forward-lookingstatements that are subject to risks and uncertainties that could cause actualresults to differ materially from those projected in the forward-lookingstatements. Such risks and uncertainties include, among others, (1) competitivepressure in the banking industry increasing significantly; (2) changes in the interestrate environment reduces margins; (3) general economic conditions, eithernationally or regionally, are less favorable than expected, resulting in, amongother things, a deterioration in credit quality; (4) changes in the regulatoryenvironment; (5) changes in business conditions and inflation; and (6) changesin securities markets. Therefore, the information set forth therein should becarefully considered when evaluating the business prospects of the Corporation.

 

**ITEM 1.BUSINESS**

 

**GENERAL**

 

Northern CaliforniaBancorp, Inc. (the “Corporation”) was incorporated on August 29, 1995, as afor-profit corporation under the California Corporate laws for the principalpurpose of engaging in banking and non-banking activities as allowed for a bankholding company. The Corporation owns 100% of Monterey County Bank (the “Bank”).The Corporation’s sources of revenues at this time are dividends oninvestments, gains on securities transactions and potential dividends,management fees and tax equalization payments, if any, from the Bank.

 

Compliance withenvironmental laws has not had a material impact on the operations of the Bankor the Corporation, although the Bank faces potential liability or losses ifits borrowers fail to comply with such laws and the Bank acquires contaminatedproperties in foreclosure.

 

**BANK SUBSIDIARY**

 

Monterey County Bank, anindependent, California chartered commercial banking corporation was charteredby 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 its customers a wide variety of the normalpersonal, consumer and commercial services expected of a locally owned,independently operated bank. The Bank’s deposits are insured by the FederalDeposit Insurance Corporation “FDIC”, and, as such, the Bank is subject toregulations by that federal agency and to periodic audits of its operations anddocumentary compliance by “FDIC” personnel. As a state chartered bank, which isnot a member of the Federal Reserve System, it is also regulated andperiodically examined by the California State Department of FinancialInstitutions.

 

The Bank’s activities areconducted at its principal offices, 601 Munras Ave., Monterey, California andat its three branch offices in Carmel-By-The-Sea, Carmel Valley and PacificGrove, California and a loan production office in Monterey, California.

 

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At December 31, 2006 theBank had total assets, deposits and shareholders’ equity of approximately$188,375,900, $131,770,800 and $18,522,100, respectively.

 

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

 

On March 27, 2003,Northern California Bancorp, Inc. Trust I, a newly formed Delaware statutorybusiness trust and a wholly owned subsidiary of the Company (Trust I), issuedan aggregate of $3.0 million of principal amount of Floating Rate TRUPSâ(Capital Trust Pass-through Securities of the Trust) (the Trust PreferredSecurities). Bear Stearns & Co., Inc. acted as placement agent inconnection with the offering of the Trust Preferred Securities. The securitiesissued by Trust I are fully guaranteed by the Company with respect todistributions and amounts payable upon liquidation, redemption or repayment. Theentire proceeds to Trust I from the sale of the Trust Preferred Securities wereused by Trust I in order to purchase $3.0 million in principal amount of theFloating Rate Junior Subordinated Deferrable Interest Debentures due 2033issued by the Company (the Subordinated Debt Securities).

 

Pursuantto Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidationof Variable Interest Entities (VIE’s) (FIN 46),” this trust is not reflected ona consolidated basis in our financial statements.

 

The Subordinated DebtSecurities bear a variable interest rate equal to the three-month LIBOR plus3.25%. The effective rate at December 31, 2006 was 8.62%. Total broker andlegal costs associated with the issuance of $115,000 are being amortized over a30 year period.

 

# **NorthernCalifornia Bancorp, Inc. Trust II**

#  

On November 13, 2003, Northern CaliforniaBancorp, Inc. Trust II, a newly formed Delaware statutory business trust and awholly owned subsidiary of the Company (Trust II), issued an aggregate of $5.0million of principal amount of Floating Rate TRUPSâ(Capital Trust Pass-through Securities of the Trust) (the Trust PreferredSecurities). Citigroup Global Markets, Inc. acted as placement agent inconnection with the offering of the Trust Preferred Securities. The securitiesissued by Trust II are fully guaranteed by the Company with respect todistributions and amounts payable upon liquidation, redemption or repayment. Theentire proceeds to Trust II from the sale of the Trust Preferred Securitieswere used by Trust II in order to purchase $5.0 million in principal amount ofthe Floating Rate Junior Subordinated Deferrable Interest Debentures due 2033issued by the Company (the Subordinated Debt Securities).

 

Pursuantto Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidationof Variable Interest Entities (VIE’s) (FIN 46),” this trust is not reflected ona consolidated basis in our financial statements.

 

The Subordinated DebtSecurities bear a variable interest rate equal to the three-month LIBOR plus2.85%. The effective rate at December 31, 2006 was 8.22%. Total broker andlegal costs associated with the issuance of $54,000 are being amortized over a30 year period.

 

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**EMPLOYEES**

 

AtDecember 31, 2006 the Northern California Bancorp, Inc. and its subsidiaryMonterey County Bank employed a total of 53 full time equivalent persons.

 

**COMPETITION**

 

Allphases of the Bank’s business have been, since inception, and will continue tobe subject to significant competitive forces. 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 willalso compete with respect to its lending activities, as well as in attractingdemand deposits, with savings banks, savings and loan associations, insurancecompanies, regulated small loan companies and credit unions, as well assecurities brokerage offices which can issue commercial paper and othersecurities (such as shares in money market funds).

 

Amongthe advantages such institutions have over the Bank are their ability tofinance wide ranging advertising campaigns and to allocate their investmentassets to regions of highest yields and demand. Many institutions offer certainservices, such as trust services and international banking, which the Bank doesnot currently offer or plan to offer. By virtue of their greater total capital,such institutions have substantially higher lending limits than the Bank (legallending limits to an individual customer being limited to a percentage of abank’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 oflegislation enacted earlier in the decade, there is increased competitionbetween banks, savings and loan associations and credit unions for the depositand loan business of individuals. These activities may hinder the Bank’sability 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. Itsactivities in this regard include an ability and intention to respond quicklyto changes in the interest rates paid on time and savings deposits and chargedon loans, and to charges imposed on depository accounts, so as to remaincompetitive in the market place. It also will continue to emphasize specializedservices for the small business person and professional and personal contactsby the Bank’s officers, directors and employees. If there are customers whoseloan demands exceed the Bank’s lending limits, the Bank has the ability toarrange for such loans on a participation basis with other financialinstitutions. No assurance can be given, however, that the Bank’s efforts tocompete with other financial institutions in its primary service area will besuccessful.

 

TheBank provides a range of competitive retail and commercial banking services. Thedeposit services offered include various types of personal and businesschecking accounts, savings accounts, money market investment accounts,certificates of deposit, and retirement accounts. Lending services includeconsumer loans, various type of mortgage loans for residential and commercialreal estate, personal lines of credit, home equity loans, real estateconstruction, accounts receivable financing, commercial loans to small andmedium size businesses and professionals. The Bank also provides drive-throughfacilities, at its Monterey and Carmel offices, and night depository facilitiesfor customer convenience. The Bank offers safe deposit box facilities, cashiers’checks, travelers’ checks, U.S. Savings Bonds, and wire transfers. The Bankdoes not provide trust services.

 

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Whilethe Bank has the authority to engage in a wide range of banking activities, andoffers most of the types of banking services of a commercial bank, over thepast three years it has derived much of its profitability and differentiateditself from its competitors through (i) commercial and real estate loansguaranteed by the Small Business Administration (“SBA”); and (ii) credit carddepository services for merchants.

 

TheBank entered into an agreement with Genesis Financial Solutions, a purchaser ofcharged-off consumer credit card balances, to market a MasterCard credit cardprogram. The Bank will be issuing the cards, but the credit card balances willbe 100 percent owned by Genesis Financial Solutions. The program wasimplemented in the first quarter of 2005 with the initial card solicitationsbeing mailed in February 2005 resulting in 14,741 active cards on file at December31, 2005. The Bank’s 2006 and 2005 fee revenue from the program wereapproximately $71,400 and $95,400, respectively. Genesis Financial Solutionsmaintains deposits with the Bank equal to the sum of the total available creditof the portfolio plus the total of five (5) days average settlement activityfor the prior month. The average deposits maintained during 2006 and 2005 were$648,400 and $275,800, respectively.

 

TheBank entered into an agreement in February 2006 with GC Acquisitions, LLC (“GCA”), the owner of a portfolio of consumer credit card contracts andreceivables, under which the Bank will offer MasterCard® credit cards toqualifying GCA credit card contract holders. GCA will, through its affiliates, agents and vendors, establish newcredit card accounts with the Bank for certain of its existing credit cardcontract holders, service the credit card accounts and own the receivablesgenerated from the accounts. A total of approximately 252,000 cards were issuedduring March and April 2006, as a result of GCA’s purchase of a credit cardportfolio. GCA requested and the Bank granted permission for GCA to transfer atotal of approximately 87,000 accounts from the portfolio to another cardissuer. In consideration the Bank’s granting permission to transfer theaccounts GCA paid one time transfer fees totaling approximately $381,700. TheBank’s 2006 fee revenue from the program was approximately $1,209,400 includingthe on time transfer fees. GCA maintained average reserve deposits with theBank of $7,488,400. The Bank’s future revenues from the program and reservebalances maintained will be diminished as result of 87,000 accounts transferredfrom the portfolio.

 

TheBank has implemented a pre-paid debit card program. The program is marketed bythird parties through employer payroll programs and check cashing facilities,through Internet websites for purchasers of the websites’ products and services.Holders of the pre-paid cards will be able to have additional funds added tothe card balance, make point of sale purchases and withdraw cash throughautomated teller machines. The Bank will be issuing the pre-paid cards andmaintaining the funds held on the cards. The Bank’s revenues from the programwill be in the form of transaction fees and earnings from investing the fundsheld on the cards. Revenues from the program were $75,300, $13,800 and $8,300in 2006, 2005 and 2004, respectively.

 

TheBank depends largely on rate differentials. In general, the difference betweenthe interest rate paid by the Bank on its deposits and its other borrowings,and the interest rate received by the Bank on loans extended to its customersand securities held in the Bank’s portfolio, comprise the major portion of theBank’s earnings. These rates are highly sensitive to many factors that arebeyond 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.

 

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Monetaryand fiscal policies of the federal government and the policies of regulatoryagencies, particularly the Federal Reserve Board, also impact on the Bank’sbusiness. The Federal Reserve Board implements national monetary policies (withobjectives such as curbing inflation and combating recession) by its open-marketoperations in U.S. Government securities, by adjusting the required level ofreserves for financial intermediaries subject to its reserve requirements andby varying the discount rates applicable to borrowings by depositoryinstitutions. The actions of the Federal Reserve Board in these areas influencethe growth of bank loans, investments and deposits and also affect interestrates charged on loans and paid on deposits. The nature and impact of anyfuture changes in monetary policies cannot be predicted.

 

**SUPERVISIONAND REGULATION**

 

**TheCorporation**

 

Futureoffers or sales of the stock of the Corporation will be subject to theregistration requirements of the Securities Act of 1933, and qualificationunder the California Corporate Securities Act of 1968, and possibly other stateBlue Sky laws, (unless an exemption is available), although the Bank’s commonstock is exempt from such requirements.

 

OnDecember 29, 1995, after receipt of appropriate approvals, and/or passage ofnotice periods without objection, from the California Superintendent of Banks,the Federal Deposit Insurance Corporation, the Board of Governors of theFederal Reserve System and the shareholders of the Bank, the Corporationacquired the Bank through a reverse triangular merger (the “Merger”). As aresult, by operation of law, each outstanding share of common stock of the Bankprior to the Merger was converted into a share of common stock of the Corporation,while the Corporation became the sole owner of the newly issued shares ofcommon stock of the Bank.

 

TheBank Holding Company Act of 1956, as amended, places the Corporation under thesupervision of the Board of Governors of the Federal Reserve System (the “FRB”).The Corporation must generally obtain the approval of the FRB before acquiringall or substantially all of the assets of any bank, or ownership or control ofany voting securities of any bank if, after giving effect to such acquisition,the Corporation would own or control more than 5% of the voting shares of suchbank.

 

Abank holding company is generally prohibited from engaging in, or acquiringdirect or indirect control of more than 5% of the voting shares of any companyengaged in non-banking activities unless the FRB, by order or regulation, hasfound such activities to be so closely related to banking or managing orcontrolling banks as to be a proper incident thereto. In making suchdeterminations, the FRB considers whether the performance of such activities bya bank holding company would offer advantages to the public, which outweighpossible adverse effects.

 

TheFRB’s Regulation “Y” sets out the non-banking activities that are permissiblefor bank holding companies under the law, subject to the FRB’s approval inindividual cases. Most of these activities are now permitted for Californiabanks that are well-capitalized. The Corporation and its subsidiaries will alsobe subject to certain restrictions with respect to engaging in the underwriting,public sale and distribution of securities. The Gramm-Leach-Bliley Act (the “Act”)was signed by the President and enacted into law on November 12, 1999. The Actdoes three fundamental things: 1) it repeals key provisions of the GlassSteagal Act to permit commercial banks to affiliate with 

 

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investmentbanks, 2) it substantially modifies the Bank Holding Company Act of 1956 topermit companies that own commercial banks to engage in any type of financialactivity and 3) it allows subsidiaries of banks to engage in a broad range offinancial activities that are not permitted by banks. Management cannot predictwhat effect these changes will have on the Bank or the Corporation.

 

TheCorporation will be required to file reports with the FRB and provide suchadditional information as the FRB may require. The FRB will also have theauthority to examine the Corporation and each of its subsidiaries with the costthereof to be borne by the Corporation. Under California banking law, theCorporation and its subsidiaries are also subject to examination by, and may berequired to file reports with, the Superintendent Department of FinancialInstitutions.

 

TheCorporation and any subsidiaries which it may acquire or organize after thereorganization will be deemed affiliates of the Bank within the meaning of theFederal Reserve Act. Pursuant thereto, loans by the Bank to affiliates,investments by the Bank in affiliates’ stock, and taking affiliates’ stock bythe Bank as collateral for loans to any borrower will be limited to 10% of theBank’s capital, in the case of any one affiliate, and will be limited to 20% ofthe Bank’s capital, in the case of all affiliates. Federal and State law placeother limitations on transactions between the Bank and its affiliates designedto ensure that the Bank receives treatment in such transactions comparable tothat available from unaffiliated third parties.

 

TheCorporation and its subsidiaries are prohibited from engaging in certain tie-inarrangements in connection with any extension of credit, sale or lease ofproperty or furnishing of services. 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**

 

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

 

•      Expanded oversight of the accounting profession by creating a newindependent public company oversight board to be monitored by the SEC.

•      Revised rules on auditor independence to restrict the nature ofnon-audit services provided to audit clients and to require such services to bepre-approved by the audit committee.

•      Improved corporate responsibility through mandatory listing standardsrelating to audit committees, certifications of periodic reports by the ChiefExecutive Officer and Chief Financial Officer, and making issuer interferencewith an audit a crime.

•      Enhanced financial disclosures, including periodic reviews for thelargest issuers and real time disclosure of material company information.

•      Enhanced criminal penalties for a board array of white-collar crimesand increases in the statute of limitations for securities fraud lawsuits.

•      Provides for mandated internal control report and assessment with theannual report and an attestation and a report on such report by the company’sauditor.

 

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

 

**SubsidiaryBank**

 

Bothfederal and state laws provide extensive regulation of the banking business. Stateand federal statutes and regulations apply to many aspects of the Bank’soperations, including minimum capital requirements, reserves against deposits,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.

 

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

 

Californialaw restricts the amount available for cash dividends by state-chartered banksto the lesser of retained earnings or the bank’s net income for its last threefiscal years (less any distributions to stockholders made during such period). Cashdividends may also be paid in an amount not exceeding the net income for suchbank’s last preceding fiscal year after obtaining the prior approval of theSuperintendent. The FDIC also has authority to prohibit the Bank from engagingin unsafe or unsound practices. The FDIC can use this power, under certaincircumstances, to restrict or prohibit a bank from paying dividends.

 

Federallaw imposes restrictions on banks with regard to transactions with affiliates,including any extensions of credit to, or the issuance of a guarantee or letterof credit on behalf of, its affiliates, as well as the purchase of orinvestments in stock or other securities thereof, or the taking of suchsecurities 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 bythe Bank are limited to 10% of the Bank’s capital and surplus (as defined byfederal regulations) in the case of any one affiliate, and 20% thereof in thecase of all affiliates. California law also imposes certain restrictions withrespect to transactions involving other controlling persons of the Bank.

 

Fromtime to time, legislation is enacted which has the effect of increasing thecost of doing business, limiting or expanding permissible activities oraffecting the competitive balance between banks and other financialintermediaries. Proposals to change the laws and regulations governing theoperations and taxation of banks, bank holding companies and other financialintermediaries are frequently made in Congress, in the California legislatureand before various bank regulatory and other professional agencies. The Bankcannot predict what, if any legislation or regulations will be enacted, or theimpact thereof on its business and profitability.

 

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**Capital Adequacy Standards**

 

Governmentagencies have traditionally regulated bank capital through explicit andimplicit guidelines and rules. State law requires “adequate” capital, withoutobjective definition. Federal law and regulations require minimum levels ofrisk-based and so-called “Leverage” capital.

 

FDICguidelines implement the risk-based capital requirements. The guidelinesestablish a systematic analytical framework that makes regulatory capitalrequirements more sensitive to differences in risk profiles (using the roughmeasures set forth therein) among banking organizations, take certainoff-balance sheet items into account in assessing capital adequacy and minimizedisincentives to holding liquid, low-risk assets. Under these guidelines,assets and credit equivalent amounts of off-balance sheet items, such asletters of credit and outstanding loan commitments, are assigned to one ofseveral risk categories, which range from 0% for risk-free assets, such as cashand certain U.S. government securities, to 100% for relatively high-riskassets, such as loans and investments in fixed assets, premises and other realestate owned. The aggregate dollar amount of each category is then multipliedby the risk-weight associated with that category. The resulting weighted valuesfrom each of the risk categories are then added together to determine the totalrisk-weighted assets.

 

Abanking organization’s risk-based capital ratios are obtained by dividing itsqualifying capital by its total risk adjusted assets, including dollarequivalents for certain off-balance sheet assets.

 

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

 

Abanking organization’s qualifying total capital consists of two components:Tier 1 capital (core capital) and Tier 2 capital (supplementary capital). Tier1 capital consists primarily of common stock, related surplus and retainedearnings, qualifying noncumulative perpetual preferred stock and minorityinterests in the equity accounts of consolidated subsidiaries. Trust preferredsecurities qualify as Tier 1 capital up to a maximum of 25% of capital. Anyadditional portion will qualify as Tier 2 capital. Intangibles, such asgoodwill, are generally deducted from Tier 1 capital; however, purchasedmortgage servicing 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.

 

Tier2 capital may consist of (i) the allowance for loan and lease losses in anamount up to 1.25% of risk-weighted assets; (ii) cumulative perpetual preferredstock and long-term preferred stock and related surplus; (iii) hybrid capitalinstruments (instruments with characteristics of both debt and equity),perpetual debt and mandatory convertible debt securities; and (iv) eligibleterm subordinated debt and intermediate-term preferred stock with an originalmaturity of five years or more, including related surplus, in an amount up to50% of Tier 1 capital. The inclusion of the foregoing elements of Tier 2capital is subject to certain requirements and limitations of the federalbanking agencies.

 

TheFDIC imposes a minimum leverage ratio of Tier I capital to average total assetsof 3% for the highest rated banks, and 4% for all other banks. Institutionsexperiencing or anticipating significant growth or those with other thanminimum risk profiles are expected to maintain capital at least 100-200 basispoints above the minimum level.

 

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Inaddition, the Federal Reserve Board and the FDIC have issued or proposed rulesto take account of interest rate risk, concentration of credit risk and therisks of nontraditional activities in calculating risk-based capital.

 

Forcapital adequacy purposes, deferred tax assets that can be realized from taxespaid in prior carry-back years, and from the future reversal of temporarydifferences, are generally unlimited. However, deferred tax assets that canonly be realized through future taxable earnings, including the implementationof a tax planning strategy, count toward regulatory capital purposes only up tothe lesser 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 deferredtaxes in excess of this limit, if any, would be deducted from Tier I capitaland total assets in regulatory capital calculations.

 

EffectiveJanuary 17, 1995, the federal banking agencies issued a final rule relating tocapital standards and the risks arising from the concentration of credit andnontraditional activities. Institutions which have significant amounts of theirassets concentrated in high risk loans or nontraditional banking activities andwho fail to adequately manage these risks, will be required to set asidecapital in excess of the regulatory minimums. The federal banking agencies havenot imposed any quantitative assessment for determining when these risks aresignificant, but have identified these issues as important factors they willreview in assessing an individual bank’s capital adequacy. Management of theCompany does not believe that the Bank’s assets and activities, as currentlystructured, would lead the FDIC to require additional capital under this rule.

 

InDecember 1993, the federal banking agencies issued an interagency policystatement on the allowance for loan and lease losses (the “ALLL”) which callsfor the maintenance of the ALLL at a level at least equal to the “estimatedcredit losses” in the bank’s loan portfolio. “Estimated credit losses” aredefined as “an estimate of the current amount of the loan and lease portfolio(net of unearned income) that is not likely to be collected; that is, netcharge-offs that are likely to be realized for a loan or pool of loans givenfacts and circumstances as of the evaluation date.”   The policy statement also suggests that atest of reasonableness be applied to the ALLL, which test is satisfied if theALLL equals or exceeds the sum of (a) assets classified loss; (b) 50% of assetsclassified doubtful; (c) 15% of assets classified substandard; and (d)estimated credit losses on other assets over the upcoming twelve months. TheBank believes that its ALLL exceeds the amounts that would be required underthe terms of this policy statement and under such test of reasonableness. However,this is a very subjective matter, and the Bank cannot assure that any bankexaminer would agree with its evaluation, or that losses ultimately incurredfrom the Bank’s portfolio would not exceed the amounts so provided.

 

Futurechanges in regulations or practices could further reduce the amount of capitalrecognized for purposes of capital adequacy. Such a change could affect theability of the Bank to grow and could restrict the amount of profits, if any,available for the payment of dividends.

 

**Prompt Corrective Action and OtherEnforcement Mechanisms**

 

UnderSection 38 of the FDIA, as added by the Federal Deposit Insurance CorporationImprovement Act of 1991 (“FDICIA”), each federal banking agency is required toimplement a system of prompt corrective action for institutions which itregulates. The federal banking agencies have promulgated substantially similarregulations to implement this system of prompt corrective 

 

11

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action.Under the regulations, an institution shall generally be deemed to be:(i) “well capitalized” 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 of 4.0%or more and a Tier I leverage capital ratio of 4.0% or more (3.0% undercertain circumstances) and does not meet the definition of “well capitalized;”(iii) “undercapitalized” if it has a total risk-based capital ratio that isless than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or aTier I leverage capital ratio that is less than 4.0% (3.0% under certaincircumstances); (iv) “significantly undercapitalized” if it has a totalrisk-based capital ratio that is less than 6.0%, a Tier I risk-basedcapital ratio that is less than 3.0% or a Tier I leverage capital ratiothat is less than 3.0%; and (v) “critically undercapitalized” if it has aratio of tangible equity to total assets that is equal to or less than 2.0%.

 

Section38 of the FDIA and the implementing regulations also provide that a federalbanking agency may, after notice and an opportunity for a hearing, reclassify awell capitalized institution as adequately capitalized and may require anadequately capitalized institution or an undercapitalized institution to complywith supervisory actions as if it were in the next lower category if theinstitution is in an unsafe or unsound condition or engaging in an unsafe orunsound practice. (The FDIC may not, however, reclassify a significantlyundercapitalized institution as critically undercapitalized.)

 

Aninstitution generally must file a written capital restoration plan which meetsspecified requirements, as well as a performance guaranty by each company thatcontrols the institution, with the appropriate federal banking agency within 45days of the date that the institution receives notice or is deemed to havenotice that it is undercapitalized, significantly undercapitalized orcritically undercapitalized. Immediately upon becoming undercapitalized, aninstitution shall become subject to the provisions of Section 38 of theFDIA, which sets forth various mandatory and discretionary restrictions on itsoperations.

 

AtDecember 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**

 

Federallaw requires the federal banking regulatory agencies to prescribe, byregulation, standards for all insured depository institutions relating to:(i) internal controls, information systems and internal audit systems;(ii) loan documentation; (iii) credit underwriting;(iv) interest rate risk exposure; (v) asset growth; and(vi) compensation, fees and benefits. The federal banking agenciesrecently adopted final regulations and Interagency Guidelines PrescribingStandards for Safety and Soundness (“Guidelines”) to implement safety andsoundness standards required by the FDIA. The Guidelines set forth the safetyand soundness standards that the federal banking agencies use to identify andaddress problems at insured depository institutions before capital becomesimpaired. The agencies also proposed asset quality and earnings standardswhich, if adopted in final, would be added to the Guidelines. Under the finalregulations, if the FDIC determines that the Bank fails to meet any standardprescribed by the Guidelines, the agency may require the Bank to submit to theagency an acceptable plan to achieve compliance with the standard, as requiredby the FDIA. The final regulations establish deadlines for the submission andreview of such safety and soundness compliance plans.

 

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**Premiums for Deposit Insurance**

 

TheFDIC adopted regulations implementing a risk-based premium system required byfederal law. Under the regulations which cover the assessment periodscommencing on and after January 1, 1994, insured depository institutions arerequired to pay insurance premiums within a range of $.23 cents per $100 ofdeposits to $.31 cents per $100 of deposits depending on their riskclassification. The FDIC, effective September 30, 1995, lowered assessmentsfrom their rates of $.23 to $.31 per $100 of insured deposits to rates of $.04to $.31, depending on the health of the bank, as a result of there-capitalization of the BIF. The FDIC may alter the existing assessment ratestructure for deposit insurance and may change the base assessment rate(currently, 4 to 31 basis points per year) by rulemaking with notice andcomment. Without notice or comment, the FDIC may increase or decrease thecurrent rate schedule uniformly by as much as 5 basis points, as deemednecessary to maintain the target designated reserve ratio 1.25 percent (fundbalance to estimated insured deposits). The insured deposit rates for 2006 were$.00 to $.27.

 

OnFebruary 8, 2006, the President signed The Federal Deposit Insurance Reform Actof 2005 (the Reform Act) into law. The Federal Deposit Insurance ReformConforming Amendments Act of 2005, which the President signed into law onFebruary 15, 2006, contains necessary technical and conforming changes toimplement deposit insurance reform, as well as a number of study and surveyrequirements.

 

TheReform Act provides for the following changes:

 

•          Merging the Bank Insurance Fund (BIF) and the Savings AssociationInsurance Fund (SAIF) into a new fund, the Deposit Insurance Fund (DIF). Thischange was made effective March 31, 2006.

 

•          Increasing the coverage limit for retirement accounts to $250,000 andindexing the coverage limit for retirement accounts to inflation as with thegeneral deposit insurance coverage limit. This change was made effective April1, 2006.

 

•          Establishing a range of 1.15 percent to 1.50 percent within which theFDIC Board of Directors may set the Designated Reserve Ratio (DRR).

 

•          Allowing the FDIC to manage the pace at which the reserve ratio varieswithin 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 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.

 

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•          Eliminating the restrictions on premium rates based on the DRR andgranting the FDIC Board the discretion to price deposit insurance according torisk for all insured institutions regardless of the level of the reserve ratio.

 

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

 

•          The Federal Deposit Insurance Reform Conforming Amendments Act of 2005requires the FDIC to conduct studies of three issues: (1) further potentialchanges to the deposit insurance system, (2) the appropriate deposit base indesignating the reserve ratio, and (3) the Corporation’s contingent lossreserving methodology and accounting for losses.

 

•          The 2005 act requires the Comptroller General to conduct studies of (1)federal bank regulators’ administration of the prompt corrective action programand recent changes to the FDIC deposit insurance system, and (2) theorganizational structure of the FDIC.

 

The final rule consolidates the existing nine riskcategories into four and names them Risk Categories I, II, III and IV. RiskCategory I replaces the 1A risk category.

 

Within Risk Category I, the final rule combinessupervisory ratings with other risk measures to differentiate risk. For mostinstitutions, the final rule combines CAMELS component ratings with financialratios to determine an institution’s assessment rate. For large institutionsthat have long-term debt issuer ratings, the final rule differentiates risk bycombining CAMELS component ratings with these ratings. For large institutionswithin Risk Category I, initial assessment rate determinations may be modifiedwithin limits upon review of additional relevant information.

 

The final rule defines a large institution as aninstitution that has $10 billion or more in assets. With certain exceptions,beginning in 2010, the final rule treats new institutions (those establishedfor less than five years) in Risk Category I the same, regardless of size, andassesses them at the maximum rate applicable to Risk Category I institutions.

 

The final rule sets actualrates beginning January 1, 2007, as follows: 

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

 

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

 

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

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

 

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

 

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The final rule continues to allow the FDIC Board toadjust rates uniformly from one quarter to the next, except that no singleadjustment can exceed three basis points. In addition, cumulative adjustmentscannot exceed a maximum of three basis points higher or lower than the baserates without further notice-and-comment rulemaking.

 

Thebilling for deposit insurance is now quarterly and in the arrears. Payment forthe first quarter 2007 deposit insurance premiums will be collected in June2007. The Bank’s portion of the one-time initial assessment credit is estimatedto be approximately $49,000, which will be used to offset deposit insurancepremiums; the assessment credit cannot be used to offset FICO premiums.

 

TheFinancing Corporation (FICO), established by the Competitive Equality BankingAct of 1987, is a mixed-ownership government corporation whose sole purpose wasto function as the financing vehicle for the Federal Savings & LoanInsurance Corporation (FSLIC). Effective December 12, 1991, as provided by theResolution Trust Corporation Refinancing, Restructuring and Improvement Act of1991, the FICO’s ability to issue new debt was terminated. Outstanding FICObonds, which are 30-year non-callable bonds with a principal amount ofapproximately $8.1 billion, mature in 2017 through 2019.

 

TheFICO has assessment authority, separate from the FDIC’s authority to assessrisk-based premiums for deposit insurance, to collect funds from FDIC-insuredinstitutions sufficient to pay interest on FICO bonds. The FDIC acts ascollection agent for the FICO. The Deposit Insurance Funds Act of 1996 (DIFA)authorized the FICO to asses both Bank Insurance Fund (BIF) and SavingsAssociation Insurance Fund (SAIF) insured deposits, and required the BIF rateto equal one-fifth the SAIF rate through the year 1999, or until the insurancefunds are merged, whichever occurs first. Thereafter, BIF and SAIF insureddeposits will be assessed at the same rate by FICO.

 

TheFICO assessment rate is adjusted quarterly to reflect changes in the assessmentbasis of the respective funds based on the quarterly Call Report and the ThriftFinancial Report submissions. The FICO quarterly rates for 2006 were 1.32,1.28, 1.26 and 1.24. The FICO quarterly rate for the first quarter of 2007 is1.22.

 

**Interstate Banking and Branching**

 

On September 29, 1994,the President signed into law the Riegle-Neal Interstate Banking and BranchingEfficiency Act of 1994 (the “Interstate Act”). Under the Interstate Act,beginning one year after the date of enactment, a bank holding company that isadequately capitalized and managed may obtain regulatory approval to acquire anexisting bank located in another state without regard to state law. A bankholding company would not be permitted to make such an acquisition if, uponconsummation, it would control (a) more than 10% of the total amount ofdeposits of insured depository institutions in the United States or (b) 30% ormore of the deposits in the state in which the bank is located. A state maylimit the percentage of total deposits that may be held in that state by anyone bank or bank holding company if application of such limitation does notdiscriminate against out-of-state banks. 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.

 

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The Interstate Act alsopermitted affective June 1, 1997, mergers of insured banks located in differentstates and conversion of the branches of the acquired bank into branches of theresulting bank. Each state may permit such combinations earlier than June 1,1997, and may adopt legislation to prohibit interstate mergers after that datein that state or in other states by that state’s banks. The same concentrationlimits discussed in the preceding paragraph apply. The Interstate Act alsopermits a national or state bank to establish branches in a state other thanits home state if permitted by the laws of that state, subject to the samerequirement and conditions as for a merger transaction.

 

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

 

On October 2, 1995, the “CaliforniaInterstate Banking and Branching Act of 1995” (the “1995 Act”) became effective.The 1995 Act generally allows out-of-state banks to enter California by mergingwith, or purchasing, a California bank or industrial loan company which is atleast five years old. Also, the 1995 Act repeals the California Interstate(National) Banking Act of 1986, which previously regulated the acquisition ofCalifornia banks by out-of-state bank holding companies. In addition, the 1995Act permits California state banks, with the approval of the Superintendent ofBanks, to establish agency relationships with FDIC-insured banks and savingsassociations. Finally, the 1995 Act provides for regulatory relief, including(i) authorization for the Superintendent to exempt banks from the requirementof obtaining approval before establishing or relocating a branch office orplace of business, (ii) repeal of the requirement of directors’ oaths(Financial Code Section 682), and (iii) repeal of the aggregate limit on realestate loans (Financial Code Section 1230).

 

**Community Reinvestment Act and Fair LendingDevelopments**

 

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

 

In May, 1995, thefederal banking agencies issued final regulations which change the manner inwhich they measure a bank’s compliance with its CRA obligations. The finalregulations adopt a performance-based evaluation system which bases CRA ratingson an institution’s actual lending service and investment performance ratherthan the extent to which the institution conducts needs assessments, documentscommunity outreach or complies with other procedural requirements. In March1994, the Federal Interagency Task Force on Fair Lending issued a policystatement on discrimination in lending. The policy statement describes thethree methods that federal agencies will use to prove discrimination: overtevidence of discrimination, evidence of disparate treatment and evidence ofdisparate impact. Management of the Bank believes that the Bank is insubstantial compliance with all requirements under these provisions. Followingthe Bank’s most recent CRA examination, the Bank’s rating was “satisfactory”.

 

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**Other Regulations and Policies**

 

The federal regulatoryagencies have adopted regulations that implement Section 304 of FDICIA whichrequires federal banking agencies to adopt uniform regulations prescribingstandards for real estate lending. Each insured depository institution mustadopt and maintain a comprehensive written real estate lending policy,developed in conformance with prescribed guidelines, and each agency hasspecified loan-to-value limits in guidelines concerning various categories ofreal 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 regulationsdealing with equity investments, an insured state bank generally may notdirectly or indirectly acquire or retain any equity investment of a type, or inan amount, that is not permissible for a national bank. An insured state bankis not prohibited from, among other things, (i) acquiring or retaining amajority interest in a subsidiary, (ii) investing as a limited partner in apartnership the sole purpose of which is direct or indirect investment in theacquisition, rehabilitation or new construction of a qualified housing project,provided that such limited partnership investments may not exceed 2% of thebank’s total assets, (iii) acquiring up to 10% of the voting stock of a companythat solely provides or reinsures directors’, trustees’ and officers’ liabilityinsurance coverage or bankers’ blanket bond group insurance coverage forinsured 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 insured state-chartered bank directly or indirectlyengaged in any activity that is not permitted for a national bank must ceasethe impermissible activity.

 

**Financial Modernization Act**

** **

Effective March 11,2000, the Gramm-Leach-Bliley Act eliminated most barriers to affiliations amongbanks and securities firms, insurance companies, and other financial serviceproviders, and enabled full affiliations to occur between such entities. Thisnew legislation permits bank holding companies to become “financial holdingcompanies” and thereby acquire securities firms and insurance companies andengage in other activities that are financial in nature. A bank holding companymay become a financial holding company if each of its subsidiary banks is wellcapitalized under the prompt corrective action provisions discussed above, iswell managed, and has at least a satisfactory rating under the CommunityReinvestment Act by filing a declaration that the bank holding company wishesto become a financial holding company. No regulatory approval will be requiredfor a financial holding company to acquire a company, other than a bank orsavings association, engaged in activities that are financial in nature orincidental to activities that are financial in nature, as determined by theFederal Reserve Board. The Bank has no current intention of becoming afinancial holding company, but may do so at some point in the future if deemedappropriate in view of opportunities or circumstances at the time.

 

The Gramm-Leach-BlileyAct defines “financial in nature” to include securities underwriting, dealingand market making; sponsoring mutual funds and investment companies; insuranceunderwriting and agencies; merchant banking activities; and activities that theFederal Reserve Board has determined to be closely related to banking. Anational bank (and therefore, a state bank as well) may also engage, subject tolimitations on investment, in activities that are financial in nature, otherthan insurance underwriting, insurance company portfolio investment, real 

 

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estate development and real estate investment, througha financial subsidiary of the bank, if the bank is well capitalized, wellmanaged and has at least a satisfactory Community Reinvestment 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 financialholding company or a bank may not acquire a company that is engaged in activitiesthat are financial in nature unless each of the subsidiary banks of thefinancial holding company or the bank has a Community Reinvestment Act ratingof satisfactory or better.

 

The Gramm-Leach-BlileyAct also imposes significant new requirements on financial institutions withrespect to the privacy of customer information, and modifies other existinglaws, 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 theterrorist attacks in New York, Pennsylvania and Washington, D.C. onSeptember 11, 2001, the USA Patriot Act is intended to strengthen U.S. lawenforcement’s and the intelligence communities’ ability to work cohesively tocombat terrorism on a variety of fronts. The potential impact of the USAPatriot Act on financial institutions of all kinds is significant and wideranging. The USA Patriot Act contains sweeping anti-money laundering andfinancial transparency laws and requires various regulations applicable tofinancial 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 Bank implemented therequirements under the USA Patriot Act during 2001 and 2002. Compliance withsuch requirements has all been accomplished with existing staff, so thefinancial impact on the Bank has been negligible.

 

# **Regulatory Enforcement Powers**

#  

Commercial banking organizations,such as the Bank, may be subject to enforcement actions by the FDIC and theSuperintendent for engaging in unsafe or unsound practices in the conduct oftheir businesses or for violations of any law, rule, regulation or anycondition imposed in writing by the agency or any written agreement with theagency. Enforcement actions may include the imposition of a conservator orreceiver, the issuance of a cease-and-desist order that can be judiciallyenforced, the termination of insurance of deposits, the imposition of civilmoney penalties, the issuance of directives to increase capital, the issuanceof formal and informal agreements, the issuance of removal and prohibitionorders against institution-affiliated parties and the imposition of restrictionsand sanctions under the prompt corrective action provisions of the FDICIA.

 

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# **California and Federal Banking Law**

#  

The Federal Change inBank Control Act of 1978 prohibits a person or group of persons “acting inconcert” from acquiring “control” of a bank or holding company unless theappropriate federal regulatory agency has been given 60 days’ prior writtennotice of such proposed acquisition and, within that time period, has notissued a notice disapproving the proposed acquisition or extending for up toanother 30 days the period during which such a disapproval may be issued. Anacquisition may be made prior to the expiration of the disapproval period ifthe agency issues written notice of its intent not to disapprove the action. Theacquisition of more than 10% of a class of voting stock of a bank (or holdingcompany) with a class of securities registered under Section 12 of theSecurities Exchange Act of 1934, as amended (such as the Common stock), isgenerally presumed, subject to rebuttal. to constitute the acquisition ofcontrol.

 

Under the CaliforniaFinancial Code, no person shall, directly or indirectly, acquire control of aCalifornia licensed bank or a bank holding company unless the Superintendenthas approved such acquisition of control. A person would be deemed to haveacquired control of the Corporation under this state law if such person,directly or indirectly, has the power (i) to vote 25% or more of the votingpower of the Corporation or (ii) to direct or cause the direction of themanagement and policies of the Corporation. For purposes of this law, a personwho directly or indirectly owns or controls 10% or more of the Common stockwould 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 andsuch regulations provide that the appropriate regulatory authority will assessthe records of regulated financial institutions in satisfying their continuingand affirmative obligations to help meet the credit needs of their localcommunities as part of their regulatory examination of the institution. Theresults of such examinations are made public and are taken into account uponthe filing of any application to establish a domestic branch, to merge or toacquire the assets or assume the liabilities of a bank. In the case of a bankholding company, the CRA performance record of the subsidiary bank(s) involvedin the transaction is reviewed in connection with the filing of an applicationto acquire ownership or control of shares or assets of a bank or to merge withany other bank holding company. An unsatisfactory record can substantiallydelay or block the transaction.

 

**RESEARCH**

 

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

 

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**DEPENDENCE UPON A SINGLE CUSTOMER**

 

Neither the Corporationnor the Bank is dependent upon a single customer or very few customers. TheBank’s business is concentrated in, and largely dependent upon the strength ofthe local economy in, the Monterey Peninsula area of Northern California. Thelocal economy is affected by both national trends and by local factors. Tourismand the activities at the former Fort Ord military base are among the majorcontributors to the local economy.

 

**ITEM 2.PROPERTIES**

 

The main office of theBank, which also serves as the principal office of the Corporation, is locatedat 601 Munras Ave., Monterey, California 93940. This facility contains a lobby,executive and customer service offices, teller stations, safe deposit boxes andrelated non-vault area, vault, operations area, lounge and miscellaneous areas.A drive-through facility and adequate paved parking are also on the premises. Boththe land and all improvements thereto are owned by the Bank**.**TheBank currently operates three branch offices in Carmel-By-The-Sea, CarmelValley and Pacific Grove, California, all within approximately 10 miles fromthe Bank’s main office. The Bank also has a loan production office located inMonterey, California. The land and improvements dedicated to theCarmel-By-The-Sea, Carmel Valley and Pacific Grove branch offices. See Footnote12 to the Corporation’s financial statements included herewith. In March 2005the Bank purchased a building located at 556 Abrego St., Monterey, CA 93940. Thisfacility located within a city block of the Bank’s main office will be utilizedfor additional office space, when renovations are completed.

 

Generally, neither theBank nor the Corporation may invest in equity interests in real estate, exceptfor the direct use of the Bank or the Corporation in their business. The Bankmakes and/or purchases loans secured by real estate, subject to normal bankingpractices, 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 Corporation or its subsidiary is a party, or to which any of their properties is subject, other than ordinary litigation arising in the normal course of business activities. Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of management, any such liability will not have a material effect on the consolidated financial position of the Corporation and its subsidiary.

 

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

 

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

 

**PART II**

 

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

 

TheCorporation’s stock, which is held by approximately 530 persons, began tradingon the National Association ofSecurities Dealers Automated Quotations (NASDAQ) system in May 2005.

 

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Inaddition to the limited trading on the NASDAQ, stock symbol NRLB; theCorporation also has knowledge of a limited number of transactions conductedbetween individual shareholders.

 

TheCorporation repurchased 3,795 shares of common stock at $4.00 per share in2005; no shares were repurchased in 2006 or 2004.

 

Thefollowing table sets forth, according to information known to the Corporation,the price paid per share in, and volume of, transactions in the Corporation’sstock during the quarters ended March 31, 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)   For theperiod presented, the information indicated might not include information onshares which may have been traded directly by shareholders or through dealers.

 

Theprincipal source of cash flow of the Corporation, including cash flow to paydividends on its stock or principal and interest on debt, is interest anddividends on investments and tax benefit payments and dividends from the Bank. Thereare statutory and regulatory limitations on the payment of dividends by theBank to the Corporation, as well as by the Corporation to its shareholders.

 

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

 

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

 

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TheBank’s payment of dividends, as a California chartered commercial bankingcorporation, is regulated by the California Financial Code. Under theCalifornia Financial Code, funds available for cash dividend payments by theBank are restricted to the lessor of: (i) retained earnings; or (ii) the Bank’snet income for its last three fiscal years (less any distributions to thestockholders made during such period). As of December 31, 2006 the Bank had$10,913,400 in retained earnings. The Bank’s net income for the last threefiscal years less distributions to stockholders was $7,312,900.

 

InDecember 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 FINANCIAL CONDITION AND RESULTSOF OPERATION**

 

**Statements Regarding Forward-Looking Information**

 

Exceptfor historical information contained herein, the matters discussed orincorporated by reference in this report contain forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933, as amended (the “SecuritiesAct”), and Section 21E of the Securities Exchange Act of 1934 (the “ExchangeAct”), that involve substantial risks and uncertainties.  When used inthis report, or in the documents incorporated by reference herein, the words “anticipate,”“believe,” “estimate,” “may,” “intend,” “expect,” and similar expressionsidentify certain of such forward-looking statements.  Actual results ofMonterey County Bank could differ materially from such forward-lookingstatements contained herein.  Factors that could cause future results tovary from current expectations include, but are not limited to, the following:changes in economic conditions (both generally and more specifically in themarkets in which the Bank operates); changes in interest rates, deposit flows,loan demand, real estate values and competition; changes in accountingprinciples, policies or guidelines and in government legislation and regulation(which change from time to time and over which the Bank has no control); otherfactors affecting the Bank’s operations, markets, products and services; andother risks detailed in this Form 10-KSB and in the Bank’s other reports filedwith the Comptroller of the Currency pursuant to the rules and regulations ofthe Securities and Exchange Commission.  Readers are cautioned not toplace undue reliance on these forward-looking statements, which reflectmanagement’s analysis only as of the date hereof.  The Bank undertakes noobligation to publicly revise these forward-looking statements to reflectevents or circumstances that arise after the date thereof.

 

**OVERVIEW**

 

Thefollowing discussion reviews and analyzes the operating results and financialcondition of the Corporation, focusing on the Bank. It should be read inconjunction with the financial statements and the other financial datapresented elsewhere herein.

 

Netincome for each of the last three years was $3,837,200 in 2006, $1,929,300 in2005, and $1,065,200 in 2004. The primary net income per share for each of thelast three years was $2.31, $1.20, and $.68 respectively. The diluted netincome per share for the same time periods was $2.09, $1.00 and $.56,respectively. Return on average shareholders’ equity was 34.94%, 24.15% and 

 

22

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15.35%in 2006, 2005 and 2004, respectively. Return on average assets was 2.24%,1.24%, and 0.88% in 2006, 2005 and 2004, respectively.

 

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

 

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

 

Theincrease in earnings in 2004 was due to increases of $1,240,700 in net interestincome after provision for loan losses; partially offset by a decrease of$181,500 in non-interest income and increases of $711,700 in non-interestexpense and $122,100 in income tax expense.

 

23

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Thefollowing table provides a summary of the income statement, balance sheet, andselected ratios for the last five years. A more detailed analysis of eachcomponent of net income is included under the appropriate captions, whichfollows.

 
| ** **                                         | ** ** | **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 | % |

 

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(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 numberof shares used for this computation was 1,658,675 for 2006, 1,614,196 for 2005,1,576,589 for 2004, 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. Common stock equivalents include employee stockoptions. The weighted average number of shares used for this computation was1,831,982, 1,923,532, 1,919,512, 1,796,859 and 1,744,082 in 2006, 2005, 2004,2003 and 2002, respectively.

 

(3)   Weighted average common shares.

 

(4)   Includes loans being held forsale.

 

(5)   Averages are of daily balances.

 

**CriticalAccounting Policies**

 

Thepreparation of financial statements in accordance with accounting principlesgenerally accepted in the United States of America requires management to makea number of judgments, estimates and assumptions that affect the reportedamount of assets, liabilities, income and expenses in the Bank’s financialstatements and accompanying notes.  Management believes that thejudgments, estimates and assumptions used in preparation of the Bank’s financialstatements are appropriate given the factual circumstances as of December 31,2006.

 

25

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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 cannot reasonablybe predicted at this time.   For further information regarding theallowance for loan losses see “Provision and Allowance for Loan Losses,” andNote 6 to the Bank’s audited financial statements included elsewhere herein.

 

**RecentlyIssued Accounting Standards**

 

Referto Note 1 to the Financial Statements – “Summary of Significant AccountingPolicies” for discussion of the recently issued accounting standards.

 

**NET INTEREST INCOME**

 

Net interest income, thedifference between (a) interest and fees earned on interest-earning assets and(b) interest paid on interest-bearing liabilities, is the most significantcomponent of the Bank’s earnings. Changes in net interest income from period toperiod result from increases or decreases in the average balances of interestearning assets portfolio, the availability of particular sources of funds andchanges in prevailing interest rates.

 

The following tablesummarizes the Corporation’s net interest income.

 
| ** **           | ** ** | ** **                           | ** ** | **Increase (Decrease)**  | ** ** |
|----------------------|------------|--------------------------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **Years Ended**                 | ** ** | **From Prior Year** | ** ** |
| ** **           | ** ** | **December 31,**                | ** ** | **2006/2005**                 | ** ** | **2005/2004** | ** ** |
| ** **           | ** ** | **2006**                             | ** ** | **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 bearingassets increased 10.61%, while the average rate earned increased 115 basispoints, resulting in an increase of $3,069,200 in total interest income. Interestexpense increased $1,525,400 the result of a 6.56% increase in average interestbearing liabilities, while the average rate paid increased 100 basis points.

 

26

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Net interest incomeincreased $2,099,500 or 42.68% from 2004 to 2005. Average interest bearingassets increased 28.21%, while the average rate earned increased 72 basispoints, resulting in an increase of $3,335,900 in total interest income. Interestexpense increased $1,236,400 the result of a 29.72% increase in averageinterest bearing liabilities, while the average rate paid increased 43 basispoints.

 

The following table showsthe components of net interest income, setting forth, for each of the threeyears ended December 31, 2006, 2005 and 2004 (i) average assets, liabilitiesand investments, (ii) interest income earned on interest-earning assets andinterest expense paid on interest-bearing liabilities, (iii) average yieldsearned on interest-earning assets and average rates paid on interest-bearingliabilities, (iv) the net interest spread (i.e., the average yield earned oninterest-earning assets less the average rate paid on interest-bearingliabilities) and (v) the net interest yield on average interest-earning assets(i.e., net interest income divided by average interest-earning assets). Yieldsare computed on a tax-equivalent basis, resulting in adjustments to interestearned on non-taxable securities of $148,700, $137,900 and $70,200 in 2006,2005 and 2004, respectively. Non-accrual loans and overdrafts are included inaverage loan balances. Average loans are presented net of unearned income.

 

27

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**INTEREST SPREAD ANALYSIS:**

 
| ** **                                                  | ** ** | **As of and for the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                  | ** ** | **Avg   Bal**                                                                          | ** ** | **Int  Earn  Paid** | ** ** | **Avg  %  Rate** | ** ** | **Avg  Bal** | ** ** | **Int  Earn  Paid** | ** ** | **Avg  %  Rate** | ** ** | **Avg  Bal** | ** ** | **Int  Earn  Paid** | ** ** | **Avg  %  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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| ** **                                | ** ** | **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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**Provision and Allowance for LoanLosses**

 

The provision for loanlosses is an expense charged against operating income and added to theallowance for loan losses. The allowance for loan losses represents amountswhich have been set aside for the specific purpose of absorbing losses whichmay occur in the Bank’s loan portfolio.

 

The allowance for loanlosses reflects management’s ongoing evaluation of the risks inherent in theloan portfolio both generally and with respect to specific loans, the state ofthe economy, and the level of net loan losses experienced in the past. Managementand the Board of Directors review the results of the State Banking Departmentand FDIC examinations, independent accountants’ observations, and the Bank’sinternal review as additional indicators to determine if the amount in theallowance for loan losses is adequate to protect against estimated futurelosses. It is the Bank’s current practice, which could change in accordancewith the factors mentioned above, to maintain an allowance which is at leastequal to the sum of the following percentage of loan balances 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 Estate -  Loan to value 80% or less      |       | 0.10               | %          |
| Real Estate -  Loan to value over 80%         |       | 0.70               | %          |
| Real Estate -  Construction                   |       | 0.25               | %          |
| Loans to  Individuals                         |       | 3.00               | %          |
| Commercial                                    |       | 2.00               | %          |
| SBA Loans –  Unguaranteed portion        |       | 2.00               | %          |
| Unfunded Loan  Commitments                    |       | .10                | %          |
| Concentration  Risk Factor – Real Estate |       | .10                | %          |
| Economic Risk  Factor                         |       | .20                | %          |
| SBA Loans -  Guaranteed portion               |       | 0.00               | %          |
| Cash Secured  Loans                           |       | 0.00               | %          |

 

Although no assurance canbe given that actual losses will not exceed the amount provided for in theallowance, Management believes that the allowance is adequate to provide forall estimated credit losses in light of all known relevant factors. At the endof 2006, 2005 and 2004, the Bank’s allowance stood at 1.07%, 1.02%, and 1.00%of gross loans, respectively. Provisions were made to the allowance for loanlosses 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’s non-performing(delinquent 90 days or more and on non-accrual) loans as a percentage of totalloans were 0.12 percent 0.00 percent and 0.04 percent as of the end of 2006,2005 and 2004, respectively.

 

Based upon statisticsreleased by Federal and state banking authorities regarding banks of similarsize or otherwise located in California, Management believes that the Bank’sratios of delinquent and non performing loans to total loans are far betterthan average. Prudent collection efforts, and tighter lending controls, areresponsible for the Bank’s strong performance on these measures of creditquality. However, no assurance can be given that the Bank’s loan portfolio willcontinue to measure well against its peers on these ratios and quality measures,or that losses will not otherwise occur in the future.

 

**Non-Interest Income**

 

The following tablepresents 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 |   |

 

Total non-interest incomeincreased $2,815,200 or 64.84% in 2006 when compared with 2005. The increaseresulted from the gain on sale of the Bank’s investment in Pacific CoastBankers’ Bank of $1,313,400, an increase in income from other service charges,commissions and fees of $1,819,900, and decreases of $301,700 in income fromsales and servicing of Small Business Administration Loans and $16,400 inservice charges on deposit accounts. The increase in other service charges,commissions and fees was due primarily to a $50,000 mark to market gain ontrading assets compared with a $427,300 mark to market loss in 2005, andincreases of $1,099,800 in fee income from credit card programs, $271,700 inmerchant discount fees and $29,800 from stored value card programs, whilecommercial banking origination fees decreased $287,200.

 

Total non-interest incomeincreased $135,200 or 3.20% in 2005 when compared with 2004. Income from salesand servicing of SBA loans increased $275,000 and service charges on depositaccounts increased $47,300; while other income decreased $187,100. The decreasein other income was due primarily to a mark to market loss of $427,300 intrading asset activities; partially offset by increases of $102,100 in creditcard program fees and $138,100 in commercial banking origination fees.

 

Total non-interest incomedecreased $181,500 or 3.03% in 2004 when compared with 2003. Income from salesand servicing of SBA loans increased $55,800 and service charges on depositaccounts increased $10,800; while other income decreased $248,100. The decreasein other income was due primarily to decreases of $265,400 in commercialbanking origination fees.

 

31

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The sale of SmallBusiness Administration (SBA) guaranteed loans is a significant contributor tothe Bank’s income. SBA guaranteed loans yield up to 3 3/4% over the New Yorkprime rate, and the guaranteed portions can be sold at premiums which vary withmarket conditions. SBA loans are guaranteed by the full faith of the UnitedStates Government up to 85 percent of the principal amount. The guaranteedportion has risks comparable for an investor to a U. S. Government security andcan usually be sold in the secondary financial market, either at a premium orat a yield which allows the Bank 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 Business Administration has recently increased theguarantee fees borrowers must pay. Increasing competition among lenders forqualified SBA borrowers makes it difficult for the Bank to continually expandits program in this area, and may limit the level of premium that can be earnedwith regard thereto.

 

The following tablepresents a summary of the activity in SBA loans for the years ended 2006, 2005and 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 Incomefrom 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-Interest Expense**

 

The following tablepresents 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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Salaryand benefits expense increased $572,000 in 2006 as a result the addition of aMarketing Officer, Business Development Officer and a Credit Analyst, increasedcommission paid due to increased credit card and stored value card programrevenues, and merit increases and bonus payments. Salary and benefits expenseincreased $278,200 in 2005 as a result merit increases and bonus payments. Salaryand benefits expense increased $437,600 in 2004 as a result of the first fullyear of salary expense related to the hiring of an Executive VicePresident/Chief Lending Officer during the fourth quarter of 2003, meritincreases and bonus payments.

 

Occupancyand equipment expenses increased $125,700 in 2006, due to increases of netmerchant terminal expense $41,900, $16,000 in depreciation expense, $11,100 inpremises rent and $6,000 in property taxes; while sublease rental incomedecreased $45,100. Occupancy and equipment expenses increased $67,800 in 2005,due to increases of $48,300 in depreciation expense, $18,000 in property taxes,$11,100 in premises rent, $10,000 in premises other expense and $8,800 injanitorial expense; while net merchant terminal decreased $30,800. Occupancy andequipment expenses increased $86,000 in 2004, due to increases of $19,800 indepreciation expense, $22,700 in merchant terminal expense, $14,100 in repairsand maintenance expense, $7,800 in janitorial expense and $4,700 in premisesrent.

 

Dataprocessing expense decreased $33,400 in 2006, the result of continued effortsto implement more cost effective programs. Data processing expense decreased$8,100 in 2005, the result of renegotiation of the data services contractduring the fourth quarter of 2004. Data processing expense increased $6,800 in2004.

 

In2005, professional fees increased $8,700 due to increased legal fees. In 2005,professional fees increased $27,000 due to accounting/audit fees increasing$21,600 while legal fees increased $5,400. In 2004, professional fees increased$24,400 due to accounting/audit fees increasing $19,500 while legal feesincreased $4,900.

 

Otherexpenses for 2006 totaled $3,511,200 compared with $3,369,900 for 2005, anincrease of $141,300. Significant changes occurred in the following categorieswith increases in merchant processing expense of $104,400, advertising of$82,900, operational losses 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 expenseof $9,600; while decreases occurred in provision for debt securities losses of$229,400, provision for loss unfunded loan commitments of $71,000, directorfees of $13,300, and meals of $10,400.

 

Otherexpenses for 2005 totaled $3,369,900 compared with $3,038,000 for 2004, anincrease of $331,900. Significant changes occurred in the following categorieswith the recording of the provision for debt securities losses of $119,500 andprovision for loss unfunded loan commitments of $52,000; increases in directorfees of $53,400, donations of $49,900, merchant processing expense of $44,500telephone expense 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 loanexpense of $41,300, operational losses of $30,600, collection expense of$21,300, postage expense of $9,100 and business development of $9,000.

 

33

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**Income Taxes**

 

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. Thisrepresents 42.76% of income before taxes in 2006, 43.57% in 2005, and 42.30% in2004. The increase in the tax provision from 2005 to 2006 was due to a $591,000provision related to the gain on sale of the Bank’s investment in Pacific CoastBankers’ Bank and increased income. The increase in the tax provision from 2005to 2006 was due to an increase in volume of taxable income.

 

Theamount of the tax provision is determined by applying the Bank’s statutoryincome tax rates to pre-tax book income, adjusted for permanent differencesbetween pre-tax book income and actual taxable income. Such permanentdifferences include but are not limited to tax-exempt interest income, increasesin the cash surrender value of life insurance, and certain other expenses thatare not allowed as tax deductions.

 

**LOANS**

 

Loans,the largest component of earning assets, represented 76.28% of average earningassets, and 69.46% of average total assets during 2006, compared with 77.46%and 70.53%, respectively during 2005. In 2006, average loans increased 8.94%from $108,962,800 in 2005 to $118,699,100. Average real estate loans increased$10,892,600 or 15.72%, average construction loans increased $2,062,900 or20.73% while average commercial loans decreased $3,210,100 or 11.12%, andaverage installment loans decreased $9,100 or 1.06%.

 

Loanpolicies and procedures provide the overall direction to the administration ofthe loan portfolio. The Bank’s loan underwriting process is intended toencourage sound and consistent credit decisions are made. Emphasis is placedupon credit quality, the borrower’s ability to repay through cash flow,secondary and (occasionally tertiary) repayment sources, and the value ofcollateral.

 

TheBank’s commercial and industrial loans are generally made for the purpose ofproviding working capital, financing the purchase of equipment or inventory,and other business purposes. Such loans generally have maturities ranging fromone year to several years. Short-term business loans are generally intended tofinance current transactions and typically provide for monthly interestpayments with principal being payable at maturity or at 90-day intervals. Termloans (usually for a term of two to five years) normally provide for monthlyinstallments of principal and interest. The Bank from time to time utilizesaccounts 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 areguaranteed by the SBA for up to 85 percent of their principal amount, which canbe retained in portfolio or sold to investors. Such loans are made at floatinginterest rates, but generally for longer terms (up to 25 years) than areavailable on a conventional basis to small businesses.  The unguaranteedportion of the loans, although generally supported by collateral, is consideredto be more risky than conventional commercial loans because they may be basedupon credit standards the Bank would not otherwise apply, such as lower cashflow coverage, or longer repayment terms.

 

The Bank’s real estateloan portfolio consists both of real estate construction loans and real estatemortgage loans. The Bank has initiated a program to generate more commercialand industrial real estate loans, which generally yield higher returns thannormal commercial loans. The Bank has also developed a broker program forgenerating residential real estate loans. The Bank does not make real estatedevelopment loans.  Real estate construction loans are made for a muchshorter term, and often at higher interest rates, than conventionalsingle-family residential real estate loans. The cost of administering suchloans is often higher than for other real estate loans, as principal is drawnon periodically as construction progresses.

 

34

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The Bank also makes realestate loans secured by a first deed of trust on single family residentialproperties and commercial and industrial real estate. California commercialbanks are permitted, depending on the type and maturity of the loan, to lend upto 90 percent of the fair market value of real property (or more if the loan isinsured either by private mortgage insurers or governmental agencies). Incertain instances, the appraised value may exceed the actual amount which couldbe realized on foreclosure, or declines in market value subsequent to makingthe loan can impair the Bank’s security.

 

Consumer loans are madefor the purpose of financing the purchase of various types of consumer goods,home improvement loans, auto loans and other personal loans. Consumerinstallment loans generally provide for monthly payments of principal and interest,at a fixed rate. Most of the Bank’s consumer installment loans are generallysecured by the personal property being purchased. The Bank generally makesconsumer loans to those customers with a prior banking relationship with theBank.

 

The following tablepresents the composition of the loan portfolio, including loans held for sale,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 following table showsthe maturity distribution and repricing intervals of the Bank’s outstandingloans at December 31, 2006. Balances of fixed rate loans are displayed in thecolumn representative of the loan’s stated maturity date. Balances for variablerate loans are displayed in the column representative of the loan’s nextinterest rate change.

 
| ** **                                       | ** ** | **Loan Maturities and Repricing Schedule** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **($ in thousands)**                                 | ** ** |
| ** **                                       | ** ** | **Within One  Year**                                      | ** ** | **After One  But Within  Five Years** | ** ** | **After Five  Years** | ** ** | **Total** | ** ** |
| 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-performing and Non-accrualLoans**

 

The Bank’s present policyis to cease accruing interest on loans which are past due as to principal orinterest 90 days or more, except for loans which are well secured or whencollection of interest and principal is deemed likely. When a loan is placed onnon-accrual, previously accrued and unpaid interest is generally reversed outof income unless adequate collateral from which to collect the principal of andinterest on, the loan appears to be available.

 

35

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

 
| ** **                                                                  | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                  | ** ** | **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 ofnon-performing loans is the result of underwriting criteria intended to beconservative, frequent review of new and delinquent loans and a firm collectionpolicy (with the assistance of outside legal counsel). The Bank does not haveany foreign loans or loans for highly leveraged transactions.

 

36

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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 | % |

 

37

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Funding Sources

 

Average depositsincreased 8.30% to $119,887,300 in 2006 from $110,699,800 in 2005. In 2006average demand deposits increased 26.00% and average certificates of depositincreased 5.91% while average interest checking, money market and savingsaccounts as a group decreased 2.78%. Average certificates of depositrepresented 54.54% of average deposits in 2006 compared with 55.91% in 2005. Averageinterest checking, money market and savings accounts as a group were 20.13% ofaverage deposits in 2006 compared with 22.47% in 2005. Average demand depositsrepresented 25.09% of average deposits in 2006 compared with 21.62% in 2005.

 

The following tablesummarizes the distribution of average daily deposits and the average dailyrates paid for the years ended December 31, 2006, 2005, 2004, respectively.

 
| ** **                                                      | ** ** | **For the year ended  December 31, 2006** | ** ** | **Average deposits  For the year ended  December 31, 2005** | ** ** | **For the year ended  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 | % |

 

Thefollowing table sets forth the scheduled maturities of the Company’s timedeposits in denominations of $100,000 or greater which amounted to $35,825,800at December 31, 2006:

 

Maturities of Time Depositsof $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 ofcredit 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 (based onpledged collateral), $4,500,000, $6,000,000 and $5,000,000, respectively. TheFederal Home Loan Bank line of credit has a 

 

38

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maximum borrowing capacity of twenty fivepercent (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 balanceof pledged loans was $33,463,500 and securities of $15,364,900. The followingtable provides information on thirteen FHLB advances totaling $34,750,000 andoutstanding at December 31, 2006.

 
| **Advance  Amount** | ** ** | **Fixed Interest  Rate** | ** ** | **Funding  Date** | ** ** | **Maturity  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 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 $330,000letter of credit issued by the Federal Home Loan Bank of San Francisco tosecure the uninsured portion of local agency deposits maintained with the Bank.The letter of credit matures April 17, 2011.

 

**Capital Resources**

 

The Corporation maintainscapital to comply with legal requirements, to provide a margin of safety forits depositors and stockholders, and to provide for future growth and theability to pay dividends. 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 cash dividends totaling $625,000 to the Corporationin 2006, no cash dividends were paid in 2005 and 2004.

 

The FDIC and FederalReserve Board have adopted capital adequacy guidelines for use in theirexamination and regulation of banks and bank holding companies. If the capitalof a bank or bank holding company falls below the minimum levels established bythese guidelines, it may be denied approval to acquire or establish additionalbanks or non-bank businesses, or the FDIC or Federal Reserve Board may takeother administrative actions. The guidelines employ two measures of capital:  (1) risk-based capital and (2) leveragecapital.

 

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, 

 

39

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depending upon theperceived degree of credit risk associated with each asset. Each asset isassigned to one of four risk-weighted categories. For example, 0 percent forcash and unconditionally guaranteed government securities; 20 percent fordeposits with other banks and fed funds; 50 percent for state bonds and certainresidential real estate loans; and 100 percent for commercial loans and otherassets. 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 define and set minimum capital requirements(risk-based capital ratios), which increased over a transition period, endedDecember 31, 1992. Under the final 1992 rules, all banks were required tomaintain Tier 1 capital of at least 4 percent and total capital of 8.0% ofrisk-adjusted assets. The Bank had a Tier 1 capital ratio of 12.40% and 12.07%at December 31, 2006 and 2005, respectively. The Bank’s Tier 1 capital exceedsthe minimum regulatory requirement by $12,291,000. The Bank had a TotalRisk-Based capital ratio of 13.40% and 12.48% at December 31, 2006 and 2005,respectively. The Bank’s Total Risk-Based capital exceeds the minimumregulatory requirement by $7,907,000.

 

The Tier 1 leveragecapital ratio guidelines require a minimum leverage capital ratio of 3% of Tier1 capital to total assets less goodwill. The Bank had a leverage capital ratioof 10.20% and 9.60% at December 31, 2006 and 2005, respectively. The Bank’sTier 1 leverage capital exceeds the minimum regulatory requirement by$10,980,000.

 

The significant increasein each of the Bank’s risk-based capital ratios from December 31, 2002 toDecember 31, 2003 was the result of $4,000,000 in capital contributions fromthe Corporation. The Corporation utilized a portion of the proceeds from twotrust preferred security issuances to make the capital contributions.

 

As of the end of 2006, theBank was considered to be “well capitalized” by regulatory standards. We do notforesee any circumstances that would cause either the Corporation or the Bankto be less than “well capitalized”, although no assurance can be given thatthis will not occur.

 

OnMarch 27, 2003, the Company’s wholly owned special-purpose trust subsidiary,Northern California Bancorp, Inc. Trust I (“Trust I”) issued $3 million incumulative Trust Preferred Securities.The securities bear a floating rate of interest of 3.25% over the three monthLIBOR rate, payable quarterly. The effective rate at December 31, 2006 was8.62%. 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 SubordinatedDebentures are the sole assets of Trust I and are eliminated, along withthe related income statement effects, in the consolidated financial statements.The Company will pay interest on the Junior Subordinated Debentures to Trust I,which represents the sole revenue and sole source of dividend distributions tothe holders of the Trust Preferred Securities. The Company has the right,assuming no default has occurred, to defer payments of interest on the JuniorSubordinated Debentures at any time for a period not to exceed 20 consecutivequarters. The Trust Preferred Securities will mature on April 7, 2033, but canbe redeemed under certain 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 orOctober 7 on or after April 7, 2008 at par. The Company fully andunconditionally guarantees the obligations Trust I, on a subordinated basis.

 

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.

 

40

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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 afloating rate of interest of 2.85% over the three month LIBOR rate, payablequarterly. The effective rate atDecember 31, 2006 was 8.22%. Concurrentwith the issuance of the Trust Preferred Securities, Trust II used the proceedsfrom the Trust Preferred Securities offering to purchase a like amount ofJunior Subordinated Debentures of the Company. The Subordinated Debentures arethe sole assets of Trust II and are eliminated, along with the related incomestatement effects, in the consolidated financial statements. The Company willpay interest on the Junior Subordinated Debentures to Trust II, whichrepresents the sole revenue and sole source of dividend distributions to theholders of the Trust Preferred Securities. The Company has the right, assumingno default has occurred, to defer payments of interest on the JuniorSubordinated Debentures at any time for a period not to exceed 20 consecutivequarters. The Trust Preferred Securities will mature on August 8, 2033, but canbe redeemed under certain circumstances at a premium prior to August 8, 2008,and can be redeemed, in whole or in part, on any February 8, May 8, August 8 orNovember 8 on or after August 8, 2008 at par. The Company fully andunconditionally guarantees the obligations of Trust II, on a subordinatedbasis.

 

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**

 

Liquidity represents abank’s ability to provide sufficient cash flows or cash resources in a mannerthat enables it to meet obligations in a timely fashion and adequately providesfor 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 the Bank’s business, funds are generatedfrom the repayment of loans, maturities within the investment securitiesportfolio and the acquisition of deposit balances 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 theBank has unsecured federal funds lines of credit with Bank of the West $4,500,000, Pacific CoastBankers’ Bank $6,000,000 and The Independent Bank $5,000,000 to meettemporary liquidity requirements. Availableborrowing capacities on December 31, 2006 were $1,065,800, $4,500,000,$6,000,000 and $5,000,000, respectively.

 

As a matter of policy,the Bank seeks to maintain a level of liquid assets, including marketableinvestment securities, equal to a least 15 percent of total assets (“primaryliquidity”), while maintaining sources of secondary liquidity (borrowing linesfrom other institutions) equal to at least an additional 10 percent of assets. Inaddition, it seeks to generally limit loans to not more 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 totalliquidity at December 31, 2006, 2005 and 2004 was 24.31%, 27.09%, and 22.70%,respectively, while its average loan to deposit ratio for such years was99.76%, 90.84% and 97.71%, respectively.

 

41

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Brokered deposits aredeposit instruments, such as certificates of deposit, deposit notes, bank investmentcontracts and certain municipal investment contracts that are issued throughbrokers and dealers who then offer and/or sell these deposit instruments to oneor more investors. Additionally, deposits on which a financial institution paysan interest rate significantly higher than prevailing rates are considered tobe brokered deposits. Federal law and regulation restricts banks fromsoliciting or accepting brokered deposits, unless the bank is well capitalizedunder 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 ofthe Bank’s brokered deposits paid an interest rate significantly higher thanprevailing rates.

 

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 Bankinstituted formal asset/liability policies 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 expectsto generate earnings from increasing loan volume, appropriate loan pricing andexpense control and not from trying to accurately forecast interest rates. Anotherimportant function of asset/liability management is managing the risk/returnrelationships between interest rate risk, liquidity, market risk and capitaladequacy. The Bank gives priority to liquidity concerns followed by capitaladequacy, then interest rate risk and market risk in the investment portfolio. Thepolicy of the Bank will be to control the exposure of the Bank’s earnings tochanging interest rates by generally maintaining a position within a narrowrange around an “earnings neutral position.” An earnings neutral position isdefined as the mix of assets and liabilities that generate a net interestmargin that is not affected by interest rate changes. However, Management doesnot believe that the Bank can maintain a totally earnings neutral position. Further,the actual timing of repricing of assets and liabilities does not alwayscorrespond to the timing assumed by the Bank for analytical purposes. Therefore,changes in market rates of interest will generally impact on the Bank’s netinterest income and net interest margin for long or short periods of time.

 

The Bank monitors itsinterest rate risk on a quarterly basis through the use of a model whichcalculates the effect on earnings of changes in the fed funds rate. The modelconverts a fed funds rate change into rate changes for each major class ofasset and liability, then simulates the bank’s net interest margin based on thebank’s actual repricing over a one year period, assuming that maturities arereinvested in instruments identical to 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.

 

42

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

 

**Investment Securities**

 

TheCorporation maintains a trading account, at fair value, consisting ofmarketable securities. At December 31, 2006 and 2005 the account value was$1,762,300 and $1,027,500, respectively. The Corporation has investments of$20,100 in AT Service LLC, which provides title insurance services forcommercial, industrial and residential properties, as well as other real estaterelated financial and informational services, including escrow, real estateinformation, trustee sale guarantees and real estate tax exchanges, and $10,000in Metrocities Mortgage, LLC. In addition the Corporation has investments inNorthern California Bancorp Trust I ($93,000) and Northern California BancorpTrust II ($155,000), these are special-purpose trust subsidiaries which wereformed to facilitate the issuance of trust preferred securities.

 

43

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The following table setsforth the book and market value of the Bank’s investment securities as ofDecember 31, 2006 and 2005:

 
| ** **                                     | ** ** | **INVESTMENT PORTFOLIO MIX** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|
| ** **                                     | ** ** | **(Dollars in thousands)**   | ** ** |
| ** **                                     | ** ** | **2006**                     | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **Book  value**              | ** ** | **Market  value** | ** ** | **Book  value** | ** ** | **Market  value** | ** ** |
| 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 following tablessummarize the maturity of the Bank’s investment securities at December 31,2006:

 
| ** **                         | ** ** | **INVESTMENT PORTFOLIO MATURITIES** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **(Dollars in thousands)**          | ** ** |
| ** **                         | ** ** | **Available for Sale**    | ** ** |
| ** **                         | ** ** | **Amortized**                       | ** ** | **Fair** | ** ** |
| ** **                         | ** ** | **Cost**                            | ** ** | **Value** | ** ** |
| 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 |   |

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

 

44

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**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 AND FINANCIAL DISCLOSURE**

 

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

 

**ITEM 8A.CONTROLS AND PROCEDURES**

 

(a)           **Evaluation of Disclosure Controls 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 of December 31, 2006 have concluded that 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.

 

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, 

 

45

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summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

(b)           **Changes in Internal Controls**

 

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 corrective actions were taken.

 

**ITEM 8B.OTHER INFORMATION**

 

Not Applicable

 

46

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**PART III**

 

**ITEM 9.DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITHSECTION 16(a) OF THE EXCHANGE ACT**

 

**Code of Ethics**

 

TheBank has adopted a code of ethics applicable to all of its officers, directorsand employees, including its principal executive officer, principal financialofficer, principal accounting officer and persons performing similar functions.

 

The name, age, title andfive-year business background of each director, executive officers andsignificant employees of the Corporation (including the Bank) as of December31, 2006, are as follows:

 
| **Name & Position with Bank** | ** ** | **Age** | ** ** | **Principal Occupation During Past Five Years**                                                                                                          |
|-------------------------------------------------------|------------|---------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                  |       |    |       |                                                                                                                                                                              |
| Charles T. Chrietzberg,  Jr.                          |       | 65      |       | Chairman of the Board  & Chief Executive Officer                                                                                                                              |
| Director  since 1985,                                 |       |    |       | Monterey County Bank  since 3/87                                                                                                                                                  |
| Chairman  of the Board &                          |       |    |       |                                                                                                                                                                              |
| Chief  Executive Officer                              |       |    |       |                                                                                                                                                                              |
|                                                  |       |    |       |                                                                                                                                                                              |
| Sandra G. Chrietzberg                                 |       | 63      |       | Formerly President and  CEO Queen of Chardonnay, Inc.,                                                                                                                            |
| Director, 1988  to 1994 and since 1995                |       |    |       | dba La Reina Winery  8/84-12/93                                                                                                                                                   |
|                                                  |       |    |       |                                                                                                                                                                              |
| Peter J. Coniglio, Esq.                               |       | 77      |       | Partner - Hudson,  Martin, Ferrante & Street, Monterey, CA                                                                                                                    |
| Director  since 1976                                  |       |    |       |                                                                                                                                                                              |
|                                                  |       |    |       |                                                                                                                                                                              |
| Carla S. Hudson, CPA                                  |       | 53      |       | Partner – Bianchi,  Lorinez, Huey, Hudson and Company, LLP                                                                                                                   |
| Director  since 1994                                  |       |    |       |                                                                                                                                                                              |
|                                                  |       |    |       |                                                                                                                                                                              |
| 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                                        |       | 59      |       | Owner Fashion Streaks  Screenprinting, Embroidery, Signs and                                                                                                                      |
| Director  since 2006                                  |       |    |       | Banners, Sand City, CA                                                                                                                                                            |
|                                                  |       |    |       | Owner, Sandy Creek  Olive Ranch, Carmel Valley, CA                                                                                                                                |
|                                                  |       |    |       |                                                                                                                                                                              |
| David A. Bernahl                                      |       | 28      |       | Chief Executive Officer  & President, Pacific Tweed, Inc.                                                                                                                     |
| Director  since 2006                                  |       |    |       | Carmel, CA                                                                                                                                                                        |
|                                                  |       |    |       |                                                                                                                                                                              |
| Timothy M. Leveque                                    |       | 63      |       | Executive Vice  President, Chief Lending Officer of Monterey                                                                                                                      |
| Executive  Vice President                             |       |    |       | County Bank since  11/03, Senior Executive Vice President,                                                                                                                        |
| Chief  Lending Officer                                |       |    |       | Chief Lending Officer,  Pacific Coast Bankers’ Bank 1997-2003                                                                                                                |

 

47

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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 theCorporation serve in similar capacities with the Bank. The Chairman of theBoard, Chief Executive Officer and Executive Vice President, Chief FinancialOfficer of the Corporation serve in similar capacities with the Bank, althoughthe limited operations of the Corporation do not require significant amounts oftheir time. There is no family relationships among the persons listed above,except that Mr. and Mrs. Chrietzberg are spouses.

 

Based solely upon areview of the relevant forms furnished to the Bank and the Corporation, exceptas disclosed below, the Corporation believes that all officers, directors andprincipal shareholders filed appropriate forms as required by Section 16(a) ofthe Exchange Act, and related regulations, during 2006. The following latereports on Form 3 were filed; Messrs. Bernahl and Briant, one report.

 

48

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**ITEM 10.EXECUTIVE COMPENSATION**

 

The following table sets forth certaininformation regarding the compensation paid to the Chief Executive Officer,Executive Officers and the next two highest compensated officer of theCorporation/Bank whose total compensation exceeded $100,000 for 2006.

 
| **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.                     |       | 2006     |       | 307,730         |       | 300,000        |       | None                   |       | None                                                   |       | None                                                     |       | 56,054                                | (1)        | 663,784        |       |
| Chairman,  President & CEO                   |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
|                                             |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Timothy M.  Leveque                              |       | 2006     |       | 173,287         |       | 75,000         |       | None                   |       | None                                                   |       | None                                                     |       | 27,577                                | (2)        | 275,864        |       |
| Executive Vice  President,                       |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Chief Lending  Officer                           |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
|                                             |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Bruce N. Warner                                  |       | 2006     |       | 152,515         |       | 75,000         |       | None                   |       | None                                                   |       | None                                                     |       | 13,831                                | (3)        | 241,346        |       |
| Executive Vice  President,                       |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Chief Financial  Officer                         |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Chief Operating  Officer                         |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
|                                             |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Andre G. Herrera                                 |       | 2006     |       | 218,970         |       | None           |       | None                   |       | None                                                   |       | None                                                     |       | 13,518                                | (4)        | 232,488        |       |
| Senior Vice  President,                          |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Chief  Information Officer                       |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Manager BankCard  Services                       |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
|                                             |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Patricia D.  Weber                               |       | 2006     |       | 98,058          |       | 30,000         |       | None                   |       | None                                                   |       | None                                                     |       | 7,796                                 | (5)        | 135,854        |       |
| Senior Vice President,                           |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |
| Senior  Operations Manager                       |       |     |       |            |       |           |       |                   |       |                                                   |       |                                                     |       |                                  |       |           |       |

 

----

| (1) |   | Includes $28,896 in  expense accrued in the Salary Continuation Plan net of earnings on life  insurance policies as more fully described in the Long Term Incentive Plan  Table, $15,000 in matching 401K plan contributions, health insurance premiums  $6,510, $4,088 personal use of a Bank owned automobile and $1,560 in life  insurance 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 insurance premiums.                                                                                                                                                                                                                                                            |
| (4) |   | Includes $12,488 in  matching 401K plan contributions and $1,030 in life insurance premiums.                                                                                                                                                                                                                                                            |
| (5) |   | Includes $6,788 in  matching 401K plan contributions and $1,008 in life insurance premiums.                                                                                                                                                                                                                                                             |

 

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

 

TheBoard of Directors authorized the Bank to enter into a three year employmentcontract with Mr. Chrietzberg, effective January 1, 2005. It provides for abase salary of $240,000 per year, a Bank furnished automobile or automobileallowance, and a bonus based on profits. The bonus, not to exceed $250,000annually, will equal $10,000 for each 0.1 percent that the Bank’s profitsexceed 1.0 percent return on average assets plus $10,000 for each 1 percentthat the Bank’s return on equity exceeds 10.0 percent. Under the terms of thecontract, if Mr. Chrietzberg is terminated other than for cause (as defined inthe contract), he is entitled to severance compensation for his 

 

49

----

 

monthlysalary plus a pro rated incentive bonus for the greater of 24 months or theremaining term of his contract (which ends in December, 2008); however, if thetermination follows within twelve (12) months after a change in controltransaction (as defined in the contract), he is entitled to such severancecompensation for the greater of 24 months or the remainder of the term of thecontract.

 

TheBoard of Directors authorized the Bank to execute Addendum 1 to the three yearemployment contract with Mr. Chrietzberg effective January 1, 2006. Addendum 1provides for a base salary of $300,000 and a bonus not to exceed $300,000. Allother terms of the employment contract remain the same.

 

Thefollowing table sets forth certain information regarding the long termincentive plan provided for Mr. Chrietzberg.

 
| ** **                  | ** ** | **Number of  Shares, Units** | ** ** | **Performance or  Other Period  Until**                               | ** ** | **Estimated Future Payouts under   Non-Stock Price-Based Plans** |
|-----------------------------|------------|----------------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|
| **Name**                    | ** ** | **or Other Rights  (#)**     | ** ** | **Maturation or  Payment**                                                 | ** ** | **Threshold  ($ or #)**                                                              | ** ** | **Target  ($ or #)** | ** ** | **Maximum  ($ 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 |

 

InDecember 1993, the Board of Directors approved a Salary Continuation Agreementfor the benefit of Mr. Chrietzberg that provided for payments of $75,000 peryear, for 15 years, if he remains with the Bank until normal retirement,commencing age 65. After consideration of the impact of such an agreement onthe Bank’s income, the Bank amended the Agreement to provide for one half theoriginal benefit amounts, but adopted Surviving Income Agreements which providebenefits upon the death of the executive to his beneficiary in a singlepayment, in an amount equal to the retirement benefit. The Salary ContinuationAgreement provides for lesser payments in the event of early retirement,generally designated to coincide with increases in the anticipated surrendervalue for the life insurance 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 amended Salary Continuation Agreement provides forpayments of $90,000 per year, for Mr. 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 be entitled to an amountequal to $2,940,000 or the net at risk insurance portion of the proceeds,whichever amount is less. The net at risk insurance portion is the total proceedsless the cash value of the policy. Should Mr. Chrietzberg die on or subsequentto his sixty-fifth (65th) birthday, his beneficiary(ies) shall beentitled to an amount equal to $1,000,000 plus the present value of theremaining retirement benefits due to Mr. Chrietzberg or the net at riskinsurance portion of the proceeds, whichever is less, and the Bank shall beentitled to the remainder of such proceeds.

 

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 accruednet of earnings on life insurance policies in 2006,

 

50

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2005and 2004 was $28,900, $47,200, and $76,800, respectively. Based upon thecurrent projected earnings of the insurance used to informally fund the Bank’sobligations under the Agreement, and the anticipated salary continuationexpense to be booked, net of tax benefits, the Bank anticipates (based uponcurrent tax laws and assumptions regarding the yield on alternativeinvestment(s)) that the cost of the benefits to be provided under the agreementwill not have a material adverse impact on the Bank’s net income after taxes inthe future, although no assurance can be given in this regard. The SurvivingIncome Agreement was terminated upon adoption of the amended SalaryContinuation Agreement.

 

TheCorporation did not grant any stock options under the Corporation’s 1998 AmendedStock Option Plan during the year ended December 31, 2006.

 

The following table setsforth the number of shares of Common stock represented by outstanding stockoptions and stock awards held by each of the named executive officers as ofDecember 31, 2006 under the Coporation’s 1998 Amended Stock Option 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 for  Mr. Chrietzberg’s options were March 20, 2003 and February 2, 2004.                                                      |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | The vesting dates for  Mr. Leveque’s options were 20,000 options on February 2, 2004, 20,000 on  January 1, 2005 and 20,000 on January 1, 2006. |
| (3) |   | The vesting date for  Mr. Warner’s options was June 16, 2005.                                                                                   |
| (4) |   | The vesting dates for  Ms. Weber’s options were February 23, 2002, March 20, 2003 and February 2,  2004.                                        |

 

51

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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 memberof 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.               Includes a retainerof $2,500 (elected to the Board in October 2006) and $1,875 in fees for monthlyBoard of Director meetings.

 

**ITEM 11.  SECURITY OWNERSHIP OF 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.

 
| **Name and Address** | ** ** | **Amount and Nature of  Beneficial Ownership** | ** ** | **Percent of  Class** | ** ** |
|--------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------|------------|
| Charles T.  Chrietzberg, Jr.   |       | 768,874                                                            | (1)        | 44.72                      |       |
| P.O. Box 1344                  |       |                                                               |       |                       |       |
| Carmel, CA 93921               |       |                                                               |       |                       |       |
|                           |       |                                                               |       |                       |       |
| David S. Lewis  Trust          |       | 153,863                                                            |       | 8.94                       |       |
| 30500 Aurora del  Mar          |       |                                                               |       |                       |       |
| Carmel, CA 93923               |       |                                                               |       |                       |       |
|                           |       |                                                               |       |                       |       |
| Bruce N. Warner                |       | 114,530                                                            | (2)        | 6.61                       |       |
| 601 Munras Ave.                |       |                                                               |       |                       |       |
| Monterey, CA  93940            |       |                                                               |       |                       |       |

 

----

(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 Commonstock owned by Mr. Chrietzberg are pledged to secure a loan from anunaffiliated bank.

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

 

The following table setsforth similar information regarding the beneficial ownership, both 

 

52

----

 

by numerical holding and percentageinterest of each of the Company’s directors and all of its directors andexecutive officers as a group. All addresses are in care of the Corporation at601 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)    |   | Includes  88,000 shares subject to his employee stock options. 400,000 shares of the  Common stock owned by Mr. Chrietzberg are pledged to secure a loan from an  unaffiliated bank. Should he default under such credit, the shares could be  acquired by the lender, or sold pursuant to applicable terms of the Uniform  Commercial Code, in a transaction that could result in a change of control of  the Corporation. Such transaction may require approval under provisions of  Federal and California change in bank control laws. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (2)    |   | The shares include an  aggregate of 18,414 shares held beneficially by Mr. Chrietzberg and Mrs.  Chrietzberg in Individual Retirement Accounts, where voting power is also  shared with the custodian of the account.                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (3)    |   | Includes shares of  spouse pursuant to California’s community property laws.                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (4)    |   | Sole voting power.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (5)    |   | Includes 21,213 shares  subject to the respective director’s stock options. Of the remaining shares,  24,158 are held by Mr. Coniglio, 26,530 are held in a family trust controlled  by Mr. Coniglio, as to which he has sole voting and investment power, while  8,453 shares are held by Hudson, Martin, Ferrante & Street, a partnership  of which Mr. Coniglio is the managing partner, with voting and investment  power.                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (6)    |   | Includes 2,500 shares  subject to the respective director’s stock options. The remaining shares are  held jointly with family members, other than 1,610 shares held in a corporate  pension, as to which Ms. Hudson has voting and investment power.                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (7)    |   | Shares are held in a  profit sharing plan, as to which Mr. Briant has voting and investment power.                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (8)    |   | Includes 176,541 shares  held by executive officers who are not also directors, 70,000 shares are  subject to employee stock options.                                                                                                                                                                                                                                                                                                                                                                                                      |

 

**ITEM 12.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

The Bank has had, and expects to have in thefuture, banking transactions in the ordinary course of its business withdirectors, officers, principal shareholders and their associates. Management ofthe Bank believes that these transactions have been (and those in the futureare intended to be) on substantially the same terms, including interest rates,collateral and repayment terms on extensions of credit, as those prevailing atthe same time for comparable transactions with others and did not involve morethan the normal risk of collectibility or present other unfavorable features. Managementdoes not believe that any such loans are outside the ordinary course ofbusiness. The following table sets forth information on extensions of credit todirectors and to directors, principal shareholders and officers.

 
| ** **                                                                | ** ** | ** **  | ** ** | **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.

 

53

----

 

**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.                                                                                                                                                                      |

 

54

----

 
| 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. PRINCIPAL ACCOUNTANT 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.

 

55

----

 

**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:   November 19, 2007 | By:                                | /s/  Charles T. Chrietzberg, Jr. |   |
|                                     |                               |  Charles  T. Chrietzberg, Jr. |
|                                     |                               |  Chief  Executive Officer |
|                                     |                               |  and  President |

 
| Date:   November 19, 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. |       |         |       |     | November 19, 2007 |
|  Charles T.  Chrietzberg, Jr.     |       | Director     |       |     |
|                                   |       |         |       |     |
|  /s/ Sandra G. Chrietzberg        |       |         |       |     | November 19, 2007 |
|  Sandra G. Chrietzberg            |       | Director     |       |     |
|                                   |       |         |       |     |
|  /s/ Peter J. Coniglio            |       |         |       |     | November 19, 2007 |
|  Peter J. Coniglio                |       | Director     |       |     |
|                                   |       |         |       |     |
|  /s/ Carls S. Hudson              |       |         |       |     | November 19, 2007 |
|  Carla S. Hudson                  |       | Director     |       |     |
|                                   |       |         |       |     |
|  /s/ John M. Lotz                 |       |         |       |     | November  19, 2007 |
|  John M. Lotz                     |       | Director     |       |     |
|                                   |       |         |       |     |
|  /s/ Mark A. Briant               |       |         |       |     | November  19, 2007 |
|  Mark A. Briant                   |       | Director     |       |     |
|                                   |       |         |       |     |
|  /s/ David Bernahl                |       |         |       |     | November  19, 2007 |
|  David Bernahl                    |       | Director     |       |     |
|                                   |       |         |       |     |
|  /s/ Stephanie G. Chrietzberg     |       |         |       |     | November  19, 2007 |
|  Stephanie G. Chrietzberg         |       | Director     |       |     |

 

56

----

 

**NORTHERN CALIFORNIA BANCORP, INC.**

**AND SUBSIDIARY**

 

**CONSOLIDATED FINANCIAL REPORT**

 

**Years Ended December 31, 2006 and 2005**

 

----

 

**TABLE OF CONTENTS**

 
| ** **                                                         | **Page**   |
|--------------------------------------------------------------------|------------|
| ** **                                                         | ** ** |
| **INDEPENDENT AUDITORS’ REPORT ON THE  FINANCIAL STATEMENTS** | 1          |
|                                                               |       |
| **FINANCIAL STATEMENTS**                                           |       |
|                                                               |       |
| Consolidated  Balance Sheets                                       | 2          |
| Consolidated  Statements of Income                                 | 3          |
| Consolidated  Statements of Changes in Shareholders’ Equity   | 4          |
| Consolidated  Statements of Cash Flows                             | 5-6        |
| Notes to  Consolidated Financial Statements                        | 7-48       |

 

----

 
|  | **HUTCHINSON and**BLOODGOOD LLP****CERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS | 17 Aspen Way  Watsonville, CA 95076  t 831.724.2441 f 831.761.2136  www.hbllp.com |
|--|---------------------------------------------------------------------------------|-----------------------------------------------------------------------------------|

 

**IndependentAuditors’ Report**

 

To the Board of Directors Northern California Bancorp, Inc. Monterey, California

 

We have audited the accompanying consolidatedbalance sheets of Northern California Bancorp, Inc. and its wholly ownedsubsidiary, Monterey County Bank, as of December 31, 2006 and 2005 and therelated consolidated statements of income, changes in shareholders’ equity, andcash flows for each of the years in the three-year period ended December 31,2006. These consolidated financial statements are the responsibility of theCorporation’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

 

We conducted our audits in accordance withstandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of Northern California Bancorp, Inc. and its wholly ownedsubsidiary, as of December 31, 2006 and 2005, and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2006 in conformity with accounting principles generallyaccepted in the United States of America.

 

Hutchinson andBloodgood LLP

 

Watsonville, California 

February 14, 2007

 

1

----

 

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

 

**CONSOLIDATEDBALANCE SHEETS**

**December31, 2006 and 2005**

 
| ** **                                                                                                                                                            | ** **                                      | **2006**    | ** **  | **2005**    | ** **  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------|-------------|-------------|-------------|-------------|
| **ASSETS**                                                                                                                                                            | ** **                                      | ** **  | ** **  | ** **  | ** **  |
| 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 consolidated financial statements are an integral part ofthese statements.

 

2

----

 

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

 

**CONSOLIDATEDSTATEMENTS OF INCOME**

**Years Ended 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 consolidated financial statements are an integral part ofthese statements.

 

3

----

 

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

 

**CONSOLIDATED STATEMENTS OF CHANGESIN SHAREHOLDERS’ EQUITY**

**Years Ended 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 consolidated financial statements are an integral part ofthese statements.

 

4

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

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**Years Ended 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 |   |

 

Thenotes to consolidated financial statements are an integral part of thesestatements.

 

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| ** **                      | ** ** | **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 consolidated financialstatements are an integral part of these statements.

 

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**NORTHERN CALIFORNIA BANCORP, INC. ANDSUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Years Ended December 31, 2006 and 2005**

 

**Note1.          SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

***Nature of Business***

 

The Bankprovides a variety of financial services to individuals and small businessesthrough its four offices on the Monterey Peninsula. Its primary depositproducts are demand and term certificate accounts. Its primary lending productsare 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****significantinter-company balances and transactions 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 votinginterest. As defined in applicable accounting standards, variable interestentities (VIEs) are entities that lack one or more of the characteristics of avoting interest entity. A controlling financial interest in an entity ispresent 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, or both. Theenterprise with a controlling financial interest, known as the primarybeneficiary, consolidates the VIE. The Corporation’s wholly owned subsidiaries,Northern California Bancorp, Inc. Trust I and Northern California Bancorp, Inc.Trust II, are VIEs for which the Corporation is not the primary beneficiary. Accordingly,the accounts of these entities are not included in the Corporation’sconsolidated financial statements at December 31, 2006 and 2005.

 

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***Use of Estimates***

 

In preparingconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America, management is required tomake estimates and assumptions that affect the reported amounts of assets andliabilities as of the date of the balance sheet and reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates. Material estimates that are particularly susceptible tosignificant change in the near term relate to the determination of the allowancefor loan losses, and the valuation of deferred tax assets.

 

***Cash and Cash Equivalents***

 

For purposesof reporting cash flows, cash and cash equivalents include cash, amounts duefrom banks and Federal funds sold on a daily basis, all of which mature withinninety days.

 

***Time Deposits with Other FinancialInstitutions***

 

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

 

***Trading Activities***

 

TheCorporation engages in trading activities consisting of securities that are heldprincipally for resale in the near term. The securities are recorded in thetrading assets account at fair value with changes in fair value recorded inearnings. Interest and dividends are included in net interest income.

 

Quoted marketprices, when available, are used to determine the fair value of tradinginstruments. If quoted market prices are not available, then the fair valuesare estimated using pricing models, quoted prices of instruments with similarcharacteristics, or discounted cash flows.

 

8

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***Investment Securities***

 

Investments indebt securities that management has the positive intent and ability to hold tomaturity are classified as “held to maturity” and reflected at cost, adjustedfor amortization of premiums and accretion of discounts, which are recognizedas adjustments to interest income. Other marketable securities are classifiedas “available for sale” and are reflected at fair value, with unrealized gainsand losses excluded from earnings 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 impairment losses, management considers (1)the length of time and the extent to which the fair value has been less thancost, (2) the financial condition and near-term prospects of the issuer, and(3) the intent and ability of the Bank to retain its investment in the issuerfor a period of time sufficient to allow for any anticipated recovery in fairvalue. 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***

 

The Bankoriginates loans to customers under the Small Business Administration (SBA)program that generally provides for SBA guarantees of 70% to 85% of each loan. TheBank generally sells the guaranteed portion of each loan to a third party andretains only the non-guaranteed portion in its own portfolio. A gain isrecognized on these loans through collection on sale of a premium over theadjusted carrying value, or through retention of an ongoing rate differential,less a normal service fee between the rate paid by the borrower to the Bank andthe rate paid by the Bank to the purchaser (excess servicing fee). Incalculating the gain, the Bank assumes that the loans sold will be outstandingfor one-half of their contractual lives.

 

9

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The Bank’sinvestment in an SBA loan is allocated among the retained portion of the loan,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 notcarry an SBA guarantee, part of the gain recognized on the sold portion of theloan is deferred and amortized as a yield enhancement on the retained portionof the loan. Excess servicing fees are reflected as an asset which is amortizedover an assumed half life; in the event future prepayments are significant andfuture expected cash flows are inadequate to cover the unamortized excessservicing asset, additional amortization is recognized.

 

***Loans Held for Sale***

 

Loans held forsale consist of the portion of loans that are guaranteed by the SBA and arecarried at the lower of cost or market. Market value for loans guaranteed bythe SBA is generally determined based on the price at which the loans were committedto be sold on the trade date. Direct loan origination costs are recorded atsettlement as an adjustment to gain or loss on sale.

 

***Loans and Loan Fees***

 

The Bankgrants mortgage, commercial, construction, and consumer loans to customers. Asubstantial portion of the loan portfolio is represented by****mortgage loans 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.

 

Loans thatmanagement has the intent and ability to hold for the foreseeable future oruntil 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 onthe 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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The accrual ofinterest on mortgage and commercial loans is discontinued at the time the loanis 90 days past due unless the credit is well-secured and in process ofcollection. Credit card loans and other personal loans are typically chargedoff no later than 180 days past due. Past due status is based on contractualterms of the loan. In all cases, loans are placed on nonaccrual or charged-offat an earlier date if collection of principal or interest is considereddoubtful.

 

All interestaccrued but not collected for loans that are placed on nonaccrual or chargedoff is reversed against interest income. The interest on these loans isaccounted for on the cash-basis or cost-recovery method, until qualifying forreturn to accrual. Loans are returned to accrual status when all the principaland interest amounts contractually due are brought current and future paymentsare reasonably assured.

 

***Allowance for Loan Losses***

 

The allowancefor loan losses is established through a provision for loan losses charged toearnings and is maintained at a level considered adequate to provide forreasonably foreseeable loan losses.

 

The provisionand the level of the allowance are evaluated on a regular basis by managementand are based upon management’s periodic review of the collectibility of theloans in light of historical experience, known and inherent risks in the natureand volume of the loan portfolio, adverse situations that may affect theborrower’s ability to repay, estimated value of any underlying collateral, andprevailing economic conditions. This evaluation is inherently subjective as itrequires estimates that are susceptible to significant change. In addition,various regulatory agencies, as an integral part of their examination process,periodically review the Bank’s allowance for losses on loans and other realestate owned. Such agencies may require the Bank to recognize additions to theallowance based on their judgment of information available to them at the timeof their examination. Ultimately, losses may vary from current estimates andfuture additions to the allowance may be necessary.

 

Loan lossesare charged against the allowance when management believes the collectibilityof the loan balance is unlikely. Subsequent recoveries, if any, are credited tothe allowance.

 

11

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The allowanceconsists of specific, general and unallocated components. The specificcomponent relates to loans that are classified as either doubtful, substandardor special mention. For such loans that are also classified as impaired, anallowance is established when the discounted cash flows (or collateral value orobservable market price) of the impaired loan is lower than that of thecarrying value of that loan. The general component covers non-classified loansand is based on historical loss experience adjusted for qualitative factors. Anunallocated component is maintained to cover uncertainties that could affectmanagement’s estimate of probable losses. 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 loan isconsidered 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 by management in determining impairment includepayment status, collateral value, and the probability of collecting scheduledprincipal and interest payments when due. Loans that experience insignificantpayment delays and payment shortfalls generally are not classified as impaired.Management determines the significance of payment delays and payment shortfallson a case-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 ismeasured on a loan-by-loan basis by either the present value of expected futurecash flows discounted at the loan’s effective interest rate, the loan’sobtainable market price, or the fair value of the collateral if the loan iscollateral dependent. Substantially, all of the Bank’s loans that have beenidentified as impaired have been measured by the fair value of existingcollateral.

 

Large groupsof smaller balance homogeneous loans are collectively evaluated for impairment.Accordingly, the Bank does not separately identify individual consumer loansfor impairment disclosures.

 

***Loan Servicing***

 

Rights toservice loans for others are capitalized as separate assets, whether acquiredthrough purchase or origination, if such loans are sold or securitized withservicing rights retained. Accordingly, the total cost of the loan is allocatedto the related servicing right and to the loan based on the relative fairvalues if it is practicable to estimate those fair values.

 

12

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The Bankestimates fair value based on the present value of estimated expected futurecash flows using prepayment speeds and discount rates commensurate with therisks involved, and servicing costs determined on an incremental cost basis.

 

Capitalizedmortgage servicing rights are reported in other assets and amortized toservicing revenue in proportion to, and over the period of, estimated netservicing revenues. Impairment of mortgage servicing rights is assessed basedon the fair value of those rights. For purposes of measuring impairment, therights 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 Bankspremises and equipment are stated at cost less accumulated depreciation andamortization. Depreciation is provided for in amounts sufficient to relate thecost of depreciable assets to operations over their estimated service lives. Leaseholdimprovements are amortized over the term of the lease or the service lives ofthe improvements, whichever is shorter. The straight-line method ofdepreciation is followed for financial reporting purposes, while bothaccelerated and straight-line methods are followed for income tax purposes.

 

It is generalpractice to charge the cost of****maintenanceand repairs to earnings when incurred; major expenditures for betterments arecapitalized and depreciated.

 

***Income Taxes***

 

Deferredincome taxes are recognized for estimated future tax effects attributable toincome tax carry forwards as well as temporary differences between income taxand financial reporting purposes. Valuation allowances are established whennecessary to reduce the deferred tax asset to the amount expected to berealized. Deferred tax assets and liabilities are reflected at currentlyenacted income tax rates applicable to the period in which the deferred taxassets or liabilities are expected to be realized or settled. As changes in taxlaws or rates are enacted, deferred tax assets and liabilities are adjustedaccordingly through the provision for income taxes.

 

13

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***Transfers of Financial Assets***

 

Transfers offinancial assets are accounted for as sales when control over the assets hasbeen surrendered. Control over transferred assets is deemed to be surrenderedwhen 1) the assets have been isolated from the Bank, 2) the transferee (buyer)obtains the right to pledge or exchange the transferred assets, free ofconditions that would constrain it from taking advantage of that right, and 3)the Bank does not maintain effective control over the transferred assetsthrough an agreement to repurchase them before their maturity.

 

***Stock Option Plan***

 

Under theCorporation’s Stock Option Plan, the Bank may grant incentive stock options andnon-qualified stock options to directors, officers, and employees of theCorporation and it’s subsidiary, so long as the Corporation owns a majority ofthe equity interest of such subsidiary. Incentive Stock Options are granted atfair value of the common stock on the date of grant. However, an incentivestock option granted to an individual owning 10% or more of the Corporation’sstock after such grant must have an exercise price of at least 110%****of such fair market value and an exerciseperiod of not more than five years. Non-qualified stock options may be grantedat prices not lower than 85% of the fair market value of the common stock onthe date of grant. The Board of Directors is authorized to determine whenoptions become exercisable within a period not exceeding 10 years from the dateof grant. Under the Plan, 211,081 shares of common stock have been reserved forthe granting of these options. At December 31, 2006, 202,864 options wereoutstanding. During 2006, no options were granted, and 90,276 options wereexercised by officers, employees, and board members. As of December 31, 2006,all options have been vested.

 

14

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In December2004, the Financial Accounting Standards Board (“FASB”) issued Statement No.123 (revised 2004), *Share-Based Payment.*SFASNo. 123(R) requires that the compensation cost relating to share-based paymenttransactions be recognized in financial statements. That cost will be measuredbased on the fair value of the equity or liability instruments issued. SFAS No.123(R) covers a wide range of share-based compensation arrangements includingstock options, restricted share plans, performance-based awards, shareappreciation rights, and employee share purchase plans. SFAS No. 123(R) is areplacement of SFAS No. 123, *Accounting forStock-Based Compensation,*and supersedes APB Opinion No. *25, Accounting for Stock Issued to Employees,*andits related interpretive guidance. The effect of the Statement will be torequire entities to measure the cost of employee services received in exchangefor stock options based on the grant-date fair value of the award, and torecognize the cost over the period the employee is required to provide servicesfor the award. SFAS No. 123(R) permits entities to use any option-pricing modelthat meets the fair value objective 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 original provisionsof SFAS No. 123; that is, the Corporation was not required to re-measure thegrant-date fair value estimate of the unvested portion of awards granted priorto 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.

 

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

 

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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 |   |

 

The fair valueof these options was estimated at the grant date using the Black-Scholes optionpricing model with the following weighted-average assumptions for 2005 and2004: risk-free interest rate of 4.6% and 4.8%, respectively; dividend yield of1.3% and 1.0%, respectively; expected option life of 4 years and 8 years,respectively; and volatility of 20% for both years.

 

The expectedvolatility is based on historical volatility. The risk-free interest rates forperiods within the contractual life of the awards are based on the U.S.Treasury yield curve in effect at the time of the grant. The expected life isbased on historical exercise experience. The dividend yield assumption is basedon the Company’s history and expectation of dividend payouts.

 

16

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***Earnings per share***

 

Basic earningsper share represents income available to common shareholders divided by theweighted-average number of common shares outstanding during the period. Dilutedearnings per share reflects additional common shares that would have beenoutstanding if dilutive potential common shares had been issued, as well as anyadjustment to income that would result from the assumed issuance. Potentialcommon shares that may be issued by the Corporation relate solely tooutstanding stock options, and are determined using the treasury stock method. Theweighted average number of shares used in the computation of basic earnings pershare was 1,658,675 for 2006, 1,614,196 for 2005, and 1,576,589 for 2004. Theweighted average number of shares used in the computation of earnings per shareassuming dilution of stock options was 1,831,892 for 2006, 1,923,532 for 2005,and 1,919,512 for 2004. The Corporation paid cash dividends of $.35, $.20, and$.165 per share in 2006, 2005 and 2004, respectively.

 

***Recent Accounting Pronouncements***

 

In March of2006, the FASB published SFAS No. 156, *Accountingfor Servicing of Financial Assets*, which amends SFAS No. 140, *Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities,*with respect to theaccounting for servicing of financial assets. SFAS No. 156 requires that allseparately recognized servicing rights be initially measured at fair value, ifpracticable. For each class of separately recognized servicing assets andliabilities, SFAS No. 156 permits an entity to choose either of the followingsubsequent measurement methods: (1) the amortization of servicing assets orliabilities in proportion to and over the period of estimated net servicingincome or net servicing loss or (2) the reporting of servicing assets orliabilities at fair value at each reporting date and reporting changes in fairvalue in earnings in the period in which the changes occur. SFAS No. 156 alsorequires additional disclosures for all separately recognized servicing rights.Early adoption is permitted as of the beginning of an entity’s fiscal year,provided the entity has not yet issued financial statements, including interimfinancial statements, for any period of that fiscal year. SFAS No. 156 iseffective the earlier of the date an entity adopts the requirements of SFAS No.156, or as of the beginning of its first fiscal year beginning after September15, 2006. An entity should apply the requirements for recognition and initialmeasurement of servicing assets and servicing liabilities prospectively to alltransactions after the effective date of SFAS No. 156. The Bank is currentlyevaluating the impact of the adoption of this standard.

 

17

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In September 2006,the FASB issued Interpretation No. 48 (“FIN 48”), *“Accounting for Uncertainty in Income Taxes*, aninterpretation 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.

 

In September2006, the FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS157”), *“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.

 

This statementestablishes a fair value hierarchy that distinguishes between valuationsobtained from sources independent of the entity and those from the entity’s ownunobservable inputs that are not corroborated by observable market data. SFAS157 expands disclosures about the use of fair value to measure assets andliabilities in interim and annual periods subsequent to initial recognition. Thedisclosures focus on the inputs used to measure fair value and for recurringfair value measurements using significant unobservable inputs, the effect ofthe measurements on earnings or changes in net assets for the period. Thisstatement encourages an entity to combine the fair value information disclosedunder this statement with the fair value information disclosed under otheraccounting pronouncements, including SFAS 107, “Disclosures about Fair Value ofFinancial Instruments”, where practicable. The Bank is currently assessing theimpact of this guidance on its financial statements.

 

18

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In September2006, the EITF reached a consensus on EITF Issue 06-5, Accounting for Purchasesof Life Insurance-Determining the Amount That Could Be Realized in Accordancewith FASB 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. EITF06-5 is effective for fiscal years beginning after December 15, 2006 and itrequires that recognition of the effects of adoption should be either by (a) achange in accounting principle through a cumulative-effect adjustment toretained earnings as of the beginning of the year of adoption or (b) a changein accounting principle through retrospective application to all prior periods.The Bank is currently evaluating what effect, if any, adoption of EITF 06-5will have on its Financial Statements.

 

***Comprehensive Income (Loss)***

 

Accountingprinciples generally require that recognized revenue, expenses, gains, andlosses be included in net income. Although certain changes in assets andliabilities, such as unrealized gains and losses on available-for-salesecurities, are reported as a separate component of the equity section of thebalance sheet, such items, along with net income, are components ofcomprehensive income.

 

The componentsof other comprehensive income (loss) and related tax effects for the yearsended December 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 componentsof accumulated other comprehensive income (loss) and related tax effects forthe years 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 |   |

 

***Advertising Costs***

 

Advertisingcosts are charged to operations when incurred. The amount expensed foradvertising as of December 31, 2006, 2005, and 2004 was $223,800, $140,900, and$127,300, respectively.

 

***Reclassification***

 

Certainamounts have been reclassified in the 2005 and 2004 financial statements toconform to the 2006 presentation.

 

**Note2.****          CASHAND DUE FROM BANKS**

 

TheCorporation is required to maintain aggregate reserves (in the form of cash anddeposits with the Federal Reserve Bank) to satisfy federal regulatoryrequirements. At December 2006 and 2005, these reserve balances amounted to$1,184,000 and $800,000, respectively.

 

**Note3.****          TRADINGASSETS**

 

At December31, 2006 and 2005, the Corporation’s trading assets consisted of marketableequity securities in the amount of $1,762,300 and $1,027,500, respectively.

 

20

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**Note4.          INVESTMENT SECURITIES ANDOTHER INVESTMENTS**

 

The amortized cost and fair value of investment securities, with grossunrealized gains and losses, follows:

 

| ** **                                          | ** ** | ** **    | ** ** | **Gross**                       | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|---------------|------------|---------------------------------|------------|----------------|------------|------------|------------|
| ** **                                          | ** ** | **Amortized** | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                                          | ** ** | **Cost**      | ** ** | **Gains**                       | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| ** **                                          | ** ** | ** **    | ** ** | **December 31, 2006** | ** ** | ** **     | ** ** |
| **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**      | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|---------------|------------|---------------------------------|------------|----------------|------------|------------|------------|
| ** **                                 | ** ** | **Amortized** | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                                 | ** ** | **Cost**      | ** ** | **Gains**                       | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| ** **                                 | ** ** | ** **    | ** ** | **December 31, 2005** | ** ** | ** **     | ** ** |
| **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 |   |

 

22

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The amortized cost and fair value of debt securities by contractualmaturity 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 from maturity and sales of investment securities for the yearsended 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 ofNorthern California Bancorp, Inc., sold its shares of common stock in PacificCoast Banker’s Bancshares (“PCBB”). The gross sales proceeds were $1,757,025.After subtracting the book value of $439,900, the resulting pretax gain was$1,313,426. The after tax gain will approximate $790,000. Monterey County Bankowned 3,699 shares of PCBB that sold for $475.00 per share less a $3,699 salescharge.

 

23

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As a member ofthe Federal 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 December31, 2006 and 2005, U.S. Government obligations with a carrying value of$15,364,900 and $11,201,900, respectively, were pledged to secure advances fromthe 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.

 

24

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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 time sufficientto allow for any anticipated recovery in fair value.

 

On December31, 2006, 7 securities have an unrealized loss with aggregate depreciation of0.65% 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 has the ability to hold these securitiesuntil estimated maturity, no decline is deemed to be other than temporary.

 

25

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**Note5.****          SALESAND SERVICING OF SBA LOANS**

 

A summary of the activity 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 of income 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 |   |

 

26

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**Note6.****          LOANSAND ALLOWANCE FOR LOAN LOSSES**

 

A summary of loan balances 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 the allowance 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 December31, 2006 there were $154,900 in impaired loans; at December 31, 2005 there wereno impaired loans. No additional amounts are committed to be advanced inconnection with impaired loans.

 

During theyears ended December 31, 2006, 2005, and 2004 the average recorded investmentin impaired loans amounted to approximately $142,200, $82,400, and $617,100,respectively. At December 31, 2006 there was $154,900 in impaired loans with anallowance of $31,000. If interest on non-accrual loans had been accrued, suchincome would have approximated $10,700 and $8,200 for 2006 and 2004,respectively. There were no non-accrual loans at December 31, 2005.

 

As of December31, 2006 and 2005, there were no loans past due ninety days or more and stillaccruing interest.

 

Loans servicedfor others are not included in the accompanying balance sheets. The unpaidprincipal balance of loans serviced for others was $101,138,400 and $85,033,900at December 31, 2006 and 2005, respectively.

 

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

 

A summary ofthe cost and accumulated depreciation of banking premises and equipment andtheir estimated 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             |       |   |   |

 

28

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Depreciationand amortization 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. The estimated total cost of the remodeling is$400,000. The project is expected to be completed in April 2007.

 

**Note8.****          DEPOSITS**

 

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

 

| 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 |   |

 

**Note9.****          JUNIORSUBORDINATED DEBT SECURITIES**

 

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. The securities bear a floating rate of interest of3.25% over the three month LIBOR rate, payable quarterly. 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 Company will pay interest on the Junior SubordinatedDebentures to Trust I, which represents the sole revenue and sole source ofdividend distributions to the holders of the 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 Company fully and unconditionally guaranteesthe obligations of Trust I, on a subordinated 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 regulatoryguidelines, a portion of the Trust Preferred Securities will qualify as Tier ICapital, and the remainder as Tier II Capital.

 

On November13, 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 securities bear a floating rate of interest of2.85% 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. 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. 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 and unconditionally guarantees the obligations of TrustII, on a subordinated basis.

 

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 costsof $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 theyears ended December 31, 2006, 2005 and 2004 interest expense on JuniorSubordinated Debentures totaled $675,600, $526,200, and $372,500, respectively.The amortization of the issuance cost totaled $5,700 for each year endedDecember 31, 2006, 2005 and 2004, respectively.

 

30

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**Note10.****       FUNDINGSOURCES**

 

The Bank haslines of credit from the Federal Home Loan Bank (FHLB) of San Francisco, Bankof the West, Pacific Coast Bankers’ Bank and The Independent Bank withremaining available 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 Bankline of credit has a maximum borrowing capacity of twenty five percent (25%) ofthe Bank’s total assets, adjusted quarterly. The Federal Home Loan Bank line ofcredit is secured by a portion of the Bank’s real estate secured loans andsecurities at December 31, 2006. The total principal balance of pledged loanswas $33,463,500 and securities of $15,364,900. The following table providesinformation on thirteen 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 ofthe West, Pacific Coast Bankers’ Bank and The Independent Bank lines of creditare unsecured. The Bank did not utilize any overnight borrowings in 2006 or2005.

 

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

 

31

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**Note11.****       INCOMETAXES**

 

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 |   |

 

Thedifferences between the statutory federal income tax rate and the effective taxrates are summarized 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 componentsof the 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 taxeffects of each type of income and expense item that give rise to deferredtaxes are as follows:

 

| ** **                               | ** ** | **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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**Note12.****       COMMITMENTS**

 

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

 

***Operating lease commitments***

 

The Bankleases its branch offices in Carmel By-The-Sea, Carmel Valley, and PacificGrove. The Carmel By-The-Sea office has a five and one half year lease withfour, five year options and commenced in April 2002. The Carmel Valley buildinghas a twenty-five year lease which commenced in March 1981 and an addendum tothe lease 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 Grove building has a five-year lease withfive, five-year options and commenced in April 1997. The Bank leasesapproximately 1,000 square feet at 321 Webster Street, Monterey, CA. The 321Webster Street lease has a term of three years commencing September 2000, witha three-year option. An addendum to the lease was executed in 2004 and providedfor two, five year options to extend the lease, which commenced in September2006. The Bank also leases certain equipment used in the normal course ofbusiness.

 

Rent expensefor operating leases is included in occupancy and equipment expense and amountedto approximately $275,200, $286,400, and $275,200 in 2006, 2005, and 2004,respectively.

 

EffectiveApril 1, 2000, the Bank entered into a 5 year sublease agreement to rent one ofthe units in the Carmel Valley branch, upon expiration of the sublease in 2005the Bank elected to retain the space for its own use. Sublease rental incomefor the years ending 2005 and 2004 was approximately $26,500 and $37,400,respectively.

 

Effective July1, 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 terminatedin 2006 due to default for non-payment of rent. Sublease rental income for theyeas ending 2006, 2005, and 2004 was approximately $24,100, $40,200, and$37,200, respectively. The Bank has decided to retain the subleased portion ofthe facility for its own use.

 

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 financialinstruments include commitments to extend credit. Such commitments involve, tovarying degrees, elements of credit and interest rate risk in excess of theamount recognized in the consolidated balance sheets.

 

The Bank’sexposure to credit loss is represented by the contractual amount of thesecommitments. The Bank uses the same credit policies in making commitments as itdoes for on-balance-sheet instruments.

 

At December31, 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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**Note13.****       CONCENTRATIONOF RISK**

 

The Bankgrants commercial, construction, real estate and installment loans tobusinesses and individuals primarily in the Monterey Peninsula area of NorthernCalifornia. Most loans are secured by business assets, and commercial andresidential real estate. Real estate and construction loans held for investmentrepresented 79% of total loans held for investment at December 31, 2006 and2005. The Bank has no concentration of loans with any one customer.

 

The Bank doeshave concentrations of loans in the real estate and accommodation and foodservices industries. Loans held for investment in the real estate industryrepresented 35.65% and 31.13% of total loans held for investment at December31, 2006 and 2005, respectively. Loans held for investment in the accommodationand food services industry represented 16.58% and 20.57% of total loans heldfor investment at December 31, 2006 and 2005, respectively.

 

**Note14.****       OTHERINCOME AND OTHER GENERAL AND ADMINISTRATIVE EXPENSES**

 

Other incomefor the years ended December 31, 2006, 2005, and 2004 totaled $4,626,700,$2,806,800, and $2,993,900, respectively. Significant categories comprisingother income in the years ending December 31, 2006, 2005, and 2004 were netmerchant discount fees of $2,614,300, $2,342,600, and $2,343,400, commercialbanking broker fees of $125,000, $412,200, and $274,000, life insurance cashsurrender value earnings of $108,200, $79,900, and $65,200, credit cardmarketing program income of $1,308,300, $222,100 and $120,000, and tradingasset activities of $283,100, ($392,400) and $53,200, respectively.

 

Other generaland administrative expenses for the years ended December 31, 2006, 2005, and2004 totaled $3,511,200, $3,369,900, and $3,038,000, respectively.

 

Significant categoriescomprising other general and administrative expenses in the years endingDecember 31, 2006, 2005, and 2004 were merchant credit processing expense 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

----

 

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

 

The Corporation (on a consolidated basis) and the Bank are subject tovarious regulatory capital requirements administered by the federal bankingagencies. Failure to meet minimum capital requirements can initiate certainmandatory and possibly additional discretionary actions by regulators that, ifundertaken, could have a direct material effect on the Corporation’s and Bank’sfinancial statements.

 

Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Corporation and the Bank must meet specificcapital guidelines that involve quantitative measures of their assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices. The capital amounts and classifications are also subjectto qualitative judgments by the regulators about components, risk weightings,and other factors. Under applicable regulatory guidelines, a portion of theTrust Preferred Securities qualify as Tier I Capital, and the remainder as TierII Capital. Prompt corrective action provisions are not applicable to bankholding companies.

 

Quantitative measures established by regulation to ensure capitaladequacy require the Corporation and the Bank to maintain minimum amounts andratios (set forth in the following table) of total and Tier 1 capital (asdefined in the regulations) to risk-weighted assets (as defined) and of Tier 1capital (as defined) to average assets (as defined). Management believes, as ofDecember 31, 2006 and 2005, that the Corporation and the Bank met allcapital adequacy requirements to which they are subject.

 

As of December 31, 2006, the most recent notification from theFederal Deposit Insurance Corporation categorized the Bank as well capitalizedunder the regulatory framework for prompt corrective action. To be categorizedas well capitalized, an institution must maintain minimum total risk-based,Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the followingtables. There are no conditions or events since the notification thatmanagement believes have changed the Bank’s category. The Corporation’s and theBank’s actual capital amounts and ratios as of December 31, 2006 and 2005are also presented in the tables.

 

37

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**December 31, 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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**December 31, 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 | % |
|                                          |            |                                               |            |                 |            |                |            |                |            |                           |            |  |  |  |  |  |  |  |  |  |

 

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

 

The Corporation is subject to regulation by the Board of Governors ofthe Federal Reserve System under the Bank Holding Corporation Act. The Bank issubject to regulation, supervision, and regular examination by the CaliforniaDepartment of Financial Institutions and the Federal Deposit InsuranceCorporation. The regulations of these agencies affect most aspects of theCorporation’s business and prescribe permissible types of loans andinvestments, the amount of required reserves, requirements for branch offices,the permissible scope of the Corporation’s activities, and various otherrequirements. The Corporation is also subject to certain regulations of theFederal Reserve Bank dealing primarily with check clearing activities,establishment of banking reserves, Truth-in-Lending (Regulation Z), and EqualCredit 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 sharesof the Corporation’s common stock were outstanding and exercisable at pricesranging from $1.86 - $ 4.40. The status of all stock options is as 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 weighted average exercise price was$3.19, $2.47, and $2.15 for the years ending December 31, 2006, 2005, and2004, respectively. No options were granted in 2006, the weighted average fairvalue of options granted during the years ending December 31, 2005 and2004 were $4.00 and $2.89, respectively. All of the options are exercisable asof December 31, 2006.

 

40

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Information pertaining to options outstanding at December 31, 2006is 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.****                           RELATEDPARTY TRANSACTIONS**

 

The Corporation has, and expects to have in the future, bankingtransactions in the ordinary course of its business with directors, officers,principal shareholders, and their associates. These transactions, includingloans and deposits, are granted on substantially the same terms, includinginterest rates and collateral on loans, as those prevailing at the same timefor comparable transactions with others and do not involve more than the normalrisk of collectibility or present other unfavorable features.

 

Aggregate loan transactions with related parties are approximately asfollows:

 
| 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 party deposits 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, the Corporation established an employee stock ownershipplan (ESOP) to invest in the Corporation’s common stock for the benefit ofeligible employees. The Board of Directors determines the Corporation’scontribution to the plan. Shares in the plan generally vest after seven years. TheCorporation did not contribute to the ESOP trust in 2006, 2005, or 2004. Therewere no shares in the plan as of December 31, 2006.

 

The Bank has a salary reduction plan under Section 401(k) of theInternal Revenue Code. The plan covers substantially all full-time employeeswho have completed one year of service with the Bank. Employees are allowed todefer up to 15% of their compensation subject to certain limits based onfederal tax laws. Under the provisions of the plan, the Bank’s contributionpolicy is discretionary. The Bank initiated a matching contribution in 2001 of100% of each employee’s contribution up to 6% of the employee’s compensation. TheBank’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 state banking regulations place certain restrictions ondividends paid and loans or advances made by the Bank to the Corporation. Thetotal amount of dividends which may be paid at any date is generallylimited to the lesser of: (i) retained earnings; or (ii) the Bank’snet income for its last three fiscal years (less any distributions to thestockholders made during such period), and loans or advances are limited to 25%of the Bank’s primary capital plus the allowance for loan losses on a securedbasis and 15% on an unsecured basis.

 

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

 

The Corporation has established salary continuation plans, whichprovide for payments to a certain officer at retirement. Included in otherliabilities at December 31, 2006 and 2005, respectively, is $854,700 and$720,300 of deferred compensation related to the continuation plans. The plansare funded through life insurance policies that generate value to fund thefuture benefits.

 

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

 

The Bank had a non-cash transaction relating to the trade in of avehicle of $12,700 and $0 for the years ended December 31, 2006 and 2005,respectively.

 

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

 

SFAS No. 107, “Disclosures about Fair Value of FinancialInstruments” requires disclosure of estimated fair values of all financialinstruments where it is practicable to estimate such values. In cases wherequoted market prices are not available, fair values are based on estimatesusing present value or other valuation techniques. Those techniques aresignificantly affected by the assumptions used, including the discount rate andestimates 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. StatementNo. 107 excludes certain financial instruments and all non-financial instrumentsfrom its disclosure requirements. Accordingly, the aggregate fair value amountspresented do not represent the underlying value of the Corporation.

 

The Corporation in estimating fair value disclosures for financialinstruments used the following methods and assumptions:

 

***Cash and cashequivalents:*** The carrying amounts of cash andshort-term instruments approximate fair values.

 

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

 

***Loans:*** For variable-rate loans that repricefrequently and with no significant change in credit risk, fair values are basedon carrying values. The fair value of performing fixed-rate loans is estimatedby discounting future cash flows using the Corporation’s current offering ratefor loans with similar characteristics. The fair value of performingadjustable-rate loans is considered the same as book value. The fair value ofnon-performing loans is estimated at the fair value of the related collateralor, when in management’s opinion foreclosure upon the collateral is unlikely,by discounting future cash flows using rates which take into account management’sestimate of credit risk.

 

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***Commitments toExtend Credit and Standby Letters of Credit:*****The Corporation does not generally enterinto long-term fixed rate commitments or letters of credit. These commitmentsare generally priced at current prevailing rates. These rates are generallyvariable and, therefore, there is no interest rate exposure. Accordingly, thefair market value of these instruments is equal to the carrying value amount oftheir net deferred fees. The net deferred fees associated with theseinstruments are not material. The Corporation has no unusual credit riskassociated 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 for fixed-rate certificates of deposit areestimated using a discounted cash flow calculation that applies interest ratescurrently being offered on certificates to a schedule of aggregatedexpected monthly maturities on time deposits.

 

***Accrued interest:***The carrying amounts of accrued interest approximate fair value.

 

***Cash Surrender Valueof Life Insurance:*** The carrying amount of lifeinsurance approximate fair value.

 

***Short-termborrowing:*** The carrying amounts of federalfunds purchased, borrowings under repurchase agreements, and other short-termborrowings maturing within ninety days approximate their fair values. Fairvalues of other borrowings are estimated using discounted cash flow analysesbased on the Corporation’s current incremental borrowing rates for similartypes of borrowing arrangements.

 

***Long-term borrowing:***The fair values of the Corporation’s long-term borrowings are estimated usingdiscounted cash flow analyses based on the Corporation’s current incrementalborrowing rates for similar types of borrowing arrangements

 

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The estimatedfair values, 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. (PARENTCORPORATION ONLY)**

 

The following are the financial statements of Northern CaliforniaBancorp, Inc. (Parent Corporation only) as of December 31, 2006 and2005:

 
| **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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