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

**WashingtonD.C.  20549**

 

**FORM 10-KSB**

 
| **ý**                         | **Annual  report under Section 13 or 15(d) of the Securities Exchange Act of 1934  (Fee required)**                                                                                                                                                                      |
|------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                               | **for fiscal year ended December 31,  2003**                                                                                                                                                                                                                             |
|                               |                                                                                                                                                                                                                                                                          |
| **o**                              | **Transition  report under Section 13 or 15(d) of the Securities Exchange Act of 1934  (No fee required)**                                                                                                                                                               |
|                               | **for the period from                      to                      ** |
|                               |                                                                                                                                                                                                                                                                          |
| **Commission File Number 0-27666** |

 

**NORTHERNCALIFORNIA BANCORP, INC.**

(Name of Small Business Issuer in itsCharter)

 

**Incorporated in the State of California****IRS Employer Identification Number 77-0421107Address:  601 Munras Avenue, Monterey, CA 93940Telephone: (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 bySection 13 or 15(d) of the Securities Exchange Act during the past 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý               No o

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B is not contained in this form, and no disclosurewill be contained, to the best of registrant’s knowledge, in definitive proxyor information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB o

 

Revenues for the year ended December 31, 2003; $ 7,972,800.

 

As of March 1, 2004, the Corporation had 1,566,658 shares ofcommon stock out-standing.  Theaggregate market value of voting stock held by non-affiliates of theCorporation was $2,351,300, based on the most recent sale at $3.00 per share onFebruary 3, 2004.

 

The following documents are incorporated by reference to the partsindicated of this Form 10-KSB:

 

1.               Portions of the Independent Auditor’sReport for the fiscal year ended December 31, 2003 are incorporated byreference in Part II Item 7.

 

 

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FORM 10-KSB CROSS REFERENCE INDEX

 
| **PART I**   |                                                                                                                                     |   |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------|--------|
| ITEM 1       | Business                                                                                                                                 |   |
| ITEM 2       | Properties                                                                                                                               |   |
| ITEM 3       | Legal Proceedings                                                                                                                        |   |
| ITEM 4       | Submission of Matters to a Vote of Security  Holders                                                                                     |   |
|         |                                                                                                                                     |   |
| **PART II**  |                                                                                                                                     |   |
| ITEM 5       | Market for the Corporation’s Common Stock  and Related Stockholder Matters                                                          |   |
| ITEM 6       | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                              |   |
| ITEM 7       | Financial Statements and Supplementary Data                                                                                              |   |
|         | Independent Auditors’ Report on the Financial Statements                                                                            |   |
|         | Consolidated Balance Sheets at December 31, 2003 and 2002                                                                           |   |
|         | Consolidated Statements of Operations for  each of the three years in the period ended December 31, 2003                            |   |
|         | Consolidated Statements of Changes in  Stockholders’ Equity for each of the three years in the period ended  December 31, 2003 |   |
|         | Consolidated Statements of Cash Flows for each of the three years in  the period ended December 31, 2003                            |   |
|         | Notes to Consolidated Financial Statements                                                                                               |   |
| ITEM 8       | Changes in and Disagreements with Accountants and Financial  Disclosure                                                                  |   |
| ITEM 8A      | Controls and Procedures                                                                                                                  |   |
|         |                                                                                                                                     |   |
| **PART III** |                                                                                                                                     |   |
| ITEM 9       | Directors, Executive Officers, Promoters and Control Persons:  Compliance with Section 16(a) of the Exchange Act                    |   |
| ITEM 10      | Executive Compensation                                                                                                                   |   |
| ITEM 11      | Security Ownership of Certain Beneficial Owners and Management                                                                           |   |
| ITEM 12      | Certain Relationships and Related Transactions                                                                                           |   |
| ITEM 13      | Exhibits and Reports                                                                                                                     |   |
| ITEM 14      | Principal Accountant Fees and Services                                                                                                   |   |
|         | Signatures                                                                                                                               |   |
|              |                                                                                                                                          |        |  |

 

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**PART I**

 

Certain matters discussed or incorporated byreference in this Annual Report of Form 10-K including, but not limited to,those described in “Item 6 - Management’s Discussion and Analysis of FinancialCondition and Results of Operations”, are forward-looking statements that aresubject to risks and uncertainties that could cause actual results to differmaterially from those projected in the forward-looking statements. Such risksand uncertainties include, among others, (1) competitive pressure in thebanking industry increases significantly; (2) changes in the interest rate environmentreduces margins; (3) general economic conditions, either nationally orregionally, are less favorable than expected, resulting in, among other things,a deterioration in credit quality; (4) changes in the regulatory environment;(5) changes in business conditions and inflation; and (6) changes in securitiesmarkets. Therefore, the information set forth therein should be carefullyconsidered when evaluating the business prospects of the Company.

 

**ITEM 1. BUSINESS**

 

**GENERAL**

 

Northern California Bancorp, Inc. (the “Corporation”) was incorporatedon August 29, 1995, as a for-profit corporation under the CaliforniaCorporate laws for the principal purpose of engaging in banking and non-bankingactivities as allowed for a bank holding company.  The Corporation owns 100% of Monterey County Bank (the“Bank”).  The Corporation’s sources ofrevenues at this time are dividends on investments, gains on securitiestransactions and potential dividends, management fees and tax equalizationpayments, if any, from the Bank.

 

Compliance with environmental laws has not had a material impact on theoperations of the Bank or the Corporation, although the Bank faces potentialliability or losses if its borrowers fail to comply with such laws and the Bankacquires contaminated properties in foreclosure.

 

**BANKSUBSIDIARY**

 

Monterey County Bank, an independent, California chartered commercialbanking corporation was chartered by the State of California on July 30,1976.  The Bank’s customer base includesindividuals, small and medium sized businesses and a variety of governmentagencies with residences, offices or other relationships located in or aboutthe city and county of Monterey, California, including the cities of Carmel andPacific Grove.  The Bank offers itscustomers a wide variety of the normal personal, consumer and commercialservices expected of a locally owned, independently operated bank.  The Bank’s deposits are insured by the FDIC,and, as such, the Bank is subject to regulations by that federal agency and toperiodic audits of its operations and documentary compliance by FDICpersonnel.  As a state chartered bank,which is not a member of the Federal Reserve System, it is also regulated andperiodically examined by the California State Department of Financial Institutions.

 

The Bank’s activities are conducted at its principal offices, 601Munras Ave., Monterey, California and at its three branch offices inCarmel-By-The-Sea, Carmel Valley and Pacific Grove, California.

 

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At December 31, 2003 the Bank had total assets, deposits andshareholders’ equity of approximately $107,052,200, $80,760,500 and$11,284,100, respectively.

 

**NorthernCalifornia Bancorp, Inc. Trust I**

 

On March 27, 2003, Northern California Bancorp, Inc. Trust I, anewly formed Delaware statutory business trust and a wholly owned subsidiary ofthe Company (the Trust), issued an aggregate of $3.0 million of principalamount of Floating Rate TRUPSâ(Capital Trust Pass-through Securities of the Trust) (the Trust PreferredSecurities).  Bear Stearns & Co.,Inc. acted as placement agent in connection with the offering of the TrustPreferred Securities.  The securitiesissued by the Trust are fully guaranteed by the Company with respect todistributions and amounts payable upon liquidation, redemption orrepayment.  The entire proceeds to theTrust from the sale of the Trust Preferred Securities were used by the Trust inorder to purchase $3.0 million in principal amount of the Floating Rate JuniorSubordinated Deferrable Interest Debentures due 2033 issued by the Company (theSubordinated Debt Securities).

 

The Subordinated Debt Securities bear a variable interest rate equal tothe three-month LIBOR plus 3.25%.  Totalbroker and legal costs associated with the issuance of $115,000 are beingamortized over a 30 year period.

#  

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

 

On November 13, 2003,Northern California Bancorp, Inc. Trust II, a newly formed Delaware statutorybusiness trust and a wholly owned subsidiary of the Company (the Trust), issuedan aggregate of $5.0 million 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 in connection with the offering of the TrustPreferred Securities.  The securitiesissued by the Trust are fully guaranteed by the Company with respect todistributions and amounts payable upon liquidation, redemption or repayment.  The entire proceeds to the Trust from thesale of the Trust Preferred Securities were used by the Trust in order topurchase $5.0 million in principal amount of the Floating Rate JuniorSubordinated Deferrable Interest Debentures due 2033 issued by the Company (theSubordinated Debt Securities).

 

The Subordinated Debt Securities bear a variable interest rate equal tothe three-month LIBOR plus 2.85%.  Totalbroker and legal costs associated with the issuance of $54,000 are beingamortized over a 30 year period.

 

**EMPLOYEES**

 

At December 31, 2003 the Northern California Bancorp, Inc. and itssubsidiary Monterey County Bank employed a total of 41 full time equivalentpersons.

 

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**COMPETITION**

 

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

 

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

 

To compete with the financial institutions in its primary service area,the Bank intends to use the flexibility, which its independent status willpermit.  Its activities in this regardinclude an ability and intention to respond quickly to changes in the interestrates paid on time and savings deposits and charged on loans, and to chargesimposed on depository accounts, so as to remain competitive in the marketplace.  It also will continue toemphasize specialized services for the small business person and professionaland personal contacts by the Bank’s officers, directors and employees.  If there are customers whose loan demandsexceed the Bank’s lending limits, the Bank has the ability to arrange for suchloans on a participation basis with other financial institutions.  No assurance can be given, however, that theBank’s efforts to compete with other financial institutions in its primaryservice area will be successful.

 

The Bank provides a range of competitive retail and commercial bankingservices.  The deposit services offeredinclude various types of personal and business checking accounts, savingsaccounts, money market investment accounts, certificates of deposit, andretirement accounts.  Lending servicesinclude consumer loans, various type of mortgage loans for residential andcommercial real estate, personal lines of credit, home equity loans, realestate construction, accounts receivable financing, commercial loans to smalland medium size businesses and professionals. The Bank also provides drive-through facilities, at its Monterey andCarmel offices, and night depository facilities for customer convenience.  The Bank offers safe deposit box facilities,cashiers’ checks, travelers’ checks, U.S. Savings Bonds, and wiretransfers.  The Bank does not providetrust services.

 

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While the Bank has the authority to engage in a wide range of bankingactivities, and offers most of the types of banking services of a commercialbank, over the past three years it has derived much of its profitability anddifferentiated itself from its competitors through (i) commercial and realestate loans guaranteed by the Small Business Administration (“SBA”); and (ii)credit card depository services for merchants.

 

The Bank has entered into an agreement with CrediTrends TechnologyCorporation, a purchaser of charged off consumer credit card balances, tomarket a co-branded MasterCard credit card program.  The Bank will be issuing the cards, but the credit card balanceswill be 100 percent owned by CrediTrends Technology Corporation.  The Bank’s 2003 revenues from the programwere approximately $49,100.  The Bank’sprojected 2004 revenues from the program are $120,000.  CreditTrends Technology Corporation willmaintain on deposit with the Bank amounts equal to the total available creditof the portfolio, the total of five (5) days average settlement activity forthe prior month and fees due to the third party processor.

 

The Bank is developing a pre-paid debit card program.  The program will be marketed by thirdparties to the un-banked, through employer payroll programs and check cashingfacilities, through Internet websites for purchasers of the websites’ productsand services.  Holders of the pre-paidcards will be able to have additional funds added to the card balance, makepoint of sale purchases and withdraw cash through automated tellermachines.  The Bank will be issuing thepre-paid cards and maintaining the funds held on the cards.  The Bank’s revenues from the program will bein the form of transaction fees and earnings from investing the funds held onthe cards.  Revenues from the program in2003 were $2,100.  Revenues from theprogram in 2004 should increase moderately as the program implementationcontinues.

 

The Bank depends largely on rate differentials.  In general, the difference between theinterest rate paid by the Bank on its deposits and its other borrowings, andthe interest rate received by the Bank on loans extended to its customers andsecurities held in the Bank’s portfolio, comprise the major portion of the Bank’searnings.  These rates are highlysensitive to many factors that are beyond the control of the Bank.  Accordingly, the earnings and growth of theBank are subject to the influence of domestic and foreign economic conditions,including inflation, recession and unemployment.

 

Monetary and fiscal policies of the federal government and the policiesof regulatory agencies, particularly the Federal Reserve Board, also impact onthe Bank’s business.  The FederalReserve Board implements national monetary policies (with objectives such ascurbing inflation and combating recession) by its open-market operations inU.S. Government securities, by adjusting the required level of reserves forfinancial intermediaries subject to its reserve requirements and by varying thediscount rates applicable to borrowings by depository institutions.  The actions of the Federal Reserve Board inthese areas influence the growth of bank loans, investments and deposits andalso affect interest rates charged on loans and paid on deposits.  The nature and impact of any future changesin monetary policies cannot be predicted.

 

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**SUPERVISIONAND REGULATION**

 

**TheCorporation**

 

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

 

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

 

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

 

A bank holding company is generally prohibited from engaging in, oracquiring direct or indirect control of more than 5% of the voting shares ofany company engaged in non-banking activities unless the FRB, by order orregulation, has found such activities to be so closely related to banking ormanaging or controlling 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.

 

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

 

The Corporation will be required to file reports with the FRB andprovide such additional information as the FRB may require. The FRB will alsohave the authority to examine the Corporation and each of its subsidiaries withthe cost thereof to be borne by the Corporation.  Under California banking law, the Corporation and itssubsidiaries are also subject to

 

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examination by, and may be required to file reports with, theSuperintendent Department of Financial Institutions.

 

The Corporation and any subsidiaries which it may acquire or organizeafter the reorganization will be deemed affiliates of the Bank within themeaning of the Federal Reserve Act. Pursuant thereto, loans by the Bank to affiliates, investments by theBank in affiliates’ stock, and taking affiliates’ stock by the Bank ascollateral for loans to any borrower will be limited to 10% of the Bank’scapital, in the case of any one affiliate, and will be limited to 20% of theBank’s capital, in the case of all affiliates. Federal and State law place other limitations on transactions betweenthe Bank and its affiliates designed to ensure that the Bank receives treatmentin such transactions comparable to that available from unaffiliated third parties.

 

The Corporation and its subsidiaries are prohibited from engaging incertain tie-in arrangements in connection with any extension of credit, sale orlease of property or furnishing of services. For example, with certain exceptions, the Bank may not condition anextension of credit on a customer’s obtaining other services provided by it,the Corporation or any other subsidiary, or on a promise from its customer notto obtain other services from a competitor.

 

**Sarbanes-Oxley Act**

 

The Sarbanes-Oxley Act of 2002 (the Act) was signed into law onJuly 30, 2002.  The Act was inresponse to recent issues in corporate governance and accountability.  Key provisions of the Act provide for:

 

•                  Expandedoversight of the accounting profession by creating a new independent publiccompany oversight board to be monitored by the SEC.

•                  Revised rules onauditor independence to restrict the nature of non-audit services provided toaudit clients and to require such services to be pre-approved by the auditcommittee.

•                  Improvedcorporate responsibility through mandatory listing standards relating to auditcommittees, certifications of periodic reports by the Chief Executive Officerand Chief Financial Officer, and making issuer interference with an audit acrime.

•                  Enhancedfinancial disclosures, including periodic reviews for the largest issuers andreal time disclosure of material company information.

•                  Enhancedcriminal penalties for a board array of white-collar crimes and increases inthe statute of limitations for securities fraud lawsuits.

 

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

 

**SubsidiaryBank**

 

Both federal and state laws provide extensive regulation of the bankingbusiness.  State and federal statutesand regulations apply to many aspects of the Bank’s operations, includingminimum capital requirements, reserves against deposits, interest rates payableon deposits,

 

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loans, investments, mergers and acquisitions, borrowings, dividends andlocations of branch offices. The California Superintendent of Banks and theFDIC provide primary supervision, periodic examination and regulation of theBank.

 

The FDIC, through its Bank Insurance Fund (the “BIF”) insures theBank’s deposits, currently up to a maximum of $100,000 per depositor.  For this protection, the Bank, like allinsured banks, pays a semi-annual statutory assessment and is subject to therules and regulations of the FDIC. Although the Bank is not a member of the Federal Reserve System, certainregulations of the Federal Reserve Board also apply to its operations.

 

California law restricts the amount available for cash dividends bystate-chartered banks to the lesser of retained earnings or the bank’s netincome for its last three fiscal years (less any distributions to stockholdersmade 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 hasauthority to prohibit the Bank from engaging in unsafe or unsoundpractices.  The FDIC can use this power,under certain circumstances, to restrict or prohibit a bank from payingdividends.

 

Federal law imposes restrictions on banks with regard to transactionswith affiliates, including any extensions of credit to, or the issuance of aguarantee or letter of credit on behalf of, its affiliates, as well as thepurchase of or investments in stock or other securities thereof, or the takingof such securities as collateral for loans, and the purchase of assets of fromaffiliates.  These restrictions have theeffect of preventing affiliates (such as the Corporation) from borrowing fromthe Bank unless the loans are secured by marketable obligations of designatedamounts.  Secured loans and investmentsby the 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 lawalso imposes certain restrictions with respect to transactions involving othercontrolling persons of the Bank.

 

From time to time, legislation is enacted which has the effect ofincreasing the cost of doing business, limiting or expanding permissibleactivities or affecting the competitive balance between banks and otherfinancial intermediaries.  Proposals tochange the laws and regulations governing the operations and taxation of banks,bank holding companies and other financial intermediaries are frequently madein Congress, in the California legislature and before various bank regulatoryand other professional agencies. The Bank cannot predict what, if anylegislation or regulations will be enacted, or the impact thereof on itsbusiness and profitability.

 

**Capital Standards**

 

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

 

FDIC guidelines implement the risk-based capital requirements. Theguidelines establish a systematic analytical framework that makes regulatorycapital requirements more sensitive to differences in risk profiles (using therough measures 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

 

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credit equivalent amounts of off-balance sheet items, such as lettersof credit and outstanding loan commitments, are assigned to one of several riskcategories, which range from 0% for risk-free assets, such as cash and certainU.S. government securities, to 100% for relatively high-risk assets, such asloans and investments in fixed assets, premises and other real estate owned.The aggregate dollar amount of each category is then multiplied by therisk-weight associated with that category. The resulting weighted values fromeach of the risk categories are then added together to determine the totalrisk-weighted assets.

 

The guidelines require a minimum ratio of qualifying total capital torisk-weighted assets of 8%, of which at least 4% must consist of Tier Icapital.  Higher risk-based ratios arerequired to be considered “well capitalized” under prompt corrective actionprovisions.

 

A banking organization’s qualifying total capital consists of twocomponents: Tier I capital (core capital) and Tier 2 capital (supplementarycapital).  Tier I capital consistsprimarily of common stock, related surplus and retained earnings, qualifyingnoncumulative perpetual preferred stock and minority interests in the equityaccounts of consolidated subsidiaries. Intangibles, such as goodwill, aregenerally deducted from Tier 1 capital; however, purchased mortgage servicingrights and purchased credit card relationships may be included, subject tocertain limitations. At least 50% of the banking organization’s totalregulatory capital must consist of Tier 1 capital.

 

Tier 2 capital may consist of (i) the allowance for loan and leaselosses in an amount up to 1.25% of risk-weighted assets; (ii) cumulativeperpetual preferred stock and long-term preferred stock and related surplus;(iii) hybrid capital instruments (instruments with characteristics of both debtand equity), perpetual debt and mandatory convertible debt securities; and (iv)eligible term subordinated debt and intermediate-term preferred stock with anoriginal maturity of five years or more, including related surplus, in anamount up to 50% of Tier 1 capital. The inclusion of the foregoing elements ofTier 2 capital is subject to certain requirements and limitations of thefederal banking agencies.

 

The FDIC imposes a minimum leverage ratio of Tier I capital to averagetotal assets of 3% for the highest rated banks, and 4% for all otherbanks.  Institutions experiencing oranticipating significant growth or those with other than minimum risk profilesare expected to maintain capital at least 100-200 basis points above theminimum level.

 

In addition, the Federal Reserve Board and the FDIC have issued orproposed rules to take account of interest rate risk, concentration of creditrisk and the risks of nontraditional activities in calculating risk-basedcapital.

 

For capital adequacy purposes, deferred tax assets that can be realizedfrom taxes paid in prior carry-back years, and from the future reversal oftemporary differences, are generally unlimited.  However, deferred tax assets that can only be realized throughfuture taxable earnings, including the implementation of a tax planningstrategy, count toward regulatory capital purposes only up to the lesser of (i)the amount that can be realized within one year of the quarter-end report dateor (ii) 10% of Tier I capital.  Theamount of deferred taxes in excess of this limit, if any, would be deductedfrom Tier I capital and total assets in regulatory capital calculations.

 

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A banking organization’s risk-based capital ratios are obtained bydividing its qualifying capital by its total risk adjusted assets, including dollarequivalents for certain off-balance sheet assets.

 

Effective January 17, 1995, the federal banking agencies issued afinal rule relating to capital standards and the risks arising from theconcentration of credit and nontraditional activities.  Institutions which have significant amountsof their assets concentrated in high risk loans or nontraditional bankingactivities and who fail to adequately manage these risks, will be required toset aside capital in excess of the regulatory minimums.  The federal banking agencies have notimposed 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 the Company does not believethat the Bank’s assets and activities, as currently structured, would lead theFDIC to require additional capital under this rule.

 

In December 1993, the federal banking agencies issued aninteragency policy statement on the allowance for loan and lease losses (the“ALLL”) which calls for the maintenance of the ALLL at a level at least equalto the “estimated credit losses” in the bank’s loan portfolio.  “Estimated credit losses” are defined as “anestimate of the current amount of the loan and lease portfolio (net of unearnedincome) that is not likely to be collected; that is, net charge-offs that arelikely to be realized for a loan or pool of loans given facts and circumstancesas of the evaluation date.”   The policystatement also suggests that a test of reasonableness be applied to the ALLL,which test is satisfied if the ALLL equals or exceeds the sum of (a) assetsclassified loss; (b) 50% of assets classified doubtful; (c) 15% of assetsclassified substandard; and (d) estimated credit losses on other assets overthe upcoming twelve months.  The Bankbelieves that its ALLL exceeds the amounts that would be required under theterms of this policy statement and under such test of reasonableness.  However, this is a very subjective matter,and the Bank cannot assure that any bank examiner would agree with itsevaluation, or that losses ultimately incurred from the Bank’s portfolio wouldnot exceed the amounts so provided.

 

Future changes in regulations or practices could further reduce theamount of capital recognized for purposes of capital adequacy.  Such a change could affect the ability ofthe Bank to grow and could restrict the amount of profits, if any, availablefor the payment of dividends.

 

**Prompt Corrective Action and Other Enforcement Mechanisms**

 

Under Section 38 of the FDIA, as added by the Federal DepositInsurance Corporation Improvement Act of 1991 (“FDICIA”), each federal bankingagency is required to implement a system of prompt corrective action forinstitutions which it regulates.  Thefederal banking agencies have promulgated substantially similar regulations toimplement this system of prompt corrective action.  Under the regulations, an institution shall generally be deemedto be: (i) ”well capitalized” if it has a total risk-based capital ratioof 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more,has a Tier 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 totalrisk-based capital ratio of 8.0% or more, a Tier I risk-based capitalratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more(3.0% under certain circumstances) and does not meet the definition of “wellcapitalized;” (iii) ”undercapitalized” if it has a total risk-basedcapital ratio that is less than 8.0%, a Tier I risk-based capital ratio that isless than 4.0% or a Tier I leverage capital ratio that is less than

 

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4.0% (3.0% under certain circumstances); (iv) ”significantlyundercapitalized” if it has a total risk-based capital ratio that is less than6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier Ileverage capital ratio that is less than 3.0%; and (v) ”criticallyundercapitalized” if it has a ratio of tangible equity to total assets that isequal to or less than 2.0%.

 

Section 38 of the FDIA and the implementing regulations alsoprovide that a federal banking agency may, after notice and an opportunity fora hearing, reclassify a well capitalized institution as adequately capitalizedand may require an adequately capitalized institution or an undercapitalizedinstitution to comply with supervisory actions as if it were in the next lowercategory if the institution is in an unsafe or unsound condition or engaging inan unsafe or unsound practice.  (TheFDIC may not, however, reclassify a significantly undercapitalized institutionas critically undercapitalized.)

 

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

 

At December 31, 2003, the Bank met the tests to be categorized as“well capitalized” under the prompt corrective action regulations of the FDIC.

 

**Safety and Soundness Standards**

 

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

 

**Premiums for Deposit Insurance**

 

The FDIC adopted regulations implementing a risk-based premium systemrequired by federal law.  Under theregulations which cover the assessment periods commencing on and afterJanuary 1, 1994, insured depository institutions are required to payinsurance premiums within a range of $.23 cents per $100 of deposits to $.31cents per $100 of deposits depending on their risk classification.  The FDIC, effective September 30, 1995,lowered assessments from their

 

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rates of $.23 to $.31 per $100 of insured deposits to rates of $.04 to$.31, depending on the health of the bank, as a result of the re-capitalizationof the BIF.  The FDIC may alter theexisting assessment rate structure for deposit insurance and may change thebase assessment rate (currently, 4 to 31 basis points per year) by rulemakingwith notice and comment.  Without noticeor comment, the FDIC may increase or decrease the current rateschedule uniformly by as much as 5 basis points, as deemed necessary tomaintain the target designated reserve ratio 1.25 percent (fund balance toestimated insured deposits).  Theinsured deposit rates for 2003 were $.00 to $.27. These rates are projected tocontinue through the first half of 2004.

 

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

 

The FICO has assessment authority, separate from the FDIC’s authorityto assess risk-based premiums for deposit insurance, to collect funds fromFDIC-insured institutions sufficient to pay interest on FICO bonds.  The FDIC acts as collection agent for theFICO.  The Deposit Insurance Funds Actof 1996 (DIFA) authorized the FICO to asses both Bank Insurance Fund (BIF) andSavings Association Insurance Fund (SAIF) insured deposits, and required theBIF rate to equal one-fifth the SAIF rate through the year 1999, or until theinsurance funds are merged, whichever occurs first.  Thereafter, BIF and SAIF insured deposits will be assessed at thesame rate by FICO.

 

The FICO assessment rate is adjusted quarterly to reflect changes inthe assessment basis of the respective funds based on the quarterly Call Reportand the Thrift Financial Report submissions. The FICO quarterly rates for 2003 were 1.68, 1.62, 1.60 and 1.52.  The FICO quarterly rate for the firstquarter of 2004 is 1.54.

 

**Interstate Banking and Branching**

 

On September 29, 1994, the President signed into law theRiegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the“Interstate Act”).  Under the InterstateAct, beginning one year after the date of enactment, a bank holding companythat is adequately capitalized and managed may obtain regulatory approval toacquire an existing bank located in another state without regard to statelaw.  A bank holding company would notbe permitted to make such an acquisition if, upon consummation, it wouldcontrol (a) more than 10% of the total amount of deposits of insured depositoryinstitutions in the United States or (b) 30% or more of the deposits in thestate in which the bank is located.  Astate may limit the percentage of total deposits that may be held in that stateby any one bank or bank holding company if application  of such limitation does not discriminateagainst out-of-state banks.  Anout-of-state bank holding company may not acquire a state bank in existence forless than a minimum length of time that may be prescribed by state law exceptthat a state may not impose more than a five year existence requirement.

 

The Interstate Act also permits, beginning June 1, 1997, mergersof insured banks located in different states and conversion of the branches ofthe acquired bank into branches of the

 

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resulting bank.  Each state maypermit such combinations earlier than June 1, 1997, and may adoptlegislation to prohibit interstate mergers after that date in that state or inother states by that state’s banks.  Thesame concentration limits discussed in the preceding paragraph apply.  The Interstate Act also permits a nationalor state bank to establish branches in a state other than its home state ifpermitted by the laws of that state, subject to the same requirement and conditionsas for a merger transaction.

 

The Interstate Act is likely to increase competition in the Bank’smarket areas especially from larger financial institutions and their holdingcompanies.  It is difficult to asses theimpact such likely increased competition will have on the Bank’ operations.

 

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

 

**Community Reinvestment Act and Fair Lending Developments**

 

The Bank is subject to certain fair lending requirements, reportingobligations involving home mortgage lending operations and CommunityReinvestment 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 substantial penalties and corrective measures thatmay be required for a violation of certain fair lending laws, the federalbanking agencies may take compliance with such laws and CRA into account whenregulating and supervising other activities.

 

In May, 1995, the federal banking agencies issued final regulationswhich change the manner in which they measure a bank’s compliance with its CRAobligations.  The final regulationsadopt a performance-based evaluation system which bases CRA ratings on aninstitution’s actual lending service and investment performance rather than theextent to which the institution conducts needs assessments, documents communityoutreach or complies with other procedural requirements.  In March 1994, the Federal InteragencyTask Force on Fair Lending issued a policy statement on discrimination inlending.  The policy statement describesthe three methods that federal agencies will use to prove discrimination: overtevidence of discrimination, evidence of disparate treatment and evidence ofdisparate impact.  Management of theBank believes that the Bank is in substantial compliance with all requirementsunder these provisions.  Following theBank’s most recent CRA examination, the Bank’s rating was “satisfactory”.

 

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**Other Regulations and Policies**

 

The federal regulatory agencies have adopted regulations that implementSection 304 of FDICIA which requires federal banking agencies to adoptuniform regulations prescribing standards 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 the Federal Deposit Insurance Act (the “FDIA”), asamended by the FDICIA, generally limits the activities and equity investmentsof FDIC-insured, state-chartered banks to those that are permissible fornational 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 bank is not prohibitedfrom, among other things, (i) acquiring or retaining a majority interest in asubsidiary, (ii) investing as a limited partner in a partnership the solepurpose of which is direct or indirect investment in the acquisition,rehabilitation or new construction of a qualified housing project, providedthat such limited partnership investments may not exceed 2% of the bank’s totalassets, (iii) acquiring up to 10% of the voting stock of a company that solelyprovides or reinsures directors’, trustees’ and officers’ liability insurancecoverage or bankers’ blanket bond group insurance coverage for insureddepository institutions, and (iv) acquiring or retaining the voting shares of adepository institution if certain requirements are met.

 

FDIC regulations implementing Section 24 of the FDIA provide thatan insured state-chartered bank may not, directly, or indirectly through asubsidiary, engage as “principal” in any activity that is not permissible for anational bank unless the FDIC has determined that such activities would pose norisk to the insurance fund of which it is a member and the bank is incompliance with applicable regulatory capital requirements.  Any insured state-chartered bank directly orindirectly engaged in any activity that is not permitted for a national bankmust cease the impermissible activity.

 

**FinancialModernization Act**

 

Effective March 11, 2000, the Gramm-Leach-Bliley Act eliminatedmost barriers to affiliations among banks and securities firms, insurancecompanies, and other financial service providers, and enabled full affiliationsto 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 company may become afinancial holding company if each of its subsidiary banks is well capitalizedunder the prompt corrective action provisions discussed above, is well managed,and has at least a satisfactory rating under the Community Reinvestment Act byfiling a declaration that the bank holding company wishes to become a financialholding company.  No regulatory approvalwill be required for a financial holding company to acquire a company, otherthan a bank or savings association, engaged in activities that are financial innature or incidental to activities that are financial in nature, as determinedby the Federal Reserve Board.  The Bankhas no current intention of becoming a financial holding company, but may do soat some point in the future if deemed appropriate in view of opportunities orcircumstances at the time.

 

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The Gramm-Leach-Bliley Act defines “financial in nature” to includesecurities underwriting, dealing and market making; sponsoring mutual funds andinvestment companies; insurance underwriting and agency; merchant bankingactivities; and activities that the Federal Reserve Board has determined to beclosely related to banking.  A nationalbank (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, realestate development and real estate investment, through a financial subsidiaryof the bank, if the bank is well capitalized, well managed and has at least asatisfactory Community Reinvestment Act rating.  Subsidiary banks of a financial holding company or national bankswith financial subsidiaries must continue to be well capitalized and wellmanaged in order to continue to engage in activities that are financial innature without regulatory actions or restrictions, which could includedivestiture of the financial in nature subsidiary or subsidiaries.  In addition, a financial holding company ora bank may not acquire a company that is engaged in activities that arefinancial in nature unless each of the subsidiary banks of the financialholding company or the bank has a Community Reinvestment Act rating ofsatisfactory or better.

 

The Gramm-Leach-Bliley Act also imposes significant new requirements onfinancial institutions with respect to the privacy of customer information, andmodifies other existing laws, including those related to communityreinvestment.

 

**USA Patriot Act of2001**

 

On October 26, 2001, President Bush signed the USA Patriot Act of2001.  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 USA Patriot Act on financial institutions ofall kinds is significant and wide ranging. 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 the requirements under the USA Patriot Act during2001 and 2002.  Compliance with suchrequirements has all been accomplished with existing staff, so the financialimpact on the Bank has been negligible.

 

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**Regulatory Enforcement Powers**

 

Commercial banking organizations, such as the Bank, may be subject toenforcement actions by the FDIC and the Superintendent for engaging in unsafeor unsound practices in the conduct of their businesses or for violations ofany law, rule, regulation or any condition imposed in writing by the agency orany written agreement with the agency. 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 ofrestrictions and sanctions under the prompt corrective action provisions of theFDICIA.

 

# **Californiaand Federal Banking Law**

 

The Federal Change in Bank Control Act of 1978 prohibits a person orgroup of persons “acting in concert” from acquiring “control” of a bank orholding company unless the appropriate federal regulatory agency has been given60 days’ prior written notice of such proposed acquisition and, within thattime period, has not issued a notice disapproving the proposed acquisition or extendingfor up to another 30 days the period during which such a disapproval may beissued. An acquisition may be made prior to the expiration of the disapprovalperiod if the agency issues written notice of its intent not to disapprove theaction.  The acquisition of more than10% of a class of voting stock of a bank (or holding company) with a class ofsecurities registered under Section 12 of the Securities Exchange Act of1934, as amended (such as the Common Stock), is generally presumed, subject torebuttal. to constitute the acquisition of control.

 

Under the California Financial Code, no person shall, directly orindirectly, acquire control of a California licensed bank or a bank holdingcompany unless the Superintendent has approved such acquisition ofcontrol.  A person would be deemed tohave acquired 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 person who directly or indirectly owns orcontrols 10% or more of the Common Stock would be presumed to control theCorporation, subject to rebuttal.

 

In addition, any “company” would be required to obtain the approval ofthe Federal Reserve under the Bank Holding Company Act of 1956, as amended (the“BHC Act”), before acquiring 25% (5% in the case of an acquirer that is, or isdeemed to be, a bank holding company) or more of the outstanding Common Stockof, or such lesser number of shares as constitute control over, the Bank or theCorporation.

 

The Community Reinvestment Act of 1977 (“CRA”) and the relatedRegulations of the Comptroller of the Currency, the Board of Governors of theFederal Reserve and the Federal Deposit Insurance Corporation (“FDIC”) areintended to encourage regulated financial institutions to help meet the creditneeds of their local community or communities, including low and moderateincome neighborhoods, consistent with the safe and sound operation of suchfinancial institutions.  The CRA andsuch regulations provide that the appropriate regulatory

 

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authority will assess the records of regulated financial institutionsin satisfying their continuing and affirmative obligations to help meet thecredit needs of their local communities as part of their regulatory examinationof the institution.  The results of suchexaminations are made public and are taken into account upon the filing of anyapplication to establish a domestic branch, to merge or to acquire the assetsor assume the liabilities of a bank.  Inthe case of a bank holding company, the CRA performance record of thesubsidiary bank(s) involved in the transaction is reviewed in connection withthe filing of an application to acquire ownership or control of shares orassets of a bank or to merge with any other bank holding company.  An unsatisfactory record can substantiallydelay or block the transaction.

 

**RESEARCH**

 

Neither the Corporation nor the Bank makes any material expendituresfor research and development.

 

**DEPENDENCEUPON A SINGLE CUSTOMER**

 

Neither the Corporation nor the Bank is dependent upon a singlecustomer 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.  The local economy is affected by bothnational trends and by local factors. Tourism and the activities at the former Fort Ord military base areamong the major contributors to the local economy.

 

**ITEM 2. PROPERTIES**

 

The main office of the Bank, which also serves as the principal officeof the Corporation, is located at 601 Munras Ave., Monterey, California93940.  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 pavedparking are also on the premises.  Boththe land and all improvements thereto are owned by the Bank**.**  The Bank currently operates three branch offices inCarmel-By-The-Sea, Carmel Valley and Pacific Grove, California, all withinapproximately 10 miles from the Bank’s main office.  The land and improvements dedicated to the Carmel-By-The-Sea,Carmel Valley and Pacific Grove branch offices are leased.  See Footnote 13 to the Corporation’sfinancial statements included herewith.

 

Generally, neither the Bank nor the Corporation may invest in equityinterests in real estate, except for the direct use of the Bank or theCorporation 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. LEGALPROCEEDINGS**

 

None

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters were submitted to a vote of security holders during thefourth quarter.

 

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**PARTII**

 

**ITEM5. MARKET FOR THE CORPORATION’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.**

 

Neither the Corporation’s, which is held by approximately 550 persons,nor the Bank’s, stock has ever been actively traded.  To the Corporation’s knowledge no brokers have handled trades inthe Bank’s stock during the past four years, and there are no published“bid/asked” quotes for such stock or the stock of the Corporation.  During the same period, no broker acted as amarket maker for the Corporation or Bank’s Common Stock.  Accordingly, the market price data containedherein does not represent the value which would be assigned in an efficientmarket.  The Common Stock is not listedon any securities exchange or quoted on the National Association of SecuritiesDealers Automated System.

 

The Corporation repurchased 5,368 shares of common stock at $4.00 pershare in 2003, 774 at $3.00 in 2002, and 11,980 at prices ranging from $3.00 to$3.50 in 2001.

 

The following table sets forth, according to information known to theCorporation, the price paid per share in, and volume of, transactions in theBank’s stock during the quarters ended March 31, 2001 to December 31,2003.

 
| **Quarter/Year**     |   | **Price** |   | **Volume****(1)** |   |
|----------------------|--------|-----------|--------|-------------------|--------|
|                 |   |      |   |              |   |
| 1st quarter  of 2001 |   | 3.00      |   | 4,877             |   |
| 2nd quarter  of 2001 |   | 3.00      |   | 207               |   |
| 3rd quarter  of 2001 |   | 3.00-3.50 |   | 7,393             |   |
| 4th quarter  of 2001 |   | 3.00      |   | 1,841             |   |
|                 |   |      |   |              |   |
| 1st quarter  of 2002 |   | 3.00      |   | 33,561            |   |
| 2nd quarter  of 2002 |   | 3.00      |   | 7,728             |   |
| 3rd quarter  of 2002 |   | 3.00      |   | 1,306             |   |
| 4th quarter  of 2002 |   | 3.00      |   | 227               |   |
|                 |   |      |   |              |   |
| 1st quarter  of 2003 |   | 3.00      |   | 46                |   |
| 2nd quarter  of 2003 |   | 3.00-4.00 |   | 1,273             |   |
| 3rd quarter  of 2003 |   | 3.00-4.00 |   | 45,948            |   |
| 4th quarter  of 2003 |   | 3.00      |   | 504               |   |

 

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(1)          For the period presented, the informationindicated might not include information on shares which may have been tradeddirectly by shareholders or through dealers.

 

The principal source of cash flow of the Corporation, including cashflow to pay dividends on its stock or principal and interest on debt, isinterest and dividends on investments and tax payments and dividends from theBank.  There are statutory andregulatory limitations on

 

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the payment of dividends by the Bank to the Corporation, as well as bythe Corporation to its shareholders.

 

If in the opinion of the applicable federal and/or state regulatoryauthority, a depository institution or holding company is engaged in or isabout to engage in an unsafe or unsound practice (which, depending on thefinancial condition of the depository institution or holding company, couldinclude the payment of dividends), such authority may require, after notice andhear (except in the case of an emergency proceeding where there in no notice orhearing), that such institution or holding company cease and desist from suchpractice.  Moreover, the Federal Reserveand the FDIC have issued policy statements which provide that bank holdingcompanies and insured depository institutions generally should only paydividends out of current operating earnings.

 

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

 

The Bank’s payment of dividends, as a California chartered commercialbanking corporation, is regulated by the California Financial Code.  Under the California Financial Code, fundsavailable for cash dividend payments by the Bank are restricted to the lessorof: (i) retained earnings; or (ii) the Bank’s net income for its last threefiscal years (less any distributions to the stockholders made during suchperiod).  As of December 31, 2003the Bank had $3,613,600 in retained earnings. The Bank’s net income for the last three fiscal years less distributionsto stockholders was $1,899,800.

 

In December 2003 the Corporation paid a $0.15 per share cashdividend and ten (10) percent stock dividends in 2002 and 2001.  The Bank paid cash dividends totaling $50,000,$75,000 and $200,000 to the Corporation during 2003, 2002 and 2001,respectively.

 

**Recent Sales ofUnregistered Securities**

 

The following information relates to securities of the Company or itssubsidiaries issued or sold within the past three years, which were notregistered under the Securities Act of 1933, as amended (the “Securities Act”):

 

On March 27, 2003, the Company’s wholly owned special-purposetrust subsidiary, Northern California Bancorp, Inc. Trust I (the “Trust”)issued $3,000,000 of principal amount of Floating Rate TRUPSâ(Capital Trust Pass-through Securities) (the “Trust PreferredSecurities”).  Bear Stearns & Co.acted as placement agent in connection with the offering of the Trust PreferredSecurities with aggregate commission of approximately $90,000 paid to BearStearns & Co. by Northern California Bancorp, Inc. Trust I in connectionwith such placement services.  Thesecurities bear a floating rate of interest of 3.25% over the three month LIBORrate(1.15% + 3.250% = 4.40% at December 31, 2003, payable quarterly.  Concurrent with the issuance of the TrustPreferred Securities, the Trust used the proceeds from the Trust PreferredSecurities offering to purchase a like amount of Junior Subordinated Debenturesof the Company.  The SubordinatedDebentures are the sole assets of the Trust and are eliminated, along with therelated income statement effects, in the consolidated financialstatements.  The

 

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Company will pay interest on the Junior Subordinated Debentures to theTrust, which represents the sole revenue and sole source of dividenddistributions to the holders of the Trust Preferred Securities.  The Company has the right, assuming no defaulthas occurred, to defer payments of interest on the Junior SubordinatedDebentures at any time for a period not to exceed 20 consecutive quarters.  The Trust Preferred Securities will matureon April 7, 2033, but can be redeemed under certain circumstances at apremium prior to April 7, 2008, and can be redeemed, in whole or in part,on any January 7, April 7, July 7 or October 7 on or afterApril 7, 2008 at par.  The Companyfully and unconditionally guarantees the obligations of the Trust, on asubordinated basis.  The Company received $2.91 million from theTrust upon issuance of the Junior Subordinated Debentures, of which $1 millionwas contributed by the Company to the Bank to increase its capital, $1.14million was used to retire existing Company debt and the remainder held asworking capital.  TheSubordinated Debt Securities were not registered under the Securities Act inreliance on the exemption set forth in Section 4(2) thereof.

 

The sale of the Trust Preferred Securities was part of a largertransaction arranged by Bear Stearns & Co., Inc. pursuant to which theTrust Preferred Securities were deposited into a special purpose vehicle alongwith similar securities issued by a number of other banks and the specialpurpose vehicle then issued its securities to the public (the “Pooled TRUPSâ“).  The Pooled TRUPSâwere sold by Bear Stearns & Co., Inc. only (i) to those entities BearStearns & Co., Inc. reasonably believed were qualified institutional buyers(as defined in Rule 144A under the Securities Act), (ii) to “accreditedinvestors” (as defined in Rule 501(a)(1), (2), (3) or (7) or Regulation Dpromulgated under the Securities Act) or (iii) in offshore transactions incompliance with Rule 903 of Regulation S under the Securities Act.  The Trust Preferred Securities were notregistered under the Securities Act in reliance on exemptions set forth in Rule144A, Regulation D and Regulation S, as applicable.

 

On November 13, 2003, the Company’swholly owned special-purpose trust subsidiary, Northern California Bancorp,Inc. Trust II (the “Trust”) issued $5,000,000 of principal amountof Floating Rate TRUPSâ (Capital TrustPass-through Securities) (the “Trust Preferred Securities”).  CitigroupGlobal Markets, Inc. acted as placement agent in connection with the offeringof the Trust Preferred Securities with aggregate commission of approximately$40,000 paid to Citigroup Global Markets, Inc. by Northern California Bancorp,Inc. Trust I in connection with such placement services.  Thesecurities bear a floating rate of interest of 2.85% over the three month LIBORrate (1.17% + 2.85% = 4.02% at December 31, 2003), payable quarterly.  Concurrent with the issuance of the TrustPreferred Securities, the Trust used the proceeds from the Trust PreferredSecurities offering to purchase a like amount of Junior Subordinated Debenturesof the Company.  The SubordinatedDebentures are the sole assets of the Trust and are eliminated, along with therelated income statement effects, in the consolidated financial statements.  The Company will pay interest on the JuniorSubordinated Debentures to the Trust, which represents the sole revenue andsole source of dividend distributions to the holders of the Trust PreferredSecurities.  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 PreferredSecurities will mature on November 8, 2033, but can be redeemed undercertain circumstances at a premium prior to August 8, 2008, and can beredeemed, in whole or in part, on any February 8, May 8, August 8 orNovember 8 on or after August 8, 2008 at par.  The Company fully and unconditionallyguarantees the obligations of the Trust, on a subordinated basis.  The Company received $4.96 million from theTrust upon issuance of the Junior Subordinated Debentures, of which $2.5million was

 

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contributed by the Company to the Bank toincrease its capital and the remainder held as working capital.

 

The sale of the Trust Preferred Securities was part of a largertransaction arranged by Citigroup Global Markets, Inc., Inc. pursuant to whichthe Trust Preferred Securities were deposited into a special purpose vehiclealong with similar securities issued by a number of other banks and the specialpurpose vehicle then issued its securities to the public (the “Pooled TRUPSâ”).  The Pooled TRUPSâwere sold by Citigroup Global Markets, Inc., Inc. only (i) to those entitiesCitigroup Global Markets, Inc., Inc. reasonably believed were qualifiedinstitutional buyers (as defined in Rule 144A under the Securities Act), (ii)to “accredited investors” (as defined in Rule 501(a)(1), (2), (3) or (7) orRegulation D promulgated under the Securities Act) or (iii) in offshoretransactions in compliance with Rule 903 of Regulation S under the SecuritiesAct.  The Trust Preferred Securitieswere not registered under the Securities Act in reliance on exemptions setforth in Rule 144A, Regulation D and Regulation S, as applicable.

 

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

** **

**OVERVIEW**

 

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

 

Net income for each of the last three years was $839,800 in 2003,$508,600 in 2002, and $360,500 in 2001. The primary net income per share for each of the last three years was$.55, $.34, and $.27 respectively.  Thediluted net income per share for the same time periods were $.47 $.29 and $.23,respectively.  Return on averageshareholders’ equity was 13.84%, 10.49% and 7.87% in 2003, 2002 and 2001,respectively.  Return on average assetswas 0.88%, 0.63%, and 0.48% in 2003, 2002 and 2001, respectively.

 

The increase in earnings in 2003 was due to increases of $658,800 innet interest income after provision for loan losses and $622,300 in otherincome; partially offset by increases of $645,400 in other expense and $304,500in income tax expense.

 

The increase in earnings in 2002 was due to increases of $106,300 innet interest income after provision for loan losses and $285,300 in otherincome; partially offset by increases of $120,800 in operating expense and$122,700 in income tax expense.

 

The decrease in earnings in 2001 was due to net interest income afterprovision for loan losses decreasing $232,800, other income increased $50,400,operating expenses increased $324,000 and income tax expense decreased$130,600.  Net income was significantlyimpacted as the result of realized losses on securities transactions anddeclines in the market value of the trading asset.  Realized losses on securities transactions were $27,800 while themark to market of the trading asset resulted in a charge to earnings of$199,400.

 

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The following table provides a summary of the income statement, balancesheet, and selected ratios for the last five years.  A more detailed analysis of each component of net income isincluded under the appropriate captions, which follows.

 
|                                               |   | **As of and  for the years Ended December 31,** |   |
|----------------------------------------------------|--------|------------------------------------------------------|--------|
|                                               |   | **2003**                                             |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                               |   | **(Dollars  in thousands except per share data)**    |   |
| Summary of Operating Results:                      |   |                                                 |   |   |   |   |   |   |   |   |   |
| Total interest income                              |   | 5,569                                                |   | 4,900 |   | 5,440 |   | 5,501 |   | 4,296 |   |
| Total interest expense                             |   | 1,920                                                |   | 1,948 |   | 2,526 |   | 2,410 |   | 1,788 |   |
| Net interest income                                |   | 3,649                                                |   | 2,952 |   | 2,914 |   | 3,092 |   | 2,508 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Provision for possible loan losses                 |   | 155                                                  |   | 117 |   | 185 |   | 130 |   | 174 |   |
| Net interest income after provision for  loan loss |   | 3,494                                                |   | 2,835 |   | 2,729 |   | 2,962 |   | 2,333 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Total other income                                 |   | 4,359                                                |   | 1,781 |   | 1,496 |   | 1,445 |   | 1,254 |   |
| Total other expense                                |   | 6,354                                                |   | 3,754 |   | 3,633 |   | 3,309 |   | 2,986 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Income (loss) before taxes                         |   | 1,498                                                |   | 863 |   | 592 |   | 1,098 |   | 601 |   |
| Provision for income tax                           |   | 659                                                  |   | 354 |   | 231 |   | 362 |   | 147 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                  |   | 840                                                  |   | 509 |   | 361 |   | 736 |   | 454 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Per Common Share Data:                             |   |                                                 |   |   |   |   |   |   |   |   |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Basic Earnings                                     |   |                                                 |   |   |   |   |   |   |   |   |   |
| Income before extraordinary item (1)               |   | 0.55                                                 |   | 0.34 |   | 0.27 |   | 0.50 |   | 0.32 |   |
| Extraordinary Item (1)                             |   | —                                               |   | — |   | — |   | — |   | — |   |
| Net Income (1)                                     |   | 0.55                                                 |   | 0.34 |   | 0.27 |   | 0.50 |   | 0.32 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Diluted Earnings                                   |   |                                                 |   |   |   |   |   |   |   |   |   |
| Income before extraordinary item (2)               |   | 0.47                                                 |   | 0.29 |   | 0.23 |   | 0.44 |   | 0.27 |   |
| Extraordinary Item (2)                             |   | —                                               |   | — |   | — |   | — |   | — |   |
| Net Income (2)                                     |   | 0.47                                                 |   | 0.29 |   | 0.23 |   | 0.44 |   | 0.27 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Book value, end of period                          |   | 4.09                                                 |   | 3.77 |   | 3.48 |   | 3.29 |   | 2.70 |   |
| Avg shares outstanding (3)                         |   | 1,528,268                                            |   | 1,483,493 |   | 1,469,489 |   | 1,479,520 |   | 1,422,287 |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Balance Sheet Data:                                |   |                                                 |   |   |   |   |   |   |   |   |   |
|                                               |   |                                                 |   |   |   |   |   |   |   |   |   |
| Total loans, net of unearned income (4)            |   | 76,908                                               |   | 60,257 |   | 52,562 |   | 43,251 |   | 39,217 |   |
| Total assets                                       |   | 107,872                                              |   | 86,279 |   | 79,735 |   | 83,872 |   | 65,214 |   |
| Total deposits                                     |   | 78,132                                               |   | 67,616 |   | 68,332 |   | 72,218 |   | 55,563 |   |
| Stockholders’ equity                          |   | 6,411                                                |   | 5,639 |   | 5,087 |   | 4,861 |   | 3,993 |   |

 

23

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|                                                 |   | **As of and  for the Years Ended December 31,** |   |
|------------------------------------------------------|--------|------------------------------------------------------|--------|
|                                                 |   | **2003**                                             |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| Selected Financial Ratios (5):                       |   |                                                 |   |   |   |   |   |   |   |   |   |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Return on average assets                             |   | 0.88                                                 | %      | 0.63 | % | 0.48 | % | 1.06 | % | 0.80 | % |
| Return on average stockholders’ equity          |   | 13.84                                                | %      | 10.49 | % | 7.87 | % | 16.95 | % | 12.37 | % |
| Net interest spread                                  |   | 3.92                                                 | %      | 3.22 | % | 3.57 | % | 4.73 | % | 3.88 | % |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Net interest margin                                  |   | 4.30                                                 | %      | 3.88 | % | 4.37 | % | 5.59 | % | 4.60 | % |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Avg shareholders’ equity to average assets      |   | 6.35                                                 | %      | 5.99 | % | 6.09 | % | 6.23 | % | 6.48 | % |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Primary capital to assets at end of period           |   | 6.72                                                 | %      | 7.22 | % | 6.73 | % | 6.32 | % | 6.70 | % |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Total loans to total deposits at end of  period      |   | 99.42                                                | %      | 89.12 | % | 76.92 | % | 59.88 | % | 70.58 | % |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Allowance to total loans at end of period            |   | 1.00                                                 | %      | 1.04 | % | 1.06 | % | 1.05 | % | 1.01 | % |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Nonperforming loans to total loans at end  of period |   | 0.04                                                 | %      | 0.06 | % | 0.70 | % | 0.03 | % | 0.48 | % |
|                                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Net charge-offs to average loans                     |   | 0.03                                                 | %      | 0.18 | % | 0.18 | % | 0.15 | % | 0.32 | % |

 

----

(1)          Primary earnings (loss) per share amountswere computed on the basis of the weighted average number of shares of commonstock during the year.  The weightedaverage number of shares used for this computation was 1,528,268 for 2003,1,483,493 for 2002, 1,469,489 for 2001, 1,479,520 for 2000 and 1,422,287 for1999.

 

(2)          Fully diluted earnings (loss) per shareamounts were computed on the basis of the weighted average number of shares ofcommon stock and common stock equivalents outstanding during the year.  Common stock equivalents include employeestock options.  The weighted averagenumber of shares used for this computation was 1,796,859, 1,744,082, 1,701,827,1,705,258 and 1,702,585 in 2003, 2002, 2001, 2000 and 1999, respectively.

 

(3)          Weighted average common shares.

 

(4)          Includes loans being held for sale.

 

(5)          Averages are of daily balances.

 

24

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**NETINTEREST INCOME**

 

Net interest income, the difference between (a) interest and feesearned on interest-earning assets and (b) interest paid on interest-bearingliabilities, is the most significant component of the Bank’s earnings.  Changes in net interest income from periodto period result from increases or decreases in the average balances ofinterest earning assets portfolio, the availability of particular sources offunds and changes in prevailing interest rates.

 

The following table summarizes the Corporation’s net interest income.  Yields are computed on a tax-equivalentbasis, no tax-exempt securities were held during the years endedDecember 31, 2003 or 2002.

 
|                |   | **Years  Ended  December 31,** |   | **Increase  (Decrease)  From Prior Year** |   |
|---------------------|--------|-------------------------------------|--------|-------------------------------------------|--------|
|                |   | **2003**                            |   | **2002**                                  |   | **2001** |   | **2003/2002** |   | **2002/2001** |   |
|                |   |                                |   |                                      |   |   |   | **Amt** |   | **%** |   | **Amt** |   | **%** |   |
|                |   | **(Dollars  in thousands)**         |   |
| Interest Income     |   | 5,569                               |   | 4,900                                     |   | 5,440 |   | 669 |   | 13.65 |   | (540 | ) | (9.92 | ) |
| Interest Expense    |   | 1,920                               |   | 1,948                                     |   | 2,526 |   | (28 | ) | (1.42 | ) | (578 | ) | (22.88 | ) |
| Net Interest Income |   | 3,649                               |   | 2,952                                     |   | 2,914 |   | 697 |   | 23.61 |   | 38 |   | 1.31 |   |

 

Net interest income increased $696,800 (23.61%) from 2002 to 2003.  Average interest bearing assets increased12.52%, while the average rate earned increased 7 basis points, resulting in anincrease of $669,600 in total interest income. Interest expense decreased $27,200 the result of a 20.95% increase inaverage interest bearing liabilities and a decrease of 60 basis points in theaverage rate paid.

 

Net interest income increased $38,300 (1.31%) from 2001 to 2002.  Average interest bearing assets increased6.76%, while the average rate earned decreased 165 basis points, resulting in adecrease of $539,700 in total interest income. Interest expense decreased $578,000 the result of an 8.13% increase inaverage interest bearing liabilities and a decrease of 133 basis points in theaverage rate paid.

 

The following table shows the components of net interest income,setting forth, for each of the three years ended December 31, 2003, 2002and 2001 (i) average assets, liabilities and investments, (ii) interest incomeearned on interest-earning assets and interest expense paid on interest-bearingliabilities, (iii) average yields earned on interest-earning assets and averagerates paid on interest-bearing liabilities, (iv) the net interest spread (i.e.,the average yield earned on interest-earning assets less the average rate paidon interest-bearing liabilities) and (v) the net interest yield on averageinterest-earning assets (i. e., net interest income divided by averageinterest-earning assets).  Yields arecomputed on a tax-equivalent basis, resulting in adjustments to interest earnedon non-taxable securities of $8,500 in 2001, not tax-exempt securities wereheld in 2003 or 2002.  Non-accrual loansand overdrafts are included in average loan balances.  Average loans are presented net of unearned income.

 

25

----

 

**INTERESTSPREAD ANALYSIS:**

 
|                                     |   | **2003**                    |   | **2002**            |   | **2001**         |   |
|------------------------------------------|--------|-----------------------------|--------|---------------------|--------|------------------|--------|
|                                     |   | **Avg  Bal**                |   | **Int  Earn  Paid** |   | **Avg  %  Rate** |   | **Avg  Bal** |   | **Int  Earn  Paid** |   | **Avg  %  Rate** |   | **Avg  Bal** |   | **Int  Earn  Paid** |   | **Avg  %  Rate** |   |
|                                     |   | **(Dollars  in thousands)** |   |
| Interest Earning Assets:                 |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits at other banks |   | 0                           |   | 0                   |   | 0.00             |   | 88 |   | 3 |   | 3.30 |   | 178 |   | 12 |   | 6.99 |   |
| Invest securities - Taxable              |   | 8,113                       |   | 299                 |   | 3.69             |   | 11,593 |   | 417 |   | 3.60 |   | 7,444 |   | 469 |   | 6.30 |   |
| Invest securities - Non-Taxable          |   | —                      |   | —              |   | —           |   | — |   | — |   | — |   | 377 |   | 25 |   | 6.65 |   |
| Federal funds sold                       |   | 8,891                       |   | 97                  |   | 1.09             |   | 7,063 |   | 115 |   | 1.63 |   | 10,310 |   | 363 |   | 3.52 |   |
|                                     |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total investments                        |   | 17,004                      |   | 396                 |   | 2.33             |   | 18,744 |   | 535 |   | 2.85 |   | 18,308 |   | 870 |   | 4.75 |   |
|                                     |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                    |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Construction                             |   | 3,847                       |   | 369                 |   | 9.59             |   | 2,753 |   | 272 |   | 9.86 |   | 2,209 |   | 227 |   | 10.29 |   |
| Real estate                              |   | 47,264                      |   | 3,585               |   | 7.59             |   | 37,729 |   | 2,846 |   | 7.54 |   | 31,258 |   | 2,805 |   | 8.97 |   |
| Installment                              |   | 494                         |   | 38                  |   | 7.62             |   | 681 |   | 66 |   | 9.62 |   | 767 |   | 90 |   | 11.67 |   |
| Commercial                               |   | 16,344                      |   | 1,182               |   | 7.23             |   | 15,595 |   | 1,183 |   | 7.58 |   | 14,335 |   | 1,454 |   | 10.15 |   |
|                                     |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total loans                              |   | 67,949                      |   | 5,173               |   | 7.61             |   | 56,758 |   | 4,365 |   | 7.69 |   | 48,570 |   | 4,576 |   | 9.42 |   |
|                                     |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Interest earning assets            |   | 84,953                      |   | 5,569               |   | 6.56             |   | 75,502 |   | 4,900 |   | 6.49 |   | 66,878 |   | 5,446 |   | 8.14 |   |
|                                     |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Bearing Liabilities:            |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Int-bearing demand                       |   | 10,892                      |   | 27                  |   | 0.25             |   | 10,960 |   | 73 |   | 0.67 |   | 9,422 |   | 93 |   | 0.99 |   |
| Money market savings                     |   | 2,592                       |   | 22                  |   | 0.86             |   | 2,021 |   | 21 |   | 1.04 |   | 1,328 |   | 22 |   | 1.66 |   |
| Savings deposits                         |   | 6,011                       |   | 62                  |   | 1.03             |   | 4,200 |   | 54 |   | 1.29 |   | 3,885 |   | 71 |   | 1.82 |   |
| Time deposits >$100M                  |   | 16,378                      |   | 511                 |   | 3.12             |   | 16,059 |   | 600 |   | 3.74 |   | 15,216 |   | 833 |   | 5.47 |   |
| Time deposits <$100M                  |   | 20,074                      |   | 618                 |   | 3.08             |   | 20,383 |   | 825 |   | 4.05 |   | 20,263 |   | 1,126 |   | 5.56 |   |
| Other Borrowing                          |   | 16,781                      |   | 680                 |   | 4.05             |   | 6,510 |   | 374 |   | 5.74 |   | 5,146 |   | 381 |   | 7.41 |   |
| Total interest bearing liabilities       |   | 72,729                      |   | 1,920               |   | 2.64             |   | 60,134 |   | 1,948 |   | 3.24 |   | 55,260 |   | 2,526 |   | 4.57 |   |
|                                     |   |                        |   |                |   |             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                      |   |                        |   | 3,649               |   |             |   |   |   | 2,952 |   |   |   |   |   | 2,920 |   |   |   |
| Net interest spread                      |   |                        |   |                |   | 3.92             |   |   |   |   |   | 3.25 |   |   |   |   |   | 3.57 |   |
| Net yield on interest earning assets     |   |                        |   |                |   | 4.30             |   |   |   |   |   | 3.91 |   |   |   |   |   | 4.37 |   |

 

26

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|                                |   | **2003 vs  2002  Increase(Decrease)  Due to changes** |   | **2002 vs  2001  Increase(Decrease)  Due to Changes** |   |
|-------------------------------------|--------|-------------------------------------------------------|--------|-------------------------------------------------------|--------|
|                                |   | **Avg  Volume**                                       |   | **Avg  Rate**                                         |   | **Total** |   | **Avg  Volume** |   | **Avg  Rate** |   | **Total** |   |
|                                |   | **(Dollars  in thousands)**                           |   |
| Interest Earning Assets:            |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Int-bearing deposits at other banks |   | (3                                                    | )      | 0                                                     |   | (3 | ) | (6 | ) | (3 | ) | (9 | ) |
| Invest securities - Taxable         |   | (126                                                  | )      | 8                                                     |   | (118 | ) | 261 |   | (314 | ) | (52 | ) |
| Invest securities - Non-Taxable     |   | 0                                                     |   | 0                                                     |   | 0 |   | (25 | ) | 0 |   | (25 | ) |
| Federal funds sold                  |   | 30                                                    |   | (48                                                   | )      | (18 | ) | (114 | ) | (134 | ) | (249 | ) |
|                                |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Total investments                   |   | (99                                                   | )      | (40                                                   | )      | (139 | ) | 116 |   | (451 | ) | (335 | ) |
|                                |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Loans                               |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Construction                        |   | 108                                                   |   | (11                                                   | )      | 97 |   | 56 |   | (12 | ) | 44 |   |
| Real estate                         |   | 719                                                   |   | 20                                                    |   | 740 |   | 581 |   | (540 | ) | 41 |   |
| Installment                         |   | (18                                                   | )      | (10                                                   | )      | (28 | ) | (10 | ) | (14 | ) | (24 | ) |
| Commercial                          |   | 57                                                    |   | (58                                                   | )      | (1 | ) | 128 |   | (400 | ) | (272 | ) |
|                                |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Total loans                         |   | 866                                                   |   | (58                                                   | )      | 808 |   | 754 |   | (965 | ) | (211 | ) |
|                                |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Total Interest Earning Assets       |   | 767                                                   |   | (98                                                   | )      | 669 |   | 870 |   | (1,416 | ) | (546 | ) |
|                                |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Interest Bearing Deposits:          |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
|                                |   |                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Int-bearing demand                  |   | (0                                                    | )      | (46                                                   | )      | (47 | ) | 15 |   | (35 | ) | (20 | ) |
| Money market savings                |   | 6                                                     |   | (5                                                    | )      | 1 |   | 11 |   | (13 | ) | (1 | ) |
| Savings deposits                    |   | 23                                                    |   | (16                                                   | )      | 8 |   | 6 |   | (22 | ) | (16 | ) |
| Time deposits >$100M             |   | 12                                                    |   | (102                                                  | )      | (90 | ) | 46 |   | (279 | ) | (233 | ) |
| Time deposits <$100M             |   | (12                                                   | )      | (194                                                  | )      | (207 | ) | 7 |   | (308 | ) | (301 | ) |
| Other Borrowing                     |   | 590                                                   |   | (283                                                  | )      | 307 |   | 101 |   | (108 | ) | (7 | ) |
| Total interest bearing deposits     |   | 618                                                   |   | (645                                                  | )      | (27 | ) | 186 |   | (764 | ) | (578 | ) |
| Net change in net interest          |   | 149                                                   |   | 547                                                   |   | 696 |   | 684 |   | (652 | ) | 32 |   |

 

27

----

 

**Provisionand Allowance for Loan Losses**

 

The provision for loan losses is an expense charged against operatingincome and added to the allowance for loan losses.  The allowance for loan losses represents amounts which have beenset aside for the specific purpose of absorbing losses which may occur in theBank’s loan portfolio.

 

The allowance for loan losses reflects management’s ongoing evaluationof the risks inherent in the loan portfolio both generally and with respect tospecific loans, the state of the economy, and the level of net loan lossesexperienced in the past.  Management andthe Board of Directors review the results of the State Banking Department andFDIC 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 currentpractice, which could change in accordance with the factors mentioned above, tomaintain an allowance which is at least equal to the sum of the followingpercentage 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                         |   | 2.00          | %      |
| Commercial                                   |   | 2.00          | %      |
| SBA Loans - Unguaranteed portion             |   | 2.00          | %      |
| Unfunded Loan Commitments                    |   | .25           | %      |
| Concentration Risk Factor – Real Estate |   | .10           | %      |
| Economic Risk Factor                         |   | .20           | %      |
| SBA Loans - Guaranteed portion               |   | 0.00          | %      |
| Cash Secured Loans                           |   | 0.00          | %      |

 

Although no assurance can be given that actual losses will not exceedthe amount provided for in the allowance, Management believes that theallowance is adequate to provide for all estimated credit losses in light ofall known relevant factors.  At the endof 2003, 2002 and 2001, the Bank’s allowance stood at 1.00 percent, 1.04 percent,and 1.06 percent of gross loans, respectively. Provisions were made to the allowance for loan losses in 2003, 2002 and2001 of $155,000, $117,000, and $185,000, respectively.  Loans charged off totaled $18,400 in 2003,$59,700 in 2002, and $88,900 in 2001. Recoveries for these same periods were $1,300, $13,300, and $1,700.

 

28

----

 

The Bank’s non-performing (delinquent 90 days or more and non-accrual)loans as a percentage of total loans were 0.04 percent 0.06 percent and 0.70percent as of the end of 2003, 2002 and 2001, respectively.

 

Based upon statistics released by Federal and state banking authoritiesregarding banks of similar size or otherwise located in California, Managementbelieves that the Bank’s ratios of delinquent and non performing loans to totalloans are far better than average. Prudent collection efforts, and tighter lending controls, areresponsible for the Bank’s strong performance on these measures of creditquality.  However, no assurance can begiven that the Bank’s loan portfolio will continue to measure well against itspeers on these ratios and quality measures, or that losses will not otherwiseoccur in the future.

 

**Non-Interest Income**

 

The following table presents a summary of theBank’s non-interest income:

 
|                                          |   | **Years  Ended December 31,** |   |
|-----------------------------------------------|--------|------------------------------------|--------|
|                                          |   | **2003**                           |   | **2002** |   | **2001** |   |
|                                          |   | **(Dollars  in thousands)**        |   |
| Service charges on deposit accounts           |   | 505                                |   | 508 |   | 494 |   |
| Other service charges, commissions and fees   |   | 1,237                              |   | 747 |   | 489 |   |
| Income from sales and servicing of SBA  loans |   | 661                                |   | 526 |   | 513 |   |
|                                          |   |                               |   |   |   |   |   |
| Total non-interest Income                     |   | 2,403                              |   | 1,781 |   | 1,496 |   |

 

Total non-interest income increased $598,200 (33.14%) in 2003 whencompared with 2002. Other income increased $466,200, income from sales andservicing of SBA loans increased $134,600; while service charges on depositaccounts decreased $2,600.  The increasein other income was due primarily to increases of $348,000 in commercialbanking origination fees and $48,700 in net income from merchant credit cardprocessing.

 

Total non-interest income increased $285,300 (20.69%) in 2002 whencompared with 2001. Service charges on deposit accounts increased $14,100,income from sales and servicing of SBA loans increased $13,300 and otherservice charges, commissions and fees increased $257,900.

 

Total non-interest income increased $50,400 (3.48%) in 2001 whencompared with 2000. Service charges on deposit accounts increased $76,000,income from sales and servicing of SBA loans increased $118,700; while otherservice charges, commissions and fees decreased $80,400.  Merchant credit card processing incomeincreased by $64,400 during 2001 compared to 2000.

 

The sale of Small Business Administration (SBA) guaranteed loans is asignificant contributor to the Bank’s income. SBA guaranteed loans yield up to 3 3/4% over the New York prime rate,and the guaranteed portions can be sold at premiums which vary with market

 

29

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conditions.  SBA loans areguaranteed by the full faith of the United States Government from 70 to 80percent of the principal amount.  Theguaranteed portion has risks comparable for an investor to a U. S. Governmentsecurity and can usually be sold in the secondary financial market, either at apremium or at a yield which allows the Bank to maintain a significant spreadfor itself.

 

There can be no assurance that the gains on sale will continue at, orabove, the levels realized in the past three years.  The Small Business Administration has recently decreased themaximum loan amount from $2,000,000 to $750,000, and proposed increasing theguarantee fees.  The reduction in themaximum loan amount will have an impact on the Bank’s income, although it isdifficult to project what the impact will be on 2004 income.  In addition, increasing competition amonglenders for qualified SBA borrowers makes it difficult for the Bank tocontinually expand its program in this area, and may limit the level of premiumthat can be earned with regard thereto.

 

The following table presents a summary of the activity in SBA loans forthe years ended 2003, 2002 and 2001:

 
|                 |   | **2003** |      | **2002** |   | **2001**  |   |
|----------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                 |   |     |      |     |   |      |   |
| SBA loans authorized |   | $        | 8,882,900 |     | $      | 5,916,900 |   | $ | 5,141,000 |   |
| SBA loans sold       |   | $        | 4,994,100 |     | $      | 4,689,300 |   | $ | 5,264,300 |   |

 

Summary of Income from sales and Servicing ofSBA Loans

 
|                                                |   | **2003** |    | **2002** |   | **2001** |   |
|-----------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Income from premium                                 |   | $        | 440,000 |     | $      | 332,800  |   | $ | 363,800 |   |
| Income from servicing                               |   | 220,600  |    | 193,200  |   | 148,900  |   |
| Total income from sales and servicing of  SBA loans |   | $        | 660,600 |     | $      | 526,000  |   | $ | 512,700 |   |

 

30

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**Non-Interest Expense**

 

The following table presents a summary of the Bank’s other non-interestexpense:

 

 
|                            |   | **Years  Ended December 31,** |   |
|---------------------------------|--------|------------------------------------|--------|
|                            |   | **2003**                           |   | **2002** |   | **2001** |   |
|                            |   | **(Dollars  in thousands)**        |   |
| Salaries and benefits           |   | 2,566                              |   | 2,201 |   | 2,153 |   |
| Occupancy and equipment expense |   | 511                                |   | 372 |   | 326 |   |
| Professional fees               |   | 89                                 |   | 84 |   | 107 |   |
| Data processing                 |   | 357                                |   | 364 |   | 244 |   |
| Other expenses                  |   | 876                                |   | 733 |   | 803 |   |
| Total other expenses            |   | 4,399                              |   | 3,754 |   | 3,633 |   |

 

Salary and benefits expense increased $365,500 in 2003 as a result ofthe first full year of salary expense related to the Carmel-by-the Sea branchoffice, the hiring of an Executive Vice President/Chief Lending Officer duringthe fourth quarter, merit increases and bonus payments.  Salary expense increased $47,000 in 2002 asthe result of adding a business development officer and three full timeequivalent positions to staff the new Carmel-By-The-Sea Branch that opened inNovember 2002; these increased were partially offset by not replacing thePresident when he left the Bank in February. Salary expense increased $226,800in 2001 as a result of the addition of an individual as President, employeemerit increases and bonus payments.

 

Occupancy and equipment expenses increased $138,400 in 2003, withsignificant increases of $65,700 in premises rent net of sublease income,$46,100 in depreciation, $9,200 in repairs and maintenance expense, $3,800 inproperty taxes and $3,300 in merchant terminal.  Occupancy and equipment expenses increased $46,000 in 2002, dueprimarily to expenses related to opening the Carmel-By-The-Sea Branch.  Occupancy and equipment expenses increased$21,900 in 2001, with increases of $15,100 in rent expense, $4,000 indepreciation, property taxes $17,600 while utilities decreased $3,700 andrepair and maintenance decreased $10,000. Occupancy and equipment expenses increased $7,300 in 2000 due toadditional premises rental expense.

 

Data processing expense decreased $6,900 in 2003.  Data processing expense increased $120,100in 2002 due to expense associated with the development of an internet website,software license fees for an information management reporting program andincreased numbers of accounts and transaction activity.  Data processing expense decreased $5,200 in2001.

 

In 2003 professional fees increased $4,900 due to accounting feesincreasing $8,500 while legal fees decreased $3,600.  In 2002 professional fees decreased $22,400 with accounting feesincreasing $7,100, while legal fees decreased $29,600.  In 2001 professional fees increased $15,600with accounting and audit fees increasing $2,300 and legal fees increasing$13,300.

 

Other expenses for 2003 totaled $876,100 compared with $732,600 for2002, an increase of $143,500.  Significantchanges occurred in the following categories with in increases operationallosses $68,000, insurance $20,400, advertising $13,300, FDIC & Stateassessments $10,400, bank fees $10,100, director fees $10,000, businessdevelopment $8,800, telephone expense $8,300, stationary & supplies $7,800and subscriptions $5.600; while decreases occurred

 

31

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in donations $8,100, travel expense $6,500, prepaid card programexpense $5,200, entertainment/meals $5,000 and poppy account expense $5,000.

 

Other expenses for 2002 totaled $732,600 compared with $802,500 in2001, a decrease of $69,900. Significant changes occurred in the following categories with increasesin ATM expense $4,300, business development $5,200, director fees $3,100,insurance expense $26,000, prepaid card expense $5,200, messenger & freight$20,100, stationary/supply expense $11,500 and telephone expense $5,200; whiledecreases occurred in auto allowance/expense $8,300, collections expense $24,400,miscellaneous expense $8,900, postage $13,300, donations $10,900,entertainment/meals $3,800, FDIC & State assessments $5,800, loan expense$3,800, operations losses $55,200, postage $13,300 and bank security $15,600.

 

Other expenses for 2001 totaled $808,500 compared with $737,400 in2000, an increase of $70,300. Significant changes occurred in the following categories with increasesATM expense $6,400, auto allowance/expense $8,000, bank fees $17,600, collectionsexpense $16,600, donations $5,400, entertainment/meals $5,300, FDIC & Stateassessments $10,100, loan expense $5,900, messenger & freight $4,700,miscellaneous expense $17,800, postage $4,100, security $14,400 and shareholderexpense $4,500; while decreases occurred in business development $2,600,operations losses $28,500, subscriptions/publications $5,300 and travel$12,200.

 

**Income Taxes**

 

In February 1992, the Financial Accounting Standards Board issuedStatement of Financial Accounting Standards No. 109, “Accounting for IncomeTaxes,” (Statement 109).  Under theasset and liability method of Statement 109, deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enactedtax rates expected to apply to taxable income in the years in which thosetemporary differences are expected to be recovered or settled.  Under Statement 109, the effect on deferredtax assets and liabilities of a change in tax rates is recognized in income inthe period that includes the enactment date. Deferred assets are recognized for deductible temporary differences andoperating loss and tax credit carry forwards, and then a valuation allowance isestablished to reduce that deferred tax asset if it is “more likely than not”that the related tax benefits will not be realized.  The Bank adopted Statement 109 and has applied the provisions ofthe statement as of January 1, 1992.

 

Allocation of federal and California income taxes between current anddeferred portions is as follows:

 

32

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|                              |   | **2003** |    | **2002** |   | **2001** |   |
|-----------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Current tax provision:            |   |     |    |     |   |     |   |
| Federal                           |   | $        | 484,300 |     | $      | 216,400  |   | $ | 228,300 |   |
| California                        |   | 166,100  |    | 81,300   |   | 82,900   |   |
|                              |   | 650,400  |    | 297,700  |   | 311,200  |   |
|                              |   |     |    |     |   |     |   |
| Deferred tax provision (benefit): |   |     |    |     |   |     |   |
| Federal                           |   | 27,500   |    | 45,000   |   | (63,900  | )      |
| California                        |   | (19,400  | )       | 11,300   |   | (16,000  | )      |
|                              |   | 8,100    |    | 56,300   |   | (79,900  | )      |
|                              |   | $        | 658,500 |     | $      | 354,000  |   | $ | 231,300 |   |

 

The differences between the statutory federalincome tax rate and the effective tax rates are summarized as follows:

 
|                                          |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                          |   |     |   |     |   |     |   |
| Statutory federal tax rate                    |   | 34.00    | %      | 34.00    | %      | 34.00    | %      |
| California taxes, net of federal tax  benefit |   | 7.20     |   | 7.20     |   | 7.20     |   |
| Other, net                                    |   | 2.74     |   | (0.16    | )      | (2.20    | )      |
| Effective tax rates                           |   | 43.94    | %      | 41.04    | %      | 39.00    | %      |

 

In addition, the Corporation has applied all unused general businesstax credit carryforwards for financial reporting and income tax purposes.

 

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

 
|                   |   | **2003** |    | **2002** |   |
|------------------------|--------|----------|---------|----------|--------|
| Deferred tax asset     |   |     |    |     |   |
| Federal                |   | $        | 190,200 |     | $      | 217,700 |   |
| California             |   | 50,100   |    | 61,000   |   |
|                   |   |     |    |     |   |
| Net deferred tax asset |   | $        | 240,300 |     | $      | 278,700 |   |

 

The taxeffects of each type of income and expense item that give rise to deferredtaxes are as follows:

 
|                              |   | **2003** |    | **2002** |   |
|-----------------------------------|--------|----------|---------|----------|--------|
| Deferred tax assets (liabilities) |   |     |    |     |   |
| Net unrealized loss on securities |   | $        | (30,500 | )        | $      | 66,300 |   |
| California franchise tax          |   | 73,500   |    | 48,400   |   |
| Allowance for loan losses         |   | 299,700  |    | 236,500  |   |
| Depreciation                      |   | (102,400 | )       | (72,500  | )      |
|                              |   |     |    |     |   |
| Net deferred tax asset            |   | $        | 240,300 |     | $      | 278,700 |   |

 

33

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As of December 31, 2003 and 2002, management expects all temporarydifferences to be offset against future taxable income, and no valuationreserve was deemed necessary

 

**LOANS**

 

Loans, the largest component of earning assets, represented 79.49% ofaverage earning assets, and 75.49% of average total assets during 2003,compared with 75.17% and 70.07%, respectively during 2002.  In 2003, average loans increased 19.72% from$56,757,700 in 2002 to $67,949,300. Average real estate loans increased $9,535,100 (25.27%), averageconstruction loans increased $976,900 (34.03%) and average commercial loansincreased $889,400 (5.76%); while average installment loans decreased $209,900(29.81%).

 

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

 

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

 

The Bank is the recognized leader for Small Business Administrationlending in Monterey County, and holds SBA’s coveted Preferred LenderStatus.  Generally, SBA loans areguaranteed by the SBA for 70 to 80 percent of their principal amount, which canbe retained in portfolio or sold to investors. Such loans are made at floating interest rates, but generally for longerterms (up to 25 years) than are available on a conventional basis to smallbusinesses.  The unguaranteed portion of the loans, although generallysupported by collateral, is considered to be more risky than conventionalcommercial loans because they may be based upon credit standards the Bank wouldnot otherwise apply, such as lower cash flow coverage, or longer repaymentterms.

 

The Bank’s real estate loan portfolio consists both of real estateconstruction loans and real estate mortgage loans.  The Bank has initiated a program to generate more commercial andindustrial real estate loans, which generally yield higher returns than normalcommercial loans.  The Bank has also developeda broker program for generating 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 conventional single-familyresidential real estate loans.  The costof administering such loans is often higher than for other real estate loans,as principal is drawn on periodically as construction progresses.

 

The Bank also makes real estate loans secured by a first deed of truston single family residential properties and commercial and industrial realestate.  California commercial banks are

 

34

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permitted, depending on the type and maturity of the loan, to lend upto 90 percent of the fair market value of real property (or more if the loan isinsured either by private mortgage insurers or governmental agencies).  In certain instances, the appraised valuemay exceed the actual amount which could be realized on foreclosure, or declinesin market value subsequent to making the loan can impair the Bank’s security.

 

Consumer loans are made for the purpose of financing the purchase ofvarious types of consumer goods, home improvement loans, auto loans and otherpersonal loans.  Consumer installmentloans generally provide for monthly payments of principal and interest, at afixed rate.  Most of the Bank’s consumerinstallment loans are generally secured by the personal property beingpurchased.  The Bank generally makesconsumer loans to those customers with a prior banking relationship with theBank.

 

The following table presents the composition of the loan portfolio,including loans held for sale, at December 31 for the last five years.

 
|                                  |   | **Years  Ended December 31,** |   |
|---------------------------------------|--------|------------------------------------|--------|
|                                  |   | **2003**                           |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                  |   | **(Dollars  in thousands)**        |   |
| Commercial and industrial             |   | 18,607                             |   | 14,432 |   | 14,469 |   | 12,988 |   | 11,441 |   |
| Real estate, construction             |   | 5,934                              |   | 4,066 |   | 1,896 |   | 2,314 |   | 3,459 |   |
| Real estate, mortgage                 |   | 52,698                             |   | 42,000 |   | 36,010 |   | 27,802 |   | 23,788 |   |
| Installment                           |   | 580                                |   | 462 |   | 703 |   | 518 |   | 435 |   |
| Government guaranteed loans purchased |   | 57                                 |   | 63 |   | 130 |   | 139 |   | 145 |   |
|                                  |   | 77,876                             |   | 61,024 |   | 53,207 |   | 43,760 |   | 39,267 |   |
| Less:                                 |   |                               |   |   |   |   |   |   |   |   |   |
| Allowance for possible loan losses    |   | (775                               | )      | (637 | ) | (566 | ) | (468 | ) | (400 | ) |
| Deferred origination fees, net        |   | (193                               | )      | (130 | ) | (79 | ) | (41 | ) | (49 | ) |
| Net Loans                             |   | 76,908                             |   | 60,257 |   | 52,562 |   | 43,251 |   | 38,817 |   |

 

**Non-performing and Non-accrual Loans**

 

The Bank’s present policy is to cease accruing interest on loans whichare past due as to principal or interest 90 days or more, except for loanswhich are well secured or when collection of interest and principal is deemedlikely.  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,and interest on, the loan appears to be available.

 

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

 

35

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|                                                          |   | **As of  December 31,** |   |
|---------------------------------------------------------------|--------|------------------------------|--------|
|                                                          |   | **2003**                     |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                                          |   | **(Dollars  in thousands)**  |   |
| Accruing,past due 90 days or more:                            |   |                         |   |   |   |   |   |   |   |   |   |
|                                                          |   |                         |   |   |   |   |   |   |   |   |   |
| Real Estate                                                   |   | 0                            |   | 0 |   | 0 |   | 0 |   | 63 |   |
| Commercial                                                    |   | 0                            |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Installment                                                   |   | 0                            |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Total accruing                                                |   | 0                            |   | 0 |   | 0 |   | 0 |   | 63 |   |
|                                                          |   |                         |   |   |   |   |   |   |   |   |   |
| Nonaccrual Loans:                                             |   |                         |   |   |   |   |   |   |   |   |   |
|                                                          |   |                         |   |   |   |   |   |   |   |   |   |
| Real Estate                                                   |   | 0                            |   | 0 |   | 320 |   | 0 |   | 0 |   |
| Commercial                                                    |   | 28                           |   | 24 |   | 50 |   | 15 |   | 125 |   |
| Installment                                                   |   | 0                            |   | 10 |   | 0 |   | 0 |   | 0 |   |
| Total nonaccrual                                              |   | 28                           |   | 34 |   | 370 |   | 15 |   | 125 |   |
|                                                          |   |                         |   |   |   |   |   |   |   |   |   |
| Total nonperforming                                           |   | 28                           |   | 34 |   | 370 |   | 15 |   | 188 |   |
|                                                          |   |                         |   |   |   |   |   |   |   |   |   |
| Total loans end of period                                     |   | 77,876                       |   | 61,024 |   | 53,207 |   | 43,760 |   | 39,267 |   |
|                                                          |   |                         |   |   |   |   |   |   |   |   |   |
| Ratio of nonperforming loans to total loans  at end of period |   | 0.04                         | %      | 0.06 | % | 0.70 | % | 0.03 | % | 0.48 | % |

 

The low level of non-performing loans is the result of underwritingcriteria intended to be conservative, frequent review of new and delinquentloans and a firm collection policy (with the assistance of outside legalcounsel).  The Bank does not have anyforeign loans or loans for highly leveraged transactions.

 

36

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**Summary of Loan LossExperience**

 
|                                                                           |   | **For the  Years ended December 31,** |   |
|--------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                           |   | **2003**                                   |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                                                           |   | **(Dollars  in thousands)**                |   |
| Average loans outstanding                                                      |   | 67,949                                     |   | 56,758 |   | 48,570 |   | 41,512 |   | 34,115 |   |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Allowance, beginning of period                                                 |   | 637                                        |   | 566 |   | 468 |   | 400 |   | 336 |   |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Loans charged off during period:                                               |   |                                       |   |   |   |   |   |   |   |   |   |
| Commercial                                                                     |   | 18                                         |   | 58 |   | 80 |   | 67 |   | 128 |   |
| Installment                                                                    |   | 0                                          |   | 1 |   | 9 |   | 2 |   | 0 |   |
| Real Estate                                                                    |   | 0                                          |   | 1 |   | 0 |   | 0 |   | 0 |   |
| Other                                                                          |   | 0                                          |   | 0 |   | 0 |   | 0 |   | 1 |   |
| Total charge offs                                                              |   | 18                                         |   | 60 |   | 89 |   | 69 |   | 129 |   |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Recoveries during period:                                                      |   |                                       |   |   |   |   |   |   |   |   |   |
| Commercial                                                                     |   | 1                                          |   | 13 |   | 1 |   | 7 |   | 13 |   |
| Installment                                                                    |   | 0                                          |   | 0 |   | 1 |   | 0 |   | 5 |   |
| Other                                                                          |   | 0                                          |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Total recoveries                                                               |   | 1                                          |   | 13 |   | 2 |   | 7 |   | 18 |   |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Net Loans charged off during the period                                        |   | 17                                         |   | 46 |   | 87 |   | 62 |   | 111 |   |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Additions to allowance for possible loan  losses                               |   | 155                                        |   | 117 |   | 185 |   | 130 |   | 174 |   |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Allowance, end of period                                                       |   | 775                                        |   | 637 |   | 566 |   | 468 |   | 400 |   |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Ratio of net loans charged off to average  Loans outstanding during the period |   | 0.03                                       | %      | 0.08 | % | 0.18 | % | 0.15 | % | 0.32 | % |
|                                                                           |   |                                       |   |   |   |   |   |   |   |   |   |
| Ratio of allowance to total at end of  period                                  |   | 1.00                                       | %      | 1.04 | % | 1.06 | % | 1.05 | % | 1.01 | % |

 

**Funding Sources**

 

Average deposits increased 5.80% to $72,045,700 in 2003 from$68,093,900 in 2002.  In 2003 averagedemand deposits increased 11.14% and average interest checking, money marketand savings accounts as a group increased 13.47% while average certificates ofdeposit were unchanged.  Averagecertificates of deposit represented 53.50% of average deposits in 2003 comparedwith 53.52% in 2002.  Average interestchecking, money market and savings accounts as a group were 27.06% of averagedeposits in 2003 compared with 25.23% in 2002. Average

 

37

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demand deposits represented 22.34% of average deposits in 2003 comparedwith 21.27% in 2002.

 

The following table sets forth the scheduled maturities of theCompany’s time deposits in denominations of $100,000 or greater atDecember 31, 2003:

 

Maturities of Time Deposits of

$100,000 or More

(Dollars in Thousands)

 

| Three months or less                  |   | $     | 3,244  |   |
|---------------------------------------|--------|-------|--------|--------|
| Over three months through six months  |   | 4,998 |   |
| Over six months through twelve months |   | 1,249 |   |
| Over twelve months                    |   | 6,641 |   |
| Total                                 |   | $     | 16,132 |   |

 

The Corporation borrowed $1,000,000 on an unsecured basis from UnitedSecurity Bank, Fresno, California on June 28, 2001.  The rate of interest is the United SecurityBank Reference Rate (the “Index”) plus .750 percentage points over theIndex.  The note requires monthlyinterest payments beginning August 5, 2001, quarterly principal andinterest payments beginning October 5, 2002 through April 5, 2011,and a final payment of principal and interest on July 5, 2011.  The proceeds from the borrowing were used topayoff an $800,000 term loan and to pay down the $200,000 line of credit withPacific Coast Bankers’ Bank.  TheCorporation renewed the $200,000 revolving line of credit for one year, withinterest due monthly.  The credit lineis secured by 93,069 shares of Monterey County Bank common stock.  The rate of interest on the credit line isthe prime rate as published in the Wall Street Journal (the “Index”) plus .750percentage points over the Index, with floor rate of 6.50%.  The Corporation paid off both the term noteand line of credit with proceeds from its March 27, 2003 Trust PreferredSecurities issuance.

 

The Bank has lines of credit from the Federal Home Loan Bank of SanFrancisco and Pacific Coast Bankers’ Bank with available borrowing capacity onDecember 31, 2003 of $2,363,400 and $2,500,000, respectively.  The Federal Home Loan Bank line of credithas a maximum borrowing capacity of twenty five percent (25%) of the Bank’stotal assets, adjusted quarterly.  TheFederal Home Loan Bank line of credit is secured by certain of the Bank’s realestate secured loans and securities at December 31, 2003 the totalprincipal balances of pledged loans was $12,079,300 and securities of$4,137,100.  The following tableprovides information on nine (9) advances totaling $13,750,000 outstanding atDecember 31, 2003.

 

| **Advance  Amount** |   | **Interest  Rate** |   | **Funding  Date** |   | **Maturity  Date** |   |
|---------------------|--------|--------------------|--------|-------------------|--------|--------------------|--------|
| 1,000,000           |   | 6.81               | %      | 06/03/97          |   | 06/03/04           |   |
| 1,500,000           |   | 1.01               | %      | 06/20/03          |   | 06/21/04           |   |
| 1,000,000           |   | 6.86               | %      | 08/10/00          |   | 08/10/05           |   |
| 100,000             |   | 2.89               | %      | 10/29/02          |   | 10/31/05           |   |
| 3,900,000           |   | 2.83               | %      | 10/29/02          |   | 10/31/05           |   |
| 1,000,000           |   | 2.54               | %      | 02/04/03          |   | 02/06/06           |   |
| 2,750,000           |   | 3.44               | %      | 09/27/02          |   | 09/27/07           |   |
| 1,500,000           |   | 3.34               | %      | 02/14/03          |   | 02/14/08           |   |
| 1,000,000           |   | 7.72               | %      | 06/01/00          |   | 06/03/30           |   |

 

38

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The Pacific Coast Bankers’ Bank line of credit is unsecured.  The Bank did not utilize any overnightborrowings in 2003, 2002 or 2001.

 

The Bank has a $105,000 letter of credit issued by the Federal HomeLoan Bank of San Francisco to secure the uninsured portion of local agencydeposits maintained with the Bank.  Theletter of credit matures April 17, 2006.

 

**Capital Resources**

 

The Corporation maintains capital to comply with legal requirements, toprovide a margin of safety for its depositors and stockholders, and to providefor future growth and the ability to pay dividends.  At December 31, 2003, stockholders’ equity was $6,410,500versus $5,638,900 at December 31, 2002. The Corporation paid a $.15 per share cash dividend in 2003 and issued10% stock dividends in 2002 and 2001. The Bank paid cash dividends totaling $50,000, $75,000, and $200,000, tothe Corporation in 2003, 2002 and 2001, respectively.

 

The FDIC and Federal Reserve Board have adopted capital adequacyguidelines for use in their examination and regulation of banks and bankholding companies.  If the capital of abank 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.  Theguidelines employ two measures of capital: (1) risk-based capital and (2) leverage capital.

 

In general, the risk-based capital guidelines provide detaileddefinitions of which obligations will be treated as capital, and assigndifferent weights to various assets and off-balance sheet items, depending uponthe perceived degree of credit risk associated with each asset.  Each asset is assigned to one of fourrisk-weighted categories.  For example,0 percent for cash and unconditionally guaranteed government securities; 20percent for deposits with other banks and fed funds; 50 percent for state bondsand certain residential real estate loans; and 100 percent for commercial loansand other assets.  Capital iscategorized as either Tier 1 capital, consisting of common stock and retainedearnings (or deficit), or Tier 2 capital, which includes limited-life preferredstock and allowance for loan losses (subject to certain limitations).  The guidelines also define and set minimumcapital requirements (risk-based capital ratios), which increased over atransition period, ended December 31, 1992.  Under the final 1992 rules, all banks were required to maintainTier 1 capital of at least 4 percent and total capital of 8.0% of risk-adjustedassets. The Bank had a Tier 1 capital ratio of 12.91% and 9.40% atDecember 31, 2003 and 2002, respectively, and a total risk-based capital ratioof 13.81% and 10.24% at December 31, 2002 and 2001, respectively.

 

The Tier 1 leverage capital ratio guidelines require a minimum leveragecapital ratio of 3% of Tier 1 capital to total assets less goodwill.  The Bank had a leverage capital ratio of 11.02%and 7.24% at December 31, 2003 and 2002, respectively.

 

39

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The significant increase in each of the Bank’s risk-based capitalratios was the result of $4,000,000 in capital contributions from the Corporation.  The Corporation utilized a portion of theproceeds from two trust preferred security issuances to make the capitalcontributions.

 

On March 27, 2003, the Company’s wholly owned special-purposetrust subsidiary, Northern California Bancorp, Inc. Trust I (the “Trust”)issued $3 million in cumulative Trust Preferred Securities.  The securities bear a floating rate ofinterest of 3.25% over the three month LIBOR rate, payable quarterly.  Concurrent with the issuance of the TrustPreferred Securities, the Trust used the proceeds from the Trust PreferredSecurities offering to purchase a like amount of Junior Subordinated Debenturesof the Company.  The SubordinatedDebentures are the sole assets of the Trust and are eliminated, along with therelated income statement effects, in the consolidated financialstatements.  The Company will payinterest on the Junior Subordinated Debentures to the Trust, which representsthe sole revenue and sole source of dividend distributions to the holders ofthe Trust Preferred Securities.  TheCompany has the right, assuming no default has occurred, to defer payments ofinterest on the Junior Subordinated Debentures at any time for a period not toexceed 20 consecutive quarters.  TheTrust Preferred Securities will mature on April 7, 2033, but can beredeemed 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 or October 7 on or after April 7, 2008 at par.  The Company fully and unconditionallyguarantees the obligations of the Trust, on a subordinated basis.

 

The Company received $2.91 million from theTrust upon issuance of the Junior Subordinated Debentures, of which $1 millionwas contributed by the Company to the Bank to increase its capital, $1.14million was used to retire existing Company debt and the remainder held asworking capital.

 

On November 13, 2003, the Company’swholly owned special-purpose trust subsidiary, Northern California Bancorp,Inc. Trust II (the “Trust”) issued $5 million in cumulative Trust PreferredSecurities.  The securities bear afloating rate of interest of 2.85% over the three month LIBOR rate, payablequarterly.  Concurrent with the issuanceof the Trust Preferred Securities, the Trust used the proceeds from the TrustPreferred Securities offering to purchase a like amount of Junior SubordinatedDebentures of the Company.  TheSubordinated Debentures are the sole assets of the Trust and are eliminated,along with the related income statement effects, in the consolidated financialstatements.  The Company will payinterest on the Junior Subordinated Debentures to the Trust, which representsthe sole revenue and sole source of dividend distributions to the holders ofthe Trust Preferred Securities.  The Companyhas the right, assuming no default has occurred, to defer payments of intereston the Junior Subordinated Debentures at any time for a period not to exceed 20consecutive quarters.  The TrustPreferred Securities will mature on Augus 8, 2033, but can be redeemed undercertain circumstances at a premium prior to August 8, 2008, and can beredeemed, in whole or in part, on any February 8, May 8, August 8 orNovember 8 on or after August 8, 2008 at par.  The Company fully and unconditionallyguarantees the obligations of the Trust, on a subordinated basis.

 

The Company received $4.96 million from theTrust upon issuance of the Junior Subordinated Debentures, of which $2.5million was contributed by the Company to the Bank to increase its capital andthe remainder held as working capital.

 

40

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Under applicable regulatory guidelines, aportion of the Trust Preferred Securities will qualify as Tier I Capital, andthe remainder as Tier II Capital.

 

**Liquidity**

 

Liquidity represents a bank’s ability to provide sufficient cash flowsor cash resources in a manner that enables it to meet obligations in a timelyfashion and adequately provides for anticipated future cash needs.  For the Bank, liquidity considerations involvethe capacity to meet expected and potential requirements of depositors seekingaccess to balances and to provide for the credit demands of borrowingcustomers.  In the ordinary course ofthe Bank’s business, funds are generated from the repayment of loans,maturities within the investment securities portfolio and the acquisition ofdeposit balances and short-term borrowings. In addition, the Bank has lines of credit from the Federal Home LoanBank of San Francisco of approximately $26,760,000, subject to pledging ofacceptable collateral, and a $2,500,000 unsecured federal funds line of creditwith the Pacific Coast Bankers’ Bank to meet temporary liquidity requirements.

 

As a matter of policy, the Bank seeks to maintain a level of liquidassets, including marketable investment securities, equal to a least 15 percentof total assets (“primary liquidity”), while maintaining sources of secondaryliquidity (borrowing lines from other institutions) equal to at least anadditional 10 percent of assets.  In addition,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 primary liquidity atDecember 31, 2003, 2002 and 2001 was 20.84 percent, 22.22 percent, and25.79 percent respectively, while its average loan to deposit ratio for suchyears was 94.31 percent, 83.35 percent and 75.91 percent respectively.

 

Brokered deposits are deposit instruments, such as certificates ofdeposit, deposit notes, bank investment contracts and certain municipalinvestment contracts that are issued through brokers and dealers who then offerand/or sell these deposit instruments to one or more investors.  Additionally, deposits on which a financialinstitution pays an interest rate significantly higher than prevailing ratesare considered to be brokered deposits. Federal law and regulation restricts banks from soliciting or acceptingbrokered deposits, unless the bank is well capitalized under Federalguidelines.  The Bank’s brokereddeposits totaled approximately $5,995,000, 7.53% of total deposits atDecember 31, 2003; the Bank had no brokered deposits at December 31,2002. None of the Bank’s brokered deposits paid an interest rate significantlyhigher than prevailing rates.

 

Management of interest rate sensitivity (asset/liability management)involves matching and repricing rates of interest-earning assets withinterest-bearing liabilities in a manner designed to optimize net interestincome within the constraints imposed by regulatory authorities, liquiditydeterminations and capital considerations. The Bank instituted formal asset/liability policies at the end of 1989.

 

The purpose for asset/liability management is to provide stable netinterest income growth by protecting the Bank’s earnings from undue interestrate risk.  The Bank expects to generateearnings from increasing loan volume, appropriate loan pricing and expensecontrol and not from trying to accurately forecast interest rates.  Another important function ofasset/liability

 

41

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management is managing the risk/return relationships between interestrate risk, liquidity, market risk and capital adequacy.  The Bank gives priority to liquidityconcerns followed by capital adequacy, then interest rate risk and market riskin the investment portfolio.  The policyof the Bank will be to control the exposure of the Bank’s earnings to changinginterest rates by generally maintaining a position within a narrow range aroundan “earnings neutral position.” An earnings neutral position is defined as themix of assets and liabilities that generate a net interest margin that is notaffected by interest rate changes. However, Management does not believe that the Bank can maintain atotally earnings neutral position. Further, the actual timing of repricing of assets and liabilities doesnot always correspond to the timing assumed by the Bank for analyticalpurposes.  Therefore, changes in marketrates of interest will generally impact on the Bank’s net interest income andnet interest margin for long or short periods of time.

 

The Bank monitors its interest rate risk on a quarterly basis throughthe use of a model which calculates the effect on earnings of changes in thefed funds rate.  The model converts afed funds rate change into rate changes for each major class of asset andliability, then simulates the bank’s net interest margin based on the bank’sactual repricing over a one year period, assuming that maturities arereinvested in instruments identical to those maturing during the period.  At December 31, 2003 the affect of a 2%increase in the fed funds rate, expressed, as a percentage of equity was apositive 5.0%. At December 31, 2003 the fed funds target rate was 1.25%;therefore, the model assumed a 1% decrease in the fed funds rate resulting innegative affect on capital of 2.5%.

 

The Corporation’s sources of revenues and liquidity are the dividends,tax equalization payments or management fees from the Bank, gains on securitiesheld in a trading account and the line of credit from the Pacific CoastBankers’ Bank.  The ability of the Bankto pay such items to the Corporation is subject to limitations under state andFederal law.

 

42

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**Investment Securities**

 

The Corporation maintains a trading account, at fair value, consistingof marketable securities.  At December 31,2003 the account value was $163,300.  Inaddition the Corporation has a $25,000 investment in Mission Valley Bank stockand a $202,000 investment in AT Service LLC. In 2001 the Corporation took a charge to earnings of $40,000representing its investment in the Community Bank Insurance Agency, LLC.

 

The following table sets forth the book and market value of the Bank’sinvestment securities as of December 31, 2003 and 2002:

 
|                                       |   | **INVESTMENT  PORTFOLIO MIX  (Dollars in thousands)** |   |
|--------------------------------------------|--------|-------------------------------------------------------|--------|
|                                       |   | **2003**                                              |   | **2002** |   |
|                                       |   | **Book  value**                                       |   | **Market  value** |   | **Book  value** |   | **Market  value** |   |
| Available for sale:                        |   |                                                  |   |   |   |   |   |   |   |
| Corporate Debt Securities                  |   | 1,790                                                 |   | 1,842 |   | 1,508 |   | 1,487 |   |
| Government National Mortgage Association   |   | 2,294                                                 |   | 2,247 |   | 4,560 |   | 4,553 |   |
| U.S. Government Agencies                   |   | 2,000                                                 |   | 1,988 |   | — |   | — |   |
| Total                                      |   | 6,084                                                 |   | 6,076 |   | 6,068 |   | 6,040 |   |
|                                       |   |                                                  |   |   |   |   |   |   |   |
| Other Securities:                          |   |                                                  |   |   |   |   |   |   |   |
| Federal Home Loan Bank Stock               |   | 753                                                   |   | 753 |   | 541 |   | 541 |   |
| Pacific Coast Bankers’ Bank Stock     |   | 440                                                   |   | 440 |   | 440 |   | 440 |   |
| AT Services, LLC                           |   | 202                                                   |   | 202 |   | 204 |   | 204 |   |
| Northern California Bancorp, Inc. Trust I  |   | 93                                                    |   | 93 |   | — |   | — |   |
| Northern California Bancorp, Inc. Trust II |   | 155                                                   |   | 155 |   | — |   | — |   |
| Total                                      |   | 981                                                   |   | 981 |   | 981 |   | 981 |   |

 

The following table summarizes the maturity of the Bank’s investmentsecurities at December 31, 2003:

 
|                           |   | **INVESTMENT  PORTFOLIO MATURITIES  (Dollars in thousands)****Available  for Sale** |   |
|--------------------------------|--------|-------------------------------------------------------------------------------------|--------|
|                           |   | **Amortized  Cost**                                                                 |   | **Fair  Value** |   |
| Due between one and five years |   | 3,040,000                                                                           |   | 3,068,400 |   |
| Due between five and ten years |   | 750,000                                                                             |   | 760,800 |   |
| Over ten years                 |   | 2,293,500                                                                           |   | 2,246,300 |   |
|                           |   | 6,083,500                                                                           |   | 6,075,500 |   |

 

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**ITEM7. FINANCIAL STATEMENTS**

 

The following consolidated financial statements included in theConsolidated Financial Report issued by Hutchinson and Bloodgood LLP, CertifiedPublic Accountants at the pages indicated are incorporated herein by reference:

 
| Independent Auditors’ Report on the Financial Statements                                                                            |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                     |   |
| Consolidated Balance Sheets at December 31, 2003 and 2002                                                                           |   |
|                                                                                                                                     |   |
| Consolidated Statements of Operations for  each of the three years in the period ended December 31, 2003                            |   |
|                                                                                                                                     |   |
| Consolidated Statements of Changes in  Stockholders’ Equity for each of the three years in the period ended  December 31, 2003 |   |
|                                                                                                                                     |   |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2003                           |   |
|                                                                                                                                     |   |
| Notes to Consolidated  Financial Statements                                                                                              |   |

#  

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

 

The Company had no disagreements with its independent accountants onany matter of accounting principles, practices or financial statementdisclosure during 2003, 2002 or 2001.

 

**ITEM8A.  CONTROLS AND PROCEDURES**

 

(a)                                  **Evaluationof Disclosure Controls and Procedures**

 

Northern California Bancorp, Inc.’s Chief Executive Officer and itsChief Financial Officer, after evaluating the effectiveness of NorthernCalifornia Bancorp, Inc.’s disclosure controls and procedures (as defined inExchange Act Rules 13a-14(c) and 15-d-14(c) as of a date within 90 days of thefiling date of this annual report (the “Evaluation Date”) have concluded thatas of the Evaluation Date, Northern California Bancorp, Inc.’s disclosure controlsand procedures were adequate and effective to ensure that material informationrelating to Northern California Bancorp, Inc. and its consolidated subsidiarieswould be made known to them by others within those entities, particularlyduring the period in which this annual 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, 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 

 

44

 

management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

(b)                                 **Changes inInternal Controls**

 

There were no significant changes in Northern California Bancorp,Inc.’s internal controls or in other factors that could significantly affectNorthern California Bancorp, Inc.’s internal controls subsequent to theEvaluation Date, nor any significant deficiencies or material weaknesses insuch controls requiring corrective actions. As a result, no corrective actions were taken.

 

45

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**PART III**

 

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

 

The name, age, title and five-year business background of eachdirector, executive officers and significant employees of the Corporation(including the Bank) as of December 31, 2003, are as follows:

 
| **Name & Position with Bank**                                                                       |   | **Age** |   | **Principal  Occupation During Past Five Years**                                                                                                                                                                                         |
|---------------------------------------------------------------------------------------------------------|--------|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                    |   |    |   |                                                                                                                                                                                                                                     |
| Charles T. Chrietzberg, Jr.  Director since 1985,  Chairman of the Board &  Chief Executive Officer |   | 62      |   | Chairman of the Board & Chief Executive Officer Monterey County  Bank since 3/87                                                                                                                                                     |
|                                                                                                    |   |    |   |                                                                                                                                                                                                                                     |
| Sandra G. Chrietzberg  Director, 1988 to 1994 and  since 1995                                           |   | 60      |   | Formerly President and CEO Queen of Chardonnay, Inc., dba La Reina  Winery 8/84-12/93                                                                                                                                                    |
|                                                                                                    |   |    |   |                                                                                                                                                                                                                                     |
| Peter J. Coniglio, Esq.  Director since 1976                                                            |   | 74      |   | Partner - Hudson, Martin, Ferrante & Street, Monterey                                                                                                                                                                                |
|                                                                                                    |   |    |   |                                                                                                                                                                                                                                     |
| Carla S. Hudson, CPA  Director since 1994                                                               |   | 50      |   | Partner - Huey and Hudson, Certified Public Accountants                                                                                                                                                                                  |
|                                                                                                    |   |    |   |                                                                                                                                                                                                                                     |
| John M. Lotz  Director since 1991                                                                       |   | 62      |   | Chairman, Chief Executive Officer & President The Monterey Bay  Aviation Institute Inc dba DelMonte Aviation.  President and Chief Executive Officer, of Couroc of Monterey  1996-2001.                                         |
|                                                                                                    |   |    |   |                                                                                                                                                                                                                                     |
| Timothy M. Leveque  Executive Vice President  Chief Lending Officer                                     |   | 60      |   | Executive Vice President, Chief Financial Officer of Monterey County  Bank since 11/03, Senior Executive Vice President, Chief Lending Officer,  Pacific Coast Bankers’ Bank 1997-2003                                              |
|                                                                                                    |   |    |   |                                                                                                                                                                                                                                     |
| Bruce N. Warner  Executive Vice President,  Chief Financial Officer  and Chief Operating Officer        |   | 56      |   | 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. |

 

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| Virginia L. Cooper                        |   | 59     |   | Senior Vice President, Manager SBA Loan Department 11/02.  Vice President SBA Loan Department 3/98.                                                                                          |
|-------------------------------------------|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                      |   |   |   |                                                                                                                                                                                              |
| Mary Ellen Stanton  Senior Vice President |   | 66     |   | Senior Vice President, Loan Administration, Monterey County Since  10/98.                                                                                                                         |
|                                      |   |   |   |                                                                                                                                                                                              |
| Andre G. Herrera  Vice President          |   | 39     |   | Vice President, Chief Information Officer 11/01.  Vice President, Corporate Secretary of  Northern California Bancorp, Inc. and Corporate Secretary of Monterey County  Bank since 1996-2001 |

 

Directors of the Corporation serve in similar capacities with theBank.  The Chairman of the Board, ChiefExecutive Officer and Executive Vice President, Chief Financial Officer of theCorporation serve in similar capacities with the Bank, although the limitedoperations of the Corporation do not require significant amounts of theirtime.  There are no family relationshipsamong the persons listed above, except that Mr. and Mrs. Chrietzberg arespouses.

 

Based solely upon a review of the relevant forms furnished to the Bankand the Corporation, except as disclosed below, the Corporation believes thatall officers, directors and principal shareholders filed appropriate forms asrequired by Section 16(a) of the Exchange Act, and related regulations,during 2003.  The following late reportson Form 4 were filed; Mr. Chrietzberg, two reports; Messrs. Coniglio, Lotz andWarner and Ms. Hudson, one report.

 

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**ITEM 10****. EXECUTIVECOMPENSATION**

 

Thefollowing table sets forth certain information regarding the compensation paidto the officers of the Corporation/Bank whose salary and bonus exceeded$100,000 for 2003.

 
|                              |   |   |   | **Annual  Compensation** |    | **Long Term  Compensation Awards** |   |
|-----------------------------------|--------|--------|--------|--------------------------|---------|------------------------------------|--------|
| **Name & Principal Position** |   |   |   | **Salary**               |    | **Bonus**                          |   | **Other  Annual  Compensation** |   | **Restricted  Stock  Awards** |   | **Securities  Underlying  Options/SARs** |   | **All Other  Compensation** |   |
|                              |   |   |   |                     |    |                               |   |   |   |   |   |   |   |   |   |
| Charles T. Chrietzberg, Jr.       |   | 2003   |   | $                        | 184,069 |                               | $      | 221,000 |   | $ | 2,557 | (1) | None |   | 30,000 |   | $ | 26,298 | (2) |
| Chairman & CEO                |   | 2002   |   | $                        | 190,914 |                               | $      | 161,000 |   | $ | 3,274 | (1) | None |   | 30,000 |   | $ | 0 | (2) |
|                              |   | 2001   |   | $                        | 181,296 |                               | $      | 160,800 |   | $ | 3,420 | (1) | None |   | None |   | $ | 572 | (2) |
|                              |   |   |   |                     |    |                               |   |   |   |   |   |   |   |   |   |
| Bruce N. Warner                   |   | 2003   |   | $                        | 104,899 |                               | $      | 45,601 |   | None |   | None |   | 5,000 |   | None |   |
| Senior Vice President,            |   | 2002   |   | $                        | 99,379  |                               | $      | 26,605 |   | None |   | None |   | 10,000 |   | None |   |
| Chief Financial Officer           |   | 2001   |   | $                        | 90,773  |                               | $      | 23,400 |   | None |   | None |   | None |   | None |   |
| Chief Operating Officer           |   |   |   |                     |    |                               |   |   |   |   |   |   |   |   |   |
|                              |   |   |   |                     |    |                               |   |   |   |   |   |   |   |   |   |
| Andre G. Herrera                  |   | 2003   |   | $                        | 103,975 |                               | $      | 13,743 |   | None |   | None |   | 2,500 |   | None |   |
| Vice President,                   |   | 2002   |   | $                        | 99,405  |                               | $      | 18,459 |   | None |   | None |   | 2,000 |   | None |   |
| Chief Information Officer         |   | 2001   |   | $                        | 94,110  |                               | $      | 6,571 |   | None |   | None |   | None |   | None |   |

 

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(1)                                  Represents personal useof company automobile.

(2)                                  Represents theexpense accrued in the Salary Continuation Plan net of earnings on lifeinsurance policies as more fully described in the Long Term Incentive PlanTable.

 

The Bank leases an automobile for the use of its Chief ExecutiveOfficer (the value of his personal use of the automobile is includedabove).  The Bank furnishes, on anon-discriminatory basis, to the employees: (i) insurance benefits; and (ii)other benefits.  The value of thesebenefits (excluding non-discriminatory plan benefits) was less than the lesserof $50,000 or ten percent of the compensation shown above for the respectivepersons or group, and is not included in the table.

 

The Board of Directors authorized the Bank to enter into a three yearemployment contract with Mr. Chrietzberg, effective January 1, 2003.  It provides for a base salary of $180,000per year, a Bank furnished automobile or automobile allowance, and a bonusbased on profits.  The bonus, not toexceed $220,000 annually, will equal $10,000 for each 0.1 percent that theBank’s profits exceed 1.0 percent return on average assets plus $10,000 foreach 1 percent that the Bank’s return on equity exceeds 10.0 percent.  Under the terms of the contract, if Mr.Chrietzberg is terminated other than for cause (as defined in the contract), heis entitled to severance compensation for his monthly salary plus a pro ratedincentive bonus for the greater of 24 months or the remaining term of hiscontract (which ends in December, 2005); however, if the termination followswithin twelve (12) months after a change in control transaction (as defined inthe contract), he is entitled to such severance compensation for the greater of24 months or the remainder of the term of the contract.

 

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The following table sets forth certain information regarding the longterm incentive 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 |   |

 

In December 1993, the Board of Directors approveda Salary Continuation Agreement for the benefit of Mr. Chrietzberg thatprovided for payments of $75,000 per year, for 15 years, if he remains with theBank until normal retirement, commencing age 65.  After consideration of the impact of such an agreement on theBank’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 Continuation Agreement providesfor lesser payments in the event of early retirement, generally designated tocoincide with increases in the anticipated surrender value for the lifeinsurance policies described below.

 

In August, 2001, the Board of Directors amended the Salary ContinuationAgreement for the benefit of Mr. Chrietzberg which was approved in December,1993 and amended in August 1999.  The amended Salary Continuation Agreement provides for payments of$90,000 per year, for Mr. Chrietzberg’s lifetime.  The amended Salary Continuation Agreement provides the followingwith regard to the division of death proceeds should Mr. Chrietzberg die beforehis sixty-fifth (65th) birthday; his beneficiary(ies) shall beentitled to an amount equal to $2,940,000 or the net at risk insurance portionof the proceeds, whichever amount is less. The net at risk insurance portion is the total proceeds less the cashvalue of the policy.  Should Mr.Chrietzberg die on or subsequent to his sixty-fifth (65th) birthday,his beneficiary(ies) shall be entitled to an amount equal to $1,000,000 plusthe present value of the remaining retirement benefits due to Mr. Chrietzbergor the net at risk insurance portion of the proceeds, whichever is less, andthe Bank shall be entitled to the remainder of such proceeds.

 

The Bank’s obligations under the Salary Continuation Agreement are notsecured by any segregated amounts, but are informally funded by the purchase ofsingle-premium life insurance policies. The salary continuation expense accrued net of earnings on lifeinsurance policies in 2003, 2002 and 2001 was $26,300, $0, and $600,respectively.  Based upon the currentprojected 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 Surviving Income Agreement wasterminated upon adoption of the amended Salary Continuation Agreement.

 

49

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The following table sets forth certain information concerning the grantof stock options under the Corporation’s’ 1998 Amended Stock Option Plan to thenamed executive officer during the year ended December 31, 2003.

 

Option/SAR Grants in Last fiscal Year

 
| **Name**                    |   | **Number of  Securities  Underlying  Options/Sars  granted (#)** |   | **Percent of  total options/  SARs granted  to employees  in fiscal year** |   | **Exercise  or  base price  ($/Sh)** |   | **Expiration  date** |   |
|-----------------------------|--------|------------------------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------------------------------------|--------|----------------------|--------|
| Charles T. Chrietzberg, Jr. |   | 30,000                                                           |   | 54.05                                                                      | %      | 3.30                                 |   | 3/20/08              |   |
| Bruce N. Warner             |   | 5,000                                                            |   | 9.01                                                                       | %      | 3.00                                 |   | 3/20/08              |   |

 

The following table sets forth the number of shares ofCommon Stock acquired by each of the named executive officers upon exercise ofstock options during 2003, the net value realized upon exercise, the number ofshares of Common Stock represented by outstanding stock options held by each ofthe named executive officers as of December 31, 2003 and the value of suchoptions based on the last transaction in 2003, which the Corporation hasknowledge of, and certain information concerning unexercised options under the1998 Amended Stock Option Plan.

 

Aggregated Option/Sar Exercises in LastFiscal Yearand FY-End Options/Sar Values

 
|                        |   | **Shares  Acquired on** |   | **Value**         |   | **Number of  Unexercised  Options/SARs at  FY-End (#)** |   | **Value of  Unexercised  in-the-Money  Options/SARs at  FY-End ($)** |   |
|-----------------------------|--------|-------------------------|--------|-------------------|--------|---------------------------------------------------------|--------|----------------------------------------------------------------------|--------|
| **Name**                    |   | **Exercise  (#)**       |   | **Received  ($)** |   | **Exercisable**                                         |   | **Unexercisable**                                                    |   | **Exercisable** |   | **Unexercisable** |   |
| Charles T. Chrietzberg, Jr. |   | 40,263                  |   | 45,900            |   | 76,310                                                  |   | None                                                                 |   | 6,930 |   | None |   |
| Bruce N. Warner             |   | 8,053                   |   | 9,180             |   | 25,317                                                  |   | None                                                                 |   | 9,951 |   | None |   |

 

In 2003, each director received a standard fee of $500per regular board meeting attended and $150 for each committee meetingattended.  The Chair of the AuditCommittee received a fee of $300 for each committee meeting attended.

 

50

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**ITEM 11****. SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

To the knowledge of the management of the Company, the followingshareholders own more than five percent (5%) of the outstanding common stock ofthe Company, its only class of voting securities.

 
| **Name and Address**        |   | **Amount and  Nature of  Beneficial Ownership** |   | **Percent of  Class** |   |
|-----------------------------|--------|-------------------------------------------------|--------|-----------------------|--------|
| Charles T. Chrietzberg, Jr. |   | 743,874                                         | (1)    | 42.64                 |   |
| P.O. Box 1344               |   |                                            |   |                  |   |
| Carmel, CA   93921     |   |                                            |   |                  |   |
|                        |   |                                            |   |                  |   |
| David S. Lewis, Trust       |   | 153,863                                         |   | 9.82                  |   |
| 30500 Aurora del Mar        |   |                                            |   |                  |   |
| Carmel, CA   93923     |   |                                            |   |                  |   |

 

----

(1)                Includes 76,310 shares subject toemployee stock options and 18,414 shares held beneficially for Mr. Chrietzbergand Mrs. Chrietzberg in Individual Retirement Accounts where voting power isshared with the custodian of the account. 316,000 shares of the Common Stock owned by Mr. Chrietzberg are pledgedto secure a loan from an unaffiliated bank.

 

The following table sets forth similar informationregarding the beneficial ownership, both by numerical holding and percentageinterest of each of the Company’s directors and all of its directors andexecutive officers as a group.  Alladdresses are in care of the Corporation at 601 Munras Ave. Monterey, CA  93940.

 
| **Name**                                         |   | **Amount and  Nature of  Beneficial  Ownership** |        | **Percent of  Class** |   | **Shares  Subject to  Purchase  Options** |   | **Percent of  Class without  Option Shares** |   |
|--------------------------------------------------|--------|--------------------------------------------------|-------------|-----------------------|--------|-------------------------------------------|--------|----------------------------------------------|--------|
| Charles T. Chrietzberg, Jr.                      |   | 743,874                                          | (1) (2) (3) | 45.28                 | %      | 76,310                                    |   | 42.61                                        | %      |
| Sandra G. Chrietzberg                            |   | 743,874                                          | (2) (3)     | 45.28                 | %      | 76,310                                    |   | 42.61                                        | %      |
| Peter J. Coniglio                                |   | 77,855                                           | (4) (5)     | 4.89                  | %      | 26,767                                    |   | 3.26                                         | %      |
| Carla S. Hudson                                  |   | 37,398                                           | (6)         | 2.35                  | %      | 26,767                                    |   | 0.68                                         | %      |
| John M. Lotz                                     |   | 8,000                                            |        | 0.51                  | %      | 8,000                                     |   | 0.00                                         | %      |
| All Directors and Executive Officers as a  group |   | 946,051                                          | (7)         | 54.69                 | %      | 163,161                                   |   | 49.97                                        | %      |

 

----

(1)                      Includes 76,310 shares subject to hisemployee stock options.  316,000 sharesof the Common Stock owned by Mr. Chrietzberg are pledged to secure a loan froman unaffiliated bank. Should he default under such credit, the shares could beacquired by the lender, or sold pursuant to applicable terms of the UniformCommercial Code, in a transaction that could result in a change of control ofthe Corporation.  Such transaction mayrequire approval under provisions of Federal and California change in bankcontrol laws.

 

(2)                      The sharesinclude an aggregate of 18,414 shares held beneficially by Mr. Chrietzberg andMrs. Chrietzberg in Individual Retirement Accounts, where voting power is alsoshared with the custodian of the account.

 

(3)                      Includesshares of spouse pursuant to California’s community property laws.

 

(4)                      Sole votingpower.

 

(5)                      Includes26,767 shares subject to the respective director’s stock options.  Of the remaining shares 16,105 are held byMr. Coniglio, 26,530 are held in a family trust controlled by Mr. Coniglio, asto which he has sole 

 

51

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voting and investment power, while 8,453 shares areheld by Hudson, Martin, Ferrante & Street, a partnership of which Mr.Coniglio is the managing partner, with voting and investment power.

 

(6)                      Includes 26,767 shares subject tothe respective director’s stock options. The remaining shares are held jointly with family members, other than1,610 shares held in a corporate pension, as to which Ms. Hudson has voting andinvestment power.

 

(7)                      Includes 78,924 shares held by anexecutive officer who is not also a director, 25,317 shares are subject toemployee stock options.

 

**ITEM 12****. CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

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

 
|                                                                     |   |                |   |                            |   | **Outstanding  as of  December 31, 2003** |      |
|--------------------------------------------------------------------------|--------|---------------------|--------|---------------------------------|--------|------------------------------------------------|-----------|
| **Name**                                                                 |   | **Maximum  Amount** |   | **Percent of  Equity  Capital** |   | **Amount**                                     |      | **Percent of  Equity  Capital** |   |
| Peter J. Coniglio                                                        |   | 1,162,700           | (1)    | 18.22                           | %      | 1,104,600                                      | (1)       | 9.79 | % |
| Carla S. Hudson                                                          |   | 206,600             |   | 3.24                            | %      | 176,100                                        | (2)  | 1.56 | % |
| John M. Lotz                                                             |   | 26,700              |   | 0.42                            | %      | 4,100                                          |      | 0.04 | % |
|                                                                     |   |                |   |                            |   |                                           |      |   |   |
| Directors, Principal Shareholder, and  Officers as a Group (5 in number) |   | 1,396,000           |   | 21.88                           | %      | 1,284,800                                      |      | 11.39 | % |

 

----

(1)          Included in the extensions of credit to Mr.Coniglio is a loan to the Coniglio Family Partnership, which had an outstandingbalance of $1,052,800 on December 31, 2003.

 

52

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**Item 13****. EXHIBITSAND 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10 (ii) A |   | (1)  Employment Contract of  Charles T. Chrietzberg, Jr., dated January 1, 2003  Filed as exhibit to Form 10KSB dated December 31, 2002.  (2)  Deferred Compensation Agreement,  dated December 31, 1993  Filed as exhibit to Form 10KSB dated December 31, 1995.  (3)  Northern California Bancorp, Inc.  1998 Stock Option Plan and Stock Option Agreements  Filed as exhibit to Form 10KSB dated December 31, 1998.  (4)  Amendment to the Salary  Continuation Agreement Dated December 31, 1993  Filed as exhibit to Form 10KSB dated December 31, 1999.  (5)  Life Insurance Endorsement Method  Split Dollar Plan Agreement  Filed as exhibit to Form 10KSB dated December 31, 1999.

(6)  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  (7)  Amendment to the Life Insurance  Endorsement Method Split Dollar Plan  Filed as exhibit to Form 10KSB dated December 31, 2001    (8)  Amendment to the Salary  Continuation Agreement Dated December 31, 1993.  Filed as exhibit to Form 10KSB dated December 31, 2001 |
| 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 United Security  Bancshares pursuant to Section 302 of the Sarbannes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 31.2      |   | Certification of the Chief  Financial Officer of United Security Bancshares pursuant to Section 302  of the Sarbannes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 32.1      |   | Certification of the Chief  Executive Officer of United Security Bancshares pursuant to Section 906  of  the Sarbannes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 32.2      |   | Certification of the Chief  Financial Officer of United Security Bancshares pursuant to Section 906  of the Sarbannes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

 

B.                                     REPORTS

 

None

 

53

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**ITEM 14****.  PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

**Fees**

**AuditFees.**Aggregate fees billed by Hutchinson andBloodgood for professional services rendered in connection with the audit ofthe Bank’s annual financial statements for the fiscal year endedDecember 31, 2003 and for the required review of the Bank’s financialstatements included in its Form 10–QSB’s for that same year totaled $55,800.

 

**FinancialInformation System Design and Implementation Fees.**Nofees were paid to Hutchinson and Bloodgood for financial information systemdesign and implementation services rendered for the 2002 fiscal year.

 

**AllOther Fees.**$2,800 was paid to Hutchinson &Bloodgood for all tax services rendered for the 2003 fiscal year.

 

54

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**SIGNATURES**

 

 

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

 

 
|   |                | NORTHERN CALIFORNIA BANCORP, INC. |
|--------|---------------------|-----------------------------------|
|   |                |                              |
| Date:  | March 19, 2004 | By:                               | /s/ | Charles T. Chrietzberg, Jr. |   |
|   |                |                              |   | Charles T. Chrietzberg, Jr. |   |
|   |                |                              |   | Chief Executive Officer |   |
|   |                |                              |   | and President |   |
|   |                |                              |   |   |   |
| Date:  | March 19, 2004 | By:                               | /s/ | Bruce N. Warner |   |
|   |                |                              |   | Bruce N. Warner |   |
|   |                |                              |   | Chief Financial Officer |   |
|   |                |                              |   | and  Principal Accounting Officer |   |

 

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

 
| **Name**                       |   | **Position** |   | **Date**            |   |
|--------------------------------|--------|--------------|--------|---------------------|--------|
|                           |   |         |   |                |   |
| /s/ Charles T. Chrietzberg, Jr |   |         |   | March 19, 2004 |   |
| Charles T. Chrietzberg, Jr.    |   | Director     |   |                |   |
|                           |   |         |   |                |   |
| /s/ Sandra G. Chrietzberg      |   |         |   | March 19, 2004 |   |
| Sandra G. Chrietzberg          |   | Director     |   |                |   |
|                           |   |         |   |                |   |
| /s/ Peter J. Coniglio          |   |         |   | March 19, 2004 |   |
| Peter J. Coniglio              |   | Director     |   |                |   |
|                           |   |         |   |                |   |
| /s/ Carla S. Hudson            |   |         |   | March 19, 2004 |   |
| Carla S. Hudson                |   | Director     |   |                |   |
|                           |   |         |   |                |   |
| /s/ John M. Lotz               |   |         |   | March 19, 2004 |   |
| John M. Lotz                   |   | Director     |   |                |   |

 

55

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**NORTHERNCALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

 

**CONSOLIDATEDFINANCIAL REPORT**

 

**YearsEnded December 31, 2003 and 2002**

 

----

 

**TABLEOF CONTENTS**

 
| **INDEPENDENT AUDITORS’ REPORT ON THE FINANCIAL STATEMENTS** |   |
|-------------------------------------------------------------------|--------|
|                                                              |   |
| **FINANCIAL  STATEMENTS**                                         |   |
|                                                              |   |
| Consolidated Balance Sheets                                       |   |
| Consolidated Statements of Operations                             |   |
| Consolidated Statements of Changes in  Shareholders’ Equity  |   |
| Consolidated Statements of Cash Flows                             |   |
| Notes to Consolidated Financial Statements                        |   |

 

----

 

**Independent Auditors’Report**

 

To the Board of Directors

Northern California Bancorp, Inc.

Monterey, California

 

We have audited the accompanying consolidated balance sheets ofNorthern California Bancorp, Inc. and its wholly owned subsidiary, MontereyCounty Bank, as of December 31, 2003 and 2002 and the related consolidatedstatements of operations, changes in shareholders’ equity, and cash flows foreach of the years in the three-year period ended December 31, 2003.  These consolidated financial statements arethe responsibility of the Corporation’s management.  Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of NorthernCalifornia Bancorp, Inc. and its wholly owned subsidiary, as of December 31,2003 and 2002, and the results of their operations and their cash flows foreach of the years in the three-year period ended December 31, 2003 inconformity with accounting principles generally accepted in the United Statesof America.

 

 

February 17, 2004

 

F-1

----

 

**NORTHERN CALIFORNIA BANCORP, INC. ANDSUBSIDIARY**

 

**CONSOLIDATEDBALANCE SHEETS**

**December 31, 2003 and 2002**

 
|                                                                                                                                                                       |   | **2003**    |        | **2002**   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|
| **ASSETS**                                                                                                                                                                 |   |        |        |       |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Cash and due from banks (Note 2)                                                                                                                                           |   | $           | 4,798,100   |       | $      | 13,017,100 |   |
| Federal funds sold                                                                                                                                                         |   | 12,395,000  |        | —     |   |
| Total cash and cash equivalents                                                                                                                                            |   | 17,193,100  |        | 13,017,100 |   |
| Trading assets (Note 3)                                                                                                                                                    |   | 163,300     |        | 82,200     |   |
| Investment securities available for sale  (Note 4)                                                                                                                         |   | 6,075,500   |        | 6,039,800  |   |
| Other investments (Note 4)                                                                                                                                                 |   | 1,667,500   |        | 1,210,500  |   |
| Loans held for sale                                                                                                                                                        |   | 2,347,800   |        | 982,500    |   |
| Loans, net (Notes 6 and 17)                                                                                                                                                |   | 74,560,600  |        | 59,274,400 |   |
| Bank premises and equipment, net (Note 7)                                                                                                                                  |   | 2,197,700   |        | 2,243,700  |   |
| Cash surrender value of life insurance                                                                                                                                     |   | 2,251,000   |        | 2,160,400  |   |
| Interest receivable and other assets                                                                                                                                       |   | 1,415,500   |        | 1,268,700  |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Total assets                                                                                                                                                               |   | $           | 107,872,000 |       | $      | 86,279,300 |   |
|                                                                                                                                                                       |   |        |        |       |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                              |   |        |        |       |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Deposits:                                                                                                                                                                  |   |        |        |       |   |
| Non interest-bearing demand                                                                                                                                                |   | $           | 17,859,800  |       | $      | 15,023,700 |   |
| Interest-bearing demand                                                                                                                                                    |   | 16,454,500  |        | 12,653,400 |   |
| Savings                                                                                                                                                                    |   | 8,444,900   |        | 4,667,900  |   |
| Time in denominations of $100,000 or more  (Note 8)                                                                                                                        |   | 16,132,100  |        | 16,127,500 |   |
| Time (Note 8)                                                                                                                                                              |   | 19,241,100  |        | 19,143,900 |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Total deposits                                                                                                                                                             |   | 78,132,400  |        | 67,616,400 |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Short-term borrowing (Note 9)                                                                                                                                              |   | —      |        | 200,000    |   |
| Long-term debt (Note 9)                                                                                                                                                    |   | —      |        | 972,200    |   |
| Federal Home Loan Bank borrowed funds (Note  11)                                                                                                                           |   | 13,750,000  |        | 10,750,000 |   |
| Junior subordinated debt securities (Note  10)                                                                                                                             |   | 8,248,000   |        | —     |   |
| Interest payable and other liabilities                                                                                                                                     |   | 1,331,100   |        | 1,101,800  |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Total liabilities                                                                                                                                                          |   | 101,461,500 |        | 80,640,400 |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Commitments and contingencies (Note 13)                                                                                                                                    |   |        |        |       |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Shareholders’ equity (Notes 15 and 16)                                                                                                                                |   |        |        |       |   |
| Common stock, no stated par value,  authorized: 2,500,000 shares, issued and outstanding: 1,566,658 and 1,493,816  shares at December 31, 2003 and 2002, respectively |   | 4,630,900   |        | 4,500,400  |   |
| Retained earnings                                                                                                                                                          |   | 1,725,700   |        | 1,120,900  |   |
| Accumulated other comprehensive income  (Note 1)                                                                                                                           |   | 53,900      |        | 17,600     |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Total shareholders’ equity                                                                                                                                            |   | 6,410,500   |        | 5,638,900  |   |
|                                                                                                                                                                       |   |        |        |       |   |
| Total liabilities and shareholders’ equity                                                                                                                            |   | $           | 107,872,000 |       | $      | 86,279,300 |   |

 

The notes to consolidated financialstatements are an integral part of these statements.

 

F-2

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**NORTHERN CALIFORNIA BANCORP, INC. ANDSUBSIDIARY**

 

**CONSOLIDATED STATEMENTSOF OPERATIONSYears Ended December 31, 2003, 2002, and 2001**

 
|                                                                             |   | **2003**  |      | **2002**  |   | **2001**  |   |
|----------------------------------------------------------------------------------|--------|-----------|-----------|-----------|--------|-----------|--------|
|                                                                             |   |      |      |      |   |      |   |
| Interest income                                                                  |   |      |      |      |   |      |   |
| Loans                                                                            |   | $         | 5,173,400 |      | $      | 4,365,300 |   | $ | 4,576,300 |   |
| Time deposits with other financial  institutions                                 |   | —    |      | 2,900     |   | 12,400    |   |
| Investment securities                                                            |   | 299,400   |      | 416,900   |   | 487,500   |   |
| Federal funds sold                                                               |   | 96,700    |      | 114,800   |   | 363,400   |   |
| Total interest income                                                            |   | 5,569,500 |      | 4,899,900 |   | 5,439,600 |   |
|                                                                             |   |      |      |      |   |      |   |
| Interest expense                                                                 |   |      |      |      |   |      |   |
| Interest-bearing transaction accounts                                            |   | 49,300    |      | 94,500    |   | 115,100   |   |
| Savings and time deposit accounts                                                |   | 680,200   |      | 869,000   |   | 1,196,500 |   |
| Time deposits in denominations of $100,000  or more                              |   | 510,500   |      | 610,400   |   | 833,000   |   |
| Notes payable and other                                                          |   | 680,500   |      | 373,800   |   | 381,100   |   |
| Total interest expense                                                           |   | 1,920,500 |      | 1,947,700 |   | 2,525,700 |   |
|                                                                             |   |      |      |      |   |      |   |
| Net interest income                                                              |   | 3,649,000 |      | 2,952,200 |   | 2,913,900 |   |
| Provision for loan losses (Note 6)                                               |   | 155,000   |      | 117,000   |   | 185,000   |   |
| Net interest income, after provision for  loan losses                            |   | 3,494,000 |      | 2,835,200 |   | 2,728,900 |   |
|                                                                             |   |      |      |      |   |      |   |
| Other income                                                                     |   |      |      |      |   |      |   |
| Service charges on deposit accounts                                              |   | 505,700   |      | 508,100   |   | 494,000   |   |
| Income from sales and servicing of Small  Business Administration loans (Note 5) |   | 660,600   |      | 526,000   |   | 512,700   |   |
| Other income (Note 14)                                                           |   | 1,237,000 |      | 746,900   |   | 489,000   |   |
| Total other income                                                               |   | 2,403,300 |      | 1,781,000 |   | 1,495,700 |   |
|                                                                             |   |      |      |      |   |      |   |
| Operating expense                                                                |   |      |      |      |   |      |   |
| Salaries and employee benefits                                                   |   | 2,566,000 |      | 2,200,500 |   | 2,153,500 |   |
| Occupancy and equipment expense                                                  |   | 510,700   |      | 372,300   |   | 326,300   |   |
| Professional fees                                                                |   | 89,100    |      | 84,200    |   | 106,600   |   |
| Data processing                                                                  |   | 357,100   |      | 364,000   |   | 243,900   |   |
| Other general and administrative (Note 14)                                       |   | 876,100   |      | 732,600   |   | 802,500   |   |
| Total operating expenses                                                         |   | 4,399,000 |      | 3,753,600 |   | 3,632,800 |   |
|                                                                             |   |      |      |      |   |      |   |
| Income before tax provision                                                      |   | 1,498,300 |      | 862,600   |   | 591,800   |   |
| Income tax provision (Note 12)                                                   |   | 658,500   |      | 354,000   |   | 231,300   |   |
|                                                                             |   |      |      |      |   |      |   |
| Net income                                                                       |   | $         | 839,800   |      | $      | 508,600   |   | $ | 360,500 |   |
|                                                                             |   |      |      |      |   |      |   |
| Earnings per common share                                                        |   |      |      |      |   |      |   |
|                                                                             |   |      |      |      |   |      |   |
| Basic                                                                            |   | $         | 0.55      |      | $      | 0.34      |   | $ | 0.25 |   |
|                                                                             |   |      |      |      |   |      |   |
| Diluted                                                                          |   | $         | 0.47      |      | $      | 0.29      |   | $ | 0.21 |   |

 

The notes to consolidated financialstatements are an integral part of these statements.

 

F-3

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

 

**CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**

**Years Ended December 31, 2003, 2002, and2001**

 
|                                                                             |   | **Number of  Shares** |   | **Common  Stock** |      | **Retained  Earnings** |   | **Accumulated  Other Compre-  hensive Income  (Loss)** |   | **Total** |   |
|----------------------------------------------------------------------------------|--------|-----------------------|--------|-------------------|-----------|------------------------|--------|--------------------------------------------------------|--------|-----------|--------|
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Balance at December 31, 2000                                                |   | 1,219,671             |   | $                 | 3,716,700 |                   | $      | 1,054,600                                              |   | $         | 90,000 |   | $ | 4,861,300 |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Comprehensive income:                                                            |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Net income for the year                                                          |   | —                |   | —            |      | 360,500                |   | —                                                 |   | 360,500   |   |
| Change in net unrealized gain on securities  and other assets net of tax effects |   | —                |   | —            |      | —                 |   | (81,700                                                | )      | (81,700   | )      |
| Total comprehensive income                                                       |   |                  |   |              |      |                   |   |                                                   |   | 278,800   |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| 10% common stock dividend                                                        |   | 120,516               |   | 361,600           |      | (362,300               | )      | —                                                 |   | (700      | )      |
| Repurchase of common stock                                                       |   | (11,980               | )      | (37,700           | )         | —                 |   | —                                                 |   | (37,700   | )      |
| Repurchase of stock options                                                      |   | —                |   | —            |      | (14,800                | )      | —                                                 |   | (14,800   | )      |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Balance at December 31, 2001                                                |   | 1,328,207             |   | 4,040,600         |      | 1,038,000              |   | 8,300                                                  |   | 5,086,900 |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Comprehensive income:                                                            |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Net income for the year                                                          |   | —                |   | —            |      | 508,600                |   | —                                                 |   | 508,600   |   |
| Change in net unrealized gain on securities  and other assets net of tax effects |   | —                |   | —            |      | —                 |   | 9,300                                                  |   | 9,300     |   |
| Total comprehensive income                                                       |   |                  |   |              |      |                   |   |                                                   |   | 517,900   |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| 10% common stock dividend                                                        |   | 135,637               |   | 406,900           |      | (407,400               | )      | —                                                 |   | (500      | )      |
| Repurchase of common stock                                                       |   | (774                  | )      | (2,300            | )         | —                 |   | —                                                 |   | (2,300    | )      |
| Exercise of stock options                                                        |   | 30,746                |   | 55,200            |      | —                 |   | —                                                 |   | 55,200    |   |
| Repurchase of stock options                                                      |   | —                |   | —            |      | (18,300                | )      | —                                                 |   | (18,300   | )      |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Balance at December 31, 2002                                                |   | 1,493,816             |   | 4,500,400         |      | 1,120,900              |   | 17,600                                                 |   | 5,638,900 |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Comprehensive income:                                                            |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Net income for the year                                                          |   | —                |   | —            |      | 839,800                |   | —                                                 |   | 839,800   |   |
| Change in net unrealized gain on securities  and other assets net of tax effects |   | —                |   | —            |      | —                 |   | 36,300                                                 |   | 36,300    |   |
| Total comprehensive income                                                       |   |                  |   |              |      |                   |   |                                                   |   | 876,100   |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| $.15 per share cash dividend                                                     |   | —                |   | —            |      | (235,000               | )      | —                                                 |   | (235,000  | )      |
| Repurchase of common stock                                                       |   | (5,368                | )      | (21,500           | )         | —                 |   | —                                                 |   | (21,500   | )      |
| Exercise of stock options                                                        |   | 78,210                |   | 152,000           |      | —                 |   | —                                                 |   | 152,000   |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |   |
| Balance at December 31, 2003                                                |   | 1,566,658             |   | $                 | 4,630,900 |                   | $      | 1,725,700                                              |   | $         | 53,900 |   | $ | 6,410,500 |   |

 

The notes to consolidated financialstatements are an integral part of these statements.

 

F-4

----

 

**NORTHERN CALIFORNIA BANCORP, INC.**

**AND SUBSIDIARY**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**Years Ended December 31, 2003, 2002, and2001**

 
|                                                                               |   | **2003**    |       | **2002**    |   | **2001**    |   |
|------------------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|-------------|--------|
| **CASH FLOWS FROM  OPERATING ACTIVITIES**                                          |   |        |       |        |   |        |   |
| Net income                                                                         |   | $           | 839,800    |        | $      | 508,600     |   | $ | 360,500 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |        |       |        |   |        |   |
| Depreciation and amortization expense                                              |   | 169,800     |       | 120,700     |   | 121,000     |   |
| Realized gain on sales of  available-for-sale securities, net                      |   | (21,300     | )          | (163,287    | )      | (87,494     | )      |
| Amortization of deferred loan costs                                                |   | 108,500     |       | 71,400      |   | 46,200      |   |
| Amortization (accretion) of discounts and premiums  on investment securities       |   | 85,400      |       | (11,800     | )      | 3,800       |   |
| Loss on sale of equipment                                                          |   | 100         |       | 2,900       |   | —      |   |
| Provision for loan losses                                                          |   | 155,000     |       | 117,000     |   | 185,000     |   |
| Business Administration loans                                                      |   | —      |       | —      |   | (1,500      | )      |
| (Increase) decrease in trading assets                                              |   | (81,100     | )          | 90,800      |   | (5,000      | )      |
| (Increase) decrease in interest receivable                                         |   | (78,600     | )          | (700        | )      | 291,400     |   |
| Increase in other assets                                                           |   | (154,600    | )          | (207,200    | )      | (739,100    | )      |
| (Increase) decrease in deferred tax asset                                          |   | 38,400      |       | 52,200      |   | (140,000    | )      |
| Increase (decrease) in interest payable                                            |   | (9,300      | )          | (160,800    | )      | (10,800     | )      |
| Increase in other liabilities                                                      |   | 238,600     |       | 147,000     |   | 209,500     |   |
| Net cash provided by operating activities                                          |   | 1,290,700   |       | 566,813     |   | 233,506     |   |
|                                                                               |   |        |       |        |   |        |   |
| **CASH FLOWS FROM  INVESTING ACTIVITIES**                                          |   |        |       |        |   |        |   |
| Decrease in time deposits                                                          |   | —      |       | 100,000     |   | 100,000     |   |
| Proceeds from maturity of investment  securities                                   |   | 2,974,400   |       | 15,024,000  |   | 32,908,600  |   |
| Purchase of investments                                                            |   | (3,540,500  | )          | (11,672,713 | )      | (24,894,906 | )      |
| Net (increase) decrease in loans                                                   |   | (3,003,700  | )          | 3,155,800   |   | (976,300    | )      |
| Loan purchases                                                                     |   | (12,546,000 | )          | (10,650,500 | )      | (10,511,500 | )      |
| (Increase) decrease in loans held for sale                                         |   | (1,365,300  | )          | (376,900    | )      | 1,943,900   |   |
| Proceeds from sale of equipment                                                    |   | 1,900       |       | 3,000       |   | —      |   |
| Additions to bank premises and equipment                                           |   | (122,800    | )          | (565,600    | )      | (152,500    | )      |
| Net cash used by investing activities                                              |   | (17,602,000 | )          | (4,982,913  | )      | (1,582,706  | )      |
|                                                                               |   |        |       |        |   |        |   |
| **CASH FLOWS FROM  FINANCING ACTIVITIES**                                          |   |        |       |        |   |        |   |
| Net increase (decrease) in deposits                                                |   | 10,516,000  |       | (716,000    | )      | (3,885,900  | )      |
| Proceeds from borrowings                                                           |   | 11,248,000  |       | 6,750,000   |   | —      |   |
| Repayments of borrowings                                                           |   | (1,172,200  | )          | (27,800     | )      | (675,000    | )      |
| Proceeds from exercise of stock options                                            |   | 152,000     |       | 55,200      |   | —      |   |
| Repurchase of common stock and stock  options                                      |   | (21,500     | )          | (20,600     | )      | (52,500     | )      |
| Cash dividends paid on common stock                                                |   | (235,000    | )          | (500        | )      | (700        | )      |
| Net cash provided (used) by financing  activities                                  |   | 20,487,300  |       | 6,040,300   |   | (4,614,100  | )      |
|                                                                               |   |        |       |        |   |        |   |
| Net increase (decrease) in cash and cash  equivalents                              |   | 4,176,000   |       | 1,624,200   |   | (5,963,300  | )      |
|                                                                               |   |        |       |        |   |        |   |
| **CASH AND CASH  EQUIVALENTS, BEGINNING**                                          |   | 13,017,100  |       | 11,392,900  |   | 17,356,200  |   |
|                                                                               |   |        |       |        |   |        |   |
| **CASH AND CASH  EQUIVALENTS, ENDING**                                             |   | $           | 17,193,100 |        | $      | 13,017,100  |   | $ | 11,392,900 |   |
|                                                                               |   |        |       |        |   |        |   |   |   |   |
| **OTHER CASH FLOW  INFORMATION**                                                   |   |        |       |        |   |        |   |
|                                                                               |   |        |       |        |   |        |   |
| Interest paid                                                                      |   | $           | 1,738,100  |        | $      | 2,108,600   |   | $ | 2,536,700 |   |
|                                                                               |   |        |       |        |   |        |   |
| Income taxes paid                                                                  |   | $           | 363,000    |        | $      | 353,200     |   | $ | 325,200 |   |

 

The notes to consolidated financialstatements are an integral part of these statements.

 

F-5

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**NORTHERN CALIFORNIA BANCORP, INC. ANDSUBSIDIARY**

 

**NOTES****TO CONSOLIDATEDFINANCIAL STATEMENTSYears Ended December 31, 2003 and 2002**

 

**Note 1.****                                  SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

####  

***Basis ofPresentation and Consolidation***

 

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

 

***Use of Estimates***

 

In preparing consolidated financial statements in conformity withaccounting principles generally accepted in the United States of America,management is required to make estimates and assumptions that affect thereported amounts of assets and liabilities as of the date of the balance sheetand reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.  Material estimates that areparticularly susceptible to significant change in the near term relate to thedetermination of the allowance for loan losses, and the valuation of deferredtax assets.

 

***Business***

 

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

 

***Cash and CashEquivalents***

 

For purposes of the consolidated statements of cash flows, cash andcash equivalents include cash and balances due from banks, all of which maturewithin ninety days.

 

***Time Deposits withOther Financial Institutions***

 

Interest-bearing deposits in banks mature within one year and arecarried at cost.

 

F-6

----

 

***Trading Activities***

 

The Corporation engages in trading activities for its own account.  Securities that are held principally forresale in the near term are recorded in the trading assets account at fair valuewith changes in fair value recorded in earnings.  Interest and dividends are included in net interest income.

 

Quoted market prices, when available, are used to determine the fairvalue of trading instruments.  If quotedmarket prices are not available, then fair values are estimated using pricingmodels, quoted prices of instruments with similar characteristics, ordiscounted cash flows.

 

***InvestmentSecurities***

 

Investments in debt securities that management has the positive intentand ability to hold to maturity are classified as “held to maturity” andreflected at cost, adjusted for amortization of premiums and accretion ofdiscounts, which are recognized as 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 comprehensiveincome.  In estimatingother-than-temporary impairment losses, management considers (1) the length oftime and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer, and (3) the intentand ability of the Bank to retain its investment in the issuer for a period oftime sufficient to allow for any anticipated recovery in fair value.  Gains and losses on disposition aregenerally recognized on the trade date, based on the net proceeds and theadjusted carrying amount of the securities sold using the specificidentification method.  Purchasepremiums and discounts are recognized in interest income using methodsapproximating the interest method over the terms of the securities.

 

***Sales and Servicingof SBA Loans***

 

The Bank originates loans to customers under the Small BusinessAdministration (SBA) program that generally provides for SBA guarantees of 70%to 80% of each loan.  The Bank generallysells the guaranteed portion of each loan to a third party and retains only thenon-guaranteed portion in its own portfolio. A gain is recognized on these loans through collection on sale of apremium over the adjusted carrying value, or through retention of an ongoingrate differential, less a normal service fee between the rate paid by theborrower to the Bank and the rate paid by the Bank to the purchaser (excessservicing fee).  In calculating thegain, the Bank assumes that the loans sold will be outstanding for one-half oftheir contractual lives.

 

F-7

----

 

The Bank’s investment in an SBA loan is allocated among the retained portionof the loan, excess servicing retained, and the sold portion of the loan, basedon the relative fair market value of each portion at the time of loanorigination, adjusted for payments and other activities.  Since the portion retained does not carry anSBA guarantee, part of the gain recognized on the sold portion of the loan isdeferred and amortized as a yield enhancement on the retained portion of theloan.  Excess servicing fees arereflected as an asset which is amortized over an assumed half life; in theevent future prepayments are significant and future expected cash flows areinadequate to cover the unamortized excess servicing asset, additionalamortization is recognized.

 

***Loans Held for Sale***

 

Loans held for sale consist of the portion of loans that are guaranteedby the SBA and are carried at the lower of cost or market.  Market value for loans guaranteed by the SBAis generally determined based on the price at which the loans were committed tobe sold on the trade date.  Direct loanorigination costs are recorded at settlement as an adjustment to gain or losson sale.

 

***Loans and Loan Fees***

 

The Bank grants mortgage, commercial, and consumer loans tocustomers.  A substantial portion of theloan portfolio is represented by****mortgage loans on the MontereyPeninsula.  The ability of the Bank’sdebtors to honor their contracts is dependent upon the real estate and generaleconomic sectors in the area.

 

Loans, as reported, have been reduced by****undisbursed loan funds, netdeferred loan fees, and the allowance for loan losses.

 

Loans that management has the intent and ability to hold for theforeseeable future or until maturity or pay-off generally are reported at theiroutstanding unpaid principal balances adjusted for charge-offs, the allowancefor loan losses, and any deferred fees or cost on originated loans.  Interest income is accrued on the unpaidprincipal balance.  Loan originationfees, net of certain direct origination costs, are deferred and recognized asan adjustment of the related loan yield using the interest method.

 

F-8

----

 

The accrual of interest on mortgage and commercial loans isdiscontinued at the time the loan is 90 days past due unless the credit iswell-secured and in process of collection. Credit card loans and other personal loans are typically charged off nolater than 180 days past due.  Past duestatus is based on contractual terms of the loan.  In all cases, loans are placed on nonaccrual or charged-off at anearlier date if collection of principal or interest is considered doubtful.

 

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

 

***Allowance for LoanLosses***

 

The allowance for loan losses is established through a provision forloan losses charged to earnings and is maintained at a level consideredadequate to provide for reasonably foreseeable loan losses.

 

The provision and the level of the allowance are evaluated on a regularbasis by management and are based upon management’s periodic review of thecollectibility of the loans in light of historical experience, known andinherent risks in the nature and volume of the loan portfolio, adversesituations that may affect the borrower’s ability to repay, estimated value ofany underlying collateral, and prevailing economic conditions.  This evaluation is inherently subjective asit requires estimates that are susceptible to significant change.  In addition, various regulatory agencies, asan integral part of their examination process, periodically review the Bank’sallowance for losses on loans and other real estate owned.

 

Such agencies 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 and future additions to the allowancemay be necessary.

 

Loan losses are charged against the allowance when management believesthe collectibility of the loan balance is unlikely.  Subsequent recoveries, if any, are credited to the allowance.

 

F-9

----

 

The allowance consists of specific, general and unallocatedcomponents.  The specific componentrelates to loans that are classified as either doubtful, substandard or specialmention.  For such loans that are alsoclassified as impaired, an allowance is established when the discounted cashflows (or collateral value or observable market price) of the impaired loan islower than that of the carrying value of that loan.  The general component covers non-classified loans and is based onhistorical loss experience adjusted for qualitative factors.  An unallocated component is maintained tocover uncertainties that could affect management’s estimate of probablelosses.  The unallocated component ofthe allowance reflects the margin of imprecision inherent in the underlyingassumptions used in the methodologies for estimating specific and generallosses in the portfolio.

 

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

 

Large groups of smaller balance homogeneous loans are collectivelyevaluated for impairment.  Accordingly,the Bank does not separately identify individual consumer loans for impairmentdisclosures.

 

F-10

----

 

***Loan Servicing***

 

The Bank has adopted Statement of Financial Accounting Standards(“SFAS”) No. 122, “Accounting for Mortgage Servicing Rights,” as superseded bySFAS No. 125, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities,” whereby rights to service loans for others arecapitalized as separate assets, whether acquired through purchase ororigination, if such loans are sold or securitized with servicing rightsretained.  Accordingly, the total costof the loan is allocated to the related servicing right and to the loan basedon the relative fair values if it is practicable to estimate those fair values.

 

The Bank estimates fair value based on the present value of estimatedexpected future cash flows using prepayment speeds and discount ratescommensurate with the risks involved, and servicing costs determined on anincremental cost basis.  Prior to theadoption of SFAS No. 122, the capitalization of originated mortgage servicingrights was not allowed under accounting principles generally accepted in theUnited States of America.

 

Capitalized mortgage servicing rights are amortized to servicingrevenue in proportion to, and over the period of, estimated net servicingrevenues.  Impairment of mortgageservicing rights is assessed based on 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 isrecognized through a valuation allowance for an individual stratum, to theextent that fair value is less than the capitalized amount for the stratum.

 

***Banking Premises andEquipment***

 

Land is carried at cost. Buildings and equipment are carried at cost, less accumulateddepreciation computed on the straight-line method over the estimated usefullives of the assets.

 

It is general practice to charge the cost of****maintenance and repairs toearnings when incurred; major expenditures for betterments are capitalized anddepreciated.

 

F-11

----

 

***Income Taxes***

 

Deferred tax assets and liabilities are reflected at currently enactedincome tax rates applicable to the period in which the deferred tax assets orliabilities are expected to be realized or settled.  As changes in tax laws or rates are enacted, deferred tax assetsand liabilities are adjusted accordingly through the provision for incometaxes.

 

***Transfers ofFinancial Assets***

 

Transfers of financial assets are accounted for as sales when controlover the assets has been surrendered. Control over transferred assets is deemedto be surrendered when 1) the assets have been isolated from the Bank, 2) thetransferee (buyer) obtains the right to pledge or exchange the transferredassets, free of conditions that would constrain it from taking advantage ofthat right, and 3) the Bank does not maintain effective control over thetransferred assets through an agreement to repurchase them before theirmaturity.

 

***Stock Option Plan***

 

Under the Corporation’s Stock Option Plan, the Bank may grant incentivestock options and non-qualified stock options to directors, officers, andemployees of the Corporation and it’s subsidiary, so long as the Corporationowns a majority of the equity interest of such subsidiary.  Incentive Stock Options may be granted atprices not lower than 100% of the fair market value of the common stock on thedate 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%****ofsuch fair market value and an exercise period 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 ofDirectors is authorized to determine when options become exercisable within aperiod not extending 10 years from the date of grant.  Under the Plan, 379,071 shares of common stock have been reservedfor the granting of these options.  AtDecember 31, 2003, 221,578 options were outstanding, 63,000 options weregranted, and 78,210 options were exercised by officers, employees, and boardmembers.

 

F-12

----

 

Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation,” as amended by SFAS No. 148“Accounting for Stock-Based Compensation –Transition and Disclosure,”encourages all entities to adopt a fair value based method of accounting foremployee stock compensation plans, whereby compensation cost is measured at thegrant date based on the value of the award and is recognized over the serviceperiod, which is usually the vesting period. However, it also allows an entity to continue to measure compensationcost for those plans using the intrinsic value based method of accountingprescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” whereby compensation cost is the excess, ifany, of the quoted market price of the stock at the grant date (or othermeasurement date) over the amount an employee must pay to acquire thestock.  Stock options issued under theCorporation’s stock option plan have no intrinsic value at the grant date, andunder Opinion No. 25 no compensation cost is recognized for them.

 

The Corporation applies APB Opinion 25 and related Interpretations inaccounting for the plan.  Accordingly,no compensation cost has been recognized. Had compensation cost for the Corporation’s stock-based compensationplan been determined based on the fair value at the grant date for awards underthe plan consistent with the method prescribed by SFAS No. 123 as amended bySFAS 148, the Corporation’s net income and basic earnings per share would havebeen adjusted by the compensation cost net of taxes to the pro forma amountsindicated below:

 
| Net income:                     |   |   |    |   |   |    |   |
|---------------------------------|--------|--------|---------|--------|--------|---------|--------|
| As reported                     |   | $      | 839,800 |   | $      | 508,600 |   | $ | 360,500 |   |
| Pro forma                       |   | $      | 809,900 |   | $      | 470,200 |   | $ | 360,500 |   |
|                            |   |   |    |   |   |    |   |
| Compensation cost, net of taxes |   | $      | 29,900  |   | $      | 38,400  |   | $ | — |   |
|                            |   |   |    |   |   |    |   |
| Basic earnings per share:       |   |   |    |   |   |    |   |
| As reported                     |   | $      | 0.55    |   | $      | 0.34    |   | $ | 0.25 |   |
| Pro forma                       |   | $      | 0.53    |   | $      | 0.32    |   | $ | 0.25 |   |
|                            |   |   |    |   |   |    |   |
| Diluted earnings per share:     |   |   |    |   |   |    |   |
| As reported                     |   | $      | 0.47    |   | $      | 0.29    |   | $ | 0.21 |   |
| Pro forma                       |   | $      | 0.45    |   | $      | 0.27    |   | $ | 0.21 |   |

 

F-13

----

 

The fair value of these options was estimated at the grant date usingthe Black-Scholes option pricing model with the following weighted-averageassumptions for 2003 and 2002: risk-free interest rate of 5.1% and 4.5% for2003 and 2002, respectively; dividend yield of .017% and 0% for 2003 and 2002,respectively; expected option life of 5.4 years and 5.6 years for 2003 and2002, respectively ; and volatility of 20% and 30% in 2003 and 2002,respectively.  There were no optionsgranted in 2001.

 

***Earnings per share***

 

Basic earnings per share represents income available to commonshareholders divided by the weighted-average number of common sharesoutstanding 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.  Potential common shares that may be issuedby the Corporation relate solely to outstanding stock options, and aredetermined using the treasury stock method. The weighted average number of shares used in the computation of basicearnings per share was 1,528,268 for 2003, 1,483,491 for 2002, and $1,469,489for 2001.  The weighted average numberof shares used in the computation of earnings per share assuming dilution ofstock options was 1,796,859 for 2003, 1,744,081 for 2002, and 1,701,827 for2001.  A 15% cash dividend was paid in2003.  The 10% stock dividend wasretroactively reflected in the 2001 weighted shares.

 

***Accounting Changes***

#  

In January 2003, the Financial Accounting Standards Board (FASB)issued Interpretation No. 46, *Consolidation of Variable Interest Entities*(FIN46) which establishes guidance for determining when an entity shouldconsolidate another entity that meets the definition of a variable interestentity.  FIN 46 requires a variableinterest entity to be consolidated by a company if that company will absorb amajority of the expected losses, will receive a majority of the expectedresidual returns, or both.  Transferorsto qualified special-purpose entities (“QSPEs”) and certain other interest in aQSPE are not subject to the requirements of FIN 46.  On December 17, 2003, the FASB deferred the effective dateof FIN 46 to no later than the end of the first reporting period that endsafter March 15, 2004.  However, forspecial purpose entities the Company would be required to apply FIN 46 as ofDecember 31, 2003.  TheInterpretation had no effect on the Company’s consolidated financialstatements.

 

F-14

----

 

In April 2003, the FASB issued Statement of Financial AccountingStandards (SFAS) No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities.”  The Statementamends SFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities” and clarifies accounting for derivative instruments, includingcertain derivative instruments embedded in other contracts, and for hedgingactivities under SFAS No. 133.  ThisStatement is effective for contracts entered into or modified afterJune 30, 2003.  This Statement hadno effect on the Company’s consolidated financial statements.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities andEquity.”  This Statement provides newrules on the accounting for certain financial instruments that, under previousguidance, issuers could account for as equity. Such financial instruments include mandatory redeemable shares,instruments that require the issuer to buy back some of its shares in exchangefor cash or other assets, or obligations that can be settled with shares, themonetary value of which is fixed.  Mostof the guidance in SFAS No. 150 is effective for financial instruments enteredinto or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 30, 2003.  This Statement had no effect on theCompany’s consolidated financial statements.

 

F-15

----

 

***Comprehensive Income***

 

Accounting principles generally require that recognized revenue,expenses, gains, and losses 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 ofthe balance sheet, such items, along with net income, are components ofcomprehensive income.

 

The components of other comprehensive income and related tax effectsfor the years ended December 31, are as follows:

 
|                                                                                      |   | **2003** |   | **2002** |   | **2001** |   |
|-------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Unrealized holding gains (losses) on  available for sale securities and other assets, net |   | $        | 66,100 |     | $      | 16,900   |   | $ | (194,600 | ) |
| Tax effect                                                                                |   | (29,800  | )      | (7,600   | )      | 112,900  |   |
|                                                                                      |   |     |   |     |   |     |   |
| Net-of-tax amount                                                                         |   | $        | 36,300 |     | $      | 9,300    |   | $ | (81,700 | ) |

 

The components of accumulated other comprehensive income and relatedtax effects are as follows:

 
|                                                                   |   | **2003** |   | **2002** |   |
|------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Unrealized holding losses on available for  sale securities            |   | $        | (8,000 | )        | $      | (28,500 | ) |
| Unrealized holding gains on available for  sale asset strip receivable |   | 106,100  |   | $        | 60,500 |   |
| Tax effect                                                             |   | (44,200  | )      | (14,400  | )      |
|                                                                   |   |     |   |     |   |
| Net-of-tax amount                                                      |   | $        | 53,900 |     | $      | 17,600 |   |

 

F-16

----

***Advertising Costs***

 

Advertising costs arecharged to operations when incurred. The amount expensed for advertising as of December 31, 2003, 2002,and 2001 was $113,500, $100,200, and $102,400, respectively.

 

***Reclassification***

 

Certain amounts have beenreclassified in the 2002 and 2001 financial statements to conform to the 2003presentation.

 

**Note 2.****                                  CASHAND DUE FROM BANKS**

 

The Corporation isrequired to maintain aggregate reserves (in the form of cash and deposits withthe Federal Reserve Bank) to satisfy federal regulatory requirements.  At December 2003 and 2002, thesereserve balances amounted to $517,000 and $455,000, respectively.

 

**Note 3.****                                  TRADINGASSETS**

 

At December 31, 2003and 2002, trading assets, at fair value, consisted of marketable equity securitiesin the amount of $163,300 and $82,200, respectively.

 

F-17

----

 

**Note 4.****                                  INVESTMENTSECURITIES AND OTHER INVESTMENTS**

 

The amortized cost andfair value of investment securities, with gross unrealized gains and losses,follows:

 
|                                        |   | **Amortized  Cost**        |      | **Gross  Unrealized  Gains  (Losses)** |   | **Fair  Value** |   |
|---------------------------------------------|--------|----------------------------|-----------|----------------------------------------|--------|-----------------|--------|
|                                        |   | **December 31, 2003** |      |
| Securities  Available for Sale              |   |                       |      |                                   |   |            |   |
| GNMA  - Mortgage Backed Securities          |   | $                          | 2,293,500 |                                   | $      | (47,400         | )      | $ | 2,246,100 |   |
| Government  Agency Securities               |   | 2,000,700                  |      | (12,800                                | )      | 1,987,900       |   |
| Corporate  Debt Securities                  |   | 1,789,300                  |      | 52,200                                 |   | 1,841,500       |   |
|                                        |   |                       |      |                                   |   |            |   |
| Total  securities available for sale        |   | $                          | 6,083,500 |                                   | $      | (8,000          | )      | $ | 6,075,500 |   |
|                                        |   |                       |      |                                   |   |            |   |
| Other  Investments, at cost                 |   |                       |      |                                   |   |            |   |
| AT  Services LLC                            |   | $                          | 202,000   |                                   | — |            | $      | 202,000 |   |
| Mission  Valley Bank                        |   | 25,000                     |      | —                                 |   | 25,000          |   |
| Federal  Home Loan Bank stock, restricted   |   | 752,600                    |      | —                                 |   | 752,600         |   |
| 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                    |      | —                                 |   | 439,900         |   |
|                                        |   |                       |      |                                   |   |            |   |
| Total  other investments                    |   | $                          | 1,667,500 |                                   | $      | —          |   | $ | 1,667,500 |   |

 

F-18

----

 
|                                      |   | **Amortized  Cost**         |      | **Gross  Unrealized  Losses** |   | **Fair  Value** |   |
|-------------------------------------------|--------|-----------------------------|-----------|-------------------------------|--------|-----------------|--------|
|                                      |   | **December 31,  2002** |      |
| Securities  Available for Sale            |   |                        |      |                          |   |            |   |
| GNMA  - Mortgage Backed Securities        |   | $                           | 4,559,900 |                          | $      | 6,600           |   | $ | 4,553,300 |   |
| Corporate  Debt Securities                |   | 1,508,400                   |      | 21,900                        |   | 1,486,500       |   |
|                                      |   |                        |      |                          |   |            |   |
| Total  securities available for sale      |   | $                           | 6,068,300 |                          | $      | 28,500          |   | $ | 6,039,800 |   |
|                                      |   |                        |      |                          |   |            |   |
| Other  Investments, at cost               |   |                        |      |                          |   |            |   |
| AT  Services LLC                          |   | $                           | 204,200   |                          | $      | —          |   | $ | 204,200 |   |
| Mission  Valley Bank                      |   | 25,000                      |      | —                        |   | 25,000          |   |
| Federal  Home Loan Bank stock, restricted |   | 541,400                     |      | —                        |   | 541,400         |   |
| Pacific  Coast Banker’s Bank Stock   |   | 439,900                     |      | —                        |   | 439,900         |   |
|                                      |   |                        |      |                          |   |            |   |
| Total  other investments                  |   | $                           | 1,210,500 |                          | $      | —          |   | $ | 1,210,500 |   |

 

The amortized cost andfair value of debt securities by contractual maturity at December 31, 2003are shown below.  Expected maturitieswill differ from contractual maturities because borrowers may have the right tocall or prepay obligations with or without call or prepayment penalties.

 
|                               |   | **Available  for Sale** |      |
|------------------------------------|--------|-------------------------|-----------|
|                               |   | **Amortized  Cost**     |      | **Fair  Value** |   |
| Due  between one and five years    |   | $                       | 3,040,000 |   | $ | 3,068,600 |   |
| Due  between five and ten years    |   | 750,000                 |      | 760,800 |   |
| GNMA  - Mortgage Backed Securities |   | 2,293,500               |      | 2,246,100 |   |
|                               |   |                    |      |   |   |
|                               |   | $                       | 6,083,500 |   | $ | 6,075,500 |   |

 

F-19

----

 

Proceeds from maturityand sales of investment securities during 2003 and 2002, respectively, were$2,974,400 and $15,024,000.  Realizedgains during 2003 and 2002, respectively, were $21,300 and $163,300.

 

Information pertaining tosecurities with gross unrealized losses at December 31, 2003, aggregatedby investment category and length of time that individual securities have beenin a continuous loss position follows:

 
|                                |   | **Less Than  Twelve Months**  |   |
|-------------------------------------|--------|-------------------------------|--------|
|                                |   | **Gross  Unrealized  Losses** |   | **Fair  Value** |   |
| Securities  Available-for-Sale      |   |                          |   |   |   |
| GNMA  - Mortgage Backed Securities  |   | $                             | 47,400 |   | $ | 2,246,100 |   |
| Government  Agency Securities       |   | 12,800                        |   | 1,987,900 |   |
|                                |   |                          |   |   |   |
| Total  securities avaiable for sale |   | $                             | 60,200 |   | $ | 4,234,000 |   |

 

There were no individualsecurities having a continuous loss position over twelve months.

 

Management evaluatessecurities for other-than-temporary impairment at least on a quarterly basis,and more frequently when economic or market concerns warrant such evaluation.Consideration is given to (1) the length of time and the extent to which thefair value has been less than cost, (2) the financial condition and near-termprospects of the issuer, and (3) the intent and ability of the Bank to retainits investment in the issuer for a period of time sufficient to allow for anyunanticipated recovery in fair value.

 

F-20

----

 

**Note 5.****                                  SALESAND SERVICING OF SBA LOANS**

 

A summary of the activityof SBA loans follows:

 
|                  |   | **2003** |      | **2002** |   | **2001**  |   |
|-----------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                  |   |     |      |     |   |      |   |
| SBA  loans originated |   | $        | 8,882,900 |     | $      | 5,916,900 |   | $ | 5,141,000 |   |
|                  |   |     |      |     |   |      |   |
| SBA  loans sold       |   | $        | 4,994,100 |     | $      | 4,689,300 |   | $ | 5,264,300 |   |

 

A summary of income fromSBA loans sold is as follows:

 
|                                  |   | **2003** |    | **2002** |   | **2001** |   |
|---------------------------------------|--------|----------|---------|----------|--------|----------|--------|
|                                  |   |     |    |     |   |     |   |
| Income  from premiums                 |   | $        | 440,000 |     | $      | 332,800  |   | $ | 363,800 |   |
| Income  from servicing                |   | 220,600  |    | 193,200  |   | 148,900  |   |
|                                  |   |     |    |     |   |     |   |
| Total  SBA sales and servicing income |   | $        | 660,600 |     | $      | 526,000  |   | $ | 512,700 |   |

 

**Note 6.****                                  LOANSAND ALLOWANCE FOR LOAN LOSSES**

 

A summary of loanbalances follows:

 
|                                   |   | **2003**   |       | **2002**   |   |
|----------------------------------------|--------|------------|------------|------------|--------|
|                                   |   |       |       |       |   |
| Commercial  and industrial             |   | $          | 16,869,700 |       | $      | 13,449,900 |   |
| Construction                           |   | 5,379,100  |       | 4,066,300  |   |
| Real  estate, mortgage                 |   | 52,698,400 |       | 41,999,800 |   |
| Installment                            |   | 523,600    |       | 461,900    |   |
| Government  guaranteed loans purchased |   | 57,600     |       | 63,400     |   |
|                                   |   | 75,528,400 |       | 60,041,300 |   |
| Allowance  for loan losses             |   | (774,800   | )          | (636,900   | )      |
| Deferred  origination fees, net        |   | (193,000   | )          | (130,000   | )      |
|                                   |   |       |       |       |   |
| Loans,  net                            |   | $          | 74,560,600 |       | $      | 59,274,400 |   |

 

F-21

----

 

An analysis of theallowance for loan losses follows:

 
|                       |   | **2003** |    | **2002** |   | **2001** |   |
|----------------------------|--------|----------|---------|----------|--------|----------|--------|
|                       |   |     |    |     |   |     |   |
| Beginning  balance         |   | $        | 636,900 |     | $      | 566,300  |   | $ | 468,500 |   |
| Recoveries                 |   | 1,300    |    | 13,300   |   | 1,700    |   |
| Loans  charged off         |   | (18,400  | )       | (59,700  | )      | (88,900  | )      |
| Provision  for loan losses |   | 155,000  |    | 117,000  |   | 185,000  |   |
|                       |   |     |    |     |   |     |   |
| Ending  balance            |   | $        | 774,800 |     | $      | 636,900  |   | $ | 566,300 |   |

 

As of December 31,2003 and 2002 the recorded investment in impaired loans totaled $927,200 and$328,400 with corresponding valuation allowances of $88,300 and $27,500,respectively.  No additional amounts arecommitted to be advanced in connection with impaired loans.

 

As of December 31,2003, 2002, and 2001 the average recorded investment in impaired loans amountedto approximately $705,000, $1,218,500, and $984,200, respectively.  Non-accrual loans totaled $39,400 and $34,200at December 31, 2003 and 2002, respectively.  If interest on non-accrual loans had been accrued, such incomewould have approximated $3,100, $3,000, and $21,300 for 2003, 2002, and 2001,respectively.

 

**Note 7.****                                  BANKINGPREMISES AND EQUIPMENT**

 

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

 
|                      |   | **2003**   |      | **2002**   |   | **Useful  Lives** |   |
|---------------------------|--------|------------|-----------|------------|--------|-------------------|--------|
|                      |   |       |      |       |   |              |   |
| Land                      |   | $          | 711,725   |       | $      | 711,725           |   |   |   |
| Building                  |   | 203,675    |      | 203,675    |   | 40 years          |   |
| Building  improvements    |   | 446,200    |      | 423,700    |   | 40 years          |   |
| Leasehold  improvements   |   | 803,500    |      | 710,900    |   | Lease term        |   |
| Furniture  and equipment  |   | 1,653,100  |      | 1,640,600  |   | 3-8 years         |   |
|                      |   | 3,818,200  |      | 3,690,600  |   |              |   |
| Accumulated  depreciation |   | (1,620,500 | )         | (1,446,900 | )      |              |   |
|                      |   |       |      |       |   |              |   |
|                      |   | $          | 2,197,700 |       | $      | 2,243,700         |   |   |   |

 

F-22

----

 

Depreciation expense of$166,800, $120,700, and $121,000 was included****in occupancy and equipmentexpense for the years ended December 31, 2003, 2002, and 2001, respectively.

 

 

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

 

At December 31,2003, the scheduled maturities of time deposits are as follows:

 
| 2004       |   | $         | 18,219,700 |   |
|------------|--------|-----------|------------|--------|
| 2005       |   | 7,418,200 |       |
| 2006       |   | 7,152,100 |       |
| 2007       |   | 1,606,900 |       |
| 2008       |   | 508,000   |       |
| Thereafter |   | 468,300   |       |
|       |   |      |       |
|       |   | $         | 35,373,200 |   |

 

**Note 9.****                                  SHORT-TERMBORROWING AND LONG-TERM DEBT**

 

The Corporation borrowed$1,000,000 on an unsecured basis from United Security Bank, Fresno, Californiaon June 28, 2001.  The rate ofinterest is the United Security Bank Reference Rate (the “Index”) plus .750 percentagepoints over the Index.  The noterequires monthly interest payments beginning August 5, 2001, quarterlyprincipal and interest payments beginning October 5, 2002 throughApril 5, 2011, and a final payment of principal and interest onJuly 5, 2011.  The proceeds fromthe borrowing were used to payoff an $800,000 term loan and to pay down the$200,000 line of credit with Pacific Coast Bankers’ Bank.  The Corporation renewed the $200,000revolving line of credit for one year, with interest due monthly.  The credit line is secured by 93,069 sharesof Monterey County Bank common stock. The rate of interest on the credit line is the prime rate as publishedin the Wall Street Journal (the “Index”) plus .750 percentage points over theIndex, with floor rate of 6.50%.  TheCorporation paid off both the term note and line of credit with proceeds fromits March 27, 2003 Trust Preferred Securities issuance.

 

F-23

----

 

**Note 10.****                           JUNIORSUBORDINATED DEBT SECURITIES**

 

OnMarch 27, 2003, the Company’s wholly owned special-purpose trustsubsidiary, Northern California Bancorp, Inc. Trust I (the “Trust”) issued $3million in cumulative Trust Preferred Securities.  The securities bear a floating rate of interest of 3.25% over thethree month LIBOR rate, payable quarterly. Concurrent with the issuance of the Trust Preferred Securities, theTrust used the proceeds from the Trust Preferred Securities offering topurchase a like amount of Junior Subordinated Debentures of the Company.  The Subordinated Debentures are the soleassets of the Trust and are eliminated, along with the related income statementeffects, in the consolidated financial statements.  The Company will pay interest on the Junior SubordinatedDebentures to the Trust, which represents the sole revenue and sole source ofdividend distributions to the holders of the Trust Preferred Securities.  The Company has the right, assuming nodefault has occurred, to defer payments of interest on the Junior SubordinatedDebentures at any time for a period not to exceed 20 consecutive quarters.  The Trust Preferred Securities will matureon April 7, 2033, but can be redeemed under certain circumstances at apremium prior to April 7, 2008, and can be redeemed, in whole or in part,on any January 7, April 7, July 7 or October 7 on or afterApril 7, 2008 at par.  The Companyfully and unconditionally guarantees the obligations of the Trust, on asubordinated basis.

 

TheCompany received $2.91 million from the Trust upon issuance of the JuniorSubordinated Debentures, of which $1 million was contributed by the Company tothe Bank to increase its capital, $1.14 million was used to retire existingCompany debt and the remainder held as working capital.  Under applicable regulatory guidelines, aportion of the Trust Preferred Securities will qualify as Tier I Capital, andthe remainder as Tier II Capital.

 

On November 13,2003, the Company’s wholly owned special-purpose trust subsidiary, NorthernCalifornia Bancorp, Inc. Trust II (the “Trust”) issued $5 million in cumulativeTrust Preferred Securities.  Thesecurities bear a floating rate of interest of 2.85% over the three month LIBORrate, payable quarterly.  Concurrentwith the issuance of the Trust Preferred Securities, the Trust used theproceeds from the Trust Preferred Securities offering to purchase a like amountof Junior Subordinated Debentures of the Company.  The Subordinated Debentures are the sole assets of the Trust andare eliminated, along with the related income statement effects, in theconsolidated financial statements.  TheCompany will pay interest on the Junior Subordinated Debentures to the Trust,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 deferpayments of interest on the Junior Subordinated Debentures at any time for aperiod not to exceed 20 consecutive quarters. The Trust Preferred Securities will mature on November 8, 2033, butcan be redeemed under certain circumstances at a premium prior toNovember 8, 2008, and can be redeemed, in whole or in part, on anyFebruary 8, May 8, August 8 or November 8 on or afterNovember 8, 2008 at par.  TheCompany fully and unconditionally guarantees the obligations of the Trust, on asubordinated basis.

 

F-24

----

 

TheCompany received $4.96 million from the Trust upon issuance of the JuniorSubordinated Debentures, of which $2.5 million was contributed by the Companyto the Bank to increase its capital and the remainder held as working capital.

 

Issuancecosts of $115,800 related to the March 27, 2003 Trust Preferred Securitiesissuance and $54,000 related to the November 13, 2003 issuance have beendeferred and will be amortized over the 30-year life of the securities.

 

Duringthe year ended December 31, 2003 interest expense on Junior SubordinatedDebentures totaled $130,900 and the amortization of the issuance cost totaled$3,000.

 

**Note 11.****                           FEDERALHOME LOAN BANK BORROWED FUNDS**

 

The Bank entered into anadvance and security agreement with the Federal Home Loan Bank of San Franciscoon January 21, 1993.  The followingtable provides information on the seven (7) advances totaling $13,750,000 outstandingat December 31, 2003:

 
| **Advance  Amount** |   | **Fixed  Interest  Rate** |   | **Funding  Date** |   | **Maturity  Date** |   |
|---------------------|--------|---------------------------|--------|-------------------|--------|--------------------|--------|
| 1,000,000           |   | 6.81                      | %      | 06/03/97          |   | 06/03/04           |   |
| 1,500,000           |   | 1.01                      | %      | 06/20/03          |   | 06/21/04           |   |
| 1,000,000           |   | 6.86                      | %      | 08/10/00          |   | 08/10/05           |   |
| 100,000             |   | 2.89                      | %      | 10/29/02          |   | 10/31/05           |   |
| 3,900,000           |   | 2.83                      | %      | 10/29/02          |   | 10/31/05           |   |
| 1,000,000           |   | 2.54                      | %      | 02/04/03          |   | 02/06/06           |   |
| 2,750,000           |   | 3.44                      | %      | 09/27/02          |   | 09/27/07           |   |
| 1,500,000           |   | 3.34                      | %      | 02/14/03          |   | 02/14/08           |   |
| 1,000,000           |   | 7.72                      | %      | 06/01/00          |   | 06/03/30           |   |

 

The advances are securedby pledged loans with unpaid principal in the amount of $24,452,200 andsecurities having fair value totaling $4,329,900.

 

F-25

----

 

**Note 12.****                           INCOMETAXES**

 

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

 
|                               |   | **2003** |    | **2002** |   | **2001** |   |
|------------------------------------|--------|----------|---------|----------|--------|----------|--------|
|                               |   |     |    |     |   |     |   |
| Current  tax provision:            |   |     |    |     |   |     |   |
| Federal                            |   | $        | 484,300 |     | $      | 216,400  |   | $ | 228,300 |   |
| California                         |   | 166,100  |    | 81,300   |   | 82,900   |   |
|                               |   | 650,400  |    | 297,700  |   | 311,200  |   |
|                               |   |     |    |     |   |     |   |
| Deferred  tax provision (benefit): |   |     |    |     |   |     |   |
| Federal                            |   | 27,500   |    | 45,000   |   | (63,900  | )      |
| California                         |   | (19,400  | )       | 11,300   |   | (16,000  | )      |
|                               |   | 8,100    |    | 56,300   |   | (79,900  | )      |
|                               |   | $        | 658,500 |     | $      | 354,000  |   | $ | 231,300 |   |

 

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

 
|                                          |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                          |   |     |   |     |   |     |   |
| Statutory  federal tax rate                   |   | 34.00    | %      | 34.00    | %      | 34.00    | %      |
| California  taxes, net of federal tax benefit |   | 7.20     |   | 7.20     |   | 7.20     |   |
| Other,  net                                   |   | 2.74     |   | (0.16    | )      | (2.20    | )      |
| Effective  tax rates                          |   | 43.94    | %      | 41.04    | %      | 39.00    | %      |

 

In addition, theCorporation has applied all unused general business tax credit carryforwardsfor financial reporting and income tax purposes.

 

F-26

----

 

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

 
|                    |   | **2003** |    | **2002** |   |
|-------------------------|--------|----------|---------|----------|--------|
| Deferred  tax asset     |   |     |    |     |   |
| Federal                 |   | $        | 190,200 |     | $      | 217,700 |   |
| California              |   | 50,100   |    | 61,000   |   |
|                    |   |     |    |     |   |
| Net  deferred tax asset |   | $        | 240,300 |     | $      | 278,700 |   |

 

Thetax effects of each type of income and expense item that give rise to deferredtaxes are as follows:

 
|                                        |   | **2003** |    | **2002** |   |
|---------------------------------------------|--------|----------|---------|----------|--------|
| Deferred  tax assets (liabilities)          |   |     |    |     |   |
| Net  unrealized gain and loss on securities |   | $        | (30,500 | )        | $      | 66,300 |   |
| California  franchise tax                   |   | 73,500   |    | 48,400   |   |
| Allowance  for loan losses                  |   | 299,700  |    | 236,500  |   |
| Depreciation                                |   | (102,400 | )       | (72,500  | )      |
|                                        |   |     |    |     |   |
| Net  deferred tax asset                     |   | $        | 240,300 |     | $      | 278,700 |   |

 

**Note 13.****                           COMMITMENTSAND CONTINGENCIES**

 

In the normal course ofbusiness, there are outstanding commitments and contingencies that are notreflected in the consolidated financial statements.

 

***Operating lease commitments***

 

The Bank leases itsbranch buildings in Carmel By-The-Sea, Carmel Valley, and Pacific Grove.  The Carmel By-The-Sea office has a five andone half year lease with four, five year options and commenced inApril 2002.  The Carmel buildinghas a twenty-five year lease which commenced in March 1981 and may beadjusted annually for changes in the Consumer Price Index.  The Pacific Grove building has a five-yearlease with five, five-year options and commenced in April 1997.  The Bank also leases certain equipment usedin the normal course of business.

 

F-27

----

 

Rent expense foroperating leases is included in occupancy and equipment expense and amounted toapproximately $270,800, $170,400, and $113,500 in 2003, 2002, and 2001,respectively.

 

Effective April 1,2000, the Bank entered into a 5 year sublease agreement to rent one of theunits in the Carmel Valley branch. Sublease rental income for the years ending 2003, 2002 and 2001 wasapproximately $39,300, $36,700 and $34,100, respectively.

 

Effective July 1,2002, the Bank entered into a 5 year and 3 months sublease agreement to rentone of the units in the Carmel-By-The-Sea branch.  Sublease rental income for the year ending 2003 was approximately$39,300; no sublease rental income was collected in 2002.

 

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

 
| **Year Ending  December 31** |   | **Minimum  Lease  Commitments** | ** ** | **Sublease  Income** | ** ** | **Net Lease  Commitments** | ** ** |
|-----------------------------------|--------|---------------------------------|------------|----------------------|------------|----------------------------|------------|
| 2004                              |   | $                               | 267,600    |                 | $          | 74,200                     |       | $ | 193,400 |   |
| 2005                              |   | 251,900                         |       | 46,100               |       | 205,800                    |       |
| 2006                              |   | 165,000                         |       | 36,800               |       | 128,200                    |       |
| 2007                              |   | 102,100                         |       | 27,600               |       | 74,500                     |       |
|                              |   | $                               | 786,600    |                 | $          | 184,700                    |       | $ | 601,900 |   |

 

***Loan commitments***

 

The Bank is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit.  Suchcommitments involve, to varying degrees, elements of credit and interest raterisk in excess of the amount recognized in the consolidated balance sheets.

 

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

 

At December 31, 2003and 2002, such commitments to extend credit were approximately $12,413,700 and$7,804,400, respectively, of undisbursed lines of credit, undisbursed loans inprocess, and commitment letters.

 

F-28

----

 

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

 

Other income for theyears ended December 31, 2003, 2002, and 2001 totaled $1,237,000,$746,900, and $489,000, respectively. Significant categories comprising other income in the years endingDecember 31, 2003, 2002, and 2001 were net merchant discount fees of$376,400, $327,700, and $407,000, commercial banking origination fees of$539,400, $191,500, and $67,800, and life insurance cash surrender valueearnings of $89,700, $122,200, and $85,900.

 

Other general andadministrative expenses for the years ended December 31, 2003, 2002, and2001 totaled $876,100, $732,600, and $802,500, respectively.  Significant categories comprising othergeneral and administrative expenses in the years ending December 31, 2003,2002, and 2001 were advertising of $113,500, $100,200, and $102,400, andinsurance of $84,100, $50,200, and $35,200.

 

**Note 15.****                           SHAREHOLDERS’EQUITY**

 

***Minimum regulatory requirements***

 

The Corporation (on aconsolidated basis) and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material effect on theCorporation’s and Bank’s financial statements. Under capital 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 amountsand classifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.  Under applicableregulatory guidelines, a portion of the Trust Preferred Securities qualify asTier I Capital, and the remainder as Tier II Capital.   Prompt corrective action provisions are notapplicable to bank holding companies.

 

F-29

----

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Corporationand the Bank to maintain minimum amounts and ratios (set forth in the followingtable) of total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined) and of Tier 1 capital (as defined) to averageassets (as defined).  Managementbelieves, as of December 31, 2003 and 2002, that the Corporation and theBank met all capital adequacy requirements to which they are subject.

 

As of December 31,2003, the most recent notification from the Federal Deposit Insurance Corporationcategorized the Bank as well capitalized under the regulatory framework forprompt corrective action.  To becategorized as well capitalized, an institution must maintain minimum totalrisk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in thefollowing tables.  There are noconditions or events since the notification that management believes havechanged the Bank’s category.  TheCorporation’s and the Bank’s actual capital amounts and ratios as ofDecember 31, 2003 and 2002 are also presented in the tables.

 

**December 31, 2003**

 
|                                     |   | **Actual**                      |   | **Minimum  Capital  Requirement** |   | **Minimum To  Be  Well Capitalized  Under Prompt  Corrective  Action****Provisions** |   |
|------------------------------------------|--------|---------------------------------|--------|-----------------------------------|--------|--------------------------------------------------------------------------------------|--------|
|                                     |   | **Amount**                      |   | **Ratio**                         |   | **Amount**                                                                           |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
|                                     |   | **(All  dollars in thousands)** |   |
| Total  Capital to Risk Weighted Assets:  |   |                            |   |                              |   |                                                                                 |   |   |   |   |   |   |   |
| Consolidated                             |   | $                               | 15,003 |                              | 17.3   | %                                                                                    | $      | 6,964 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey  County Bank                    |   | 11,882                          |   | 13.7                              | %      | 6,920                                                                                |   | 8.0 | % | $ | 8,649 |   | 10.0 | % |
|                                     |   |                            |   |                              |   |                                                                                 |   |   |   |   |   |   |   |
| Tier  1 Capital to Risk Weighted Assets: |   |                            |   |                              |   |                                                                                 |   |   |   |   |   |   |   |
| Consolidated                             |   | 7,784                           |   | 9.0                               | %      | 3,482                                                                                |   | 4.0 | % | N/A |   | N/A |   |
| Monterey  County Bank                    |   | 11,107                          |   | 12.8                              | %      | 3,460                                                                                |   | 4.0 | % | 5,190 |   | 6.0 | % |
|                                     |   |                            |   |                              |   |                                                                                 |   |   |   |   |   |   |   |
| Tier  1 Capital to Average Assets:       |   |                            |   |                              |   |                                                                                 |   |   |   |   |   |   |   |
| Consolidated                             |   | 7,784                           |   | 8.2                               | %      | 3,816                                                                                |   | 4.0 | % | N/A |   | N/A |   |
| Monterey  County Bank                    |   | 11,107                          |   | 11.7                              | %      | 3,784                                                                                |   | 4.0 | % | 4,730 |   | 5.0 | % |
|                                          |        |                                 |        |                                   |        |                                                                                      |        |  |  |  |  |  |  |  |  |  |

 

F-30

----

 

**December 31, 2002**

 
|                                     |   | **Actual**                     |   | **Minimum  Capital  Requirement** |   | **Minimum To Be  Well Capitalized  Under Prompt  Corrective  ActionProvisions** |   |
|------------------------------------------|--------|--------------------------------|--------|-----------------------------------|--------|---------------------------------------------------------------------------------|--------|
|                                     |   | **Amount**                     |   | **Ratio**                         |   | **Amount**                                                                      |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
|                                     |   | **(All dollars in thousands)** |   |
| Total  Capital to Risk Weighted Assets:  |   |                           |   |                              |   |                                                                            |   |   |   |   |   |   |   |
| Consolidated                             |   | $                              | 6,056  |                              | 9.1    | %                                                                               | $      | 5,347 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey  County Bank                    |   | 6,866                          |   | 10.4                              | %      | 5,312                                                                           |   | 8.0 | % | $ | 6,640 |   | 10.0 | % |
|                                     |   |                           |   |                              |   |                                                                            |   |   |   |   |   |   |   |
| Tier  1 Capital to Risk Weighted Assets: |   |                           |   |                              |   |                                                                            |   |   |   |   |   |   |   |
| Consolidated                             |   | 5,419                          |   | 8.1                               | %      | 2,674                                                                           |   | 4.0 | % | N/A |   | N/A |   |
| Monterey  County Bank                    |   | 6,229                          |   | 9.4                               | %      | 2,656                                                                           |   | 4.0 | % | 3,984 |   | 6.0 | % |
|                                     |   |                           |   |                              |   |                                                                            |   |   |   |   |   |   |   |
| Tier  1 Capital to Average Assets:       |   |                           |   |                              |   |                                                                            |   |   |   |   |   |   |   |
| Consolidated                             |   | 5,639                          |   | 7.7                               | %      | 3,240                                                                           |   | 4.0 | % | N/A |   | N/A |   |
| Monterey  County Bank                    |   | 6,380                          |   | 8.6                               | %      | 3,221                                                                           |   | 4.0 | % | 4,027 |   | 5.0 | % |
|                                          |        |                                |        |                                   |        |                                                                                 |        |  |  |  |  |  |  |  |  |  |

 

F-31

----

 

**Note 16.****                           STOCKOPTIONS AND STOCK DIVIDENDS**

 

At December 31,2003, options for the purchase of 221,578 shares of the Corporation’s commonstock were outstanding and exercisable at prices ranging from $1.55 to$3.30.  The status of all optionedshares is as follows:

 
|                                   |   | **Shares** |   | **Price Range** |   | **Weighted Average  Remaining  Contractual Life** |       |
|----------------------------------------|--------|------------|--------|-----------------|--------|---------------------------------------------------|------------|
| Outstanding  at December 31, 1999 |   | 159,115    |   | $2.07  - $2.48  |   |                                              | 4.3  Years |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Granted                                |   | 49,500     |   | $2.73  - $3.00  |   |                                              |       |   |
| Increase  due to stock dividend        |   | 18,899     |   | $1.88  - $3.00  |   |                                              |       |   |
| Cancelled                              |   | (19,623    | )      | $2.07  - $2.48  |   |                                              |       |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Outstanding  at December 31, 2000 |   | 207,891    |   | $2.07  - $2.48  |   |                                              | 3.7  Years |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Increase  due to stock dividend        |   | 18,472     |   | $1.71  - $2.73  |   |                                              |       |   |
| Cancelled                              |   | (23,183    | )      | $2.07  - $2.48  |   |                                              |       |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Outstanding  at December 31, 2001 |   | 203,180    |   | $1.71  - $2.73  |   |                                              | 2.4  Years |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Granted                                |   | 81,000     |   | $3.00  - $3.30  |   |                                              |       |   |
| Increase  due to stock dividend        |   | 22,101     |   | $1.55  - $3.00  |   |                                              |       |   |
| Exercised                              |   | (30,746    | )      | $1.71  - $1.88  |   |                                              |       |   |
| Cancelled                              |   | (32,405    | )      | $1.88  - $2.48  |   |                                              |       |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Outstanding  at December 31, 2002 |   | 243,130    |   | $1.55  - $3.00  |   |                                              | 3.2  Years |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Granted                                |   | 63,000     |   | $3.00  - $3.30  |   |                                              |       |   |
| Exercised                              |   | (78,210    | )      | $1.55  - $2.05  |   |                                              |       |   |
| Cancelled                              |   | (6,342     | )      | $1.86           |   |                                              |       |   |
|                                   |   |       |   |            |   |                                              |       |   |
| Outstanding  at December 31, 2003 |   | 221,578    |   | $1.55  - $3.30  |   |                                              | 3.8  Years |   |

 

The weighted averageexercise price was $1.84 and $1.88 for the years ending December 31, 2003and 2002, respectively.  The weightedaverage fair value of options granted during the years ending December 31,2003 and 2002 were $2.40 and $2.45, respectively.

 

F-32

----

 

**Note 17.****                           RELATEDPARTY TRANSACTIONS**

 

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

 

Aggregate loantransactions with related parties are approximately as follows:

 

| Balance  as of December 31, 2001 |   | $         | 1,375,400 |   |
|---------------------------------------|--------|-----------|-----------|--------|
| New  loans                            |   | 163,300   |      |
| Repayments                            |   | (66,000   | )         |
|                                  |   |      |      |
| Balance  as of December 31, 2002 |   | 1,472,700 |      |
| New  loans                            |   | 173,300   |      |
| Repayments                            |   | (111,200  | )         |
|                                  |   |      |      |
| Balance  as of December 31, 2003 |   | $         | 1,534,800 |   |

 

Related party depositstotaled approximately $265,700 and $165,700 at December 31, 2003 and 2002,respectively.

 

**Note 18.****                           EMPLOYEEBENEFIT PLANS**

 

During 1995, theCorporation established an employee stock ownership plan (ESOP) to invest inthe Corporation’s common stock for the benefit of eligible employees.  The Board of Directors determines theCorporation’s contribution to the plan. Shares in the plan generally vest after seven years.  The Corporation did not contribute to theESOP trust in 2003, 2002, or 2001. There were no shares in the plan as of December 31, 2003.

 

The Bank has a salaryreduction plan under Section 401(k) of the Internal Revenue Code.  The plan covers substantially all full-timeemployees who have completed one year of service with the Bank.  Employees are allowed to defer up to 15% oftheir compensation subject to certain limits based on federal tax laws.  Under the provisions of the plan, the Bank’scontribution policy is discretionary. The Bank initiated a matching contribution in 2001 of 100% of eachemployee’s contribution up to 6% of the employee’s compensation.  The Bank’s matching contributions in 2003,2002, and 2001 totaled $71,800, $65,800, and $52,500 respectively.

 

F-33

----

 

**Note 19.****                           REGULATORYMATTERS**

 

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

 

**Note 20.****                           RESTRICTIONON DIVIDENDS, LOANS AND ADVANCES**

 

Federal and state bankingregulations place certain restrictions on dividends paid and loans or advancesmade by the Bank to the Corporation. The total amount of dividends which may be paid at any date is generallylimited to the lesser of: (i) retained earnings; or (ii) the Bank’s net incomefor its last three fiscal years (less any distributions to the stockholdersmade during such period), and loan or advances are limited to 25 percent of theBank’s primary capital plus the allowance for loan losses on a secured basisand 15% on an unsecured basis.

 

**Note 21.****                           SALARYCONTINUATION PLAN**

 

The Corporation hasestablished salary continuation plans, which provide for payments to a certainofficer at the age of retirement. Included in other liabilities at December 31, 2003 and 2002,respectively, is $508,500 and $393,400 of deferred compensation related to thecontinuation plans.  The plans arefunded through life insurance policies that generate value to fund the futurebenefits.

 

F-34

----

 

**Note 22.****                           FAIRVALUE OF FINANCIAL INSTRUMENTS**

 

SFAS No. 107,“Disclosures about Fair Value of Financial Instruments” requires disclosure ofestimated fair values of all financial instruments where it is practicable toestimate such values.  In cases wherequoted market prices are not available, fair values are based on estimatesusing present value or other valuation techniques.  Those techniques are significantly affected by the assumptionsused, including the discount rate and estimates of future cash flows.  Accordingly, the derived fair value estimatescannot be substantiated by comparison to independent markets and, in many cases,could not be realized in immediate settlement of the instrument.  Statement No. 107 excludes certain financialinstruments and all non-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair valueamounts presented do not represent the underlying value of the Corporation.

 

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

 

**Cash and cash equivalents:**The carrying amounts of cash and short-term instruments approximate fairvalues.

 

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

 

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

 

**Commitments to Extend Credit andStandby Letters of Credit:** The Corporation does notgenerally enter into long-term fixed rate commitments or letters ofcredit.  These commitments are generallypriced at current prevailing rates.  Theserates are generally variable and, therefore, there is no interest rateexposure.  Accordingly, the fair marketvalue of these instruments is equal to the carrying value amount of their netdeferred fees.  The net deferred feesassociated with these instruments are not material.  The Corporation has no unusual credit risk associated with theseinstruments.

 

F-35

----

 

**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 valuesfor fixed-rate certificates of deposit are estimated using a discounted cashflow calculation that applies interest rates currently being offered oncertificates to a schedule of aggregated expected monthly maturities ontime deposits.

 

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

 

**Cash Surrender Value of LifeInsurance:**The carrying amount of life insuranceapproximate fair value.

 

**Short-term borrowing:**The carrying amounts of federal funds purchased, borrowings under repurchaseagreements, and other short-term borrowings maturing within ninety daysapproximate their fair values.  Fairvalues of other borrowings are estimated using discounted cash flow analysesbased on the Corporation’s current incremental borrowing rates for similar typesof borrowing arrangements.

 

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

 

F-36

----

 

The estimated fairvalues, and related carrying amounts, of the Corporation’s financialinstruments as of December 31, 2003 and 2002 are as follows:

 
|                            |   | **2003**             |       | **2002**        |   |
|---------------------------------|--------|----------------------|------------|-----------------|--------|
|                            |   | **Carrying  Amount** |       | **Fair  Value** |   | **Carrying  Amount** |   | **Fair  Value** |   |
| Financial  Assets:              |   |                 |       |            |   |   |   |   |   |
| Cash  and cash equivalents      |   | $                    | 17,193,100 |            | $      | 17,193,100 |   | $ | 13,017,100 |   | $ | 13,017,100 |   |
| Trading  assets                 |   | 163,300              |       | 163,300         |   | 82,200 |   | 82,200 |   |
| Securities,  available for sale |   | 6,075,500            |       | 6,075,500       |   | 6,039,800 |   | 6,039,800 |   |
| Other  investments              |   | 1,667,500            |       | 1,667,500       |   | 1,210,500 |   | 1,210,500 |   |
| Loans,  held for sale           |   | 2,347,800            |       | 2,347,800       |   | 982,500 |   | 982,500 |   |
| Loans,  net                     |   | 74,560,600           |       | 75,907,900      |   | 59,274,400 |   | 60,006,400 |   |
| Accrued  interest receivable    |   | 392,100              |       | 392,100         |   | 313,500 |   | 313,500 |   |
|                            |   |                 |       |            |   |   |   |   |   |
| Financial  Liabilities:         |   |                 |       |            |   |   |   |   |   |
| Deposits                        |   | 78,147,100           |       | 78,374,300      |   | 67,616,400 |   | 67,699,200 |   |
| Short-term  borrowings          |   | —               |       | —          |   | 200,000 |   | 200,000 |   |
| Long-term  debt                 |   | 21,998,000           |       | 22,024,800      |   | 11,722,200 |   | 11,753,300 |   |
| Accrued  interest payable       |   | 357,000              |       | 357,000         |   | 366,900 |   | 366,900 |   |
|                                 |        |                      |            |                 |        |  |  |  |  |  |  |  |  |

 

F-37

----

 

**Note 23.****                           NORTHERNCALIFORNIA BANCORP, INC. (PARENT CORPORATION ONLY)**

 

The following are thefinancial statements of Northern California Bancorp, Inc. (Parent Corporationonly) as of December 31, 2003 and 2002:

 
| **Balance  Sheets**                                 |   | **2003**   |       | **2002**  |   |
|-----------------------------------------------------|--------|------------|------------|-----------|--------|
| Assets                                              |   |       |       |      |   |
| Cash  and due from banks                            |   | $          | 2,628,300  |      | $      | 17,100 |   |
| Investment  securities - trading account            |   | 163,300    |       | 82,200    |   |
| Investment  in Mission Valley Bank Stock            |   | 25,000     |       | 25,000    |   |
| Investment  in AT Services LLC Acquisition Corp.    |   | 202,000    |       | 204,200   |   |
| Northern  California Bancorp, Inc. Trust I          |   | 93,000     |       | —    |   |
| Northern  California Bancorp, Inc. Trust II         |   | 155,000    |       | —    |   |
| Deferred  tax asset                                 |   | 14,800     |       | 87,000    |   |
| Debt  issue costs, net                              |   | 166,700    |       | 10,000    |   |
| Accounts  receivable                                |   | —     |       | 10,000    |   |
| Investment  in common stock of Monterey County Bank |   | 11,284,100 |       | 6,380,200 |   |
|                                                |   |       |       |      |   |
|                                                |   | $          | 14,732,200 |      | $      | 6,815,700 |   |
|                                                |   |       |       |      |   |
| Liabilities  and Shareholders’ Equity          |   |       |       |      |   |
| Accounts  payable and accrued expenses              |   | $          | 58,900     |      | $      | 3,600 |   |
| Dividend  payable                                   |   | 14,800     |       | 1,000     |   |
| Junior  subordinated debt securities                |   | 8,248,000  |       | —    |   |
| Notes  payable                                      |   | —     |       | 1,172,200 |   |
| Total  liabilities                                  |   | 8,321,700  |       | 1,176,800 |   |
| Shareholders’  equity                          |   | 6,410,500  |       | 5,638,900 |   |
|                                                |   |       |       |      |   |
|                                                |   | $          | 14,732,200 |      | $      | 6,815,700 |   |

 

F-38

----

 
| **Statements  of Operations**                     |   | **2003** |       | **2002** |       | **2001** |       |
|---------------------------------------------------|--------|----------|------------|----------|------------|----------|------------|
|                                              |   |     | ** ** |     | ** ** |     | ** ** |
| Equity  in income of subsidiary                   |   | $        | 917,600    |     | $          | 629,100  |       | $ | 663,300 |   |
| Investment  income from AT Services LLC           |   | 14,300   |       | 24,200   |       | —   |       |
| Gain  (loss) on sale of securities                |   | 36,200   |       | 5,400    |       | (27,800  | )          |
| Gain  (loss) on trading asset                     |   | 49,700   |       | (173,800 | )          | (199,400 | )          |
| Loss  on Community Bankers’ Insurance Agency |   | —   |       | —   |       | (40,000  | )          |
| Dividend  income                                  |   | 9,100    |       | 5,500    |       | —   |       |
| Miscellaneous  income                             |   | 100      |       | —   |       | 2,200    |       |
| Operating  expenses                               |   | (176,000 | )          | (85,600  | )          | (118,800 | )          |
| Applicable  tax benefit                           |   | (11,200  | )          | 103,800  |       | 81,000   |       |
|                                              |   |     |       |     |       |     |       |
| Net  income                                       |   | $        | 839,800    |     | $          | 508,600  |       | $ | 360,500 |   |

 

F-39

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| **Statements  of Cash Flows**                                                  |   | **2003**   |      | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------|--------|------------|-----------|----------|--------|----------|--------|
|                                                                           |   |       |      |     |   |     |   |
| Cash  flows from operating activities:                                         |   |       |      |     |   |     |   |
| Net  income                                                                    |   | $          | 839,800   |     | $      | 508,600  |   | $ | 360,500 |   |
| Adjustments  to reconcile net income to net cash used by operating activities: |   |       |      |     |   |     |   |
| Equity  in undistributed income of Monterey County Bank                        |   | (917,600   | )         | (629,100 | )      | (663,300 | )      |
| (Increase)  decrease in trading securities                                     |   | (81,100    | )         | 90,800   |   | (5,000   | )      |
| (Increase)  decrease in other assets                                           |   | (74,500    | )         | 12,700   |   | (46,100  | )      |
| Increase  (decrease) in accrued expenses                                       |   | 55,300     |      | (1,300   | )      | (4,000   | )      |
| Increase  (decrease) in other liabilities                                      |   | 13,800     |      | (300     | )      | (1,400   | )      |
| Net  cash used by operating activities                                         |   | (164,300   | )         | (18,600  | )      | (359,300 | )      |
|                                                                           |   |       |      |     |   |     |   |
| Cash  flows from investing activities:                                         |   |       |      |     |   |     |   |
| Cash  dividends received from subsidiary                                       |   | 50,000     |      | 75,000   |   | 200,000  |   |
| Increase  in investments                                                       |   | (4,245,800 | )         | (54,200  | )      | (154,800 | )      |
| Net  cash provided by investing activities                                     |   | (4,195,800 | )         | 20,800   |   | 45,200   |   |
|                                                                           |   |       |      |     |   |     |   |
| Cash  flows from financing activities:                                         |   |       |      |     |   |     |   |
| Proceeds  from borrowings                                                      |   | 8,248,000  |      | —   |   | 325,000  |   |
| Repayments  on borrowings                                                      |   | (1,172,200 | )         | (27,800  | )      | —   |   |
| Cash  dividends paid on common stock                                           |   | (235,000   | )         | (500     | )      | (700     | )      |
| Exercise  of stock options                                                     |   | 152,000    |      | 55,200   |   | —   |   |
| Stock  repurchase                                                              |   | (21,500    | )         | (20,600  | )      | (52,500  | )      |
| Net  cash provided by financing activities                                     |   | 6,971,300  |      | 6,300    |   | 271,800  |   |
|                                                                           |   |       |      |     |   |     |   |
| Net  increase (decrease) in cash and cash equivalents                          |   | 2,611,200  |      | 8,500    |   | (42,300  | )      |
|                                                                           |   |       |      |     |   |     |   |
| Cash  and cash equivalents, beginning of year                                  |   | 17,100     |      | 8,600    |   | 50,900   |   |
| Cash  and cash equivalents, end of year                                        |   | $          | 2,628,300 |     | $      | 17,100   |   | $ | 8,600 |   |

 

F-40

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