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

**Washington D.C. 20549**

 

**FORM10-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, 2004**                                                                                                                                                                                                                                                                                         |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                |
| **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 its Charter)

 

**Incorporated in the State of CaliforniaIRS 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 allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 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

 

Revenues for the year ended December 31, 2004; $9,576,700.

 

As of March 1, 2005, theCorporation had 1,608,019 shares of common stock out-standing. The aggregatemarket value of voting stock held by non-affiliates of the Corporation was$2,363,400, based on the most recent sale at $3.00 per share on August 31,2004.

 

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, 2004 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, 2004 and 2003                                                                           |       |
|          | Consolidated Statements of Operations for  each of the three years in the period ended December 31, 2004                            |       |
|          | Consolidated Statements of Changes in  Stockholders’ Equity for each of the three years in the period ended December  31, 2004 |       |
|          | Consolidated Statements of Cash Flows for  each of the three years in the period ended December 31, 2004                            |       |
|          | 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**

 

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

 

**ITEM 1.BUSINESS**

 

**GENERAL**

 

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

 

Compliance with environmental laws has 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.

 

**BANK SUBSIDIARY**

 

Monterey County Bank, an independent, California chartered commercialbanking corporation was chartered by the State of California on July 30, 1976. TheBank’s customer base includes individuals, small and medium sized businessesand a variety of government agencies with residences, offices or otherrelationships located in or about the city and county of Monterey, California,including the cities of Carmel and Pacific Grove. The Bank offers its customersa wide variety of the normal personal, consumer and commercial servicesexpected of a locally owned, independently operated bank. The Bank’s depositsare insured by the FDIC, and, as such, the Bank is subject to regulations bythat federal agency and to periodic audits of its operations and documentarycompliance by Federal Deposit Insurance Corporation “FDIC” personnel. As astate chartered bank, which is not a member of the Federal Reserve System, itis also regulated and periodically examined by the California State Departmentof 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 and a loanproduction office in Monterey, California.

 

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At December 31, 2004 the Bank had total assets, deposits andshareholders’ equity of approximately $132,622,000, $98,921,700 and$12,595,800, respectively.

 

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

 

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

 

The Subordinated DebtSecurities bear a variable interest rate equal to the three-month LIBOR plus3.25%. Total broker and legal costs associated with the issuance of $115,000are being amortized over a 30 year period.

 

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

#  

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

 

The Subordinated DebtSecurities bear a variable interest rate equal to the three-month LIBOR plus2.85%. Total broker and legal costs associated with the issuance of $54,000 arebeing amortized over a 30 year period.

 

**EMPLOYEES**

 

At December 31, 2004 the Northern California Bancorp, Inc. and itssubsidiary Monterey County Bank employed a total of 46 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 hasincreasing recognition in its primary service area and Monterey County, itnevertheless has to compete with other independent local banking institutions,including commercial banks and savings and loan associations, as well as branchoffices of regional commercial banks, some of which have assets, capital and lendinglimits substantially larger than the Bank, as well as wider geographic markets,more support services and larger media advertising capabilities. The Bank willalso compete with respect to its lending activities, as well as in attractingdemand deposits, with savings banks, savings and loan associations, insurancecompanies, regulated small loan companies and credit unions, as well assecurities brokerage offices which can issue commercial paper and othersecurities (such as shares in money market funds).

 

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 institutionsoffer certain services, such as trust services and international banking, whichthe Bank does not currently offer or plan to offer. By virtue of their greatertotal capital, such institutions have substantially higher lending limits thanthe Bank (legal lending limits to an individual customer being limited to apercentage of a bank’s total capital accounts). These competitors may intensifytheir advertising and marketing activities to counter any efforts by the Bankto further attract new business as a commercial bank. In addition, as a resultof legislation enacted earlier in the decade, there is increased competitionbetween banks, savings and loan associations and credit unions for the depositand loan business of individuals. These activities may hinder the Bank’sability to capture a significant market share.

 

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 regard include an ability and intention torespond quickly to changes in the interest rates paid on time and savingsdeposits and charged on loans, and to charges imposed on depository accounts,so as to remain competitive in the market place. 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 thereare customers whose loan demands exceed the Bank’s lending limits, the Bank hasthe ability to arrange for such loans on a participation basis with otherfinancial institutions. No assurance can be given, however, that the Bank’sefforts to compete with other financial institutions in its primary servicearea will be successful.

 

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

 

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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 Genesis FinancialSolutions, a purchaser of charged off consumer credit card balances, to marketa MasterCard credit card program. The Bank will be issuing the cards, but thecredit card balances will be 100 percent owned by Genesis Financial Solutions. Theprogram will be implemented in the first quarter of 2005 with the initial cardsolicitations being mailed in February 2005. The Bank’s 2005 revenues from theprogram will be approximately $70,000. Genesis Financial Solutions 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.

 

The Bank has implemented a pre-paid debit card program. The program ismarketed by third parties through employer payroll programs and check cashingfacilities, through Internet websites for purchasers of the websites’ productsand services. Holders of the pre-paid cards will be able to have additional fundsadded to the card balance, make point of sale purchases and withdraw cashthrough automated teller machines. The Bank will be issuing the pre-paid cardsand maintaining the funds held on the cards. The Bank’s revenues from theprogram will be in the form of transaction fees and earnings from investing thefunds held on the cards. Revenues from the program in 2004 and 2003 were $8,300and $2,100, respectively. Revenues from the program in 2005 should increasesignificantly as additional third party marketers are added to the program.

 

The Bank depends largely on rate differentials. In general, thedifference between the interest rate paid by the Bank on its deposits and itsother borrowings, and the interest rate received by the Bank on loans extendedto its customers and securities held in the Bank’s portfolio, comprise themajor portion of the Bank’s earnings. These rates are highly sensitive to manyfactors that are beyond the control of the Bank. Accordingly, the earnings andgrowth of the Bank are subject to the influence of domestic and foreigneconomic 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 Federal Reserve Board implements national monetarypolicies (with objectives such as curbing inflation and combating recession) byits open-market operations in U.S. Government securities, by adjusting therequired level of reserves for financial intermediaries subject to its reserverequirements and by varying the discount rates applicable to borrowings bydepository institutions. The actions of the Federal Reserve Board in theseareas influence the growth of bank loans, investments and deposits and alsoaffect interest rates charged on loans and paid on deposits. The nature andimpact of any future changes in monetary policies cannot be predicted.

 

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**SUPERVISION AND REGULATION**

 

**The Corporation**

 

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/orpassage of notice periods without objection, from the California Superintendentof Banks, the Federal Deposit Insurance Corporation, the Board of Governors ofthe Federal Reserve System and the shareholders of the Bank, the Corporationacquired the Bank through a reverse triangular merger (the “Merger”). As aresult, by operation of law, each outstanding share of common stock of the Bankprior to the Merger was converted into a share of common stock of theCorporation, while the Corporation became the sole owner of the newly issuedshares of common stock of the 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 makingsuch determinations, the FRB considers whether the performance of suchactivities by a bank holding company would offer advantages to the public,which outweigh possible adverse effects.

 

The FRB’s Regulation “Y” sets out the non-banking activities that arepermissible for bank holding companies under the law, subject to the FRB’sapproval in individual cases. Most of these activities are now permitted forCalifornia banks that are well-capitalized. The Corporation and itssubsidiaries will also be subject to certain restrictions with respect toengaging in the underwriting, public sale and distribution of securities. TheGramm-Leach-Bliley Act (the “Act”) was signed by the President and enacted intolaw on November 12, 1999. The Act does three fundamental things: 1) it repealskey provisions of the Glass Steagal Act to permit commercial banks to affiliatewith investment bank, 2) it substantially modifies the Bank Holding Company Actof 1956 to permit companies that own commercial banks to engage in any type offinancial activity and 3) it allows subsidiaries of banks to engage in a broadrange of financial activities that are not permitted for banks themselves. Managementcannot predict what effect these changes will have on the Bank or theCorporation.

 

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 its subsidiaries 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 toaffiliates, investments by the Bank in affiliates’ stock, and taking affiliates’stock by the Bank as collateral for loans to any borrower will be limited to10% of the Bank’s capital, in the case of any one affiliate, and will belimited to 20% of the Bank’s capital, in the case of all affiliates. Federaland State law place other limitations on transactions between the Bank and itsaffiliates designed to ensure that the Bank receives treatment in suchtransactions 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 certainexceptions, the Bank may not condition an extension of credit on a customer’sobtaining other services provided by it, the Corporation or any othersubsidiary, or on a promise from its customer not to obtain other services froma competitor.

 

**Sarbanes-Oxley Act**

 

The Sarbanes-Oxley Act of 2002 (the Act) was signed into law on July30, 2002. The Act was in response to recent issues in corporate governance andaccountability. 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 Actupon corporations is uncertain; however, it is likely that compliance costs mayincrease as corporations modify procedures if required to conform to theprovisions of the Act. The Company does not currently anticipate thatcompliance with the Act will have a material effect upon its financial positionor results or its operations or its cash flows.

 

**Subsidiary Bank**

 

Both federal and state laws provide extensive regulation of the bankingbusiness. State and federal statutes and regulations apply to many aspects ofthe Bank’s operations, including minimum capital requirements, reserves againstdeposits, interest rates payable on 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 the Bank’sdeposits, currently up to a maximum of $100,000 per depositor. For thisprotection, the Bank, like all insured banks, pays a semi-annual statutoryassessment and is subject to the rules and regulations of the FDIC. Althoughthe Bank is not a member of the Federal Reserve System, certain regulations ofthe Federal Reserve Board also apply to its operations.

 

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). Cash dividends may also be paid in an amount notexceeding the net income for such bank’s last preceding fiscal year afterobtaining the prior approval of the Superintendent. The FDIC also has authorityto prohibit the Bank from engaging in unsafe or unsound practices. The FDIC canuse this power, under certain circumstances, to restrict or prohibit a bankfrom paying dividends.

 

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 the effect of preventing affiliates (suchas the Corporation) from borrowing from the Bank unless the loans are securedby marketable obligations of designated amounts. 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 law also imposes certain restrictions withrespect to transactions involving other controlling 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 to change the laws and regulations governingthe operations and taxation of banks, bank holding companies and otherfinancial intermediaries are frequently made in Congress, in the Californialegislature and before various bank regulatory and other professional agencies.The Bank cannot predict what, if any legislation or regulations will beenacted, or the impact thereof on its business and profitability.

 

**CapitalStandards**

 

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 requireminimum levels 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 are required to be considered “wellcapitalized” under prompt corrective action provisions.

 

A banking organization’s qualifying total capital consists of twocomponents: Tier I capital (core capital) and Tier 2 capital (supplementarycapital). Tier I capital consists primarily of common stock, related surplusand retained earnings, qualifying noncumulative perpetual preferred stock andminority interests in the equity accounts of consolidated subsidiaries.Intangibles, such as goodwill, are generally deducted from Tier 1 capital;however, purchased mortgage servicing rights and purchased credit cardrelationships may be included, subject to certain limitations. At least 50% ofthe banking organization’s total regulatory capital must consist of Tier 1capital.

 

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 other banks. Institutionsexperiencing or anticipating significant growth or those with other thanminimum risk profiles are expected to maintain capital at least 100-200 basispoints above the minimum level.

 

In addition, the Federal Reserve Board 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 assetsthat can only be realized through future taxable earnings, including theimplementation of a tax planning strategy, count toward regulatory capitalpurposes only up to the lesser of (i) the amount that can be realized withinone year of the quarter-end report date or (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, includingdollar equivalents for certain off-balance sheet assets.

 

Effective January 17, 1995, the federal banking agencies issued a finalrule relating to capital standards and the risks arising from the concentrationof credit and nontraditional activities. Institutions which have significantamounts of their assets concentrated in high risk loans or nontraditionalbanking activities and who fail to adequately manage these risks, will berequired to set aside capital in excess of the regulatory minimums. The federalbanking agencies have not imposed any quantitative assessment for determiningwhen these risks are significant, but have identified these issues as importantfactors they will review in assessing an individual bank’s capital adequacy. Managementof the Company does not believe that the Bank’s assets and activities, ascurrently structured, would lead the FDIC to require additional capital underthis rule.

 

In December 1993, the federal banking agencies issued an interagencypolicy statement on the allowance for loan and lease losses (the “ALLL”) whichcalls for the maintenance of the ALLL at a level at least equal to the “estimatedcredit losses” in the bank’s loan portfolio. “Estimated credit losses” aredefined as “an estimate of the current amount of the loan and lease portfolio(net of unearned income) that is not likely to be collected; that is, netcharge-offs that are likely to be realized for a loan or pool of loans givenfacts and circumstances as of the evaluation date.” The policy statement alsosuggests that a test of reasonableness be applied to the ALLL, which test issatisfied if the ALLL equals or exceeds the sum of (a) assets classified loss;(b) 50% of assets classified doubtful; (c) 15% of assets classifiedsubstandard; and (d) estimated credit losses on other assets over the upcomingtwelve months. The Bank believes that its ALLL exceeds the amounts that wouldbe required under the terms of this policy statement and under such test of reasonableness.However, this is a very subjective matter, and the Bank cannot assure that anybank examiner would agree with its evaluation, or that losses ultimatelyincurred from the Bank’s portfolio would not 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 changecould affect the ability of the Bank to grow and could restrict the amount ofprofits, if any, available for the payment of dividends.

 

**PromptCorrective Action and Other Enforcement Mechanisms**

 

Under Section 38 of the FDIA, as added by the Federal Deposit InsuranceCorporation Improvement Act of 1991 (“FDICIA”), each federal banking agency isrequired to implement a system of prompt corrective action for institutionswhich it regulates. The federal banking agencies have promulgated substantiallysimilar regulations to implement this system of prompt corrective action. Underthe regulations, an institution shall generally be deemed to be: (i) ”wellcapitalized” if it has a total risk-based capital ratio of 10.0% or more, has aTier I risk-based capital ratio of 6.0% or more, has a Tier Ileverage capital ratio of 5.0% or more and is not subject to specifiedrequirements to meet and maintain a specific capital level for any capitalmeasure; (ii) ”adequately capitalized” if it has a total risk-basedcapital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0%or more and a Tier I leverage capital ratio of 4.0% or more (3.0% undercertain circumstances) and does not meet the definition of “well capitalized;”(iii) ”undercapitalized” if it has a total risk-based capital ratio thatis less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% ora 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 aTier I leverage capital ratio that is less than 3.0%; and (v) ”criticallyundercapitalized” if it has a ratio of tangible equity to total assets that isequal to or less than 2.0%.

 

Section 38 of the FDIA and the implementing regulations also providethat a federal banking agency may, after notice and an opportunity for ahearing, reclassify a well capitalized institution as adequately capitalizedand may require an adequately capitalized institution or an undercapitalizedinstitution to comply with supervisory actions as if it were in the next lowercategory if the institution is in an unsafe or unsound condition or engaging inan unsafe or unsound practice. (The FDIC may not, however, reclassify asignificantly undercapitalized institution as 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 becomingundercapitalized, an institution shall become subject to the provisions ofSection 38 of the FDIA, which sets forth various mandatory anddiscretionary restrictions on its operations.

 

At December 31, 2004, the Bank met the tests to be categorized as “wellcapitalized” under the prompt corrective action regulations of the FDIC.

 

**Safety andSoundness 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 agenciesrecently adopted final regulations and Interagency Guidelines PrescribingStandards for Safety and Soundness (“Guidelines”) to implement safety andsoundness standards required by the FDIA. The Guidelines set forth the safetyand soundness standards that the federal banking agencies use to identify andaddress problems at insured depository institutions before capital becomesimpaired. The agencies also proposed asset quality and earnings standardswhich, if adopted in final, would be added to the Guidelines. Under the finalregulations, if the FDIC determines that the Bank fails to meet any standardprescribed by the Guidelines, the agency may require the Bank to submit to theagency an acceptable plan to achieve compliance with the standard, as requiredby the FDIA. The final regulations establish deadlines for the submission andreview of such safety and soundness compliance plans.

 

**Premiumsfor Deposit Insurance**

 

The FDIC adopted regulations implementing a risk-based premium systemrequired by federal law. Under the regulations which cover the assessmentperiods commencing on and after January 1, 1994, insured depositoryinstitutions are required to pay insurance premiums within a range of $.23cents per $100 of deposits to $.31 cents per $100 of deposits depending on theirrisk classification. The FDIC, effective September 30, 1995, loweredassessments 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 the existing assessment rate structure fordeposit insurance and may change the base assessment rate (currently, 4 to 31basis points per year) by rulemaking with notice and comment. Without notice orcomment, the FDIC may increase or decrease the current rate schedule uniformlyby as much as 5 basis points, as deemed necessary to maintain the targetdesignated reserve ratio 1.25 percent (fund balance to estimated insureddeposits). The insured deposit rates for 2004 were $.00 to $.27. These ratesare projected to continue through the first half of 2005.

 

The FinancingCorporation (FICO), established by the Competitive Equality Banking Act of1987, is a mixed-ownership government corporation whose sole purpose was tofunction as the financing vehicle for the Federal Savings & Loan InsuranceCorporation (FSLIC). Effective December 12, 1991, as provided by the ResolutionTrust Corporation Refinancing, Restructuring and Improvement Act of 1991, theFICO’s ability to issue new debt was terminated. Outstanding FICO bonds, whichare 30-year non-callable bonds with a principal amount of approximately $8.1billion, 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 FDICacts as collection agent for the FICO. The Deposit Insurance Funds Act of 1996(DIFA) authorized the FICO to asses both Bank Insurance Fund (BIF) and SavingsAssociation Insurance Fund (SAIF) insured deposits, and required the BIF rateto equal one-fifth the SAIF rate through the year 1999, or until the insurancefunds are merged, whichever occurs first. Thereafter, BIF and SAIF insureddeposits will be assessed at the same rate by FICO.

 

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 2004were 1.54, 1.54, 1.48 and 1.46. The FICO quarterly rate for the first quarterof 2005 is 1.44.

 

**InterstateBanking and Branching**

 

On September 29, 1994, the President signed into law the Riegle-NealInterstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”).Under the Interstate Act, beginning one year after the date of enactment, abank holding company that is adequately capitalized and managed may obtainregulatory approval to acquire an existing bank located in another statewithout regard to state law. A bank holding company would not be permitted tomake such an acquisition if, upon consummation, it would control (a) more than10% of the total amount of deposits of insured depository institutions in theUnited States or (b) 30% or more of the deposits in the state in which the bankis located. A state may limit the percentage of total deposits that may be heldin that state by any one bank or bank holding company if application of suchlimitation does not discriminate against out-of-state banks. An out-of-statebank holding company may not acquire a state bank in existence for less than aminimum length of time that may be prescribed by state law except that a statemay not impose more than a five year existence requirement.

 

The Interstate Act also permits, beginning June 1, 1997, mergers ofinsured banks located in different states and conversion of the branches of theacquired bank into branches of the

 

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resulting bank. Each state may permit such combinations earlier thanJune 1, 1997, and may adopt legislation to prohibit interstate mergers afterthat date in that state or in other states by that state’s banks. The sameconcentration limits discussed in the preceding paragraph apply. The InterstateAct also permits a national or state bank to establish branches in a stateother than its home state if permitted by the laws of that state, subject tothe same requirement and conditions as for a merger transaction.

 

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

 

On October 2, 1995, the “CaliforniaInterstate Banking and Branching Act of 1995” (the “1995 Act”) becameeffective. The 1995 Act generally allows out-of-state banks to enter Californiaby merging with, or purchasing, a California bank or industrial loan companywhich 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. Inaddition, the 1995 Act permits California state banks, with the approval of theSuperintendent of Banks, to establish agency relationships with FDIC-insuredbanks 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 of directors’oaths (Financial Code Section 682), and (iii) repeal of the aggregate limit onreal estate loans (Financial Code Section 1230).

 

**CommunityReinvestment Act and Fair Lending Developments**

 

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

 

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

 

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**OtherRegulations and Policies**

 

The federal regulatoryagencies have adopted regulations that implement Section 304 of FDICIA whichrequires federal banking agencies to adopt uniform regulations prescribingstandards for real estate lending. Each insured depository institution mustadopt and maintain a comprehensive written real estate lending policy,developed in conformance with prescribed guidelines, and each agency hasspecified loan-to-value limits in guidelines concerning various categories ofreal estate loans.

 

Section 24 of theFederal Deposit Insurance Act (the “FDIA”), as amended by the FDICIA, generallylimits the activities and equity investments of FDIC-insured, state-charteredbanks to those that are permissible for national banks. Under regulationsdealing with equity investments, an insured state bank generally may notdirectly or indirectly acquire or retain any equity investment of a type, or inan amount, that is not permissible for a national bank. An insured state bankis not prohibited from, among other things, (i) acquiring or retaining amajority interest in a subsidiary, (ii) investing as a limited partner in apartnership the sole purpose of which is direct or indirect investment in theacquisition, rehabilitation or new construction of a qualified housing project,provided that such limited partnership investments may not exceed 2% of thebank’s total assets, (iii) acquiring up to 10% of the voting stock of a companythat solely provides or reinsures directors’, trustees’ and officers’ liabilityinsurance coverage or bankers’ blanket bond group insurance coverage forinsured depository institutions, and (iv) acquiring or retaining the votingshares of a depository institution if certain requirements are met.

 

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

 

**FinancialModernization Act**

** **

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

 

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The Gramm-Leach-BlileyAct defines “financial in nature” to include securities underwriting, dealingand market making; sponsoring mutual funds and investment companies; insuranceunderwriting and agency; merchant banking activities; and activities that theFederal Reserve Board has determined to be closely related to banking. Anational bank (and therefore, a state bank as well) may also engage, subject tolimitations on investment, in activities that are financial in nature, otherthan insurance underwriting, insurance company portfolio investment, 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 financialholding company or national banks with financial subsidiaries must continue tobe well capitalized and well managed in order to continue to engage inactivities that are financial in nature without regulatory actions or restrictions,which could include divestiture of the financial in nature subsidiary orsubsidiaries. In addition, a financial holding company or a bank may notacquire a company that is engaged in activities that are financial in natureunless each of the subsidiary banks of the financial holding company or thebank has a Community Reinvestment Act rating of satisfactory or better.

 

The Gramm-Leach-BlileyAct also imposes significant new requirements on financial institutions withrespect to the privacy of customer information, and modifies other existinglaws, including those related to community reinvestment.

 

**USAPatriot Act of 2001**

** **

On October 26, 2001,President Bush signed the USA Patriot Act of 2001. Enacted in response to theterrorist attacks in New York, Pennsylvania and Washington, D.C. onSeptember 11, 2001, the USA Patriot Act is intended to strengthen U.S. lawenforcement’s and the intelligence communities’ ability to work cohesively tocombat terrorism on a variety of fronts. The potential impact of the USAPatriot Act on financial institutions of all kinds is significant and wideranging. The USA Patriot Act contains sweeping anti-money laundering andfinancial transparency laws and requires various regulations applicable tofinancial institutions, including:

 

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

 

•                                          standardsfor verifying customer identification at account opening; and

 

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

 

The Bank implemented therequirements under the USA Patriot Act during 2001 and 2002. Compliance withsuch requirements has all been accomplished with existing staff, so thefinancial impact on the Bank has been negligible.

 

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# **Regulatory Enforcement Powers**

#  

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

 

# **California and Federal Banking Law**

#  

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

 

Under the 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 of control. Aperson would be deemed to have acquired control of the Corporation under thisstate law if such person, directly or indirectly, has the power (i) to vote 25%or more of the voting power of the Corporation or (ii) to direct or cause thedirection of the management and policies of the Corporation. For purposes ofthis law, a person who directly or indirectly owns or controls 10% or more ofthe Common stock would be presumed to control the Corporation, subject torebuttal.

 

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

 

The 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 and such regulations provide that theappropriate regulatory authority will assess the records of regulated financialinstitutions in satisfying their continuing

 

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and affirmative obligations to help meet the credit needs of theirlocal communities as part of their regulatory examination of the institution. Theresults of such examinations are made public and are taken into account upon thefiling of any application to establish a domestic branch, to merge or toacquire the assets or assume the liabilities of a bank. In the case of a bankholding company, the CRA performance record of the subsidiary bank(s) involvedin the transaction is reviewed in connection with the filing of an applicationto acquire ownership or control of shares or assets of a bank or to merge withany other bank holding company. An unsatisfactory record can substantiallydelay or block the transaction.

 

**RESEARCH**

 

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

 

**DEPENDENCE UPON A SINGLE CUSTOMER**

 

Neither the Corporation nor the Bank is dependent upon a singlecustomer or very few customers. The Bank’s business is concentrated in, andlargely dependent upon the strength of the local economy in, the MontereyPeninsula area of Northern California. The local economy is affected by bothnational trends and by local factors. Tourism and the activities at the formerFort Ord military base are among 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, California 93940. Thisfacility contains a lobby, executive and customer service offices, tellerstations, safe deposit boxes and related non-vault area, vault, operationsarea, lounge and miscellaneous areas. A drive-through facility and adequatepaved parking are also on the premises. Both the land and all improvementsthereto are owned by the Bank**.** The Bankcurrently operates three branch offices in Carmel-By-The-Sea, Carmel Valley andPacific Grove, California, all within approximately 10 miles from the Bank’smain office. The Bank also has a loan production office located in Monterey,California. The land and improvements dedicated to the Carmel-By-The-Sea,Carmel Valley and Pacific Grove branch offices and the loan production officeare leased. See Footnote 12 to the Corporation’s financial statements includedherewith.

 

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 Bank makes and/or purchases loans secured byreal estate, subject to normal banking practices, its own policies and therestrictions described above under Item 1.

 

**ITEM 3.LEGAL PROCEEDINGS**

 

None

 

**ITEM 4. 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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**PART II**

 

**ITEM 5. MARKET FOR THE CORPORATION’S COMMONSTOCK 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’sknowledge no brokers have handled trades in the Bank’s stock during the pastfour years, and there are no published “bid/asked” quotes for such stock or thestock of the Corporation. During the same period, no broker acted as a marketmaker for the Corporation or Bank’s Common stock. Accordingly, the market pricedata contained herein does not represent the value which would be assigned inan efficient market. The Common stock is not listed on any securities exchangeor quoted on the National Association of Securities Dealers Automated System.

 

The Corporation repurchased 5,368 shares of common stock at $4.00 pershare in 2003 and 774 at $3.00 in 2002.

 

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, 2002 to December 31, 2004.

 

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

 

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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 and regulatory 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 andhearing (except in the case of an emergency proceeding where there is in nonotice or hearing), that such institution or holding company cease and desistfrom such practice. Moreover, the Federal Reserve and the FDIC have issuedpolicy statements which provide that bank holding companies and insureddepository institutions generally should only pay dividends out of currentoperating 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 is undercapitalized.

 

The Bank’s payment of dividends, as a California chartered commercialbanking corporation, is regulated by the California Financial Code. Under theCalifornia Financial Code, funds available for cash dividend payments by theBank are restricted to the lessor of: (i) retained earnings; or (ii) the Bank’snet income for its last three fiscal years (less any distributions to thestockholders made during such period). As of December 31, 2004 the Bank had$4,890,600 in retained earnings. The Bank’s net income for the last threefiscal years less distributions to stockholders was $2,726,500.

 

In December 2004 and2003 the Corporation paid cash dividends of $0.165 and $0.15 per share,respectively and a ten percent stock dividend in 2002. The Bank paid cashdividends totaling $50,000, and $75,000 to the Corporation during 2003 and2002, respectively; no dividends were paid in 2004.

 

**Recent Sales of Unregistered Securities**

** **

Thefollowing information relates to securities of the Company or its subsidiariesissued or sold within the past three years, which were not registered under theSecurities Act of 1933, as amended (the “Securities Act”):

 

On March 27, 2003, the Company’s wholly owned special-purpose trustsubsidiary, 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 Preferred Securities”). BearStearns & Co. acted as placement agent in connection with the offering ofthe Trust Preferred Securities with aggregate commission of approximately$90,000 paid to Bear Stearns & Co. by Northern California Bancorp, Inc.Trust I in connection with such placement services. The securities bear afloating rate of interest of 3.25% over the three month LIBOR rate (1.15% +3.250% = 4.40% at December 31, 2003), payable quarterly. Concurrent with theissuance of the Trust Preferred Securities, the Trust used the proceeds fromthe Trust Preferred Securities offering to purchase a like amount of JuniorSubordinated Debentures of the Company. The Subordinated Debentures are thesole assets of the Trust and are eliminated,

 

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along with the related income statement effects, in the consolidatedfinancial 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. TheCompany has the right, assuming no default has occurred, to defer payments ofinterest on the Junior Subordinated Debentures at any time for a period not toexceed 20 consecutive quarters. The Trust Preferred Securities will mature onApril 7, 2033, but can be redeemed under certain circumstances at a premiumprior to April 7, 2008, and can be redeemed, in whole or in part, on anyJanuary 7, April 7, July 7 or October 7 on or after April 7, 2008 at par. TheCompany fully and unconditionally guarantees the obligations of the Trust, on asubordinated basis. The Companyreceived $2.91 million from the Trust upon issuance of the Junior SubordinatedDebentures, of which $1 million was contributed by the Company to the Bank toincrease its capital, $1.14 million was used to retire existing Company debt andthe remainder held as working capital. The Subordinated Debt Securitieswere not registered under the Securities Act in reliance on the exemption setforth in Section 4(2) thereof.

 

Thesale of the Trust Preferred Securities was part of a larger transactionarranged by Bear Stearns & Co., Inc. pursuant to which the Trust PreferredSecurities were deposited into a special purpose vehicle along with similarsecurities issued by a number of other banks and the special purpose vehiclethen issued its securities to the public (the “Pooled TRUPSâ“). The Pooled TRUPSâ were sold by Bear Stearns & Co., Inc.only (i) to those entities Bear Stearns & Co., Inc. reasonably believedwere qualified institutional buyers (as defined in Rule 144A under theSecurities Act), (ii) to “accredited investors” (as defined in Rule 501(a)(1),(2), (3) or (7) or Regulation D promulgated under the Securities Act) or (iii)in offshore transactions in compliance with Rule 903 of Regulation S under theSecurities Act. The Trust Preferred Securities were not registered under theSecurities Act in reliance on exemptions set forth in Rule 144A, Regulation Dand Regulation S, as applicable.

 

On November 13, 2003, the Company’s wholly owned special-purpose trustsubsidiary, Northern California Bancorp, Inc. Trust II (the “Trust”) issued$5,000,000 of principal amount of Floating Rate TRUPSâ (CapitalTrust Pass-through Securities) (the “Trust Preferred Securities”). Citigroup Global Markets, Inc. actedas placement agent in connection with the offering of the Trust PreferredSecurities with aggregate commission of approximately $40,000 paid to CitigroupGlobal Markets, Inc. by Northern California Bancorp, Inc. Trust I in connectionwith 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 Trust PreferredSecurities, the Trust used the proceeds from the Trust Preferred Securitiesoffering to purchase a like amount of Junior Subordinated Debentures of theCompany. The Subordinated Debentures are the sole assets of the Trust and areeliminated, along with the related income statement effects, in theconsolidated 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, todefer payments of interest on the Junior Subordinated Debentures at any timefor a period not to exceed 20 consecutive quarters. The Trust PreferredSecurities will mature on November 8, 2033, but can be redeemed under certaincircumstances at a premium prior to August 8, 2008, and can be redeemed, inwhole or in part, on any February 8, May 8, August 8 or November 8 on or afterAugust 8, 2008 at par. The Company fully and unconditionally guarantees theobligations of the Trust, on a subordinated basis. The Company received $4.96million from the Trust upon issuance of the Junior Subordinated Debentures, ofwhich $2.5 million was

 

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contributed bythe Company to the Bank to increase its capital and the remainder held asworking capital.

 

Thesale of the Trust Preferred Securities was part of a larger transactionarranged by Citigroup Global Markets, Inc., Inc. pursuant to which the Trust PreferredSecurities were deposited into a special purpose vehicle along with similarsecurities issued by a number of other banks and the special purpose vehiclethen issued its securities to the public (the “Pooled TRUPSâ“). The Pooled TRUPSâ were sold by Citigroup GlobalMarkets, Inc., Inc. only (i) to thoseentities Citigroup Global Markets, Inc., Inc. reasonably believed were qualified institutional buyers (as defined inRule 144A under the Securities Act), (ii) to “accredited investors” (as definedin Rule 501(a)(1), (2), (3) or (7) or Regulation D promulgated under theSecurities Act) or (iii) in offshore transactions in compliance with Rule 903of Regulation S under the Securities Act. The Trust Preferred Securities werenot registered under the Securities Act in reliance on exemptions set forth inRule 144A, Regulation D and Regulation S, as applicable.

 

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

 

**Statements Regarding Forward-Looking Information**

 

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

 

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**OVERVIEW**

 

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

 

Net income for each of the last three years was $1,065,200 in 2004,$839,800 in 2003, and $508,600 in 2002. The primary net income per share foreach of the last three years was $.68, $.55, and $.34 respectively. The dilutednet income per share for the same time periods were $.56, $.47 and $.29,respectively. Return on average shareholders’ equity was 15.35%, 13.84% and10.49% in 2004, 2003 and 2002, respectively. Return on average assets was0.88%, 0.88%, and 0.63% in 2004, 2003 and 2002, respectively.

 

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

 

The increase in earnings in 2003 was due to increases of $658,800 innet interest income after provision for loan losses and $622,300 innon-interest income; partially offset by increases of $645,400 in non-interestexpense and $304,500 in 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 innon-interest income; partially offset by increases of $120,800 in non-interestexpense and $122,700 in income tax expense.

 

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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 ofeach component of net income is included under the appropriate captions, whichfollows.

 
| ** **                                         | ** ** | **As of and for the years Ended December 31,**   | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                         | ** ** | **2004**                                         | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands except per share data)** | ** ** |
| Summary of Operating Results:                      |       |                                             |       |   |   |   |   |   |   |   |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Total interest income                              |       | 7,355                                            |       | 5,569 |   | 4,900 |   | 5,440 |   | 5,501 |   |
| Total interest expense                             |       | 2,435                                            |       | 1,920 |   | 1,948 |   | 2,526 |   | 2,410 |   |
| Net interest income                                |       | 4,920                                            |       | 3,649 |   | 2,952 |   | 2,914 |   | 3,092 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Provision for possible loan losses                 |       | 185                                              |       | 155 |   | 117 |   | 185 |   | 130 |   |
| Net interest income after provision for  loan loss |       | 4,735                                            |       | 3,494 |   | 2,835 |   | 2,729 |   | 2,962 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Total other income                                 |       | 2,222                                            |       | 2,403 |   | 1,781 |   | 1,496 |   | 1,445 |   |
| Total other expense                                |       | 5,111                                            |       | 4,399 |   | 3,754 |   | 3,633 |   | 3,309 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Income (loss) before taxes                         |       | 1,846                                            |       | 1,498 |   | 863 |   | 592 |   | 1,098 |   |
| Provision for income tax                           |       | 781                                              |       | 659 |   | 354 |   | 231 |   | 362 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                  |       | 1,065                                            |       | 840 |   | 509 |   | 361 |   | 736 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Per Common Share Data:                             |       |                                             |       |   |   |   |   |   |   |   |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Net income - Primary (1)                           |       | 0.676                                            |       | 0.550 |   | 0.343 |   | 0.246 |   | 0.498 |   |
| Net income - Diluted (2)                           |       | 0.555                                            |       | 0.480 |   | 0.292 |   | 0.212 |   | 0.442 |   |
| Book value, end of period                          |       | 4.55                                             |       | 4.09 |   | 3.77 |   | 3.48 |   | 3.29 |   |
| Avg shares outstanding (3)                         |       | 1,576,589                                        |       | 1,528,268 |   | 1,483,493 |   | 1,469,489 |   | 1,479,520 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Balance Sheet Data:                                |       |                                             |       |   |   |   |   |   |   |   |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Total loans, net of unearned income (4)            |       | 95,036                                           |       | 76,908 |   | 60,257 |   | 52,562 |   | 43,251 |   |
| Total assets                                       |       | 134,039                                          |       | 107,872 |   | 86,279 |   | 79,735 |   | 83,872 |   |
| Total deposits                                     |       | 97,263                                           |       | 78,132 |   | 67,616 |   | 68,332 |   | 72,218 |   |
| Stockholders’ equity                          |       | 7,321                                            |       | 6,411 |   | 5,639 |   | 5,087 |   | 4,861 |   |

 

24

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| ** **                                           | ** ** | **As of and for the Years Ended December 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                           | ** ** | **2004**                                       | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Selected Financial Ratios (4):                       |       |                                           |       |   |   |   |   |   |   |   |   |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Return on average assets (5)                         |       | .88                                            | %          | 0.88 | % | 0.63 | % | 0.48 | % | 1.06 | % |
| Return on average stockholders’ equity (5)      |       | 15.35                                          | %          | 13.84 | % | 10.49 | % | 7.87 | % | 16.95 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Net interest spread                                  |       | 4.02                                           | %          | 3.92 | % | 3.22 | % | 3.57 | % | 4.73 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Net interest margin                                  |       | 4.47                                           | %          | 4.30 | % | 3.88 | % | 4.37 | % | 5.59 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Avg shareholders’ equity to average assets      |       | 5.75                                           | %          | 6.35 | % | 5.99 | % | 6.09 | % | 6.23 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Risked-Based capital ratios                          |       |                                           |       |   |   |   |   |   |   |   |   |
| Tier 1                                               |       | 8.22                                           | %          | 9.00 | % | 8.10 | % | 8.20 | % | 9.50 | % |
| Total                                                |       | 14.83                                          | %          | 17.30 | % | 9.10 | % | 9.10 | % | 10.40 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Total loans to total deposits at end of  period      |       | 97.71                                          | %          | 98.43 | % | 89.12 | % | 76.92 | % | 59.88 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Allowance to total loans at end of period            |       | 1.01                                           | %          | 1.00 | % | 1.04 | % | 1.06 | % | 1.05 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Nonperforming loans to total loans at end  of period |       | 0.04                                           | %          | 0.04 | % | 0.06 | % | 0.70 | % | 0.03 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Net charge-offs to average loans                     |       | 0.00                                           | %          | 0.03 | % | 0.18 | % | 0.18 | % | 0.15 | % |

 

----

(1)          Primaryearnings (loss) per share amounts were computed on the basis of the weightedaverage number of shares of common stock during the year. The weighted averagenumber of shares used for this computation was 1,576,589 for 2004, 1,528,268for 2003, 1,483,493 for 2002, 1,469,489 for 2001 and 1,479,520 for 2000.

 

(2)          Fullydiluted earnings (loss) per share amounts were computed on the basis of theweighted average number of shares of common stock and common stock equivalentsoutstanding during the year. Common stock equivalents include employee stockoptions. The weighted average number of shares used for this computation was1,919,512, 1,796,859, 1,744,082, 1,701,827 and 1,705,258 in 2004, 2003, 2002,2001 and 2000, respectively.

 

(3)          Weightedaverage common shares.

 

(4)          Includesloans being held for sale.

 

(5)          Averagesare of daily balances.

 

**CriticalAccounting Policies**

 

The preparation of financial statements in accordance with accountingprinciples generally accepted in the United States of America requiresmanagement to make a number of judgments, estimates and assumptions that affectthe reported amount of assets, liabilities, income and expenses in the Bank’sfinancial statements and accompanying notes.  Management

 

25

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believes that the judgments, estimates and assumptions used inpreparation of the Bank’s financial statements are appropriate given thefactual circumstances as of December 31, 2004.

 

Various elements of the Bank’s accounting policies, by their nature, areinherently subject to estimation techniques, valuation assumptions and othersubjective assessments.  Critical accounting policies are those thatinvolve the most complex and subjective decisions and assessments and have thegreatest potential impact of the Bank’s results of operation.  Inparticular, management has identified one accounting policy that, due tojudgments, estimates and assumptions inherent in this policy, and thesensitivity of the Bank’s financial statements to those judgments, estimatesand assumptions, are critical to an understanding of the Bank’s financialstatements.  This policy relates to the methodology that determines theallowance for loan and lease losses.  Management has discussed thedevelopment and selection of this critical accounting policy with the AuditCommittee of the Board of Directors.  Although Management believes thelevel of the allowance at December 31, 2004 is adequate to absorb lossesinherent in the loan portfolio, a decline in the regional economy may result inincreasing losses that cannot reasonably be predicted at this time.  For further information regarding the allowance for loan losses see “Provisionand Allowance for Loan Losses,” and Note 6 to the Bank’s audited financialstatements included elsewhere herein.

 

**RecentlyIssued Accounting Standards**

 

Refer to Note 1 to the Financial Statements – “Accounting Policies” fordiscussion of the recently issued accounting standards.

 

**NET INTEREST 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. Changesin net interest income from period to period result from increases or decreasesin the average balances of interest earning assets portfolio, the availabilityof particular sources of funds and changes in prevailing interest rates.

 

The following tablesummarizes the Corporation’s net interest income. Yields are computed on atax-equivalent basis, no tax-exempt securities were held during the years endedDecember 31, 2003 or 2002.

 
| ** **          | ** ** | **Years Ended**            | ** ** | **Increase (Decrease)** | ** ** |
|---------------------|------------|----------------------------|------------|-------------------------|------------|
| ** **          | ** ** | **December 31,**           | ** ** | **From Prior Year**     | ** ** |
| ** **          | ** ** | **2004**                   | ** ** | **2003**                | ** ** | **2002** | ** ** | **2004/2003** | ** ** | **2003/2002** | ** ** |
| ** **          | ** ** | ** **                 | ** ** | ** **              | ** ** | ** ** | ** ** | **Amt** | ** ** | **%** | ** ** | **Amt** | ** ** | **%** | ** ** |
| ** **          | ** ** | **(Dollars in thousands)** | ** ** |
| Interest Income     |       | 7,355                      |       | 5,569                   |       | 4,900 |   | 1,786 |   | 32.08 |   | 669 |   | 13.65 |   |
| Interest Expense    |       | 2,435                      |       | 1,920                   |       | 1,948 |   | 515 |   | 26.80 |   | (28 | ) | (1.42 | ) |
| Net Interest Income |       | 4,920                      |       | 3,649                   |       | 2,952 |   | 1,271 |   | 34.82 |   | 697 |   | 23.61 |   |

 

26

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Net interest incomeincreased $1,270,700 (34.82%) from 2003 to 2004. Average interest bearingassets increased 29.06%, while the average rate earned increased 10 basispoints, resulting in an increase of $1,785,400 in total interest income. Interestexpense increased $514,700 the result of a 26.94% increase in average interestbearing liabilities, while the average rate paid remained the same.

 

Net interest incomeincreased $696,800 (23.61%) from 2002 to 2003. Average interest bearing assetsincreased 12.52%, while the average rate earned increased 7 basis points,resulting in an increase of $669,600 in total interest income. Interest expensedecreased $27,200 the result of a 20.95% increase in average interest bearingliabilities and a decrease of 60 basis points in the average rate paid.

 

The following table shows the components of net interest income,setting forth, for each of the three years ended December 31, 2004, 2003 and2002 (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 are computed on a tax-equivalent basis,resulting in adjustments to interest earned on non-taxable securities of$70,200 in 2004, no tax-exempt securities were held in 2003 or 2002. Non-accrualloans and overdrafts are included in average loan balances. Average loans arepresented net of unearned income.

 

27

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**INTEREST SPREAD ANALYSIS:**

** **
| ** **                           | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------|------------|----------------------------|------------|----------|------------|----------|------------|
| ** **                           | ** ** | ** **                 | ** ** | **Int**  | ** ** | **Avg**  | ** ** | ** ** | ** ** | **Int** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Int** | ** ** | **Avg** | ** ** |
| ** **                           | ** ** | **Avg**                    | ** ** | **Earn** | ** ** | **%**    | ** ** | **Avg** | ** ** | **Earn** | ** ** | **%** | ** ** | **Avg** | ** ** | **Earn** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **Bal**                    | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Bal** | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Bal** | ** ** | **Paid** | ** ** | **Rate** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)** | ** ** |
| Interest Earning Assets:             |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Invest securities - Taxable          |       | 10,755                     |       | 301      |       | 2.80     |       | 8,113 |   | 299 |   | 3.69 |   | 11,593 |   | 417 |   | 3.60 |   |
| Invest securities - Non-Taxable      |       | 3,456                      |       | 226      |       | 6.55     |       | 0 |   | 0 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Federal funds sold                   |       | 10,479                     |       | 141      |       | 1.35     |       | 8,891 |   | 97 |   | 1.09 |   | 7,063 |   | 115 |   | 1.63 |   |
| Total investments                    |       | 24,691                     |       | 669      |       | 2.71     |       | 17,004 |   | 396 |   | 2.33 |   | 18,744 |   | 532 |   | 2.85 |   |
|                                 |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Construction                         |       | 7,384                      |       | 794      |       | 10.76    |       | 3,847 |   | 369 |   | 9.59 |   | 2,753 |   | 272 |   | 9.86 |   |
| Real estate                          |       | 59,393                     |       | 4,500    |       | 7.58     |       | 47,264 |   | 3,585 |   | 7.59 |   | 37,729 |   | 2,846 |   | 7.54 |   |
| Installment                          |       | 548                        |       | 40       |       | 7.38     |       | 494 |   | 38 |   | 7.62 |   | 681 |   | 66 |   | 9.62 |   |
| Commercial                           |       | 19,545                     |       | 1,421    |       | 7.27     |       | 16,344 |   | 1,182 |   | 7.23 |   | 15,595 |   | 1,183 |   | 7.58 |   |
| Total loans                          |       | 86,870                     |       | 6,756    |       | 7.78     |       | 67,949 |   | 5,174 |   | 7.61 |   | 56,758 |   | 4,366 |   | 7.69 |   |
|                                 |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Interest earning assets        |       | 111,561                    |       | 7,425    |       | 6.66     |       | 84,953 |   | 5,570 |   | 6.56 |   | 75,502 |   | 4,898 |   | 6.49 |   |
|                                 |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Bearing Liabilities:        |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Int-bearing demand                   |       | 13,099                     |       | 33       |       | 0.25     |       | 10,892 |   | 27 |   | 0.25 |   | 10960 |   | 73 |   | 0.67 |   |
| Money market savings                 |       | 3,894                      |       | 32       |       | 0.81     |       | 2,592 |   | 22 |   | 0.86 |   | 2,021 |   | 21 |   | 1.04 |   |
| Savings deposits                     |       | 7,924                      |       | 81       |       | 1.02     |       | 6,011 |   | 62 |   | 1.03 |   | 4,200 |   | 54 |   | 1.29 |   |
| Time deposits >$100M              |       | 18,795                     |       | 562      |       | 2.99     |       | 16,378 |   | 511 |   | 3.12 |   | 16,059 |   | 600 |   | 3.74 |   |
| Time deposits <$100M              |       | 24,264                     |       | 711      |       | 2.93     |       | 20,074 |   | 618 |   | 3.08 |   | 20,383 |   | 825 |   | 4.05 |   |
| Other Borrowing                      |       | 24,347                     |       | 1,018    |       | 4.18     |       | 16,781 |   | 680 |   | 4.05 |   | 6,510 |   | 374 |   | 5.74 |   |
| Total interest bearing liabilities   |       | 92,324                     |       | 2,436    |       | 2.64     |       | 72,729 |   | 1920 |   | 2.64 |   | 60,134 |   | 1,948 |   | 3.24 |   |
|                                 |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                  |       |                       |       | 4,989    |       |     |       |   |   | 3,649 |   |   |   |   |   | 2,950 |   |   |   |
|                                 |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest spread                  |       |                       |       |     |       | 4.02     |       |   |   |   |   | 3.92 |   |   |   |   |   | 3.22 |   |
|                                 |       |                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net yield on interest earning assets |       |                       |       |     |       | 4.47     |       |   |   |   |   | 4.30 |   |   |   |   |   | 3.88 |   |

 

28

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| ** **                           | ** ** | **2004 vs 2003**           | ** ** | **2003 vs 2002**       | ** ** |
|--------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                           | ** ** | **Increase(Decrease)**     | ** ** | **Increase(Decrease)** | ** ** |
| ** **                           | ** ** | **Due to changes**         | ** ** | **Due to Changes**     | ** ** |
| ** **                           | ** ** | **Avg**                    | ** ** | **Avg**                | ** ** | ** ** | ** ** | **Avg** | ** ** | **Avg** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Volume**                 | ** ** | **Rate**               | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)** | ** ** |
| Interest Earning Assets:             |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Invest securities - Taxable          |       | 97                         |       | (96                    | )          | 2 |   | (125 | ) | 7 |   | (118 | ) |
| Invest securities – Non-Taxable |       | 227                        |       | —                 |       | 227 |   | — |   | — |   | — |   |
| Federal funds sold                   |       | 17                         |       | 27                     |       | 44 |   | 30 |   | (48 | ) | (18 | ) |
| Total investments                    |       | 341                        |       | (69                    | )          | 273 |   | (96 | ) | (40 | ) | (136 | ) |
|                                 |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Loans                                |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Construction                         |       | 339                        |       | 86                     |       | 425 |   | 108 |   | (11 | ) | 97 |   |
| Real estate                          |       | 922                        |       | (8                     | )          | 914 |   | 715 |   | 24 |   | 739 |   |
| Installment                          |       | 4                          |       | (1                     | )          | 3 |   | (18 | ) | (10 | ) | (28 | ) |
| Commercial                           |       | 231                        |       | 8                      |       | 240 |   | 57 |   | (58 | ) | (1 | ) |
| Total loans                          |       | 1,497                      |       | 85                     |       | 1,582 |   | 862 |   | (55 | ) | 807 |   |
|                                 |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
|                                 |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Total Interest Earning Assets        |       | 1,839                      |       | 16                     |       | 1,855 |   | 766 |   | (95 | ) | 671 |   |
|                                 |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Interest Bearing Deposits:           |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Int-bearing demand                   |       | 6                          |       | 0                      |       | 6 |   | (0 | ) | (46 | ) | (46 | ) |
| Money market savings                 |       | 11                         |       | (2                     | )          | 9 |   | 6 |   | (5 | ) | 1 |   |
| Savings deposits                     |       | 20                         |       | (1                     | )          | 19 |   | 23 |   | (16 | ) | 8 |   |
| Time deposits >$100M              |       | 75                         |       | (25                    | )          | 50 |   | 12 |   | (101 | ) | (89 | ) |
| Time deposits <$100M              |       | 129                        |       | (36                    | )          | 93 |   | (13 | ) | (195 | ) | (207 | ) |
| Other Borrowing                      |       | 306                        |       | 32                     |       | 338 |   | 590 |   | (284 | ) | 306 |   |
|                                 |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Total interest bearing deposits      |       | 547                        |       | (32                    | )          | 514 |   | 618 |   | (646 | ) | (28 | ) |
|                                 |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Net change in net interest           |       | 1,069                      |       | 271                    |       | 1,341 |   | 148 |   | 550 |   | 699 |   |

 

29

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**Provision and 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 loanlosses represents amounts which have been set aside for the specific purpose ofabsorbing losses which may occur in the Bank’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 and the Board of Directors review theresults of the State Banking Department and FDIC examinations, independentaccountants’ observations, and the Bank’s internal review as additionalindicators to determine if the amount in the allowance for loan losses isadequate to protect against estimated future losses. 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                         |       | 3.00         | %          |
| 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 end of 2004, 2003 and 2002, the Bank’sallowance stood at 1.00 percent, 1.00 percent, and 1.04 percent of gross loans,respectively. Provisions were made to the allowance for loan losses in 2004,2003 and 2002 of $185,000, $155,000, and $117,000, respectively. No loans werecharged off in 2004, loans charged off in 2003 totaled $18,400 and $59,700 in2002. Recoveries for these same periods were $1,000, $1,300, and $13,300.

 

30

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The Bank’s non-performing (delinquent 90 days or more and non-accrual)loans as a percentage of total loans were 0.04 percent 0.04 percent and 0.06percent as of the end of 2004, 2003 and 2002, 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 tighterlending controls, are responsible for the Bank’s strong performance on thesemeasures of credit quality. However, no assurance can be given that the Bank’sloan portfolio will continue to measure well against its peers on these ratiosand quality measures, or that losses will not otherwise occur in the future.

 

 

**Non-Interest Income**

 

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

 
| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)**   | ** ** |
| Service charges on deposit accounts           |       | 517                          |       | 505 |   | 508 |   |
| Other service charges, commissions and fees   |       | 989                          |       | 1,237 |   | 747 |   |
| Income from sales and servicing of SBA  loans |       | 716                          |       | 661 |   | 526 |   |
|                                          |       |                         |       |   |   |   |   |
| Total non-interest income                     |       | 2,222                        |       | 2,403 |   | 1,781 |   |

 

Total non-interest income decreased $181,500 (7.54%) in 2004 whencompared with 2003. Income from sales and servicing of SBA loans increased$55,800 and service charges on deposit accounts increased $10,800; while otherincome decreased $248,100. The decrease in other income was due primarily todecreases of $265,400 in commercial banking origination fees.

 

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 increase in other income was due primarily toincreases of $348,000 in commercial banking origination fees and $48,700 in netincome from merchant credit card processing.

 

Total non-interestincome increased $285,300 (20.69%) in 2002 when compared with 2001. Servicecharges on deposit accounts increased $14,100, income from sales and servicingof SBA loans increased $13,300 and other service charges, commissions and feesincreased $257,900.

 

The sale of Small Business Administration (SBA) guaranteed loans is asignificant contributor to the Bank’s income. SBA guaranteed loans yield up to3 3/4% over the New York

 

31

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prime rate, and the guaranteed portions can be sold at premiums whichvary with market conditions. SBA loans are guaranteed by the full faith of theUnited States Government up to 85 percent of the principal amount. Theguaranteed portion has risks comparable for an investor to a U. S. Government securityand can usually be sold in the secondary financial market, either at a premiumor at a yield which allows the Bank to maintain a significant spread foritself.

 

There can be no assurance that the gains on sale will continue at, orabove, the levels realized in the past three years. The Small BusinessAdministration has recently increased the guarantee fees borrowers must pay. Increasingcompetition among lenders for qualified SBA borrowers makes it difficult forthe Bank to continually expand its program in this area, and may limit thelevel of premium that can be earned with regard thereto.

 

The following table presents a summary of the activity in SBA loans forthe years ended 2004, 2003 and 2002:

 
| ** **           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**  | ** ** |
|----------------------|------------|----------|------------|----------|------------|-----------|------------|
|                 |       |     |       |     |       |      |       |
| SBA loans authorized |       | $        | 15,844,000 |     | $          | 8,882,900 |       | $ | 5,916,900 |   |
| SBA loans sold       |       | $        | 4,669,100  |     | $          | 4,994,100 |       | $ | 4,689,300 |   |

 

 

Summary of Income from sales and Servicing ofSBA Loans

 
| ** **                                          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income from premium                                 |       | $        | 412,400    |     | $          | 440,000  |       | $ | 332,800 |   |
| Income from servicing                               |       | 304,000  |       | 220,600  |       | 193,200  |       |
| Total income from sales and servicing of  SBA loans |       | $        | 716,400    |     | $          | 660,600  |       | $ | 526,000 |   |

 

32

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**Non-Interest Expense**

 

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

 
| ** **                      | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------|------------|------------------------------|------------|
| ** **                      | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)**   | ** ** |
| Salaries and benefits           |       | 3,004                        |       | 2,566 |   | 2,201 |   |
| Occupancy and equipment expense |       | 597                          |       | 511 |   | 372 |   |
| Professional fees               |       | 114                          |       | 89 |   | 84 |   |
| Data processing                 |       | 364                          |       | 357 |   | 364 |   |
| Other expenses                  |       | 1,033                        |       | 876 |   | 733 |   |
| Total other expenses            |       | 5,112                        |       | 4,399 |   | 3,754 |   |

 

Salary and benefits expense increased $437,600 in 2004 as a result ofthe first full year of salary expense related to the hiring of an ExecutiveVice President/Chief Lending Officer during the fourth quarter of 2003, meritincreases and bonus payments. Salary and benefits expense increased $365,500 in2003 as a result of the first full year of salary expense related to theCarmel-by-the Sea branch office, the hiring of an Executive VicePresident/Chief Lending Officer during the fourth quarter, merit increases andbonus payments. Salary expense increased $47,000 in 2002 as the result ofadding a business development officer and three full time equivalent positionsto staff the new Carmel-By-The-Sea Branch that opened in November 2002; theseincreases were partially offset by not replacing the President when he left theBank in February.

 

Occupancy and equipment expenses increased $86,000 in 2004, withsignificant increases of $19,800 in depreciation expense, $22,700 in merchantterminal expense, $14,100 in repairs and maintenance expense, $7,800 injanitorial expense and $4,700 in premises rent. Occupancy and equipmentexpenses increased $138,400 in 2003, with significant increases of $65,700 inpremises rent net of sublease income, $46,100 in depreciation, $9,200 inrepairs and maintenance expense, $3,800 in property taxes and $3,300 inmerchant terminal. Occupancy and equipment expenses increased $46,000 in 2002,due primarily to expenses related to opening the Carmel-By-The-Sea Branch.

 

Data processing expense increased $6,800 in 2004. Data processingexpense decreased $6,900 in 2003. Data processing expense increased $120,100 in2002 due to expenses associated with the development of an internet website,software license fees for an information management reporting program andincreased numbers of accounts and transaction activity.

 

In 2004, professional fees increased $24,400 due to accounting/auditfees increasing $19,500 while legal fees increased $4,900. In 2003,professional fees increased $4,900 due to accounting fees increasing $8,500while legal fees decreased $3,600. In 2002, professional fees decreased $22,400with accounting fees increasing $7,100, while legal fees decreased $29,500.

 

Other expenses for 2004 totaled $1,033,000 compared with $876,100 for2003, an increase of $156,900. Significant changes occurred in the followingcategories with in increases operational losses $35,200, business development$31,700, insurance $23,200, advertising

 

33

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$13,800, collection expense $20,700, telephone expense $12,600,entertainment & meals $11,500, donations $9,700, postage expense $8,300,and amortization trust preferred offering expense $5.700; while decreasesoccurred in stationary & supplies $13,800, loan expense $12,000 and autoallowance/expense $6,300.

 

Other expenses for 2003 totaled $876,100 compared with $732,600 for2002, an increase of $143,500. Significant changes occurred in the followingcategories with in increases operational losses $68,000, insurance $20,400,advertising $13,300, FDIC & State assessments $10,400, bank fees $10,100,director fees $10,000, business development $8,800, telephone expense $8,300,stationary & supplies $7,800 and subscriptions $5.600; while decreasesoccurred 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 followingcategories with increases in 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 andtelephone expense $5,200; while decreases 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 andbank security $15,600.

 

**Income Taxes**

 

In February 1992, the Financial Accounting Standards Board issuedStatement of Financial Accounting Standards No. 109, “Accounting for IncomeTaxes,” (Statement 109). Under the asset and liability method of Statement 109,deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases. Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. Under Statement 109, theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. Deferredassets are recognized for deductible temporary differences and operating lossand tax credit carry forwards, and then a valuation allowance is established toreduce that deferred tax asset if it is “more likely than not” that the relatedtax benefits will not be realized. The Bank adopted Statement 109 and hasapplied the provisions of the statement as of January 1, 1992.

 

34

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

 
| ** **                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current tax provision:            |       |     |       |     |       |     |       |
| Federal                           |       | $        | 619,800    |     | $          | 410,800  |       | $ | 244,800 |   |
| California                        |       | 236,700  |       | 142,800  |       | 90,300   |       |
|                              |       | 856,500  |       | 553,600  |       | 335,100  |       |
|                              |       |     |       |     |       |     |       |
| Deferred tax provision (benefit): |       |     |       |     |       |     |       |
| Federal                           |       | (146,700 | )          | 61,900   |       | (18,600  | )          |
| California                        |       | (36,200  | )          | (8,600   | )          | (8,900   | )          |
| Increase in valuation allowance   |       | 107,000  |       | 51,600   |       | 46,400   |       |
|                              |       | (75,900  | )          | 104,900  |       | 18,900   |       |
|                              |       | $        | 780,600    |     | $          | 658,500  |       | $ | 354,000 |   |

 

The differences between the statutory federal income tax rate and theeffective tax rates are summarized as follows:

 
| ** **                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |     |       |
| Statutory federal tax rate                    |       | 34.00    | %          | 34.00    | %          | 34.00    | %          |
| California taxes, net of federal tax  benefit |       | 7.20     |       | 7.20     |       | 7.20     |       |
| Other, net                                    |       | 1.10     |       | 2.74     |       | (0.16    | )          |
| Effective tax rates                           |       | 42.30    | %          | 43.94    | %          | 41.04    | %          |

 

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:

 
| ** **               | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Deferred tax asset       |       |     |       |     |       |
| Federal                  |       | $        | 480,100    |     | $          | 363,200 |   |
| California               |       | 131,200  |       | 105,100  |       |
|                     |       |     |       |     |       |
| Total deferred tax asset |       | 611,300  |       | 468,300  |       |
| Valuation allowance      |       | (335,000 | )          | (228,000 | )          |
|                     |       |     |       |     |       |
| Net deferred tax asset   |       | $        | 276,300    |     | $          | 240,300 |   |

 

35

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

 
| ** **                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets (liabilities)          |       |     |       |     |       |
| Net unrealized gain and loss on securities |       | $        | (70,400    | )        | $          | (30,500 | ) |
| California franchise tax                   |       | 121,800  |       | 73,500   |       |
| Allowance for loan losses                  |       | 391,000  |       | 299,700  |       |
| Accrued salary continuation liability      |       | 281,400  |       | 228,000  |       |
| Depreciation                               |       | (112,500 | )          | (102,400 | )          |
|                                       |       |     |       |     |       |
| Total deferred tax asset                   |       | 611,300  |       | 468,300  |       |
| Valuation allowance                        |       | (335,000 | )          | (228,000 | )          |
|                                       |       |     |       |     |       |
| Net deferred tax asset                     |       | $        | 276,300    |     | $          | 240,300 |   |

 

The Bank establishes a valuation allowance if, based on the weight ofevidence, it is more likely than not that some portion or all of the deferredtax assets will not be realized.

 

**LOANS**

 

Loans, the largest component of earning assets, represented 79.17% ofaverage earning assets, and 72.32% of average total assets during 2004,compared with 79.93% and 71.12%, respectively during 2003. In 2004, averageloans increased 27.85% from $67,949,300 in 2003 to $86,870,200. Average realestate loans increased $12,128,700 (25.66%), average construction loansincreased $3,537,000 (91.94%), average commercial loans increased $3,201,200(19.59%) and average installment loans decreased $54,000 (10.93%).

 

Loan policies and procedures provide the overall direction to theadministration of the loan portfolio. The Bank’s loan underwriting process isintended to encourage sound and consistent credit decisions are made. Emphasisis placed upon credit quality, the borrower’s ability to repay through cashflow, secondary, and (occasionally, tertiary) repayment sources, and the valueof 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 generallyintended to finance current transactions and typically provide for monthlyinterest payments with principal being payable at maturity or at 90-dayintervals. Term loans (usually for a term of two to five years) normallyprovide for monthly installments of principal and interest. The Bank from timeto 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 Lender Status. Generally,SBA loans are guaranteed by the SBA for up to 85 percent of their principalamount, which can be retained in

 

36

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portfolio or sold to investors. Such loans are made at floatinginterest rates, but generally for longer terms (up to 25 years) than areavailable on a conventional basis to small businesses.  The unguaranteedportion of the loans, although generally supported by collateral, is consideredto be more risky than conventional commercial loans because they may be basedupon credit standards the Bank would not otherwise apply, such as lower cashflow coverage, or longer repayment terms.

 

The Bank’s real estate loan portfolio consists both of real estateconstruction loans and real estate mortgage loans. The Bank has initiated aprogram to generate more commercial and industrial real estate loans, whichgenerally yield higher returns than normal commercial loans. The Bank has alsodeveloped a broker program for generating residential real estate loans. TheBank does not make real estate development loans.  Real estateconstruction loans are made for a much shorter term, and often at higherinterest rates, than conventional single-family residential real estate loans. Thecost of administering such loans is often higher than for other real estateloans, 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 permitted, depending on the type andmaturity of the loan, to lend up to 90 percent of the fair market value of realproperty (or more if the loan is insured either by private mortgage insurers orgovernmental agencies). In certain instances, the appraised value may exceedthe actual amount which could be realized on foreclosure, or declines in marketvalue 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 installment loans generally provide for monthlypayments of principal and interest, at a fixed rate. Most of the Bank’sconsumer installment loans are generally secured by the personal property beingpurchased. The Bank generally makes consumer loans to those customers with aprior banking relationship with the Bank.

 

37

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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,** | ** ** |
|---------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                            | ** ** | **(Dollars in thousands)**   | ** ** |
| Commercial and industrial             |       | 23,854                       |       | 18,607 |   | 14,432 |   | 14,469 |   | 12,988 |   |
| Real estate, construction             |       | 7,373                        |       | 5,934 |   | 4,066 |   | 1,896 |   | 2,314 |   |
| Real estate, mortgage                 |       | 64,339                       |       | 52,698 |   | 42,000 |   | 36,010 |   | 27,802 |   |
| Installment                           |       | 622                          |       | 580 |   | 462 |   | 703 |   | 518 |   |
| Government guaranteed loans purchased |       | 51                           |       | 57 |   | 63 |   | 130 |   | 139 |   |
|                                  |       | 96,239                       |       | 77,876 |   | 61,024 |   | 53,207 |   | 43,760 |   |
| Less:                                 |       |                         |       |   |   |   |   |   |   |   |   |
| Allowance for possible loan losses    |       | (963                         | )          | (775 | ) | (637 | ) | (566 | ) | (468 | ) |
| Deferred origination fees, net        |       | (240                         | )          | (193 | ) | (130 | ) | (79 | ) | (41 | ) |
| Net Loans                             |       | 95,036                       |       | 76,908 |   | 60,257 |   | 52,562 |   | 43,251 |   |

 

38

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**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 on non-accrual, previously accrued and unpaidinterest is generally reversed out of income unless adequate collateral fromwhich to collect the principal of, and interest on, the loan appears to beavailable.

 

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 onnon-accrual status (referred to collectively as “non-performing loans”):

 
| ** **                                                    | ** ** | **As of December 31,**     | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                    | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Accruing, past due 90 days or more:                           |       |                       |       |   |   |   |   |   |   |   |   |
|                                                          |       |                       |       |   |   |   |   |   |   |   |   |
| Real Estate                                                   |       | 0                          |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Commercial                                                    |       | 0                          |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Installment                                                   |       | 0                          |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total accruing                                                |       | 0                          |       | 0 |   | 0 |   | 0 |   | 0 |   |
|                                                          |       |                       |       |   |   |   |   |   |   |   |   |
|                                                          |       |                       |       |   |   |   |   |   |   |   |   |
| Nonaccrual Loans:                                             |       |                       |       |   |   |   |   |   |   |   |   |
|                                                          |       |                       |       |   |   |   |   |   |   |   |   |
| Real Estate                                                   |       | 0                          |       | 0 |   | 0 |   | 320 |   | 0 |   |
| Commercial                                                    |       | 43                         |       | 28 |   | 24 |   | 50 |   | 15 |   |
| Installment                                                   |       | 0                          |       | 0 |   | 10 |   | 0 |   | 0 |   |
| Total nonaccrual                                              |       | 43                         |       | 28 |   | 34 |   | 370 |   | 15 |   |
|                                                          |       |                       |       |   |   |   |   |   |   |   |   |
| Total nonperforming                                           |       | 43                         |       | 28 |   | 34 |   | 370 |   | 15 |   |
|                                                          |       |                       |       |   |   |   |   |   |   |   |   |
| Total loans end of period                                     |       | 96,239                     |       | 77,876 |   | 61,024 |   | 53,207 |   | 43,760 |   |
|                                                          |       |                       |       |   |   |   |   |   |   |   |   |
| Ratio of nonperforming loans to total loans  at end of period |       | 0.04                       | %          | 0.04 | % | 0.06 | % | 0.70 | % | 0.03 | % |

 

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

 

39

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**Summary of Loan Loss Experience**

 
| ** **                                                                     | ** ** | **For the Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)**           | ** ** |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Average loans outstanding                                                      |       | 86,870                               |       | 67,949 |   | 11,192 |   | 48,265 |   | 41,552 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Allowance, beginning of period                                                 |       | 775                                  |       | 637 |   | 566 |   | 468 |   | 400 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Loans charged off during period:                                               |       |                                 |       |   |   |   |   |   |   |   |   |
| Real Estate                                                                    |       | 0                                    |       | 0 |   | 58 |   | 80 |   | 67 |   |
| Commercial                                                                     |       | 0                                    |       | 18 |   | 1 |   | 9 |   | 2 |   |
| Installment                                                                    |       | 0                                    |       | 0 |   | 1 |   | 0 |   | 0 |   |
| Other                                                                          |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total charge offs                                                              |       | 0                                    |       | 18 |   | 60 |   | 89 |   | 69 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Recoveries during period:                                                      |       |                                 |       |   |   |   |   |   |   |   |   |
| Real Estate                                                                    |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Commercial                                                                     |       | 3                                    |       | 1 |   | 13 |   | 1 |   | 7 |   |
| Installment                                                                    |       | 0                                    |       | 0 |   | 0 |   | 1 |   | 0 |   |
| Other                                                                          |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total recoveries                                                               |       | 3                                    |       | 1 |   | 13 |   | 2 |   | 7 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Net Loans charged off during the period                                        |       | (3                                   | )          | 17 |   | 47 |   | 87 |   | 62 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Additions to allowance for possible loan  losses                               |       | 185                                  |       | 155 |   | 117 |   | 185 |   | 130 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Allowance, end of period                                                       |       | 963                                  |       | 775 |   | 636 |   | 566 |   | 468 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Ratio of net loans charged off to average  Loans outstanding during the period |       | (0.00                                | )%         | 0.03 | % | 0.42 | % | 0.18 | % | 0.15 | % |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Ratio of allowance to total loans at end of  period                            |       | 1.00                                 | %          | 1.00 | % | 1.01 | % | 1.06 | % | 1.05 | % |

 

40

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**Funding Sources**

 

Average deposits increased 22.15% to $88,005,600 in 2004 from$72,045,700 in 2003. In 2004 average demand deposits increased 24.42% andaverage interest checking, money market and savings accounts as a groupincreased 27.81% and average certificates of deposit increased 18.12%. Averagecertificates of deposit represented 48.93% of average deposits in 2004 comparedwith 50.60% in 2003. Average interest checking, money market and savingsaccounts as a group were 28.31% of average deposits in 2004 compared with27.06% in 2003. Average demand deposits represented 22.76% of average depositsin 2004 compared with 22.34% in 2003.

 

The following table setsforth the scheduled maturities of the Company’s time deposits in denominationsof $100,000 or greater at December 31, 2004:

 

Maturities of Time Deposits of$100,000 or More(Dollars in Thousands)

 

| Three months or less                  |   | $     | 5,302  |   |
|---------------------------------------|--------|-------|--------|--------|
| Over three months through six months  |   | 4,694 |   |
| Over six months through twelve months |   | 7,232 |   |
| Over twelve months                    |   | 7,040 |   |
| Total                                 |   | $     | 24,268 |   |

 

The Corporation borrowed$1,000,000 on an unsecured basis from United Security Bank, Fresno, Californiaon June 28, 2001. The rate of interest is the United Security Bank ReferenceRate (the “Index”) plus .750 percentage points over the Index. The noterequires monthly interest payments beginning August 5, 2001, quarterlyprincipal and interest payments beginning October 5, 2002 through April 5,2011, and a final payment of principal and interest on July 5, 2011. The proceedsfrom the borrowing were used to payoff an $800,000 term loan and to pay downthe $200,000 line of credit with Pacific Coast Bankers’ Bank. The Corporationrenewed the $200,000 revolving line of credit for one year, with interest duemonthly. The credit line is secured by 93,069 shares of Monterey County Bankcommon stock. The rate of interest on the credit line is the prime rate aspublished in the Wall Street Journal (the “Index”) plus .750 percentage pointsover the Index, with floor rate of 6.50%. The Corporation paid off both theterm note and line of credit with proceeds from its March 27, 2003 TrustPreferred Securities issuance.

 

The Bank has lines ofcredit from the Federal Home Loan Bank of San Francisco and Pacific CoastBankers’ Bank with available borrowing capacity on December 31, 2004 of$2,339,300 and $4,500,000, respectively. The Federal Home Loan Bank line ofcredit has a maximum borrowing capacity of twenty five percent (25%) of theBank’s total assets, adjusted quarterly. The Federal Home Loan Bank line ofcredit is secured by certain of the Bank’s real estate secured loans andsecurities at December 31, 2004 the total principal balances of pledged loanswas $28,545,200 and securities of $5,327,800. The following table providesinformation on nine (9) advances totaling $19,650,000 outstanding at December31, 2004.

 

41

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| **Advance** | ** ** | **Interest** | ** ** | **Funding** | ** ** | **Maturity** | ** ** |
|-------------|------------|--------------|------------|-------------|------------|--------------|------------|
| **Amount**  | ** ** | **Rate**     | ** ** | **Date**    | ** ** | **Date**     | ** ** |
| 1,000,000   |       | 6.86         | %          | 8/10/00     |       | 8/10/05      |       |
| 3,900,000   |       | 2.83         | %          | 10/29/02    |       | 10/31/05     |       |
| 1,000,000   |       | 2.54         | %          | 2/4/03      |       | 2/6/06       |       |
| 1,000,000   |       | 1.77         | %          | 3/9/04      |       | 3/9/06       |       |
| 2,750,000   |       | 3.44         | %          | 9/27/02     |       | 9/27/07      |       |
| 1,000,000   |       | 7.72         | %          | 6/1/00      |       | 6/3/30       |       |
| 4,000,000   |       | 5.96         | %          | 8/2/04      |       | 7/28/34      |       |
| 5,000,000   |       | 5.63         | %          | 12/24/04    |       | 12/22/34     |       |

 

The Pacific CoastBankers’ Bank line of credit is unsecured. The Bank did not utilize anyovernight borrowings in 2004, 2003 or 2002

 

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. The letter 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, 2004,stockholders’ equity was $7,321,100 versus $6,410,500 at December 31, 2003. TheCorporation paid cash dividends of $.165 and $.15 per share in 2004 and 2003,respectively and issued a 10% stock dividend in 2002. The Bank paid cashdividends totaling $50,000, and $75,000, to the Corporation in 2003, and 2002,respectively; no dividends were paid in 2004.

 

The FDIC and Federal Reserve Board have adopted capital adequacy guidelinesfor use in their examination and regulation of banks and bank holdingcompanies. If the capital of a bank or bank holding company falls below theminimum levels established by these guidelines, it may be denied approval toacquire or establish additional banks or non-bank businesses, or the FDIC orFederal Reserve Board may take other administrative actions. The guidelinesemploy two measures of capital: (1) risk-based capital and (2) leveragecapital.

 

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 isassigned to one of four risk-weighted categories. For example, 0 percent forcash and unconditionally guaranteed government securities; 20 percent fordeposits with other banks and fed funds; 50 percent for state bonds and certainresidential real estate loans; and 100 percent for commercial loans and otherassets. Capital is categorized as either Tier 1 capital, consisting of commonstock and retained earnings (or deficit), or Tier 2 capital, which includeslimited-life preferred stock and allowance for loan losses (subject to certainlimitations). The guidelines also define and set minimum capital requirements(risk-based capital ratios), which increased over a transition period, endedDecember 31, 1992. Under the final 1992 rules, all

 

42

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banks were required to maintain Tier 1 capital of at least 4 percentand total capital of 8.0% of risk-adjusted assets. The Bank had a Tier 1capital ratio of 11.58% and 12.91% at December 31, 2004 and 2003, respectively,and a total risk-based capital ratio of 12.48% and 13.81% at December 31, 2004and 2003, 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 Bankhad a leverage capital ratio of 9.37% and 11.02% at December 31, 2004 and 2003,respectively.

 

The significant increase in each of the Bank’s risk-based capitalratios from December 31, 2002 to December 31, 2003 was the result of $4,000,000in capital contributions from the Corporation. The Corporation utilized aportion of the proceeds from two trust preferred security issuances to make thecapital contributions.

 

On March 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 afloating rate of interest of 3.25% over the three month LIBOR rate, payablequarterly. 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. 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 pay interest on the Junior Subordinated Debenturesto the Trust, which represents the sole revenue and sole source of dividenddistributions to the holders of the Trust Preferred Securities. The Company hasthe right, assuming no default has occurred, to defer payments of interest onthe Junior Subordinated Debentures at any time for a period not to exceed 20consecutive quarters. The Trust Preferred Securities will mature on April 7,2033, but can be redeemed under certain circumstances at a premium prior toApril 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 Companyfully and unconditionally guarantees the obligations of the Trust, on asubordinated basis.

 

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

 

On November 13, 2003, the Company’s wholly owned special-purpose trustsubsidiary, Northern California Bancorp, Inc. Trust II (the “Trust”) issued $5million in cumulative Trust Preferred Securities. The securities bear afloating rate of interest of 2.85% over the three month LIBOR rate, payablequarterly. 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. 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 pay interest on the Junior Subordinated Debenturesto the Trust, which represents the sole revenue and sole source of dividenddistributions to the holders of the Trust Preferred Securities. The Company hasthe right, assuming no default has occurred, to defer payments of interest onthe Junior Subordinated Debentures at any time for a period not to exceed 20consecutive quarters. The Trust Preferred Securities will mature on August 8,2033, but can be redeemed under certain circumstances at a

 

43

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premium priorto August 8, 2008, and can be redeemed, in whole or in part, on any February 8,May 8, August 8 or November 8 on or after August 8, 2008 at par. The Companyfully and unconditionally guarantees the obligations of the Trust, on asubordinated basis.

 

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

 

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

 

**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 theBank, liquidity considerations involve the capacity to meet expected andpotential requirements of depositors seeking access to balances and to providefor the credit demands of borrowing customers. In the ordinary course of theBank’s business, funds are generated from the repayment of loans, maturitieswithin the investment securities portfolio and the acquisition of depositbalances and short-term borrowings. In addition, the Bank has lines of creditfrom the Federal Home Loan Bank of San Francisco of approximately $30,560,000,subject to pledging of acceptable collateral, and a $4,500,000 unsecuredfederal funds line of credit with the Pacific Coast Bankers’ Bank to meettemporary 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 loansto not more than 90 percent of deposits.  Within these ratios, the Bankgenerally has excess funds available to sell as federal funds on a daily basis,and is able to fund its own liquidity needs without the need of short-termborrowing. The Bank’s total liquidity at December 31, 2004, 2003 and 2002 was22.70 percent, 20.84 percent, and 22.22 percent respectively, while its averageloan to deposit ratio for such years was 99.19 percent, 94.31 percent and 83.35percent 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 financial institution pays an interest rate significantlyhigher than prevailing rates are considered to be brokered deposits. Federallaw and regulation restricts banks from soliciting or accepting brokereddeposits, unless the bank is well capitalized under Federal guidelines. TheBank’s brokered deposits totaled approximately $14,385,800, 14.54% at December31, 2004 compared with $5,995,000, 7.53% of total deposits at December 31,2003. 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 ofinterest-earning assets with interest-bearing liabilities in a manner designed

 

44

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tooptimize net interest income within the constraints imposed by regulatoryauthorities, liquidity determinations and capital considerations. The Bankinstituted formal asset/liability policies at the end of 1989.

 

The purpose 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 generate earnings from increasing loan volume,appropriate loan pricing and expense control and not from trying to accuratelyforecast interest rates. Another important function of asset/liabilitymanagement is managing the risk/return relationships between interest raterisk, liquidity, market risk and capital adequacy. The Bank gives priority toliquidity concerns followed by capital adequacy, then interest rate risk andmarket risk in the investment portfolio. The policy of the Bank will be tocontrol the exposure of the Bank’s earnings to changing interest rates bygenerally maintaining a position within a narrow range around an “earningsneutral position.” An earnings neutral position is defined as the mix of assetsand liabilities that generate a net interest margin that is not affected byinterest rate changes. However, Management does not believe that the Bank canmaintain a totally earnings neutral position. Further, the actual timing ofrepricing of assets and liabilities does not always correspond to the timingassumed by the Bank for analytical purposes. Therefore, changes in market ratesof interest will generally impact on the Bank’s net interest income and netinterest 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 a fed funds rate change into rate changesfor each major class of asset and liability, then simulates the bank’s netinterest margin based on the bank’s actual repricing over a one year period,assuming that maturities are reinvested in instruments identical to thosematuring during the period. At December 31, 2004 the affect of a 2% increase inthe fed funds rate, expressed, as a percentage of equity was a positive 5.0%;while the affect of a 2% decrease in the fed funds rate was a negative 5.0%.

 

The Corporation’s sources of revenues and liquidity are the dividends,tax equalization payments or management fees from the Bank and gains onsecurities held in a trading account. The ability of the Bank to pay such itemsto the Corporation is subject to limitations under state and Federal law.

 

**Investment Securities**

 

The Corporation maintains a trading account, at fair value, consistingof marketable securities. At December 31, 2004 the account value was $803,700. TheCorporation has a $202,000 investment in AT Service LLC, which provides titleinsurance services for commercial, industrial and residential properties, aswell as other real estate related financial and informational services,including escrow, real estate information, trustee sale guarantees and realestate tax exchanges. In addition the Corporation has investments in NorthernCalifornia Bancorp Trust I ($93,000) and Northern California Bancorp Trust II($155,000), these are special-purpose trust subsidiaries which were formed tofacilitate the issuance of trust preferred securities.

 

45

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The following table sets forth the book and market value of the Bank’sinvestment securities as of December 31, 2004 and 2003:

 

# INVESTMENTPORTFOLIO MIX(Dollars in thousands)

 
| ** **                                 | ** ** | **2004**  | ** ** | **2003**   | ** ** |
|--------------------------------------------|------------|-----------|------------|------------|------------|
| ** **                                 | ** ** | **Book**  | ** ** | **Market** | ** ** | **Book** | ** ** | **Market** | ** ** |
| ** **                                 | ** ** | **value** | ** ** | **value**  | ** ** | **value** | ** ** | **value** | ** ** |
| Available for sale:                        |       |      |       |       |       |   |   |   |   |
| Corporate Debt Securities                  |       | 750       |       | 752        |       | 1,790 |   | 1,842 |   |
| Government National Mortgage Association   |       | 1,400     |       | 1,377      |       | 2,294 |   | 2,247 |   |
| U.S. Government Agencies                   |       | 4,704     |       | 4,706      |       | 2,000 |   | 1,988 |   |
| Total                                      |       | 6,854     |       | 6,834      |       | 6,084 |   | 6,076 |   |
| Held to maturity:                          |       |      |       |       |       |   |   |   |   |
| State/Local Agency Securities              |       | 6,219     |       | 6,300      |       | — |   | — |   |
|                                       |       |      |       |       |       |   |   |   |   |
| Other Securities:                          |       |      |       |       |       |   |   |   |   |
| Federal Home Loan Bank Stock               |       | 924       |       | 924        |       | 753 |   | 753 |   |
| Pacific Coast Bankers’ Bank Stock     |       | 440       |       | 440        |       | 440 |   | 440 |   |
| AT Services, LLC                           |       | 202       |       | 202        |       | 202 |   | 202 |   |
| Mission Valley Bank                        |       | —    |       | —     |       | 25 |   | 25 |   |
| Northern California Bancorp, Inc. Trust I  |       | 93        |       | 93         |       | 93 |   | 93 |   |
| Northern California Bancorp, Inc. Trust II |       | 155       |       | 155        |       | 155 |   | 155 |   |
| Total                                      |       | 1,814     |       | 1,814      |       | 1,668 |   | 1,668 |   |

 

The following tables summarize the maturity of the Bank’s investmentsecurities at December 31, 2004:

 

INVESTMENT PORTFOLIO MATURITIES(Dollars in thousands)

 
| ** **                        | ** ** | **Available for Sale** | ** ** |
|-----------------------------------|------------|------------------------|------------|
| ** **                        | ** ** | **Amortized  Cost**    | ** ** | **Fair  Value** | ** ** |
| Due between one and five years    |       | $                      | 2,704,300  |   | $ | 2,703,500 |   |
| Due between five and ten years    |       | 2,750,000              |       | 2,754,300 |   |
| GNMA - Mortgage Backed Securities |       | 1,399,900              |       | 1,377,100 |   |
|                              |       | $                      | 6,854,200  |   | $ | 6,834,900 |   |

 

 
| ** **            | ** ** | **Held to  Maturity** | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | **Amortized  Cost**   | ** ** | **Fair  Value** | ** ** |
| Due in over ten years |       | $                     | 6,219,000  |   | 6,219,000 |   |
|                       |            |                       |            |  |  |  |

 

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**ITEM 7.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, 2004 and 2003                                                                           |   |
|                                                                                                                                |   |
| Consolidated Statements of Operations for  each of the three years in the period ended December 31, 2004                            |   |
|                                                                                                                                |   |
| Consolidated Statements of Changes in  Stockholders’ Equity for each of the three years in the period ended December  31, 2004 |   |
|                                                                                                                                |   |
| Consolidated Statements of Cash Flows for  each of the three years in the period ended December 31, 2004                            |   |
|                                                                                                                                |   |
| 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 2004, 2003 or 2002.

 

 

**ITEM 8A. CONTROLS AND PROCEDURES**

 

(a)           **Evaluation of Disclosure Controls and Procedures**

 

Northern California Bancorp, Inc.’s Chief ExecutiveOfficer and its Chief Financial Officer, after evaluating the effectiveness ofNorthern California Bancorp, Inc.’s disclosure controls and procedures (asdefined in Exchange Act Rules 13a-14(c) and 15-d-14(c) as of a date within 90days of the filing date of this annual report (the “Evaluation Date”) haveconcluded that as of the Evaluation Date, Northern California Bancorp, Inc.’sdisclosure controls and procedures were adequate and effective to ensure thatmaterial information relating to Northern California Bancorp, Inc. and itsconsolidated subsidiaries would be made known to them by others within thoseentities, particularly during the period in which this annual report was beingprepared.

 

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

 

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

 

(b)           **Changes in Internal Controls**

 

There were no significant changes inNorthern California Bancorp, Inc.’s internal controls or in other factors thatcould significantly affect Northern California Bancorp, Inc.’s internalcontrols subsequent to the Evaluation Date, nor any significant deficiencies ormaterial weaknesses in such controls requiring corrective actions. As a result,no corrective actions were taken.

 

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**PART III**

 

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

 

**Code of Ethics**

 

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

 

The name, age, title and five-year business background of eachdirector, executive officers and significant employees of the Corporation(including the Bank) as of December 31, 2004, 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 |       | 63      |       | Chairman of the Board & Chief Executive  Officer Monterey County Bank since 3/87                                                                                                                                                     |       |
|                                                                                                     |       |    |       |                                                                                                                                                                                                                                     |       |
| Sandra G.  Chrietzberg  Director, 1988 to 1994 and  since 1995                                           |       | 61      |       | Formerly President and CEO Queen of  Chardonnay, Inc., dba La Reina Winery 8/84-12/93                                                                                                                                                    |       |
|                                                                                                     |       |    |       |                                                                                                                                                                                                                                     |       |
| Peter J.  Coniglio, Esq.  Director since 1976                                                            |       | 75      |       | Partner - Hudson, Martin, Ferrante &  Street, Monterey                                                                                                                                                                               |       |
|                                                                                                     |       |    |       |                                                                                                                                                                                                                                     |       |
| Carla S.  Hudson, CPA  Director since 1994                                                               |       | 51      |       | Partner - Huey and Hudson, Certified Public  Accountants                                                                                                                                                                                 |       |
|                                                                                                     |       |    |       |                                                                                                                                                                                                                                     |       |
| John M. Lotz  Director since 1991                                                                        |       | 63      |       | 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                                     |       | 61      |       | Executive Vice President, Chief Lending  Officer of Monterey County Bank since 11/03, Senior Executive Vice President,  Chief Lending Officer, Pacific Coast Bankers’ Bank 1997-2003                                                |       |
|                                                                                                     |       |    |       |                                                                                                                                                                                                                                     |       |
| Bruce N.  Warner  Executive Vice President,  Chief Financial Officer  and Chief Operating Officer        |       | 57      |       | 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                        |   | 60     |   | Senior Vice President, Manager SBA Loan Department 11/02. Vice  President SBA Loan Department 3/98.                                                                                         |   |
|-------------------------------------------|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                      |   |   |   |                                                                                                                                                                                        |   |
| Mary Ellen Stanton  Senior Vice President |   | 67     |   | Senior Vice President, Loan Administration, Monterey County Bank  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 the Bank.The Chairman of the Board, Chief Executive Officer and Executive VicePresident, Chief Financial Officer of the Corporation serve in similarcapacities with the Bank, although the limited operations of the Corporation donot require significant amounts of their time. There are no familyrelationships among the persons listed above, except that Mr. and Mrs.Chrietzberg are spouses.

 

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, during2004.

 

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**ITEM 10****. EXECUTIVE COMPENSATION**

 

The following table sets forth certaininformation regarding the compensation paid to the officers of theCorporation/Bank whose salary and bonus exceeded $100,000 for 2004.

 
| ** **                             | ** ** | **Annual  Compensation** | ** ** | **Long  Term Compensation Awards** | ** ** |
|----------------------------------------|------------|--------------------------|------------|------------------------------------|------------|
| ** **                             | ** ** | ** **               | ** ** | ** **                         | ** ** | ** ** | ** ** | **Other  Annual** | ** ** | **Restricted  Stock** | ** ** | **Securities  Underlying** | ** ** | **All  Other** | ** ** |
| **Name & Principal Position** | ** ** | ** **               | ** ** | **Salary**                         | ** ** | **Bonus** | ** ** | **Compensation** | ** ** | **Awards** | ** ** | **Options/SARs** | ** ** | **Compensation** | ** ** |
|                                   |       |                     |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Charles T.  Chrietzberg, Jr.      |       | 2004                     |       | $                                  | 180,437    |   | $ | 221,700 |   | $ | 2,199 | (1) | None |   | 25,000 |   | $ | 76,806 | (2) |
| Chairman &  CEO               |       | 2003                     |       | $                                  | 184,069    |   | $ | 221,000 |   | $ | 2,557 | (1) | None |   | 30,000 |   | $ | 26,298 | (2) |
|                                   |       | 2002                     |       | $                                  | 190,914    |   | $ | 161,000 |   | $ | 3,274 | (1) | None |   | 30,000 |   | $ | 0 | (2) |
|                                   |       |                     |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Timothy M.  Leveque                    |       | 2004                     |       | $                                  | 137,356    |   | $ | 60,150 |   | $ | 12,000 | (3) | None |   | 60,000 |   | None |   |
| Executive Vice  President,             |       | 2003                     |       | $                                  | 16,925     |   | None |   | $ | 750 | (3) | None |   | None |   | None |   |
| Chief Lending  Officer                 |       |                     |       |                               |       |   |   |   |   |   |   |   |   |   |   |
|                                   |       |                     |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Bruce N. Warner                        |       | 2004                     |       | $                                  | 137,024    |   | $ | 51,100 |   | None |   | None |   | 25,000 |   | None |   |
| Executive Vice  President,             |       | 2003                     |       | $                                  | 104,899    |   | $ | 45,601 |   | None |   | None |   | 5,000 |   | None |   |
| Chief Financial  Officer               |       | 2002                     |       | $                                  | 99,379     |   | $ | 26,605 |   | None |   | None |   | 10,000 |   | None |   |
| Chief Operating  Officer               |       |                     |       |                               |       |   |   |   |   |   |   |   |   |   |   |
|                                   |       |                     |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Andre G. Herrera                       |       | 2004                     |       | $                                  | 105,092    |   | $ | 15,258 |   | None |   | None |   | 2,500 |   | None |   |
| Vice President,                        |       | 2003                     |       | $                                  | 103,975    |   | $ | 13,743 |   | None |   | None |   | 2,500 |   | None |   |
| Chief Information  Officer             |       | 2002                     |       | $                                  | 99,405     |   | $ | 18,459 |   | None |   | None |   | 2,000 |   | None |   |

 

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(1)                                  Representspersonal use of company automobile.

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

(3)                                  Mr. Levequejoined the Bank in November 2003. Other annual compensation for 2004includes an automobile allowance of $6,000, $500 per month, and a temporaryhousing expense allowance of $6,000, $2,000 per month for three months.  Other annual compensation for 2003 isprorated automobile allowance, $500 per month.

 

The Bank owns an automobile for the use of its Chief Executive Officer(the value of his personal use of the automobile is included above).  The Bank furnishes, on a non-discriminatorybasis, to the employees: (i) insurance benefits; and (ii) otherbenefits.  The value of these benefits(excluding non-discriminatory plan benefits) was less than the lesser of$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 1,2005.  It provides for a base salary of$240,000 per year, a Bank furnished automobile or automobile allowance, and abonus based on profits.  The bonus, notto exceed $250,000 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. Chrietzbergis terminated other than for cause (as defined in the contract), he is entitledto severance compensation for his monthly salary plus a pro rated incentivebonus for the greater of

 

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24 months or the remaining termof his contract (which ends in December, 2005); however, if the terminationfollows within twelve (12) months after a change in control transaction (asdefined in the contract), he is entitled to such severance compensation for thegreater of 24 months or the remainder of the term of the contract.

 

The following table sets forth certain information regarding the longterm incentive plan provided for Mr. Chrietzberg.

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

 

In December 1993,the Board of Directors approved a Salary Continuation Agreement for the benefitof Mr. Chrietzberg that provided for payments of $75,000 per year, for 15years, if he remains with the Bank until normal retirement, commencing age65.  After consideration of the impact ofsuch an agreement on the Bank’s income, the Bank amended the Agreement toprovide for one half the original benefit amounts, but adopted Surviving IncomeAgreements which provide benefits upon the death of the executive to hisbeneficiary in a single payment, in an amount equal to the retirement benefit.  The Salary Continuation Agreement providesfor lesser payments in the event of early retirement, generally designated tocoincide with increases in the anticipated surrender value for the lifeinsurance policies described below.

 

In August, 2001, the Board of Directors amended the Salary ContinuationAgreement for the benefit of Mr. Chrietzberg which was approved inDecember, 1993 and amended in August 1999.   The amended Salary Continuation Agreementprovides for payments of $90,000 per year, for Mr. Chrietzberg’s lifetime.  The amended Salary Continuation Agreementprovides the following with regard to the division of death proceeds should Mr. Chrietzbergdie before his sixty-fifth (65th) birthday; his beneficiary(ies)shall be entitled to an amount equal to $2,940,000 or the net at risk insuranceportion of the proceeds, whichever amount is less.  The net at risk insurance portion is thetotal proceeds less the cash value of the policy.  Should Mr. Chrietzberg die on orsubsequent to his sixty-fifth (65th) birthday, his beneficiary(ies)shall be entitled to an amount equal to $1,000,000 plus the present value ofthe remaining retirement benefits due to Mr. Chrietzberg or the net atrisk insurance portion of the proceeds, whichever is less, and the Bank shallbe 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 2004, 2003 and 2002 was $76,800, $26,300, and $0,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

 

52

----

 

material adverse impact on theBank’s net income after taxes in the future, although no assurance can be givenin this regard.  The Surviving IncomeAgreement was terminated upon adoption of the amended Salary ContinuationAgreement.

 

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, 2004.

 

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. |       | 25,000                                                           |       | 19.08                                                                      | %          | 4.40                                |       | 2/02/09              |       |
| Timothy M. Leveque               |       | 60,000                                                           |       | 45.80                                                                      | %          | 4.00                                |       | 2/02/09              |       |
| Bruce N. Warner                  |       | 25,000                                                           |       | 19.08                                                                      | %          | 4.00                                |       | 2/02/09              |       |

 

The following table setsforth the number of shares of Common stock acquired by each of the namedexecutive officers upon exercise of stock options during 2004, the net valuerealized upon exercise, the number of shares of Common stock represented byoutstanding stock options held by each of the named executive officers as of December 31,2004 and the value of such options based on the last transaction in 2004, whichthe Corporation has knowledge of, and certain information concerningunexercised options under the 1998 Amended Stock Option Plan.

 

Aggregated Option/Sar Exercises in LastFiscal Year

and 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. |       | 13,310                  |       | 6,921            |       | 88,000                                                 |       | None                                                                 |       | None |   | None |   |
| Timothy M. Leveque               |       | None                    |       | None             |       | 20,000                                                 |       | 40,000                                                               |       | None |   | None |   |
| Bruce N. Warner                  |       | 9,317                   |       | 6,988            |       | 41,000                                                 |       | None                                                                 |       | 3,000 |   | None |   |

 

In 2004, each directorreceived a standard fee of $500 per regular board meeting attended and $150 foreach committee meeting attended.  TheChair of the Audit Committee received a fee of $300 for each committee meetingattended.

 

53

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**ITEM 11****. SECURITY OWNERSHIP 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. |       | 768,874                                        | (1)        | 45.33                 |       |
| P.O. Box 1344                |       |                                           |       |                  |       |
| Carmel, CA 93921                  |       |                                           |       |                  |       |

 

----

(1)                Includes 88,000 shares subject toemployee stock options and 18,414 shares held beneficially for Mr. Chrietzbergand Mrs. Chrietzberg in Individual Retirement Accounts where voting poweris shared with the custodian of the account. 316,000 shares of the Common stock owned by Mr. Chrietzberg arepledged to secure a loan from an unaffiliated bank.

 

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

 
| **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)  | 45.33                 | %          | 88,000                                    |       | 42.34                                             | %          |
| Sandra G. Chrietzberg                            |       | 743,874                                          | (2)(3)     | 45.33                 | %          | 88,000                                    |       | 42.34                                             | %          |
| Peter J. Coniglio                                |       | 80,355                                           | (4)(5)     | 4.92                  | %          | 25,274                                    |       | 3.43                                              | %          |
| Carla S. Hudson                                  |       | 39,898                                           | (6)        | 2.45                  | %          | 26,767                                    |       | 0.68                                              | %          |
| John M. Lotz                                     |       | 0                                                |       | 0.00                  | %          | 0                                         |       | 0.00                                              | %          |
| John M. Lotz                                     |       | 8,000                                            |       | 0.65                  | %          | 8,000                                     |       | 0.00                                              | %          |
| All Directors and Executive Officers as a  group |       | 1,066,681                                        | (7)        | 57.51                 | %          | 245,161                                   |       | 51.01                                             | %          |

 

----

(1)                                  Includes88,000 shares subject to his employee stock options.  316,000 shares of the Common stock owned by Mr. Chrietzbergare pledged to secure a loan from an unaffiliated bank. Should he default undersuch credit, the shares could be acquired by the lender, or sold pursuant toapplicable terms of the Uniform Commercial Code, in a transaction that couldresult in a change of control of the Corporation.  Such transaction may require approval underprovisions of Federal and California change in bank control laws.

 

(2)                                  The sharesinclude an aggregate of 18,414 shares held beneficially by Mr. Chrietzbergand Mrs. Chrietzberg in Individual Retirement Accounts, where voting poweris also shared with the custodian of the account.

 

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

 

(4)                                  Solevoting power.

 

(5)                                  Includes25,241 shares subject to the respective director’s stock options.  Of the remaining shares 20,131 are held by Mr. Coniglio,26,530 are held in a family trust controlled by Mr. Coniglio, as to whichhe has sole voting and investment power, while 8,453 shares are held by Hudson,Martin, Ferrante & Street, a partnership of which Mr. Coniglio isthe managing partner, with voting and investment power.

 

54

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(6)                                  Includes21,214 shares subject to the respective director’s stock options.  The remaining shares are held jointly withfamily members, other than 1,610 shares held in a corporate pension, as towhich Ms. Hudson has voting and investment power.

 

(7)                                  Includes166,541 shares held by executive officers who are not also directors, 101,000shares are subject to employee stock options.

 

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

 

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

 
| ** **                                                                          | ** ** | **Maximum** | ** ** | ** **                      | ** ** | **Outstanding as of  December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------|------------|---------------------------------|------------|-----------------------------------------------|------------|
| **Name**                                                                            | ** ** | **Amount**  | ** ** | **Percent of  Equity  Capital** | ** ** | **Amount**                                    | ** ** | **Percent of  Equity  Capital** | ** ** |
| Peter J. Coniglio                                                                   |       | 1,104,600   | (1)        | 17.23                           | %          | 1,063,900                                     | (1)        | 14.53 | % |
| Carla S. Hudson                                                                     |       | 176,100     | (2)        | 2.75                            | %          | 139,900                                       | (2)        | 1.91 | % |
| John M. Lotz                                                                        |       | 4,100       |       | 0.04                            | %          | 4,100                                         |       | 0.04 | % |
|                                                                                |       |        |       |                            |       |                                          |       |   |   |
| Directors, Principal  Shareholder, and Officers  as a Group (7 in number) |       | 1,284,800   |       | 20.14                           | %          | 1,207,900                                     |       | 16.50 | % |

 

----

(1)                                  Includedin the extensions of credit to Mr. Coniglio is a loan to the ConiglioFamily Partnership, which had an outstanding balance of $1,028,700 on December 31,2004.

(2)                                  Theextension of credit to Ms. Hudson is a loan to a corporation which is arelated party.

 

55

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**Item 13****. EXHIBITS AND REPORTS**

 

A.                                   EXHIBITS

 
| **Item**       | ** ** | **Description**                                                                                                                                                                                                                                                                                                                     |
|----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2              |       | Plan of Merger and Merger Agreement, Monterey County Bank with  Monterey County Merger Corporation un the Charter of Monterey County Bank  under the Title of Monterey County Bank, joined in by Northern California  Bancorp, Inc. dated November 1, 1995. Filed as exhibit to  Form 10KSB dated December 31, 1995. |
| 3 (i)          |       | Articles of Incorporation                                                                                                                                                                                                                                                                                                           |
|           |       | Filed as exhibit to Form 10KSB dated December 31, 1995.                                                                                                                                                                                                                                                                   |
| 3 (ii)         |       | Bylaws                                                                                                                                                                                                                                                                                                                              |
|           |       | Filed as exhibit to Form 10KSB dated December 31, 1995.                                                                                                                                                                                                                                                                   |
| 10 (i) D  |       | (1)  Lease agreement Carmel Branch Office                                                                                                                                                                                                                                                                                      |
|           |       | Filed as exhibit to Form 10KSB dated December 31, 1995.                                                                                                                                                                                                                                                                   |
|           |       | (2)  Lease agreement Carmel By The Sea Office                                                                                                                                                                                                                                                                                  |
|           |       | Filed as exhibit to Form 10KSB dated December 31, 2002.                                                                                                                                                                                                                                                                   |
|           |       | (3)  Lease agreement 321 Webster Street, Monterey, CA 93924                                                                                                                                                                                                                                                                    |
| 10 (ii) A |       | (1)  Employment Contract of Charles T. Chrietzberg, Jr.,  dated January 1, 2005                                                                                                                                                                                                                                      |
|           |       | (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 Northern California  Bancorp, Inc. pursuant to Section 302 of the Sarbannes-Oxley Act of  2002.                                                                                                                                                                           |
| 31.2           |       | Certification of the Chief Financial Officer of Northern California  Bancorp, Inc. pursuant to Section 302 of the Sarbannes-Oxley Act of  2002.                                                                                                                                                                           |
| 32.1           |       | Certification of the Chief Executive Officer of Northern California  Bancorp, Inc. pursuant to Section 906 of  the Sarbannes-Oxley  Act of 2002.                                                                                                                                                                     |
| 32.2           |       | Certification of the Chief Financial Officer of Northern California  Bancorp, Inc. pursuant to Section 906 of the Sarbannes-Oxley Act of  2002.                                                                                                                                                                           |

 

56

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B.                                     REPORTS

 

None

 

**ITEM 14****.  PRINCIPAL ACCOUNTANTFEES 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 ended December 31,2004 and for the required review of the Bank’s financial statements included inits Form 10-QSB’s for that same year totaled $58,000.

 

**FinancialInformation System Design and Implementation Fees.**Nofees were paid to Hutchinson and Bloodgood for financial information systemdesign and implementation services rendered for the 2004 fiscal year.

 

**AllOther Fees.**$3,100 was paid to Hutchinson &Bloodgood for all tax services rendered for the 2004 fiscal year.

 

57

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**SIGNATURES**

 

 

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

 

 
|                                       | NORTHERN CALIFORNIA BANCORP, INC. |
|--------------------------------------------|-----------------------------------|
|                                       |                              |
| Date:   March 17, 2005 | By:                               |   /s/ Charles T.  Chrietzberg, Jr. |
|                                       |                              | Charles T. Chrietzberg, Jr. |
|                                       |                              | Chief Executive Officer |
|                                       |                              | and President |
|                                       |                              |   |
| Date:   March 17, 2005 | 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 17, 2005 |
|  Charles T. Chrietzberg, Jr. |       | Director     |       |                |
|                                   |       |         |       |                |
|  /s/ Sandra G. Chrietzberg        |       |         |       | March 17, 2005 |
|  Sandra G. Chrietzberg            |       | Director     |       |                |
|                                   |       |         |       |                |
|  /s/ Peter J. Coniglio            |       |         |       | March 17, 2005 |
|  Peter J. Coniglio                |       | Director     |       |                |
|                                   |       |         |       |                |
|  /s/ Carla S. Hudson              |       |         |       | March 17, 2005 |
|  Carla S. Hudson                  |       | Director     |       |                |
|                                   |       |         |       |                |
|  /s/ John M. Lotz                 |       |         |       | March 17, 2005 |
|  John M. Lotz                     |       | Director     |       |                |

 

58

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**NORTHERN CALIFORNIA BANCORP, INC.**

**AND SUBSIDIARY**

** **

**CONSOLIDATED FINANCIAL REPORT**

 

**Years Ended December 31, 2004 and 2003**

 

----

 

**TABLE OF 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,Monterey County Bank, as of December 31, 2004 and 2003 and the relatedconsolidated statements of operations, changes in shareholders’ equity, andcash flows for each of the years in the three-year period ended December 31,2004.  These consolidated financialstatements are the responsibility of the Corporation’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan andperform the audits to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable 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 31,2004 and 2003, and the results of their operations and their cash flows foreach of the years in the three-year period ended December 31, 2004 inconformity with accounting principles generally accepted in the United Statesof America.

 

Watsonville, California

# February 15, 2005

 

1

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

** **

**CONSOLIDATEDBALANCE SHEETS**

**December 31,2004 and 2003**

 
| ** **                                                                                                                                                                 | ** ** | **2004**    | ** **  | **2003**    | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                                                                                                                                                 |       |        |        |        |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Cash and due from banks                                                                                                                                                    |       | $           | 5,614,000   |        | $          | 4,798,100 |   |
| Federal funds sold                                                                                                                                                         |       | 11,195,000  |        | 12,395,000  |       |
| Total cash and cash equivalents                                                                                                                                            |       | 16,809,000  |        | 17,193,100  |       |
| Trading assets                                                                                                                                                             |       | 803,700     |        | 163,300     |       |
| Investment securities available for sale                                                                                                                                   |       | 6,834,900   |        | 6,075,500   |       |
| Investment securities held to maturity, at cost  (fair value approximates $6,299,700)                                                                                      |       | 6,219,100   |        | —      |       |
| Other investments                                                                                                                                                          |       | 1,813,500   |        | 1,667,500   |       |
| Loans held for sale                                                                                                                                                        |       | 4,539,500   |        | 2,347,800   |       |
| Loans, net of allowance for loan losses of  $963,000 in 2004; $774,800 in 2003                                                                                             |       | 90,496,300  |        | 74,560,600  |       |
| Bank premises and equipment, net                                                                                                                                           |       | 2,217,600   |        | 2,197,700   |       |
| Cash surrender value of life insurance                                                                                                                                     |       | 2,391,900   |        | 2,251,000   |       |
| Interest receivable and other assets                                                                                                                                       |       | 1,913,800   |        | 1,415,500   |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Total assets                                                                                                                                                               |       | $           | 134,039,300 |        | $          | 107,872,000 |   |
|                                                                                                                                                                       |       |        |        |        |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                             |       |        |        |        |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Deposits:                                                                                                                                                                  |       |        |        |        |       |
| Non interest-bearing demand                                                                                                                                                |       | $           | 22,840,000  |        | $          | 17,859,800 |   |
| Interest-bearing demand                                                                                                                                                    |       | 16,787,900  |        | 16,454,500  |       |
| Savings                                                                                                                                                                    |       | 6,792,800   |        | 8,444,900   |       |
| Time in denominations of $100,000 or more                                                                                                                                  |       | 26,574,700  |        | 16,132,100  |       |
| Time less than $100,000                                                                                                                                                    |       | 24,267,800  |        | 19,241,100  |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Total deposits                                                                                                                                                             |       | 97,263,200  |        | 78,132,400  |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Federal Home Loan Bank borrowed funds                                                                                                                                      |       | 19,650,000  |        | 13,750,000  |       |
| Junior subordinated debt securities                                                                                                                                        |       | 8,248,000   |        | 8,248,000   |       |
| Interest payable and other liabilities                                                                                                                                     |       | 1,557,000   |        | 1,331,100   |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Total liabilities                                                                                                                                                          |       | 126,718,200 |        | 101,461,500 |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Commitments and contingencies (Note 12)                                                                                                                                    |       |        |        |        |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Shareholders’ equity                                                                                                                                                  |       |        |        |        |       |
| Common stock, no stated par value,  authorized: 2,500,000 shares, issued and outstanding: 1,608,019 and 1,566,658  shares at December 31, 2004 and 2003, respectively |       | 4,719,900   |        | 4,630,900   |       |
| Retained earnings                                                                                                                                                          |       | 2,525,600   |        | 1,725,700   |       |
| Accumulated other comprehensive income                                                                                                                                     |       | 75,600      |        | 53,900      |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Total shareholders’ equity                                                                                                                                            |       | 7,321,100   |        | 6,410,500   |       |
|                                                                                                                                                                       |       |        |        |        |       |
| Total liabilities and shareholders’ equity                                                                                                                            |       | $           | 134,039,300 |        | $          | 107,872,000 |   |

 

The notes to consolidated financial statementsare an integral part of these statements.

 

2

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**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**Years EndedDecember 31, 2004, 2003, and 2002**

 
| ** **                                                              | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|-------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                                    |       |      |       |      |       |      |       |
| Interest income                                                         |       |      |       |      |       |      |       |
| Loans                                                                   |       | $         | 6,756,100  |      | $          | 5,173,400 |       | $ | 4,365,300 |   |
| Time deposits with other financial  institutions                        |       | —    |       | —    |       | 2,900     |       |
| Investment securities                                                   |       | 457,500   |       | 299,400   |       | 416,900   |       |
| Federal funds sold                                                      |       | 141,300   |       | 96,700    |       | 114,800   |       |
| Total interest income                                                   |       | 7,354,900 |       | 5,569,500 |       | 4,899,900 |       |
|                                                                    |       |      |       |      |       |      |       |
| Interest expense                                                        |       |      |       |      |       |      |       |
| Interest-bearing transaction accounts                                   |       | 64,400    |       | 49,300    |       | 94,500    |       |
| Savings and time deposit accounts                                       |       | 791,300   |       | 680,200   |       | 869,000   |       |
| Time deposits in denominations of $100,000  or more                     |       | 561,600   |       | 510,500   |       | 610,400   |       |
| Notes payable and other                                                 |       | 1,017,900 |       | 680,500   |       | 373,800   |       |
| Total interest expense                                                  |       | 2,435,200 |       | 1,920,500 |       | 1,947,700 |       |
|                                                                    |       |      |       |      |       |      |       |
| Net interest income                                                     |       | 4,919,700 |       | 3,649,000 |       | 2,952,200 |       |
| Provision for loan losses                                               |       | 185,000   |       | 155,000   |       | 117,000   |       |
| Net interest income, after provision for  loan losses                   |       | 4,734,700 |       | 3,494,000 |       | 2,835,200 |       |
|                                                                    |       |      |       |      |       |      |       |
| Other income                                                            |       |      |       |      |       |      |       |
| Service charges on deposit accounts                                     |       | 516,500   |       | 505,700   |       | 508,100   |       |
| Income from sales and servicing of Small Business  Administration loans |       | 716,400   |       | 660,600   |       | 526,000   |       |
| Other income                                                            |       | 988,900   |       | 1,237,000 |       | 746,900   |       |
| Total other income                                                      |       | 2,221,800 |       | 2,403,300 |       | 1,781,000 |       |
|                                                                    |       |      |       |      |       |      |       |
| Operating expense                                                       |       |      |       |      |       |      |       |
| Salaries and employee benefits                                          |       | 3,003,600 |       | 2,566,000 |       | 2,200,500 |       |
| Occupancy and equipment expense                                         |       | 596,700   |       | 510,700   |       | 372,300   |       |
| Professional fees                                                       |       | 113,500   |       | 89,100    |       | 84,200    |       |
| Data processing                                                         |       | 363,900   |       | 357,100   |       | 364,000   |       |
| Other general and administrative                                        |       | 1,033,000 |       | 876,100   |       | 732,600   |       |
| Total operating expenses                                                |       | 5,110,700 |       | 4,399,000 |       | 3,753,600 |       |
|                                                                    |       |      |       |      |       |      |       |
| Income before tax provision                                             |       | 1,845,800 |       | 1,498,300 |       | 862,600   |       |
| Income tax provision                                                    |       | 780,600   |       | 658,500   |       | 354,000   |       |
|                                                                    |       |      |       |      |       |      |       |
| Net income                                                              |       | $         | 1,065,200  |      | $          | 839,800   |       | $ | 508,600 |   |
|                                                                    |       |      |       |      |       |      |       |
| Earnings per common share                                               |       |      |       |      |       |      |       |
|                                                                    |       |      |       |      |       |      |       |
| Basic                                                                   |       | $         | 0.68       |      | $          | 0.55      |       | $ | 0.34 |   |
|                                                                    |       |      |       |      |       |      |       |
| Diluted                                                                 |       | $         | 0.56       |      | $          | 0.47      |       | $ | 0.29 |   |

 

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

 

3

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**NORTHERNCALIFORNIA BANCORP, INC.**

**AND SUBSIDIARY**

 

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

**Years EndedDecember 31, 2004, 2003, and 2002**

 
| ** **                                                                       | ** ** | **Number of  Shares** | ** ** | **Common  Stock** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other Compre-  hensive Income** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|------------------------|------------|------------------------------------------------|------------|------------|------------|
| ** **                                                                       | ** ** | ** **            | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                                     | ** ** | ** ** | ** ** |
| 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   | )          |
| Exercise of stock options                                                        |       | 78,210                |       | 152,000           |       | —                 |       | —                                         |       | 152,000    |       |
| Repurchase of common stock                                                       |       | (5,368                | )          | (21,500           | )          | —                 |       | —                                         |       | (21,500    | )          |
|                                                                             |       |                  |       |              |       |                   |       |                                           |       |       |       |
| Balance at December 31, 2003                                                |       | 1,566,658             |       | 4,630,900         |       | 1,725,700              |       | 53,900                                         |       | 6,410,500  |       |
|                                                                             |       |                  |       |              |       |                   |       |                                           |       |       |       |
| Comprehensive income:                                                            |       |                  |       |              |       |                   |       |                                           |       |       |       |
| Net income for the year                                                          |       | —                |       | —            |       | 1,065,200              |       | —                                         |       | 1,065,200  |       |
| Change in net unrealized gain on securities  and other assets net of tax effects |       | —                |       | —            |       | —                 |       | 21,700                                         |       | 21,700     |       |
| Total comprehensive income                                                       |       |                  |       |              |       |                   |       |                                           |       | 1,086,900  |       |
|                                                                             |       |                  |       |              |       |                   |       |                                           |       |       |       |
| $.165 per share cash dividend                                                    |       | —                |       | —            |       | (265,300               | )          | —                                         |       | (265,300   | )          |
| Exercise of stock options                                                        |       | 41,361                |       | 89,000            |       | —                 |       | —                                         |       | 89,000     |       |
|                                                                             |       |                  |       |              |       |                   |       |                                           |       |       |       |
| Balance at December 31, 2004                                                |       | 1,608,019             |       | $                 | 4,719,900  |                   | $          | 2,525,600                                      |       | $          | 75,600     |   | $ | 7,321,100 |   |

 

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

 

4

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**NORTHERNCALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**Years EndedDecember 31, 2004, 2003, and 2002**

 
| ** **                                                                         | ** ** | **2004**    | ** ** | **2003**    | ** ** | **2002**    | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                           |       |        |       |        |       |        |       |
| Net income                                                                         |       | $           | 1,065,200  |        | $          | 839,800     |       | $ | 508,600 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |        |       |        |       |        |       |
| Depreciation and amortization expense                                              |       | 208,500     |       | 169,800     |       | 120,700     |       |
| Realized gain on sales of available-for-sale  securities, net                      |       | (50,600     | )          | (21,300     | )          | (163,300    | )          |
| Amortization of deferred loan costs                                                |       | 126,300     |       | 108,500     |       | 71,400      |       |
| Amortization (accretion) of discounts and  premiums on investment securities       |       | 28,100      |       | 85,400      |       | (11,800     | )          |
| (Gain) loss on sale of equipment                                                   |       | (2,100      | )          | 100         |       | 2,900       |       |
| Provision for loan losses                                                          |       | 185,000     |       | 155,000     |       | 117,000     |       |
| (Increase) decrease in trading assets                                              |       | (640,400    | )          | (81,100     | )          | 90,800      |       |
| Increase in interest receivable                                                    |       | (175,300    | )          | (78,600     | )          | (700        | )          |
| Increase in other assets                                                           |       | (388,600    | )          | (154,600    | )          | (207,200    | )          |
| (Increase) decrease in deferred tax asset                                          |       | (75,900     | )          | 104,900     |       | 18,900      |       |
| Increase (decrease) in interest payable                                            |       | 24,100      |       | (9,300      | )          | (160,800    | )          |
| Increase in other liabilities                                                      |       | 201,800     |       | 238,600     |       | 147,000     |       |
| Increase in loans held for sale                                                    |       | (2,191,700  | )          | (1,365,300  | )          | (376,900    | )          |
| Net cash provided (used) by operating  activities                                  |       | (1,685,600  | )          | (8,100      | )          | 156,600     |       |
|                                                                               |       |        |       |        |       |        |       |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                           |       |        |       |        |       |        |       |
| Decrease in time deposits                                                          |       | —      |       | —      |       | 100,000     |       |
| Proceeds from maturity of investment  securities                                   |       | 8,557,800   |       | 2,974,400   |       | 15,024,000  |       |
| Purchase of investments                                                            |       | (15,643,400 | )          | (3,607,000  | )          | (11,639,400 | )          |
| Net (increase) decrease in loans                                                   |       | (5,203,700  | )          | (3,003,700  | )          | 3,155,800   |       |
| Loan purchases                                                                     |       | (11,043,300 | )          | (12,546,000 | )          | (10,650,500 | )          |
| Proceeds from sale of equipment                                                    |       | 3,200       |       | 1,900       |       | 3,000       |       |
| Additions to bank premises and equipment                                           |       | (223,600    | )          | (122,800    | )          | (565,600    | )          |
| Net cash used by investing activities                                              |       | (23,553,000 | )          | (16,303,200 | )          | (4,572,700  | )          |
|                                                                               |       |        |       |        |       |        |       |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                           |       |        |       |        |       |        |       |
| Net increase (decrease) in deposits                                                |       | 19,130,800  |       | 10,516,000  |       | (716,000    | )          |
| Proceeds from borrowings                                                           |       | 13,900,000  |       | 11,248,000  |       | 6,750,000   |       |
| Repayments of borrowings                                                           |       | (8,000,000  | )          | (1,172,200  | )          | (27,800     | )          |
| Proceeds from exercise of stock options                                            |       | 89,000      |       | 152,000     |       | 55,200      |       |
| Repurchase of common stock and stock  options                                      |       | —      |       | (21,500     | )          | (20,600     | )          |
| Cash dividends paid on common stock                                                |       | (265,300    | )          | (235,000    | )          | (500        | )          |
| Net cash provided by financing activities                                          |       | 24,854,500  |       | 20,487,300  |       | 6,040,300   |       |
|                                                                               |       |        |       |        |       |        |       |
| Net increase (decrease) in cash and cash  equivalents                              |       | (384,100    | )          | 4,176,000   |       | 1,624,200   |       |
|                                                                               |       |        |       |        |       |        |       |
| **CASH AND CASH EQUIVALENTS, BEGINNING**                                           |       | 17,193,100  |       | 13,017,100  |       | 11,392,900  |       |
|                                                                               |       |        |       |        |       |        |       |
| **CASH AND CASH EQUIVALENTS, ENDING**                                              |       | $           | 16,809,000 |        | $          | 17,193,100  |       | $ | 13,017,100 |   |
| ** **                                                                         |       |        |       |        |       |        |       |
| **OTHER CASH FLOW INFORMATION**                                                    |       |        |       |        |       |        |       |
|                                                                               |       |        |       |        |       |        |       |
| Interest paid                                                                      |       | $           | 2,411,500  |        | $          | 1,738,100   |       | $ | 2,108,600 |   |
|                                                                               |       |        |       |        |       |        |       |
| Income taxes paid                                                                  |       | $           | 815,400    |        | $          | 363,000     |       | $ | 353,200 |   |

 

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

 

5

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

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Years Ended December 31, 2004 and 2003**

####  

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

 

***Basis of Presentation and Consolidation***

 

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

 

The Corporation determines whether it has a controlling financialinterest in an entity by first evaluating whether the entity is a voting interestentity or a variable interest entity under accounting principles generallyaccepted in the United States of America. Voting interest entities are entitiesin which the total equity investment at risk is sufficient to enable the entityto finance itself independently and provides the equity holders with theobligation to absorb losses, the right to receive residual returns and theright to make decisions about the entity’s activities. The Corporationconsolidates voting interest entities in which it has all, or at least amajority of, the voting interest.  As defined in applicable accountingstandards, variable interest entities (VIEs) are entities that lack one or moreof the characteristics of a voting interest entity.  A controlling financialinterest in an entity is present when an enterprise has a variable interest, ora combination of variable interests, that will absorb a majority of the entity’sexpected losses, receive a majority of the entity’s expected residual returns,or both.  The enterprise with a controlling financial interest, known asthe primary beneficiary, consolidates the VIE.  The Corporation’s whollyowned subsidiaries, Northern California Bancorp, Inc. Trust I and NorthernCalifornia Bancorp, Inc. Trust II, are VIEs for which the Corporation isnot the primary beneficiary.  Accordingly, the accounts of these entitiesare not included in the Corporation’s consolidated financial statements at December 31,2004.

 

***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.

 

6

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***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 Cash Equivalents***

 

For purposes of reporting cash flows, cash and cash equivalents includecash, amounts due from banks and Federal funds sold on a daily basis.

 

***Time Deposits with Other FinancialInstitutions***

 

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

 

***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 fairvalue with changes in fair value recorded in earnings.  Interest and dividends are included in netinterest 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.

 

7

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***Investment Securities***

 

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 classified as“available for sale” and are reflected at fair value, with unrealized gains andlosses excluded from earnings and reported in other comprehensive income.  In estimating other-than-temporary impairmentlosses, management considers (1) the length of time and the extent towhich the fair value has been less than cost, (2) the financial conditionand near-term prospects of the issuer, and (3) the intent and ability ofthe Bank to retain its investment in the issuer for a period of time sufficientto allow for any anticipated recovery in fair value.  Gains and losses on disposition are generallyrecognized on the trade date, based on the net proceeds and the adjustedcarrying amount of the securities sold using the specific identificationmethod.  Purchase premiums and discountsare recognized in interest income using methods approximating the interestmethod over the terms of the securities.

 

***Sales and Servicing of 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 the gain,the Bank assumes that the loans sold will be outstanding for one-half of theircontractual lives.

 

8

----

 

The Bank’s investment in an SBA loan is allocated among the retainedportion of the loan, excess servicing retained, and the sold portion of theloan, based on the relative fair market value of each portion at the time ofloan origination, 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 loanson the Monterey Peninsula.  The abilityof the Bank’s debtors to honor their contracts is dependent upon the realestate and general economic sectors in the area.

 

Loans, as reported, have been reduced by****undisbursedloan funds, net deferred 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.

 

9

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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 nonaccrualor charged-off at an earlier date if collection of principal or interest isconsidered 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 Loan Losses***

 

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, lossesmay vary from current estimates and future additions to the allowance may benecessary.

 

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

 

10

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The allowance consists of specific, generaland unallocated components.  The specificcomponent relates to loans that are classified as either doubtful, substandardor special mention.  For such loans thatare also classified as impaired, an allowance is established when thediscounted cash flows (or collateral value or observable market price) of theimpaired loan is lower than that of the carrying value of that loan.  The general component covers non-classifiedloans and is based on historical loss experience adjusted for qualitativefactors.  An unallocated component ismaintained to cover uncertainties that could affect management’s estimate ofprobable losses.  The unallocatedcomponent of the allowance reflects the margin of imprecision inherent in theunderlying assumptions used in the methodologies for estimating specific andgeneral losses 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 at theloan’s effective interest rate, the loan’s obtainable market price, or the fairvalue 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.

 

11

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***Loan Servicing***

 

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

 

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.

 

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, the rightsare stratified based on the following predominant risk characteristics of theunderlying loans: loan type, size, note rate, date of origination, term, andgeographic 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 and Equipment***

 

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****maintenanceand repairs to earnings when incurred; major expenditures for betterments arecapitalized and depreciated.

 

12

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***Income Taxes***

 

Deferred income taxes are recognized for estimated future tax effectsattributable to income tax carry forwards as well as temporary differencesbetween income tax and financial reporting purposes. Valuation allowances areestablished when necessary to reduce the deferred tax asset to the amount expectedto be realized.  Deferred tax assets and liabilities are reflected atcurrently enacted income tax rates applicable to the period in which thedeferred tax assets or liabilities are expected to be realized or settled. Aschanges in tax laws or rates are enacted, deferred tax assets and liabilitiesare adjusted accordingly through the provision for income taxes.

 

***Transfersof Financial 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 at pricesnot lower than 100% of the fair market value of the common stock on the date ofgrant.  However, an incentive stockoption granted to an individual owning 10% or more of the Corporation’s stockafter such grant must have an exercise price of at least 110%****of such fair market value and an exercise period of notmore than five years.  Non-qualifiedstock options may be granted at prices not lower than 85% of the fair marketvalue of the common stock on the date of grant. The Board of Directors is authorized to determine when options becomeexercisable within a period not exceeding 10 years from the date of grant.  Under the Plan, 379,071 shares of commonstock have been reserved for the granting of these options.  At December 31, 2004, 318,717 options wereoutstanding.  During 2004, 138,500options were granted, and 41,361 options were exercised by officers, employees,and board members.

 

13

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Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accountingfor Stock-Based Compensation,” as amended by SFAS No. 148 “Accounting forStock-Based Compensation –Transition and Disclosure,” encourages all entitiesto adopt a fair value based method of accounting for employee stockcompensation plans, whereby compensation cost is measured at the grant datebased on the value of the award and is recognized over the service period,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.

 

Hadcompensation cost for the Corporation’s stock-based compensation plan beendetermined based on the fair value at the grant date for awards under the planconsistent with the method prescribed by SFAS No. 123 as amended by SFAS148, the Corporation’s net income and earnings per share would have beenadjusted by the compensation cost net of taxes to the pro forma amountsindicated below:

 
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income:                     |       |     |       |     |       |     |       |
| As reported                     |       | $        | 1,065,200  |     | $          | 839,800  |       | $ | 508,600 |   |
| Pro forma                       |       | $        | 962,500    |     | $          | 809,900  |       | $ | 470,200 |   |
|                            |       |     |       |     |       |     |       |
| Compensation cost, net of taxes |       | $        | 102,700    |     | $          | 29,900   |       | $ | 38,400 |   |
|                            |       |     |       |     |       |     |       |
| Basic earnings per share:       |       |     |       |     |       |     |       |
| As reported                     |       | $        | 0.68       |     | $          | 0.55     |       | $ | 0.34 |   |
| Pro forma                       |       | $        | 0.61       |     | $          | 0.53     |       | $ | 0.32 |   |
|                            |       |     |       |     |       |     |       |
| Diluted earnings per share:     |       |     |       |     |       |     |       |
| As reported                     |       | $        | 0.56       |     | $          | 0.47     |       | $ | 0.29 |   |
| Pro forma                       |       | $        | 0.50       |     | $          | 0.45     |       | $ | 0.27 |   |

 

14

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The fair value of these options was estimated at the grant date usingthe Black-Scholes option pricing model with the following weighted-averageassumptions for 2004, 2003, and 2002: risk-free interest rate of 4.8%, 5.1%,and 4.5%, respectively; dividend yield of 1.0%, 1.7%, and 0%, respectively;expected option life of 8 years, 5.4 years, and 5.6 years, respectively ; andvolatility of 20%, 20%, and 30%, respectively.

 

***Earnings per share***

 

Basic earnings per share represents income available to commonshareholders divided by the weighted-average number of common shares outstandingduring the period.  Diluted earnings pershare reflects additional common shares that would have been outstanding ifdilutive potential common shares had been issued, as well as any adjustment toincome that would result from the assumed issuance.  Potential common shares that may be issued bythe Corporation relate solely to outstanding stock options, and are determinedusing the treasury stock method.  Theweighted average number of shares used in the computation of basic earnings pershare was 1,576,589 for 2004, 1,528,268 for 2003, and $1,483,489 for 2002.  The weighted average number of shares used inthe computation of earnings per share assuming dilution of stock options was1,919,512 for 2004, 1,796,859 for 2003, and 1,744,081 for 2002.  The Corporation paid cash dividends of $.165and $.15 per share in 2004 and 2003, respectively and issued a 10% stockdividend in 2002.

 

# ***Accounting Changes***

#  

In January 2003, the Financial Accounting Standards Board (FASB)issued Interpretation No. 46, *Consolidation of VariableInterest Entities*(FIN 46) which establishes guidance fordetermining when an entity should consolidate another entity that meets thedefinition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a companyif that company will absorb a majority of the expected losses, will receive amajority of the expected residual returns, or both.  Transferors to qualified special-purposeentities (“QSPEs”) and certain other interest in a QSPE are not subject to therequirements of FIN 46.  On December 17,2003, the FASB deferred the effective date of FIN 46 to no later than the endof the first reporting period that ends after March 15, 2004.  However, for special purpose entities theCompany would be required to apply FIN 46 as of December 31, 2003.  The Interpretation had no effect on theCompany’s consolidated financial statements.

 

15

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In December 2003,the FASB issued Interpretation No. 46R (“FIN 46R”), which revised the January 2003,Interpretation No. 46 (“FIN 46”), Consolidationof Variable Interest Entities, an interpretation of Accounting ResearchBulletin No. 51.  The revisionclarifies how variable interest entities should be identified and evaluated forconsolidation purposes. The Company adopted FIN 46R as of December 31,2003.  The adoption of FIN 46R did nothave a material impact on the Company’s consolidated Financial statements.

 

In December 2003, the Accounting StandardsExecutive Committee of the AICPA issued Statement of Position No. 03-3(“SOP 03-3”), Accounting forCertain Loans or Debt Securities Acquired in a Transfer. SOP 03-3addresses the accounting for differences between contractual cash flows and thecash flows expected to be collected from purchased loans or debt securities ifthose differences are attributable, in part, to credit quality.  SOP 03-3 requires purchased loans anddebt securities to be recorded initially at fair value based on the presentvalue of the cash flows expected to be collected with no carryover of anyvaluation allowance previously recognized by the seller. Interest income shouldbe recognized based on the effective yield from the cash flows expected to becollected.  To the extent that thepurchased loans or debt securities experience subsequent deterioration incredit quality, a valuation allowance would be established for any additionalcash flows that are not expected to be received.   However, if more cash flows subsequently areexpected to be received than originally estimated, the effective yield would beadjusted on a prospective basis. SOP 03-3 will be effective for loans anddebt securities acquired after December 31, 2004. Management does notexpect the adoption of this statement to have a material impact on the Company’sconsolidated financial statements.

 

In April 2003, the FASB issued Statement of Financial AccountingStandards (SFAS) No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities.”  TheStatement amends SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities” and clarifies accounting for derivative instruments,including certain derivative instruments embedded in other contracts, and forhedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified afterJune 30, 2003.  This Statement hadno effect on the Company’s consolidated financial statements.

 

16

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In May 2003, the FASB issued SFAS No. 150, “Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity.”  This Statement provides new rules onthe accounting for certain financial instruments that, under previous guidance,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 instrumentsentered into or modified after May 31, 2003, and otherwise is effective atthe beginning of the first interim period beginning after June 30,2003.  This Statement had no effect onthe Company’s consolidated financial statements.

 

In March 2004, Securities and Exchange Commission (“SEC”)Staff Accounting Bulletin No. 105 (“SAB 105”) was issued, which providesguidance regarding loan commitments that are accounted for as derivativeinstruments under FASB No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities. Inthis Bulletin, the SEC ruled that the amount of the expected servicing rightsshould not be included when determining the fair value of derivative interestrate lock commitments.  This guidancemust be applied to rate locks initiated after March 31, 2004. The adoption of SAB 105 didnot have a material impact on the Company’s consolidated financial statements.

 

In March 2004,the Emerging Issues Task Force (“EITF”) reached consensus on the guidanceprovided in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary impairment and its Application toCertain Investments (“EITF 03-1”), as applicable to debt andequity securities that are within the scope of SFAS No. 115, Accounting for Certain Investments in Debtand Equity Securities, and equity securities that are accounted forusing the cost method specified in Accounting Principles Board Opinion No. 18,The Equity Method of Accounting forInvestments in Common Stock. An investment is impaired if the fair valueof the investment is less than its cost. EITF 03-1 provides guidance indetermining whether an impairment is other than temporary. The new guidance inEITF 03-01 is effective for reporting periods beginning after June 15,2004.  Management does not expect theadoption of EITF 03-01 to have a material impact on the Company’sconsolidated financial statements.

 

17

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In December 2004, the FASB issued SFAS No. 123-R(revised 2004), *Share-Based Payment*,which is a revision of SFAS No. 123. SFAS No. 123-R supersedesAPB No. 25 and amends SFAS No. 95, *Statementof Cash Flows*. This statement requires the fair value of allshare-based payments to employees (i.e., stock options) be recognized in thestatement of income. SFAS No. 123-R is effective for the Bankbeginning on January 1, 2006. The Bank expects to adopt SFAS No. 123-Rusing the modified prospective method, which requires the recognition ofexpense over the remaining vesting period for the portion of awards not fullyvested as of December 31, 2005.

 

# ***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:

 
| ** **                                                                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unrealized holding gains on available for  sale securities and other assets, net |       | $        | 39,300     |     | $          | 66,100   |       | $ | 16,900 |   |
| Tax effect                                                                       |       | (17,600  | )          | (29,800  | )          | (7,600   | )          |
|                                                                             |       |     |       |     |       |     |       |
| Net-of-tax amount                                                                |       | $        | 21,700     |     | $          | 36,300   |       | $ | 9,300 |   |

 

18

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#  

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

 
| ** **                                                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Unrealized holding losses on available for  sale securities            |       | $        | (19,300    | )        | $          | (8,000 | ) |
| Unrealized holding gains on available for  sale asset strip receivable |       | 156,700  |       | 106,100  |       |
| Tax effect                                                             |       | (61,800  | )          | (44,200  | )          |
|                                                                   |       |     |       |     |       |
| Net-of-tax amount                                                      |       | $        | 75,600     |     | $          | 53,900 |   |

 

***Advertising Costs***

 

Advertising costs are charged to operations when incurred.  The amount expensed for advertising as of December 31,2004, 2003, and 2002 was $127,300, $113,500, and $100,200, respectively.

 

***Reclassification***

 

Certainamounts have been reclassified in the 2003 and 2002 financial statements toconform to the 2004 presentation.

 

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

 

The Corporation is required to maintain aggregatereserves (in the form of cash and deposits with the Federal Reserve Bank) tosatisfy federal regulatory requirements. At December 2004 and 2003, these reserve balances amounted to$766,000 and $517,000, respectively.

 

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

 

At December 31, 2004 and 2003, trading assets, at fair value,consisted of marketable equity securities in the amount of $803,700 and$163,300, respectively.

 

19

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**Note 4.****          INVESTMENT SECURITIES ANDOTHER 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, 2004** | ** ** |
| Securities  Available for Sale                   |       |                       |       |                                   |       |            |       |
| GNMA - Mortgage  Backed Securities               |       | $                          | 1,399,900  |                                   | $          | (22,800         | )          | $ | 1,377,100 |   |
| Government  Agency Securities                    |       | 4,704,300                  |       | 1,800                                  |       | 4,706,100       |       |
| Corporate Debt  Securities                       |       | 750,000                    |       | 1,700                                  |       | 751,700         |       |
|                                             |       |                       |       |                                   |       |            |       |
| Total securities  available for sale             |       | $                          | 6,854,200  |                                   | $          | (19,300         | )          | $ | 6,834,900 |   |
|                                             |       |                       |       |                                   |       |            |       |
| Securities Held  to Maturity                     |       |                       |       |                                   |       |            |       |
| State/Local  Agency Securities                   |       | $                          | 6,219,100  |                                   | $          | 80,600          |       | $ | 6,299,700 |   |
|                                             |       |                       |       |                                   |       |            |       |
| Other  Investments, at cost                      |       |                       |       |                                   |       |            |       |
| AT Services LLC                                  |       | $                          | 202,000    |                                   | $          | —          |       | $ | 202,000 |   |
| Federal Home  Loan Bank stock, restricted        |       | 923,600                    |       | —                                 |       | 923,600         |       |
| 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                         |       | $                          | 1,813,500  |                                   | $          | —          |       | $ | 1,813,500 |   |

 

20

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| ** **                                       | ** ** | **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 |   |

 

The amortized cost andfair value of debt securities by contractual maturity at December 31, 2004are 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**    | ** ** | **FairValue** | ** ** |
|                               |       |                   |       |   |   |
| Due after one to  five years       |       | $                      | 2,704,300  |   | $ | 2,703,500 |   |
| Due after five  to ten years       |       | 2,750,000              |       | 2,754,300 |   |
| GNMA - Mortgage  Backed Securities |       | 1,399,900              |       | 1,377,100 |   |
|                               |       |                   |       |   |   |
|                               |       | $                      | 6,854,200  |   | $ | 6,834,900 |   |

 

21

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** **
| ** **           | ** ** | **Held to Maturity** | ** ** |
|----------------------|------------|----------------------|------------|
| ** **           | ** ** | **Amortized  Cost**  | ** ** | **Fair  Value** | ** ** |
|                 |       |                 |       |   |   |
| Due after ten  years |       | $                    | 6,219,100  |   | $ | 6,299,700 |   |
|                      |            |                      |            |  |  |  |  |

 

Proceeds from maturityand sales of investment securities during 2004 and 2003, respectively, were $8,557,800and $2,974,400.  Realized gains during2004 and 2003, respectively, were $50,600 and $21,300.

 

Asa member of the Federal Home Loan Bank (FHLB) system, the Bank is required tomaintain an investment in FHLB stock in an amount equal to the greater of 1% ofits outstanding mortgage loans or 5% of advances from the FHLB. As of December 31,2004 and 2003, the Bank had advances from the FHLB totaling $19,650,000 and$13,750,000, respectively. No ready market exists for FHLB stock, and it has noquoted market value. FHLB stock is evaluated for impairment based on anestimate of the ultimate recoverability of par value.

 

Information pertaining to securities with grossunrealized losses at December 31, 2004, aggregated by investment categoryand length of time that individual securities have been in a continuous lossposition follows:

 
| ** **                         | ** ** | **Less Than Twelve Months**   | ** ** |
|------------------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Securities Available-for-Sale      |       |                          |       |   |   |
| GNMA - Mortgage  Backed Securities |       | $                             | 22,800     |   | $ | 1,377,100 |   |
|                                    |            |                               |            |  |  |  |  |

 

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 whichthe fair value has been less than cost, (2) the financial condition andnear-term prospects of the issuer, and (3) the intent and ability of theBank to retain its investment in the issuer for a period of time sufficient toallow for any unanticipated recovery in fair value.

 

22

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OnDecember 31, 2004, 1 security has an unrealized loss with aggregatedepreciation of 1.6% from the Bank’s amortized cost basis. The unrealized lossrelates to a mortgage backed security issued by federally sponsored agencies,which are fully secured by conforming residential loans. Since the Bank has theability to hold this security until estimated maturity, no decline is deemed tobe other than temporary.

 

**Note 5.****          SALES AND SERVICING OFSBA LOANS**

 

A summary of the activityof SBA loans follows:

 
| ** **            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**  | ** ** |
|-----------------------|------------|----------|------------|----------|------------|-----------|------------|
|                  |       |     |       |     |       |      |       |
| SBA loans  originated |       | $        | 15,844,000 |     | $          | 8,882,900 |       | $ | 5,916,900 |   |
|                  |       |     |       |     |       |      |       |
| SBA loans sold        |       | $        | 4,669,100  |     | $          | 4,994,100 |       | $ | 4,689,300 |   |

 

A summary of income fromSBA loans sold is as follows:

 
| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |     |       |
| Income from premiums                  |       | $        | 412,400    |     | $          | 440,000  |       | $ | 332,800 |   |
| Income from  servicing                |       | 304,000  |       | 220,600  |       | 193,200  |       |
|                                  |       |     |       |     |       |     |       |
| Total SBA sales  and servicing income |       | $        | 716,400    |     | $          | 660,600  |       | $ | 526,000 |   |

 

23

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**Note 6.****          LOANS AND ALLOWANCE FORLOAN LOSSES**

 

A summary of loanbalances follows:

 
| ** **                             | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|
|                                   |       |       |       |       |       |
| Commercial and  industrial             |       | $          | 19,314,300 |       | $          | 16,869,700 |   |
| Construction                           |       | 7,372,500  |       | 5,379,100  |       |
| Real estate,  mortgage                 |       | 64,339,200 |       | 52,698,400 |       |
| Installment                            |       | 622,000    |       | 523,600    |       |
| Government  guaranteed loans purchased |       | 51,400     |       | 57,600     |       |
|                                   |       | 91,699,400 |       | 75,528,400 |       |
| Allowance for  loan losses             |       | (963,000   | )          | (774,800   | )          |
| Deferred  origination fees, net        |       | (240,100   | )          | (193,000   | )          |
|                                   |       |       |       |       |       |
| Loans, net                             |       | $          | 90,496,300 |       | $          | 74,560,600 |   |

 

An analysis of theallowance for loan losses follows:

 
| ** **                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |     |       |
| Beginning  balance         |       | $        | 774,800    |     | $          | 636,900  |       | $ | 566,300 |   |
| Recoveries                 |       | 3,200    |       | 1,300    |       | 13,300   |       |
| Loans charged  off         |       | —   |       | (18,400  | )          | (59,700  | )          |
| Provision for  loan losses |       | 185,000  |       | 155,000  |       | 117,000  |       |
|                       |       |     |       |     |       |     |       |
| Ending balance             |       | $        | 963,000    |     | $          | 774,800  |       | $ | 636,900 |   |

 

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As of December 31, 2004 and 2003 the recordedinvestment in impaired loans totaled $42,600 and $927,200 with corresponding valuationallowances of $19,900 and $88,300, respectively.  No additional amounts are committed to beadvanced in connection with impaired loans.

 

During the years ended December 31, 2004, 2003,and 2002 the average recorded investment in impaired loans amounted toapproximately $617,100, $705,000, and $1,218,500, respectively.  Non-accrual loans totaled $42,600 and $39,400at December 31, 2004 and 2003, respectively.  If interest on non-accrual loans had beenaccrued, such income would have approximated $8,200, $3,100, and $3,000 for 2004,2003, and 2002, respectively.

 

As of December 31,2004 and 2003, there were no loans past due ninety days or more and stillaccruing interest.

 

## **Note 7.**          BANKING PREMISES ANDEQUIPMENT

## ** **

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

 
| ** **                | ** ** | **2004**   | ** ** | **2003**   | ** ** | **Useful Lives** | ** ** |
|---------------------------|------------|------------|------------|------------|------------|------------------|------------|
|                      |       |       |       |       |       |             |       |
| Land                      |       | $          | 711,725    |       | $          | 711,725          |       |   |   |
| Building                  |       | 203,675    |       | 203,675    |       | 40 years         |       |
| Building  improvements    |       | 466,100    |       | 446,200    |       | 40 years         |       |
| Leasehold  improvements   |       | 826,700    |       | 803,500    |       | Lease term       |       |
| Furniture and  equipment  |       | 1,594,700  |       | 1,653,100  |       | 3-8 years        |       |
|                      |       | 3,802,900  |       | 3,818,200  |       |             |       |
| Accumulated  depreciation |       | (1,585,300 | )          | (1,620,500 | )          |             |       |
|                      |       |       |       |       |       |             |       |
|                      |       | $          | 2,217,600  |       | $          | 2,197,700        |       |   |   |

 

Depreciation expense of$202,600, $166,800, and $120,700 was included****inoccupancy and equipment expense for the years ended December 31, 2004,2003, and 2002, respectively.

 

25

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## **Note 8.**          DEPOSITS

 

At December 31, 2004, the scheduled maturities oftime deposits are as follows:

 
| 2005       |   | $          | 26,827,600 |   |
|------------|--------|------------|------------|--------|
| 2006       |   | 13,076,300 |       |
| 2007       |   | 8,903,600  |       |
| 2008       |   | 582,400    |       |
| 2009       |   | 1,103,100  |       |
| Thereafter |   | 349,500    |       |
|       |   |       |       |
|       |   | $          | 50,842,500 |   |

 

#### **Note 9.**          JUNIOR SUBORDINATED DEBTSECURITIES

 

On March 27, 2003, theCompany’s wholly owned special-purpose trust subsidiary, Northern CaliforniaBancorp, Inc. Trust I (the “Trust”) issued $3 million in cumulative TrustPreferred Securities.  The securitiesbear a floating rate of interest of 3.25% over the three month LIBOR rate,payable quarterly.  Concurrent with theissuance of the Trust Preferred Securities, the Trust used the proceeds fromthe Trust Preferred Securities offering to purchase a like amount of JuniorSubordinated Debentures of the Company. The Company will pay interest on theJunior Subordinated Debentures to the Trust, which represents the sole revenueand sole 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 Preferred Securitieswill mature on April 7, 2033, but can be redeemed under certaincircumstances at a premium prior to April 7, 2008, and can be redeemed, inwhole or in part, on any January 7, April 7, July 7 or October 7on or after April 7, 2008 at par. The Company fully and unconditionally guarantees the obligations of theTrust, on a subordinated basis.

 

26

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#### **The Company received $2.91 millionfrom the Trust upon issuance of the Junior Subordinated Debentures, of which $1million was contributed by the Company to the Bank to increase its capital,$1.14 million was used to retire existing Company debt and the remainder heldas working capital.  Under applicableregulatory guidelines, a portion of the Trust Preferred Securities will qualifyas Tier I Capital, and the remainder as Tier II Capital.**

 

On November 13, 2003, the Company’s wholly ownedspecial-purpose trust subsidiary, Northern California Bancorp, Inc. TrustII (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. 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 Preferred Securitieswill mature on November 8, 2033, but can be redeemed under certaincircumstances at a premium prior to November 8, 2008, and can be redeemed,in whole or in part, on any February 8, May 8, August 8 or November 8on or after November 8, 2008 at par. The Company fully and unconditionally guarantees the obligations of theTrust, on a subordinated basis.

 

The Company received $4.96million from the Trust upon issuance of the Junior Subordinated Debentures, ofwhich $2.5 million was contributed by the Company to the Bank to increase itscapital and the remainder held as working capital.

 

Issuance costs of $115,800related to the March 27, 2003 Trust Preferred Securities issuance and$54,000 related to the November 13, 2003 issuance have been deferred andwill be amortized over the 30-year life of the securities.

 

During the years ended December 31,2004 and 2003 interest expense on Junior Subordinated Debentures totaled $372,500and $130,900, respectively.  The amortization of the issuance cost totaled$5,700 and $3,000 during the years ended December 31, 2004 and 2003,respectively.

 

27

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#### **Note10.**   FUNDING SOURCES

#### ** **

The Bank has lines of credit from the Federal HomeLoan Bank of San Francisco and Pacific Coast Bankers’ Bank with availableborrowing capacity on December 31, 2004 of $2,339,300 and $4,500,000,respectively.  The Federal Home Loan Bankline of credit has a maximum borrowing capacity of twenty five percent (25%) ofthe Bank’s total assets, adjusted quarterly. The Federal Home Loan Bank line of credit is secured by certain of theBank’s real estate secured loans and securities at December 31, 2004 thetotal principal balances of pledged loans was $28,545,200 and securities of$5,327,800.  The following table providesinformation on nine (9) advances totaling $19,650,000 outstanding at December 31,2004.

 
| **Advance  Amount** | ** ** | **Fixed  Interest  Rate** | ** ** | **Funding  Date** | ** ** | **Maturity  Date** | ** ** |
|---------------------|------------|---------------------------|------------|-------------------|------------|--------------------|------------|
| 1,000,000           |       | 6.86                      | %          | 8/10/00           |       | 8/10/05            |       |
| 3,900,000           |       | 2.83                      | %          | 10/29/02          |       | 10/31/05           |       |
| 1,000,000           |       | 2.54                      | %          | 2/4/03            |       | 2/6/06             |       |
| 1,000,000           |       | 1.77                      | %          | 3/9/04            |       | 3/9/06             |       |
| 2,750,000           |       | 3.44                      | %          | 9/27/02           |       | 9/27/07            |       |
| 1,000,000           |       | 7.72                      | %          | 6/1/00            |       | 6/3/30             |       |
| 4,000,000           |       | 5.96                      | %          | 8/2/04            |       | 7/28/34            |       |
| 5,000,000           |       | 5.63                      | %          | 12/24/04          |       | 12/22/34           |       |

 

The Pacific Coast Bankers’ Bank line of credit isunsecured.  The Bank did not utilize anyovernight borrowings in 2004, 2003 or 2002.

 

The Bank has a $105,000letter of credit issued by the Federal Home Loan Bank of San Francisco tosecure the uninsured portion of local agency deposits maintained with theBank.  The letter of credit matures April 17,2006.

 

28

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

#### ** **

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

 
| ** **                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current tax  provision:            |       |     |       |     |       |     |       |
| Federal                            |       | $        | 619,800    |     | $          | 410,800  |       | $ | 244,800 |   |
| California                         |       | 236,700  |       | 142,800  |       | 90,300   |       |
|                               |       |     |       |     |       |     |       |
|                               |       | 856,500  |       | 553,600  |       | 335,100  |       |
|                               |       |     |       |     |       |     |       |
| Deferred tax  provision (benefit): |       |     |       |     |       |     |       |
| Federal                            |       | (146,700 | )          | 61,900   |       | (18,600  | )          |
| California                         |       | (36,200  | )          | (8,600   | )          | (8,900   | )          |
| Increase in  valuation allowance   |       | 107,000  |       | 51,600   |       | 46,400   |       |
|                               |       |     |       |     |       |     |       |
|                               |       | (75,900  | )          | 104,900  |       | 18,900   |       |
|                               |       |     |       |     |       |     |       |
|                               |       | $        | 780,600    |     | $          | 658,500  |       | $ | 354,000 |   |

 

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

 
| ** **                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |     |       |
| Statutory  federal tax rate                   |       | 34.00    | %          | 34.00    | %          | 34.00    | %          |
| California  taxes, net of federal tax benefit |       | 7.20     |       | 7.20     |       | 7.20     |       |
| Other, net                                    |       | 1.10     |       | 2.74     |       | (0.16    | )          |
|                                          |       |     |       |     |       |     |       |
| Effective tax  rates                          |       | 42.30    | %          | 43.94    | %          | 41.04    | %          |

 

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

 

29

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

 
| ** **                | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Deferred tax  asset       |       |     |       |     |       |
| Federal                   |       | $        | 480,100    |     | $          | 363,200 |   |
| California                |       | 131,200  |       | 105,100  |       |
|                      |       |     |       |     |       |
| Total deferred  tax asset |       | 611,300  |       | 468,300  |       |
| Valuation  allowance      |       | (335,000 | )          | (228,000 | )          |
|                      |       |     |       |     |       |
| Net deferred tax  asset   |       | $        | 276,300    |     | $          | 240,300 |   |

 

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

follows:

 
| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets (liabilities)          |       |     |       |     |       |
| Net unrealized  gain and loss on securities |       | $        | (70,400    | )        | $          | (30,500 | ) |
| California  franchise tax                   |       | 121,800  |       | 73,500   |       |
| Allowance for  loan losses                  |       | 391,000  |       | 299,700  |       |
| Accrued salary  continuation liability      |       | 281,400  |       | 228,000  |       |
| Depreciation                                |       | (112,500 | )          | (102,400 | )          |
|                                        |       |     |       |     |       |
| Total deferred  tax asset                   |       | 611,300  |       | 468,300  |       |
| Valuation  allowance                        |       | (335,000 | )          | (228,000 | )          |
|                                        |       |     |       |     |       |
| Net deferred tax  asset                     |       | $        | 276,300    |     | $          | 240,300 |   |

 

TheBank establishes a valuation allowance if, based on the weight of evidence, itis more likely than not that some portion or all of the deferred tax assetswill not be realized.

 

30

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#### **Note 12.**   COMMITMENTS AND CONTINGENCIES

#### ** **

In the normal course ofbusiness, there are outstanding commitments and contingencies that are not reflectedin the consolidated financial statements.

 

***Operatinglease commitments***

 

The Bank leases itsbranch offices in Carmel By-The-Sea, Carmel Valley, and Pacific Grove.  The Carmel By-The-Sea office has a five andone half year lease with four, five year options and commenced in April 2002.  The Carmel building has a twenty-five yearlease which commenced in March 1981 and may be adjusted annually forchanges in the Consumer Price Index.  ThePacific Grove building has a five-year lease with five, five-year options andcommenced in April 1997.  The Bankleases approximately 1,000 square feet at 321 Webster Street, Monterey,CA.  The 321 Webster Street lease has aterm of three years commencing September 2000, with a three-yearoption.  The Bank also leasesapproximately 1500 square feet for a Loan Production Office at 301 WebsterStreet, Monterey, CA.  The Webster Streetlease has a term of two years two months commencing July 2004, with afive-year option.   The Bank also leases certain equipment used inthe normal course of business.

 

Rent expense foroperating leases is included in occupancy and equipment expense and amounted toapproximately $275,200, $270,800, and $170,400 in 2004, 2003, and 2002,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 2004, 2003 and 2002 wasapproximately $37,400, $39,300, and $36,700, 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 ending2004 and 2003 was approximately $37,200 and $39,300; no sublease rental incomewas collected in 2002.

 

31

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#### **Future minimum rental commitmentsfor all non-cancelable operating leases are as follows:**

 
| **Year Ending  December 31** | ** ** | **Minimum Lease  Commitments** | ** ** | **Sublease  Income** | ** ** | **Net Lease  Commitments** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|----------------------|------------|----------------------------|------------|
| 2005                              |       | $275,600                       |       | $47,100              |       | $228,500                   |       |
| 2006                              |       | 170,500                        |       | 38,300               |       | 132,200                    |       |
| 2007                              |       | 74,100                         |       | 28,800               |       | 45,300                     |       |
|                              |       |                           |       |                 |       |                       |       |
|                              |       | $520,200                       |       | $114,200             |       | $406,000                   |       |

 

***Loancommitments***

 

The Bank is a party tofinancial instruments with off-balance-sheet risk in the normal course of businessto meet the financing needs of its customers. These financial instruments include commitments to extend credit.  Such commitments involve, to varying degrees,elements of credit and interest rate risk in excess of the amount recognized inthe 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, 2004 and 2003, such commitmentsto extend credit were approximately $23,971,400 and $12,413,700, respectively,of undisbursed lines of credit, undisbursed loans in process, and commitmentletters.

 

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

#### ** **

TheBank grants commercial, real estate and installment loans to businesses andindividuals primarily in the Monterey Peninsula area of NorthernCalifornia.  Most loans are secured by business assets, andcommercial and residential real estate. Real estate and construction loans heldfor investment represented 74% of total loans held for investment at December 31,2004 and 2003.  The Bank has noconcentration of loans with any one customer. The Bank does have concentrations of loans in the real estate andaccommodation and food services industries. Loans held for investment in the real estate industry represented 31% oftotal loans held for investment at December 31, 2004 and 2003.  Loans held for investment in theaccommodation and food services industry represented 24% and 29% of total loansheld for investment at December 31, 2004 and 2003, respectively.

 

32

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#### **Note 14.**   OTHER INCOME AND OTHER GENERALAND ADMINISTRATIVE EXPENSES

#### ** **

Other income for theyears ended December 31, 2004, 2003, and 2002 totaled $988,900, $1,237,000,and $746,900, respectively.  Significantcategories comprising other income in the years ending December 31, 2004,2003, and 2002 were net merchant discount fees of $338,400, $376,400, and $327,700,commercial banking broker fees of $274,000, $539,400, and $191,500, lifeinsurance cash surrender value earnings of $65,200, $89,700, and $122,200, andcredit card marketing program income of $120,000, $49,100 and $10,100.

 

Other general andadministrative expenses for the years ended December 31, 2004, 2003, and2002 totaled $1,033,000, $876,100, and $732,600, respectively.

 

Significant categoriescomprising other general and administrative expenses in the years ending December 31,2004, 2003, and 2002 were advertising of $127,300, $113,500, and $100,200, andinsurance of  $106,400, $84,100, and$50,200.

 

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

#### ** **

***Minimumregulatory 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 capitalamounts and classifications are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.  Underapplicable regulatory guidelines, a portion of the Trust Preferred Securitiesqualify as Tier I Capital, and the remainder as Tier II Capital.   Prompt corrective action provisions are notapplicable to bank holding companies.

 

33

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#### ** **

Quantitative measures established by regulation toensure capital adequacy require the Corporation and the Bank to maintainminimum amounts and ratios (set forth in the following table) of total and Tier1 capital (as defined in the regulations) to risk-weighted assets (as defined)and of Tier 1 capital (as defined) to average assets (as defined).  Management believes, as of December 31,2004 and 2003, that the Corporation and the Bank met all capital adequacyrequirements to which they are subject.

 

As of December 31, 2004, the most recentnotification from the Federal Deposit Insurance Corporation categorized theBank as well capitalized under the regulatory framework for prompt correctiveaction Provisions.  To be categorized aswell capitalized, an institution must maintain minimum total risk-based, Tier 1risk-based, and Tier 1 leverage ratios as set forth in the followingtables.  There are no conditions orevents since the notification that management believes have changed the Bank’scategory.  The Corporation’s and the Bank’sactual capital amounts and ratios as of December 31, 2004 and 2003 arealso presented in the tables.

 

**December 31, 2004**

 
| ** **                               | ** ** | **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                             |       | $                              | 15,914     |                              | 15.3       | %                                                                                | $          | 8,204 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey County  Bank                    |       | 13,189                         |       | 12.5                              | %          | 8,492                                                                            |       | 8.0 | % | $ | 10,615 |   | 10.0 | % |
|                                     |       |                           |       |                              |       |                                                                             |       |   |   |   |   |   |   |
| Tier 1 Capital  to Risk Weighted Assets: |       |                           |       |                              |       |                                                                             |       |   |   |   |   |   |   |
| Consolidated                             |       | 8,781                          |       | 8.6                               | %          | 4,102                                                                            |       | 4.0 | % | N/A |   | N/A |   |
| Monterey County  Bank                    |       | 12,226                         |       | 11.5                              | %          | 4,246                                                                            |       | 4.0 | % | 6,369 |   | 6.0 | % |
|                                     |       |                           |       |                              |       |                                                                             |       |   |   |   |   |   |   |
| Tier 1 Capital  to Average Assets:       |       |                           |       |                              |       |                                                                             |       |   |   |   |   |   |   |
| Consolidated                             |       | 8,781                          |       | 7.3                               | %          | 4,840                                                                            |       | 4.0 | % | N/A |   | N/A |   |
| Monterey County  Bank                    |       | 12,226                         |       | 9.7                               | %          | 5,068                                                                            |       | 4.0 | % | 6,334 |   | 5.0 | % |
|                                          |            |                                |            |                                   |            |                                                                                  |            |  |  |  |  |  |  |  |  |  |

 

34

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

 

35

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#### **Note 16.**   STOCK OPTIONS AND STOCKDIVIDENDS

#### ** **

At December 31, 2004,options for the purchase of 318,717 shares of the Corporation’s common stockwere outstanding and exercisable at prices ranging from $1.71-$4.40.  The status of all optioned shares is asfollows:

 
| ** **                             | ** ** | **Shares** | ** ** | **Exercise 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                                         |       |
|                                   |       |       |       |                     |       |                                              |       |
| Granted                                |       | 138,500    |       | $4.00 - $4.40            |       |                                              |       |
| Exercised                              |       | (41,361    | )          | $1.55 - $2.48            |       |                                              |       |
|                                   |       |       |       |                     |       |                                              |       |
| Outstanding at December 31,  2004 |       | 318,717    |       | $2.75 - $4.40            |       | 5.1 Years                                         |       |

 

36

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The weighted averageexercise price was $2.15, $1.84, and $1.88 for the years ending December 31,2004, 2003, and 2002 respectively.  Theweighted average fair value of options granted during the years ending December 31,2004, 2003, and 2002 were $2.89, $2.40, and $2.45, respectively.  All but 40,000 of the options are exercisableas of December 31, 2004.

 

#### **Note 17.**   RELATED PARTY TRANSACTIONS

#### ** **

The Corporation has, and expects to have in thefuture, banking transactions in the ordinary course of its business withdirectors, officers, principal shareholders, and their associates.  These transactions, including loans anddeposits, are granted on substantially the same terms, including interest ratesand collateral on loans, as those prevailing at the same time for comparabletransactions with others and do not involve more than the normal risk ofcollectibility or present other unfavorable features.

 

Aggregate loan transactions with related parties areapproximately as follows:

 

| 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 |      |
| Loan  reclassified to non-related     |   | (250,000  | )         |
| Repayments                            |   | (76,900   | )         |
|                                  |   |      |      |
| Balance as of  December 31, 2004 |   | $         | 1,207,900 |   |

 

Related party depositstotaled approximately $189,300 and $265,700 at December 31, 2004 and 2003,respectively.

 

#### **Note 18.**   EMPLOYEE BENEFIT PLANS

#### ** **

During 1995, the Corporationestablished an employee stock ownership plan (ESOP) to invest in theCorporation’s common stock for the benefit of eligible employees.  The Board of Directors determines theCorporation’s contribution to the plan. Shares in the plan generally vest after seven years.  The Corporation did not contribute to theESOP trust in 2004, 2003, or 2002.  Therewere no shares in the plan as of December 31, 2004.

 

37

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#### ** **

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 2004, 2003,and 2002 totaled $87,200, $71,800, and $65,800, respectively.

 

#### **Note 19.**   REGULATORY MATTERS

#### ** **

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 certain regulationsof the Federal Reserve Bank dealing primarily with check clearing activities,establishment of banking reserves, Truth-in-Lending (Regulation Z), and EqualCredit Opportunity (Regulation B).

 

#### **Note 20.**   RESTRICTION ON DIVIDENDS, LOANSAND ADVANCES

#### ** **

Federal and state bankingregulations place certain restrictions on dividends paid and loans or advancesmade by the Bank to the Corporation.  Thetotal amount of dividends which may be paid at any date is generally limited tothe 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% of the Bank’sprimary capital plus the allowance for loan losses on a secured basis and 15%on an unsecured basis.

 

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#### **Note 21.**   SALARY CONTINUATION 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, 2004 and 2003,respectively, is $627,600 and $508,500 of deferred compensation related to thecontinuation plans.  The plans are fundedthrough life insurance policies that generate value to fund the futurebenefits.

 

#### **Note 22.**   FAIR VALUE OF FINANCIALINSTRUMENTS

#### ** **

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

 

The Corporation in estimating fair value disclosuresfor financial instruments used the following methods 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-rate loansis estimated by discounting future cash flows using the Corporation’s currentoffering rate for loans with similar characteristics.  The fair value of performing adjustable-rateloans is considered the same as book value. The fair value of non-performing loans is estimated at the fair value ofthe related collateral or, when in management’s opinion foreclosure upon thecollateral is unlikely, by discounting future cash flows using rates which takeinto account management’s estimate of credit risk.

 

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**Commitmentsto Extend Credit and Standby Letters of Credit:** TheCorporation does not generally enter into long-term fixed rate commitments orletters of credit.  These commitments aregenerally priced at current prevailing rates. These rates are generally variable and, therefore, there is no interestrate exposure.  Accordingly, the fairmarket value of these instruments is equal to the carrying value amount oftheir net deferred fees.  The netdeferred fees associated with these instruments are not material.  The Corporation has no unusual credit riskassociated with these instruments.

 

**Depositliabilities:** The fair values disclosed for demanddeposits (e.g., interest and non-interest checking, savings, and certain typesof money market accounts) are, by definition, equal to the amount payable ondemand at the reporting date (i.e., their carrying amounts).  Fair values for fixed-rate certificates ofdeposit are estimated using a discounted cash flow calculation that appliesinterest rates currently being offered on certificates to a schedule ofaggregated expected monthly maturities on time deposits.

 

**Accruedinterest:** The carrying amounts of accrued interestapproximate fair value.

 

**CashSurrender Value of Life Insurance:**The carrying amount oflife insurance approximate fair value.

 

**Short-termborrowing:** The carrying amounts of federal fundspurchased, borrowings under repurchase agreements, and other short-termborrowings maturing within ninety days approximate their fair values.  Fair values of other borrowings are estimatedusing discounted cash flow analyses based on the Corporation’s currentincremental borrowing rates for similar types of borrowing arrangements.

 

**Long-termborrowing:**  Thefair values of the Corporation’s long-term borrowings are estimated usingdiscounted cash flow analyses based on the Corporation’s current incremental borrowingrates for similar types of borrowing arrangements

 

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The estimated fairvalues, and related carrying amounts, of the Corporation’s financial instrumentsas of December 31, 2004 and 2003 are as follows:

 
| ** **                      | ** ** | **2004**             | ** ** | **2003**        | ** ** |
|---------------------------------|------------|----------------------|------------|-----------------|------------|
| ** **                      | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| Financial  Assets:              |       |                 |       |            |       |   |   |   |   |
| Cash and cash  equivalents      |       | $                    | 16,809,000 |            | $          | 16,809,000 |   | $ | 17,193,100 |   | $ | 17,193,100 |   |
| Trading assets                  |       | 803,700              |       | 803,700         |       | 163,300 |   | 163,300 |   |
| Securities,  available for sale |       | 6,834,900            |       | 6,834,900       |       | 6,075,500 |   | 6,075,500 |   |
| Securities, held  to maturity   |       | 6,219,100            |       | 6,299,700       |       | — |   | — |   |
| Other  investments              |       | 1,813,500            |       | 1,813,500       |       | 1,667,500 |   | 1,667,500 |   |
| Loans, held for  sale           |       | 4,539,500            |       | 4,539,500       |       | 2,347,800 |   | 2,347,800 |   |
| Loans, net                      |       | 90,496,300           |       | 90,456,100      |       | 74,560,600 |   | 75,907,900 |   |
| Accrued interest  receivable    |       | 565,100              |       | 565,100         |       | 392,100 |   | 392,100 |   |
|                            |       |                 |       |            |       |   |   |   |   |
| Financial  Liabilities:         |       |                 |       |            |       |   |   |   |   |
| Deposits                        |       | 97,263,200           |       | 97,268,800      |       | 78,132,400 |   | 78,374,300 |   |
| Long-term debt                  |       | 27,898,000           |       | 27,904,800      |       | 21,998,000 |   | 22,024,800 |   |
| Accrued interest  payable       |       | 380,800              |       | 380,800         |       | 357,000 |   | 357,000 |   |
|                                 |            |                      |            |                 |            |  |  |  |  |  |  |  |  |

 

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#### **Note 23.**   NORTHERN CALIFORNIA BANCORP,INC. (PARENT CORPORATION ONLY)

#### ** **

The following are thefinancial statements of Northern California Bancorp, Inc. (ParentCorporation only) as of December 31, 2004 and 2003:

 
| **Balance Sheets**                                  | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|
| Assets                                              |       |       |       |       |       |
| Cash and due  from banks                            |       | $          | 1,657,800  |       | $          | 2,628,300 |   |
| Investment  securities - trading account            |       | 803,700    |       | 163,300    |       |
| Investment in  Mission Valley Bank Stock            |       | —     |       | 25,000     |       |
| Investment in AT  Services LLC Acquisition Corp.    |       | 202,000    |       | 202,000    |       |
| Northern California  Bancorp, Inc. Trust I     |       | 93,000     |       | 93,000     |       |
| Northern  California Bancorp, Inc. Trust II    |       | 155,000    |       | 155,000    |       |
| Deferred tax  asset                                 |       | —     |       | 14,800     |       |
| Debt issue  costs, net                              |       | 161,200    |       | 166,700    |       |
| Accounts  receivable                                |       | 2,300      |       | —     |       |
| Investment in  common stock of Monterey County Bank |       | 12,595,800 |       | 11,284,100 |       |
|                                                |       |       |       |       |       |
|                                                |       | $          | 15,670,800 |       | $          | 14,732,200 |   |
|                                                |       |       |       |       |       |
| Liabilities and  Shareholders’ Equity          |       |       |       |       |       |
| Accounts payable  and accrued expenses              |       | $          | 77,500     |       | $          | 58,900 |   |
| Dividend payable                                    |       | 15,000     |       | 14,800     |       |
| Deferred tax  liability                             |       | 9,200      |       | —     |       |
| Junior  subordinated debt securities                |       | 8,248,000  |       | 8,248,000  |       |
| Total  liabilities                                  |       | 8,349,700  |       | 8,321,700  |       |
| Shareholders’  equity                          |       | 7,321,100  |       | 6,410,500  |       |
|                                                |       |       |       |       |       |
|                                                |       | $          | 15,670,800 |       | $          | 14,732,200 |   |

 

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| **Statements of Operations**            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |     |       |
| Equity in income  of subsidiary         |       | $        | 1,290,100  |     | $          | 917,600  |       | $ | 629,100 |   |
| Investment  income from AT Services LLC |       | —   |       | 14,300   |       | 24,200   |       |
| Gain on sale of  securities             |       | 27,400   |       | 36,200   |       | 5,400    |       |
| Gain (loss) on  trading asset           |       | 25,900   |       | 49,700   |       | (173,800 | )          |
| Dividend income                         |       | 13,200   |       | 9,100    |       | 5,500    |       |
| Miscellaneous  income                   |       | 100      |       | 100      |       | —   |       |
| Operating  expenses                     |       | (421,200 | )          | (176,000 | )          | (85,600  | )          |
| Applicable tax  benefit (provision)     |       | 129,700  |       | (11,200  | )          | 103,800  |       |
|                                    |       |     |       |     |       |     |       |
| Net income                              |       | $        | 1,065,200  |     | $          | 839,800  |       | $ | 508,600 |   |

 

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| **Statements of Cash Flows**                                                   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**  | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|-----------|------------|
|                                                                           |       |       |       |       |       |      |       |
| Cash flows from  operating activities:                                         |       |       |       |       |       |      |       |
| Net income                                                                     |       | $          | 1,065,200  |       | $          | 839,800   |       | $ | 508,600 |   |
| Adjustments to  reconcile net income to net cash used by operating activities: |       |       |       |       |       |      |       |
| Equity in  undistributed income of Monterey County Bank                        |       | (1,290,100 | )          | (917,600   | )          | (629,100  | )          |
| (Increase)  decrease in trading securities                                     |       | (640,400   | )          | (81,100    | )          | 90,800    |       |
| (Increase)  decrease in other assets                                           |       | 18,000     |       | (74,500    | )          | 12,700    |       |
| Increase  (decrease) in accrued expenses                                       |       | 18,700     |       | 55,300     |       | (1,300    | )          |
| Increase  (decrease) in other liabilities                                      |       | 9,400      |       | 13,800     |       | (300      | )          |
|                                                                           |       |       |       |       |       |      |       |
| Net cash used by  operating activities                                         |       | (819,200   | )          | (164,300   | )          | (18,600   | )          |
|                                                                           |       |       |       |       |       |      |       |
| Cash flows from  investing activities:                                         |       |       |       |       |       |      |       |
| Cash dividends  received from subsidiary                                       |       | —     |       | 50,000     |       | 75,000    |       |
| (Increase)  decrease in investments                                            |       | 25,000     |       | (4,245,800 | )          | (54,200   | )          |
|                                                                           |       |       |       |       |       |      |       |
| Net cash  provided (used) by investing activities                              |       | 25,000     |       | (4,195,800 | )          | 20,800    |       |
|                                                                           |       |       |       |       |       |      |       |
| Cash flows from  financing activities:                                         |       |       |       |       |       |      |       |
| Proceeds from  borrowings                                                      |       | —     |       | 8,248,000  |       | —    |       |
| Repayments on  borrowings                                                      |       | —     |       | (1,172,200 | )          | (27,800   | )          |
| Cash dividends  paid on common stock                                           |       | (265,300   | )          | (235,000   | )          | (500      | )          |
| Exercise of  stock options                                                     |       | 89,000     |       | 152,000    |       | 55,200    |       |
| Stock repurchase                                                               |       | —     |       | (21,500    | )          | (20,600   | )          |
|                                                                           |       |       |       |       |       |      |       |
| Net cash  provided (used) by financing activities                              |       | (176,300   | )          | 6,971,300  |       | 6,300     |       |
|                                                                           |       |       |       |       |       |      |       |
| Net increase  (decrease) in cash and cash equivalents                          |       | (970,500   | )          | 2,611,200  |       | 8,500     |       |
|                                                                           |       |       |       |       |       |      |       |
| Cash and cash  equivalents, beginning of year                                  |       | 2,628,300  |       | 17,100     |       | 8,600     |       |
|                                                                           |       |       |       |       |       |      |       |
| Cash and cash  equivalents, end of year                                        |       | $          | 1,657,800  |       | $          | 2,628,300 |       | $ | 17,100 |   |

 

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