** **

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

**Washington D.C.  20549**

 

**FORM 10-KSB**

 

| **ý**                          | **Annual report under Section 13 or 15(d) of the Securities  Exchange Act of 1934**                                                                                                                                                                                                                    |
|-------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                                                                                                                                                                                                   |
|                                | **(Fee  required)****for fiscal year  ended December 31, 2002**                                                                                                                                                                                                                                        |
|                                |                                                                                                                                                                                                                                                                                                   |
| **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 SmallBusiness Issuer in its Charter)

 

| Incorporated in  the State of **California**                    |
|-----------------------------------------------------------------|
| IRS Employer  Identification Number **77-0421107**              |
| Address:  **601  Munras Avenue, Monterey, CA  93940** |
| Telephone: **(831) 649-4600**                                   |
|                                                            |   |   |
| Securities  registered under Section 12(b) of the Exchange Act: | **None** |
| Securities  registered under Section 12(g) of the Exchange Act: | **Common  Stock** |

 

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

 

Check if there is no disclosure of delinquent filersin response to Item 405 of Regulation S-B is not contained in this form, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-KSB or any amendment to this Form 10-KSB  ý

 

Revenues for the year ended December 31, 2002.  $6,680,900.

 

As of March 1, 2003, the Corporation had 1,493,816shares of common stock out-standing. The aggregate market value of voting stock held by non-affiliates of theCorporation was $2,345,900, based on the most recent sale at $3.00 per share onOctober 21, 2002.

 

The following documents are incorporated by referenceto the parts indicated of this Form 10-KSB:

 

1.Portionsof the Independent Auditor’s Report for the fiscal year ended December 31, 2002are incorporated by reference in Part II Item 7.

 

 

----

 

FORM 10-KSB CROSSREFERENCE 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, 2002 and 2001                                                                          |
|         | Consolidated  Statements of Operations for each of the three years in the period ended  December 31, 2002                           |
|         | Consolidated  Statements of Changes in Stockholders’ Equity for each of the three years in  the period ended December 31, 2002 |
|         | Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2002                           |
|         | Notes to  Consolidated Financial Statements                                                                                         |
| ITEM  8      | Changes  in and Disagreements with Accountants and Financial Disclosure                                                             |
|         |                                                                                                                                |
| **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                                                                                                                |
|         | Signatures                                                                                                                          |
|         | Certifications                                                                                                                      |

 

 

----

 

**PARTI**

 

**ITEM 1.BUSINESS**

 

**GENERAL**

 

Northern California Bancorp, Inc. (the “Corporation”)was incorporated on August 29, 1995, as a for-profit corporation under theCalifornia Corporate laws for the principal purpose of engaging in banking andnon-banking activities as allowed for a bank holding company.  The Corporation owns 100% of Monterey CountyBank (the “Bank”).  The Corporation’ssources of revenues at this time are dividends on investments, gains on securitiestransactions and potential dividends, management fees and tax equalization payments,if any, from the Bank.

 

Compliance with environmental laws has not had amaterial impact on the operations of the Bank or the Corporation, although theBank faces potential liability or losses if its borrowers fail to comply withsuch laws and the Bank acquires contaminated properties in foreclosure.

 

**BANK SUBSIDIARY**

 

Monterey County Bank, an independent, Californiachartered commercial banking corporation was chartered by the State ofCalifornia on July 30, 1976.  The Bank’scustomer base includes individuals, small and medium sized businesses and avariety of government agencies with residences, offices or other relationshipslocated in or about the city and county of Monterey, California, including thecities of Carmel and Pacific Grove.  TheBank offers its customers a wide variety of the normal personal, consumer andcommercial services expected of a locally owned, independently operatedbank.  The Bank’s deposits are insuredby the FDIC, and, as such, the Bank is subject to regulations by that federalagency and to periodic audits of its operations and documentary compliance byFDIC personnel.  As a state charteredbank, which is not a member of the Federal Reserve System, it is also regulatedand periodically examined by the California State Department of FinancialInstitutions.

 

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

 

At December 31, 2002 the Bank had total assets,deposits and shareholders’ equity of approximately $85,860,800, $67,632,500 and$6,380,100, respectively.

 

**EMPLOYEES**

 

At December 31, 2002 the Northern California Bancorp,Inc. and its subsidiary Monterey County Bank employed a total of 45 full timeequivalent persons.

 

3

----

 

**COMPETITION**

 

All phases of the Bank’s business have been, sinceinception, and will continue to be subject to significant competitiveforces.  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 andlending limits substantially larger than the Bank, as well as wider geographicmarkets, more support services and larger media advertising capabilities.  The Bank will also compete with respect toits lending activities, as well as in attracting demand deposits, with savingsbanks, savings and loan associations, insurance companies, regulated small loancompanies and credit unions, as well as securities brokerage offices which canissue commercial paper and other securities (such as shares in money marketfunds).

 

Among the advantages such institutions have over theBank are their ability to finance wide ranging advertising campaigns and toallocate their investment assets to regions of highest yields and demand.  Many institutions offer certain services,such as trust services and international banking, which the Bank does notcurrently offer or plan to offer.  By virtueof their greater total capital, such institutions have substantially higherlending limits than the Bank (legal lending limits to an individual customerbeing limited to a percentage of a bank’s total capital accounts).  These competitors may intensify theiradvertising and marketing activities to counter any efforts by the Bank tofurther attract new business as a commercial bank.  In addition, as a result of legislation enacted earlier in thedecade, there is increased competition between banks, savings and loanassociations and credit unions for the deposit and loan business ofindividuals.  These activities mayhinder the Bank’s ability to capture a significant market share.

 

To compete with the financial institutions in itsprimary service area, the Bank intends to use the flexibility, which itsindependent status will permit.  Itsactivities in this regard include an ability and intention to respond quicklyto changes in the interest rates paid on time and savings deposits and chargedon loans, and to charges imposed on depository accounts, so as to remaincompetitive in the market place.  Italso will continue to emphasize specialized services for the small businessperson and professional, and personal contacts by the Bank’s officers,directors and employees.  If there arecustomers whose loan demands exceed the Bank’s lending limits, the Bank has theability to arrange for such loans on a participation basis with other financialinstitutions.  No assurance can begiven, however, that the Bank’s efforts to compete with other financial institutionsin its primary service area will be successful.

 

The Bank provides a range of competitive retail andcommercial banking services.  Thedeposit services offered include various types of personal and businesschecking accounts, savings accounts, money market investment accounts, certificatesof deposit, and retirement accounts. Lending services include consumer loans, various type of mortgage loansfor residential and commercial real estate, personal lines of credit, homeequity loans, real estate construction, accounts receivable financing,commercial loans to small and medium size businesses and professionals.  The Bank also provides drive-throughfacilities, at its Monterey and Carmel offices, and night depository facilitiesfor customer convenience.  The Bankoffers

 

4

----

 

safe deposit box facilities, cashiers’ checks, travelers’ checks, U.S.Savings Bonds, and wire transfers.  TheBank does not provide trust services.

 

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

 

The Bank has entered intoan agreement with CrediTrends Technology Corporation, a purchaser of chargedoff consumer credit card balances, to market a co-branded MasterCard creditcard program.  The Bank will be issuingthe cards, but the credit card balances will be 100 percent owned byCrediTrends Technology Corporation.  TheBank’s 2003 revenues from the program are projected to be approximately$50,000.  CreditTrends TechnologyCorporation will maintain on deposit with the Bank amounts equal to the totalavailable credit of the portfolio, the total of five (5) days averagesettlement activity for the prior month and fees due to the third partyprocessor.

 

The Bank is developing apre-paid debit card program.  Theprogram will be marketed by third parties to the un-banked, through employerpayroll programs and check cashing facilities, through Internet websites forpurchasers of the websites’ products and services.  Holders of the pre-paid cards will be able to have additionalfunds added to the card balance, make point of sale purchases and withdraw cashthrough automated teller machines.  TheBank will be issuing the pre-paid cards and maintaining the funds held on thecards.  The Bank’s revenues from theprogram will be in the form of transaction fees and earnings from investing thefunds held on the cards.  Revenues fromthe program in 2003 will be minimal as the program development andimplementation are completed.

 

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

 

Monetary and fiscal policies of the federal governmentand the policies of regulatory agencies, particularly the Federal ReserveBoard, also impact on the Bank’s business. The Federal Reserve Board implements national monetary policies (withobjectives such as curbing inflation and combating recession) by itsopen-market operations in U.S. Government securities, by adjusting the requiredlevel of reserves for financial intermediaries subject to its reserverequirements and by varying the discount rates applicable to borrowings bydepository institutions.  The actions ofthe Federal Reserve Board in these areas influence the growth of bank loans,investments and deposits and also affect interest rates charged on loans andpaid on deposits.  The nature and impactof any future changes in monetary policies cannot be predicted.

 

5

----

 

**SUPERVISION AND REGULATION**

 

**The Corporation**

 

Future offers or sales of the stock of the Corporationwill be subject to the registration require­ments of the Securities Act of1933, and qualification under the California Corporate Securities Act of 1968,and possibly 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 appropriateapprovals, and/or passage of notice periods without objection, from theCalifornia Superintendent of Banks, the Federal Deposit Insurance Corporation,the Board of Governors of the Federal Reserve System and the shareholders ofthe Bank, the Corporation acquired the Bank through a reverse triangular merger(the “Merger”).  As a result, byoperation of law, each outstanding share of common stock of the Bank prior tothe Merger was converted into a share of common stock of the Corporation, whilethe Corporation became the sole owner of the newly issued shares of commonstock of the Bank.

 

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

 

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

 

The FRB’s Regulation “Y” sets out the non-bankingactivities that are permissible for bank holding companies under the law,subject to the FRB’s approval in individual cases.  Most of these activities are now permitted for California banksthat are well-capitalized.  TheCorporation and its subsidiaries will also be subject to certain restrictionswith respect to engaging in the underwriting, public sale and distribution ofsecurities.  The Gramm-Leach-Bliley Act(the “Act”) was signed by the President and enacted into law on November 12,1999.  The Act does three fundamentalthings: 1) it repeals key provisions of the Glass Steagal Act to permitcommercial banks to affiliate with investment bank, 2) it substantiallymodifies the Bank Holding Company Act of 1956 to permit companies that owncommercial banks to engage in any type of financial activity and 3) it allowssubsidiaries of banks to engage in a broad range of financial activities thatare not permitted for banks themselves. Management cannot predict what effect these changes will have on theBank or the Corporation.

 

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

 

6

----

 

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

 

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

 

The Corporation and itssubsidiaries are prohibited from engaging in certain tie-in arrangements inconnection with any extension of credit, sale or lease of property or furnishingof 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-OxleyAct**

 

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

 

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

•                                          Revisedrules on auditor independence to restrict the nature of non-audit servicesprovided to audit clients and to require such services to be pre-approved bythe audit committee.

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

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

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

 

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

 

**Subsidiary Bank**

 

Both federal and state laws provide extensiveregulation of the banking business. State and federal statutes and regulations apply to many aspects of theBank’s operations, including minimum capital requirements, reserves againstdeposits, interest rates payable on deposits, loans, investments, mergers andacquisitions, borrowings, dividends and locations of branch

 

7

----

 

offices. The California Superintendent of Banks and the FDIC provideprimary supervision, periodic examination and regulation of the Bank.

 

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

 

California law restricts the amount available for cashdividends by state-chartered banks to the lesser of retained earnings or thebank’s net income for its last three fiscal years (less any distributions tostockholders made during such period). Cash dividends may also be paid in an amount not exceeding the netincome for such bank’s last preceding fiscal year after obtaining the priorapproval of the Superintendent.  TheFDIC also has authority to prohibit the Bank from engaging in unsafe or unsoundpractices.  The FDIC can use this power,under certain circumstances, to restrict or prohibit a bank from payingdividends.

 

Federal law imposes restrictions on banks with regardto transactions with affiliates, including any extensions of credit to, or theissuance of a guarantee or letter of credit on behalf of, its affiliates, aswell as the purchase of or investments in stock or other securities thereof, orthe taking of such securities as collateral for loans, and the purchase ofassets of from affiliates.  Theserestrictions have the effect of preventing affiliates (such as the Corporation)from borrowing from the Bank unless the loans are secured by marketableobligations of designated amounts. Secured loans and investments by the Bank are limited to 10% of theBank’s capital and surplus (as defined by federal regulations) in the case ofany one affiliate, and 20% thereof in the case of all affiliates.  California law also imposes certainrestrictions with respect to transactions involving other controlling personsof the Bank.

 

From time to time, legislation is enacted which hasthe effect of increasing the cost of doing business, limiting or expandingpermissible activities or affecting the competitive balance between banks andother financial intermediaries.  Proposalsto change the laws and regulations governing the operations and taxation ofbanks, bank holding companies and other financial intermediaries are frequentlymade in Congress, in the California legislature and before various bankregulatory and other professional agencies. The Bank cannot predict what, ifany legislation or regulations will be enacted, or the impact thereof on itsbusiness and profitability.

 

*CapitalStandards*

 

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

 

FDIC guidelines implement the risk-based capitalrequirements. The guidelines establish a systematic analytical framework thatmakes regulatory capital requirements more sensitive to differences in riskprofiles (using the rough measures set forth therein) among bankingorganizations, take certain off-balance sheet items into account in assessingcapital adequacy and minimize disincentives to holding liquid, low-risk assets.Under these guidelines, assets and

 

8

----

 

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

 

A banking organization’s qualifying total capitalconsists of two components: Tier I capital (core capital) and Tier 2 capital(supplementary capital).  Tier I capitalconsists primarily of common stock, related surplus and retained earnings,qualifying noncumulative perpetual preferred stock and minority interests inthe equity accounts of consolidated subsidiaries. Intangibles, such asgoodwill, are generally deducted from Tier 1 capital; however, purchasedmortgage servicing rights and purchased credit card relationships may beincluded, subject to certain limitations. At least 50% of the bankingorganization’s total regulatory capital must consist of Tier 1 capital.

 

Tier 2 capital may consist of (i) the allowance forloan and lease losses in an amount up to 1.25% of risk-weighted assets; (ii)cumulative perpetual preferred stock and long-term preferred stock and relatedsurplus; (iii) hybrid capital instruments (instruments with characteristics ofboth debt and equity), perpetual debt and mandatory convertible debtsecurities; and (iv) eligible term subordinated debt and intermediate-termpreferred stock with an original maturity of five years or more, includingrelated surplus, in an amount up to 50% of Tier 1 capital. The inclusion of theforegoing elements of Tier 2 capital are subject to certain requirements andlimitations of the federal banking agencies.

 

The FDIC imposes a minimum leverage ratio of Tier Icapital to average total assets of 3% for the highest rated banks, and 4% forall other banks.  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 FDIChave issued or proposed rules to take account of interest rate risk,concentration of credit risk and the risks of nontraditional activities incalculating risk-based capital.

 

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

 

9

----

 

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

 

Effective January 17, 1995, the federal bankingagencies issued a final rule relating to capital standards and the risks arisingfrom the concentration of credit and nontraditional activities.  Institutions which have significant amountsof their assets concentrated in high risk loans or nontraditional bankingactivities and who fail to adequately manage these risks, will be required toset aside capital in excess of the regulatory minimums.  The federal banking agencies have notimposed any quantitative assessment for determining when these risks aresignificant, but have identified these issues as important factors they willreview in assessing an individual bank’s capital adequacy.  Management of the Company does not believethat the Bank’s assets and activities, as currently structured, would lead theFDIC to require additional capital under this rule.

 

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

 

Future changes in regulations or practices couldfurther reduce the amount of capital recognized for purposes of capitaladequacy.  Such a change could affectthe ability of the Bank to grow and could restrict the amount of profits, ifany, available for the payment of dividends.

 

*PromptCorrective Action and Other Enforcement Mechanisms*

 

Under Section 38 of the FDIA, as added by the FederalDeposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), each federalbanking agency is required to implement a system of prompt corrective actionfor institutions which it regulates. The federal banking agencies have promulgated substantially similarregulations to implement this system of prompt corrective action.  Under the regulations, an institution shallgenerally be deemed to be: (i) ”well capitalized” if it has a total risk-basedcapital ratio of 10.0% or more, has a Tier I risk-based capital ratio of6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and isnot subject to specified requirements to meet and maintain a specific capitallevel for any capital measure; (ii) ”adequately capitalized” if it has atotal risk-based capital ratio of 8.0% or more, a Tier I risk-basedcapital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0%or more (3.0% under certain circumstances) and does not meet the definition of“well capitalized;” (iii) ”undercapitalized” if it has a total risk-basedcapital ratio that is less than 8.0%, a Tier I

 

10

----

 

risk-based capital ratio that is less than 4.0% or a Tier Ileverage capital ratio that is less than 4.0% (3.0% under certaincircumstances); (iv) ”significantly undercapitalized” if it has a totalrisk-based capital ratio that is less than 6.0%, aTier 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) ”critically undercapitalized” if it has a ratio of tangible equity tototal assets that is equal to or less than 2.0%.

 

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

 

An institution generally must file a written capitalrestoration plan which meets specified requirements, as well as a performanceguaranty by each company that controls the institution, with the appropriatefederal banking agency within 45 days of the date that the institution receivesnotice or is deemed to have notice that it is undercapitalized, significantlyundercapitalized or critically undercapitalized.  Immediately upon becoming undercapitalized, an institution shallbecome subject to the provisions of Section 38 of the FDIA, which setsforth various mandatory and discretionary restrictions on its operations.

 

At December 31, 2002, the Bank met the tests to be categorizedas “well capitalized” under the prompt corrective action regulations of theFDIC.

 

*Safety and Soundness Standards*

 

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

 

11

----

 

*Premiums for Deposit Insurance*

 

The FDIC adopted regulations implementing a risk-basedpremium system required by federal law. Under the regulations which cover the assessment periods commencing onand after January 1, 1994, insured depository institutions are required to payinsurance premiums within a range of $.23 cents per $100 of deposits to $.31cents per $100 of deposits depending on their risk classification.  The FDIC, effective September 30, 1995,lowered assessments from their rates of $.23 to $.31 per $100 of insureddeposits to rates of $.04 to $.31, depending on the health of the bank, as aresult of the re-capitalization of the BIF. The FDIC may alter the existing assessment rate structure for depositinsurance and may change the base assessment rate (currently, 4 to 31 basispoints per year) by rulemaking with notice and comment.  Without notice or comment, the FDIC mayincrease or decrease the current rate schedule uniformly by as much as 5 basispoints, as deemed necessary to maintain the target designated reserve ratio1.25 percent (fund balance to estimated insured deposits).  The insured deposit rates for 2002 were $.00to $.27. These rates are projected to continue through the first half of 2003.

 

The Financing Corporation (FICO), established by theCompetitive Equality Banking Act of 1987, is a mixed-ownership governmentcorporation whose sole purpose was to function as the financing vehicle for theFederal Savings & Loan Insurance Corporation (FSLIC).  Effective December 12, 1991, as provided bythe Resolution Trust Corporation Refinancing, Restructuring and Improvement Actof 1991, the FICO’s ability to issue new debt was terminated.  Outstanding FICO bonds, which are 30-yearnon-callable bonds with a principal amount of approximately $8.1 billion, maturein 2017 through 2019.

 

The FICO has assessmentauthority, separate from the FDIC’s authority to assess risk-based premiums fordeposit insurance, to collect funds from FDIC-insured institutions sufficientto pay interest on FICO bonds.  The FDICacts as collection agent for the FICO. The Deposit Insurance Funds Act of 1996 (DIFA) authorized the FICO toasses both Bank Insurance Fund (BIF) and Savings Association Insurance Fund(SAIF) insured deposits, and required the BIF rate to equal one-fifth the SAIFrate through the year 1999, or until the insurance funds are merged, whicheveroccurs first.  Thereafter, BIF and SAIFinsured deposits will be assessed at the same rate by FICO.

 

The FICO assessment rate is adjusted quarterly toreflect changes in the assessment basis of the respective funds based on thequarterly Call Report and the Thrift Financial Report submissions.  The FICO quarterly rates for 2002 were 1.82,1.76, 1.72 and 1.70.  The FICO quarterlyrate for the first quarter of 2003 is 1.68.

 

*InterstateBanking and Branching*

 

On September 29, 1994, the President signed into lawthe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the“Interstate Act”).  Under the InterstateAct, beginning one year after the date of enactment, a bank holding companythat is adequately capitalized and managed may obtain regulatory approval toacquire an existing bank located in another state without regard to statelaw.  A bank holding company would notbe permitted to make such an acquisition if, upon consummation, it wouldcontrol (a) more than 10% of the total amount of deposits of insured depositoryinstitutions in the United States or (b) 30% or more of the deposits

 

12

----

 

in the state in which the bank is located.  A state may limit the percentage of total deposits that may beheld in that state by any one bank or bank holding company if application  of such limitation does not discriminateagainst out-of-state banks.  Anout-of-state bank holding company may not acquire a state bank in existence forless than a minimum length of time that may be prescribed by state law exceptthat a state may not impose more than a five year existence requirement.

 

The Interstate Act also permits, beginning June 1,1997, mergers of insured banks located in different states and conversion ofthe branches of the acquired bank into branches of the resulting bank.  Each state may permit such combinationsearlier than June 1, 1997, and may adopt legislation to prohibit interstatemergers after that date in that state or in other states by that state’sbanks.  The same concentration limitsdiscussed in the preceding paragraph apply. The Interstate Act also permits a national or state bank to establishbranches in a state other than its home state if permitted by the laws of thatstate, subject to the same requirement and conditions as for a mergertransaction.

 

The Interstate Act is likely to increase competitionin the Bank’s market areas especially from larger financial institutions andtheir holding companies.  It isdifficult to asses the impact such likely increased competition will have onthe Bank’ operations.

 

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

 

*CommunityReinvestment Act and Fair Lending Developments*

 

The Bank is subject to certain fair lendingrequirements, reporting obligations involving home mortgage lending operationsand Community Reinvestment Act (the “CRA”). The CRA generally requires the federal banking agencies to evaluate therecord of financial institutions in meeting the credit needs of their localcommunity, including low and moderate income neighborhoods.  In addition to substantial penalties andcorrective measures that may be required for a violation of certain fairlending laws, the federal banking agencies may take compliance with such lawsand CRA into account when regulating and supervising other activities.

 

In May, 1995, the federal banking agencies issuedfinal regulations which change the manner in which they measure a bank’scompliance with its CRA obligations. The final regulations adopt a performance-based evaluation system whichbases CRA ratings on an institutions’ actual lending service and investmentperformance rather than the extent to which the institution conducts needsassessments, documents community outreach or complies with

 

13

----

 

other procedural requirements. In March 1994, the Federal Interagency Task Force on Fair Lending issueda policy statement on discrimination in lending.  The policy statement describes the three methods that federalagencies will use to prove discrimination: overt evidence of discrimination,evidence of disparate treatment and evidence of disparate impact.  Management of the Bank believes that theBank is in substantial compliance with all requirements under theseprovisions.  Following the Bank’s mostrecent CRA examination, the Bank’s rating was “satisfactory”.

 

*OtherRegulations and Policies*

 

The federal regulatory agencies have adoptedregulations that implement Section 304 of FDICIA which requires federal bankingagencies to adopt uniform regulations prescribing standards for real estatelending.  Each insured depositoryinstitution must adopt and maintain a comprehensive written real estate lendingpolicy, developed in conformance with prescribed guidelines, and each agencyhas specified loan-to-value limits in guidelines concerning various categoriesof real estate loans.

 

Section 24 of the Federal Deposit Insurance Act (the“FDIA”), as amended by the FDICIA, generally limits the activities and equityinvestments of FDIC-insured, state-chartered banks to those that arepermissible for national banks.  Underregulations dealing with equity investments, an insured state bank generallymay not directly or indirectly acquire or retain any equity investment of atype, or in an amount, that is not permissible for a national bank.  An insured state bank is not prohibitedfrom, among other things, (i) acquiring or retaining a majority interest in asubsidiary, (ii) investing as a limited partner in a partnership the solepurpose of which is direct or indirect investment in the acquisition,rehabilitation or new construction of a qualified housing project, providedthat such limited partnership investments may not exceed 2% of the bank’s totalassets, (iii) acquiring up to 10% of the voting stock of a company that solelyprovides or reinsures directors’, trustees’ and officers’ liability insurancecoverage or bankers’ blanket bond group insurance coverage for insured depositoryinstitutions, and (iv) acquiring or retaining the voting shares of a depositoryinstitution if certain requirements are met.

 

FDIC regulations implementing Section 24 of the FDIAprovide that an insured state-chartered bank may not, directly, or indirectlythrough a subsidiary, engage as “principal” in any activity that is notpermissible for a national bank unless the FDIC has determined that suchactivities would pose no risk to the insurance fund of which it is a member andthe bank is in compliance with applicable regulatory capital requirements.  Any insured state-chartered bank directly orindirectly engaged in any activity that is not permitted for a national bankmust cease the impermissible activity.

 

*RegulatoryEnforcement Powers*

 

Commercial banking organizations, such as the Bank,may be subject to enforcement actions by the FDIC and the Superintendent forengaging in unsafe or unsound practices in the conduct of their businesses orfor violations of any law, rule, regulation or any condition imposed in writingby the agency or any written agreement with the agency.  Enforcement actions may include theimposition of a conservator or receiver, the issuance of a cease-and-desistorder that can be judicially enforced, the termination of insurance ofdeposits, the imposition of civil

 

14

----

 

money penalties, the issuance of directives to increase capital, theissuance of formal and informal agreements, the issuance of removal andprohibition orders against institution-affiliated parties and the imposition ofrestrictions and sanctions under the prompt corrective action provisions of theFDICIA.

 

*California and Federal Banking Law*

 

The Federal Change in Bank Control Act of 1978prohibits a person or group of persons “acting in concert” from acquiring“control” of a bank or holding company unless the appropriate federalregulatory agency has been given 60 days’ prior written notice of such proposedacquisition and, within that time period, has not issued a notice disapprovingthe proposed acquisition or extending for up to another 30 days the periodduring which such a disapproval may be issued. An acquisition may be made priorto the expiration of the disapproval period if the agency issues written noticeof its intent not to disapprove the action. The acquisition of more than 10% of a class of voting stock of a bank(or holding company) with a class of securities registered under Section 12 ofthe Securities Exchange Act of 1934, as amended (such as the Common Stock), isgenerally presumed, subject to rebuttal. to constitute the acquisition ofcontrol.

 

Under the CaliforniaFinancial Code, no person shall, directly or indirectly, acquire control of aCalifornia licensed bank or a bank holding company unless the Superintendenthas approved such acquisition of control. A person would be deemed to have acquired control of the Corporationunder this state 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 orcause the direction of the management and policies of the Corporation.  For purposes of this law, a person whodirectly or indirectly owns or controls 10% or more of the Common Stock wouldbe presumed to control the Corporation, subject to rebuttal.

 

In addition, any “company” would be required to obtainthe approval of the Federal Reserve under the Bank Holding Company Act of 1956,as amended (the “BHC Act”), before acquiring 25% (5% in the case of an acquirerthat is, or is deemed to be, a bank holding company) or more of the outstandingCommon Stock of, or such lesser number of shares as constitute control over,the Bank or the Corporation.

 

The Community Reinvestment Act of 1977 (“CRA”) and therelated Regulations of the Comptroller of the Currency, the Board of Governorsof the Federal Reserve and the Federal Deposit Insurance Corporation (“FDIC”)are intended to encourage regulated financial institutions to help meet thecredit needs of their local community or communities, including low andmoderate income neighborhoods, consistent with the safe and sound operation ofsuch financial institutions.  The CRAand such regulations provide that the appropriate regulatory authority willassess the records of regulated financial institutions in satisfying theircontinuing and affirmative obligations to help meet the credit needs of theirlocal communities as part of their regulatory examination of theinstitution.  The results of such examinationsare made public and are taken into account upon the filing of any applicationto establish a domestic branch, to merge or to acquire the assets or assume theliabilities of a bank.  In the case of abank holding company, the CRA performance record of the subsidiary bank(s)involved in the transaction is reviewed in connection with the filing of anapplication to acquire ownership or control of shares

 

15

----

 

or assets of a bank or to merge with any other bank holdingcompany.  An unsatisfactory record cansubstantially delay or block the transaction.

 

**RESEARCH**

 

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

 

**DEPENDENCE UPON A SINGLE CUSTOMER**

 

Neither the Corporationnor the Bank is dependent upon a single customer or very few customers.  The Bank’s business is concentrated in, andlargely dependent upon the strength of the local economy in, the MontereyPeninsula area of Northern California. The local economy is affected by both national trends and by localfactors.  Tourism and the activities atthe former Fort Ord military base are among the major contributors to the localeconomy.  The opening of the CaliforniaState University at Monterey Bay on the former Fort Ord military base may lessenthe impact of the base closure.

 

**ITEM2. PROPERTIES**

 

The main office of theBank, which also serves as the principal office of the Corporation, is locatedat 601 Munras Ave., Monterey, California 93940.  This facility contains a lobby, executive and customer serviceoffices, teller stations, safe deposit boxes and related non-vault area, vault,operations area, lounge and miscellaneous areas.  A drive-through facility and adequate paved parking are also onthe premises.  Both the land and allimprovements thereto are owned by the Bank**.** The Bank currently operates three branch offices in Carmel-By-The-Sea,Carmel Valley and Pacific Grove, California, all within approximately 10 milesfrom the Bank’s main office.  The landand improvements dedicated to the Carmel-By-The-Sea, Carmel Valley and PacificGrove branch offices are leased.  SeeFootnote 7 to the Corporation’s financial statements included herewith.

 

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

 

**ITEM3. LEGAL PROCEEDINGS**

 

None

 

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

 

None submitted.

 

16

----

 

**PART II**

 

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

 

Neither the Corporation’s,which is held by approximately 550 persons, nor the Bank’s, stock has ever beenactively 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 thesame period, no broker acted as a market maker for the Corporation or Bank’sCommon Stock.  Accordingly, the marketprice data contained herein does not represent the value which would beassigned in an efficient market.  TheCommon Stock is not listed on any securities exchange or quoted on the NationalAssociation of Securities Dealers Automated System.

 

The Corporationrepurchased 774 shares of common stock at $3.00 per share in 2002, 11,980 atprices ranging from $3.00 to $3.50 in 2001, and 3,754 at prices ranging from$2.70 to $3.00 in 2000.

 

The following table setsforth, according to information known to the Corporation, the price paid pershare in, and volume of, transactions in the Bank’s stock during the quartersended March 31, 2000 to December 31, 2002.

 
| **Quarter/Year**     |   | **Price** |   | **Volume****(1)** |   |
|----------------------|--------|-----------|--------|-------------------|--------|
|                 |   |      |   |              |   |
| 1st  quarter of 2000 |   | 3.00      |   | 1,662             |   |
| 2nd  quarter of 2000 |   | 3.00      |   | 1,256             |   |
| 3rd  quarter of 2000 |   | 3.00      |   | 132               |   |
| 4th  quarter of 2000 |   | 2.70-3.00 |   | 3,918             |   |
|                 |   |      |   |              |   |
| 1st  quarter of 2001 |   | 3.00      |   | 4,877             |   |
| 2nd  quarter of 2001 |   | 3.00      |   | 207               |   |
| 3rd  quarter of 2001 |   | 3.00-3.50 |   | 7,393             |   |
| 4th  quarter of 2001 |   | 3.00      |   | 1,841             |   |
|                 |   |      |   |              |   |
| 1st  quarter of 2002 |   | 3.00      |   | 33,561            |   |
| 2nd  quarter of 2002 |   | 3.00      |   | 7,728             |   |
| 3rd  quarter of 2002 |   | 3.00      |   | 1,306             |   |
| 4th  quarter of 2002 |   | 3.00      |   | 227               |   |

 

----

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

 

17

----

 

The principal source ofcash flow of the Corporation, including cash flow to pay dividends on its stockor principal and interest on debt, is interest and dividends on investments andtax payments and dividends from the Bank. There are statutory and regulatory limitations on the payment ofdividends by the Bank to the Corporation, as well as by the Corporation to itsshareholders.

 

If in the opinion of theapplicable federal and/or state regulatory authority, a depository institutionor holding company is engaged in or is about to engage in an unsafe or unsoundpractice (which, depending on the financial condition of the depositoryinstitution or holding company, could include the payment of dividends), such authoritymay require, after notice and hear (except in the case of an emergencyproceeding where there in no notice or hearing), that such institution orholding company cease and desist from such practice.  Moreover, the Federal Reserve and the FDIC have issued policystatements which provide that bank holding companies and insured depositoryinstitutions generally should only pay dividends out of current operatingearnings.

 

Under the Federal DepositInsurance Corporation Improvement Act of 1991 (“FDICIA”), an FDIC insureddepository institution may not pay any dividend if payment would cause it tobecome undercapitalized or once it is undercapitalized.

 

The Bank’s payment ofdividends, as a California chartered commercial banking corporation, isregulated by the California Financial Code. Under the California Financial Code, funds available for cash dividendpayments by the Bank are restricted to the lessor of: (I) retained earnings; or(ii) the Bank’s net income for its last three fiscal years (less any distributionsto the stockholders made during such period). As of December 31, 2002 the Bank had $2,732,900 in retainedearnings.  The Bank’s net income for thelast three fiscal years less distributions to stockholders was $1,741,500.

 

In December 2002, 2001and 2000 the Corporation paid a ten (10) percent stock dividend.  The Bank paid cash dividends totaling$75,000, $200,000 and $100,000 to the Corporation during 2002, 2001 and 2000,respectively.

 

18

----

 

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

 

**OVERVIEW**

 

The following discussionreviews and analyzes the operating results and financial condition of theCorporation, focusing on the Bank.  Itshould be read in conjunction with the financial statements and the otherfinancial data presented elsewhere herein.

 

Net income for each ofthe last three years was $508,600 in 2002, $360,500 in 2001, and $736,300 in2000.  The primary net income per sharefor each of the last three years was $.34, $.25, and $.50 respectively.  The diluted net income per share for thesame time periods were $.29, $.21 and $.44, respectively.  Return on average shareholders’ equity was10.49%, 7.87% and 16.95% in 2002, 2001 and 2000, respectively.  Return on average assets was .63%, .48%, and1.06% in 2002, 2001 and 2000, respectively.

 

The increase in earningsin 2002 was due to increases of $82,200 in net interest income after provisionfor loan losses and $309,400 in other income; partially offset by increases of$120,800 in operating expense and $122,700 in income tax expense.

 

The decrease in earningsin 2001 was due to net interest income after provision for loan lossesdecreasing $232,800, other income increased $50,400, operating expensesincreased $324,000 and income tax expense decreased $130,600.  Net income was significantly impacted as theresult of realized losses on securities transactions and declines in the marketvalue of the trading asset.  Realizedlosses on securities transactions were $27,800 while the mark to market of thetrading asset resulted in a charge to earnings of $199,400.

 

The increase in earningsin 2000 was due to increases of $628,600 in net interest income after provisionfor loan losses and $191,300 in other income; partially offset by increases of$322,500 in other expense and $214,900 in income tax expense.

 

19

----

 

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

 
|                                                 |   | **As of and for the years Ended December 31,**   |   |
|------------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                 |   | **2002**                                         |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                 |   | **(Dollars in thousands except per share data)** |   |
| Summary  of Operating Results:                       |   |                                             |   |   |   |   |   |   |   |   |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Total  interest income                               |   | 4,876                                            |   | 5,440 |   | 5,501 |   | 4,296 |   | 3,757 |   |
| Total  interest expense                              |   | 1,948                                            |   | 2,526 |   | 2,410 |   | 1,788 |   | 1,603 |   |
| Net  interest income                                 |   | 2,928                                            |   | 2,914 |   | 3,092 |   | 2,508 |   | 2,154 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Provision  for possible loan losses                  |   | 117                                              |   | 185 |   | 130 |   | 174 |   | 130 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Net  interest income after provision for loan loss   |   | 2,811                                            |   | 2,729 |   | 2,962 |   | 2,333 |   | 2,024 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Total  other income                                  |   | 1,805                                            |   | 1,496 |   | 1,445 |   | 1,254 |   | 1,152 |   |
| Total  other expense                                 |   | 3,754                                            |   | 3,633 |   | 3,309 |   | 2,986 |   | 2,585 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Income  (loss) before taxes                          |   | 863                                              |   | 592 |   | 1,098 |   | 601 |   | 591 |   |
| Provision  for income tax                            |   | 354                                              |   | 231 |   | 362 |   | 147 |   | 127 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Net  income (loss)                                   |   | 509                                              |   | 361 |   | 736 |   | 454 |   | 464 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Per  Common Share Data:                              |   |                                             |   |   |   |   |   |   |   |   |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Basic  Earnings                                      |   |                                             |   |   |   |   |   |   |   |   |   |
| Income  before extraordinary item(1)                 |   | 0.34                                             |   | 0.25 |   | 0.50 |   | 0.32 |   | 0.28 |   |
| Extraordinary  Item(1)                               |   | —                                           |   | — |   | — |   | — |   | 0.04 |   |
| Net  Income(1)                                       |   | 0.34                                             |   | 0.25 |   | 0.50 |   | 0.32 |   | 0.32 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Diluted  Earnings                                    |   |                                             |   |   |   |   |   |   |   |   |   |
| Income  before extraordinary item(2)                 |   | 0.29                                             |   | 0.21 |   | 0.44 |   | 0.27 |   | 0.24 |   |
| Extraordinary  Item(2)                               |   | —                                           |   | — |   | — |   | — |   | 0.04 |   |
| Net  Income(2)                                       |   | 0.29                                             |   | 0.21 |   | 0.44 |   | 0.27 |   | 0.28 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Book  value, end of period                           |   | 3.77                                             |   | 3.48 |   | 3.29 |   | 2.70 |   | 2.44 |   |
| Avg  shares outstanding(3)                           |   | 1,483,493                                        |   | 1,469,489 |   | 1,479,520 |   | 1,422,287 |   | 1,409,223 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Balance  Sheet Data:                                 |   |                                             |   |   |   |   |   |   |   |   |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Total  loans, net of unearned income(4)              |   | 60,257                                           |   | 52,562 |   | 43,251 |   | 39,217 |   | 28,250 |   |
| Total  assets                                        |   | 86,279                                           |   | 79,735 |   | 83,872 |   | 65,214 |   | 51,103 |   |
| Total  deposits                                      |   | 67,616                                           |   | 68,332 |   | 72,218 |   | 55,563 |   | 42,852 |   |
| Stockholders’  equity                           |   | 5,639                                            |   | 5,087 |   | 4,861 |   | 3,993 |   | 3,435 |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Selected  Financial Ratios(5):                       |   |                                             |   |   |   |   |   |   |   |   |   |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Return  on average assets                            |   | 0.63                                             | %      | 0.48 | % | 1.06 | % | 0.80 | % | 0.97 | % |
| Return  on average stockholders’ equity         |   | 10.49                                            | %      | 7.87 | % | 16.95 | % | 12.37 | % | 14.43 | % |
| Net  interest spread                                 |   | 3.64                                             | %      | 3.68 | % | 4.73 | % | 3.88 | % | 4.45 | % |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Net  interest margin                                 |   | 4.19                                             | %      | 4.50 | % | 5.59 | % | 4.60 | % | 5.20 | % |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Avg  shareholders’ equity to average assets     |   | 5.99                                             | %      | 6.09 | % | 6.23 | % | 6.48 | % | 6.73 | % |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Primary  capital to assets at end of period          |   | 7.22                                             | %      | 6.73 | % | 6.32 | % | 6.70 | % | 7.32 | % |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Total  loans to total deposits at end of period      |   | 90.06                                            | %      | 76.92 | % | 59.88 | % | 70.58 | % | 65.92 | % |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Allowance  to total loans at end of period           |   | 1.04                                             | %      | 1.06 | % | 1.05 | % | 1.01 | % | 1.18 | % |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Nonperforming  loans to total loans at end of period |   | 0.06                                             | %      | 0.70 | % | 0.03 | % | 0.48 | % | 0.25 | % |
|                                                 |   |                                             |   |   |   |   |   |   |   |   |   |
| Net  charge-offs to average loans                    |   | 0.08                                             | %      | 0.18 | % | 0.15 | % | 0.32 | % | 0.23 | % |

 

----

(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 average number of shares usedfor this computation was 1,483,493, for 2002, 1,469,489 for 2001, 1,479,520 for2000, 1,422,287 for 1999 and 1,409,223 for 1998.

 

(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.  Commonstock equivalents include employee stock options.  The weighted average number of shares used for this computationwas 1,744,082, 1,701,827, 1,705,258, 1,702,585 and 1,682,401 in 2002, 2001,2000, 1999 and 1998, respectively.

 

(3)   Weightedaverage common shares.

 

(4)   Includesloans being held for sale.

 

(5)   Averagesare of daily balances.

 

20

----

 

**NET INTEREST INCOME**

 

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

 

The following table summarizes the Bank’s net interestincome.  It is not presented on a taxequivalent basis, as the Bank ‘s tax-exempt interest income is insignificant.

 
|                 |   | **Years Ended  December 31,** |   | **Increase (Decrease)  From Prior Year** |   |
|----------------------|--------|-------------------------------|--------|------------------------------------------|--------|
|                 |   | **2002**                      |   | **2001**                                 |   | **2000** |   | **2002/2001** |   | **2001/2000** |   |
|                 |   |                          |   |                                     |   |   |   | **Amt** |   | **%** |   | **Amt** |   | **%** |   |
|                 |   |                          |   |                                     |   | **(Dollars in thousands)** |   |   |   |   |   |
| Interest  Income     |   | 4,876                         |   | 5,440                                    |   | 5,501 |   | (564 | ) | (10.36 | ) | (62 | ) | (1.12 | ) |
| Interest  Expense    |   | 1,948                         |   | 2,526                                    |   | 2,410 |   | (578 | ) | (22.88 | ) | 116 |   | 4.82 |   |
|                 |   |                          |   |                                     |   |   |   |   |   |   |   |   |   |   |   |
| Net  Interest Income |   | 2,928                         |   | 2,914                                    |   | 3,092 |   | 14 |   | 0.49 |   | (178 | ) | (5.75 | ) |

 

Net interest income increased $14,200 (0.49%) from2001 to 2002.  Average interest bearingassets increased 6.76%, while the average rate earned decreased 132 basispoints, resulting in a decrease of $563,800 in total interest income.  Interest expense decreased $578,000 theresult of a 8.13% increase in average interest bearing liabilities and adecrease of 494 basis points in the average rate paid.

 

Net interest income decreased $177,800 (5.75%) from2000 to 2001.  Average interest bearingassets increased 9.04%, while the average rate earned 124 basis points,resulting in a decrease of $61,700 in total interest income.  Interest expense increased $116,100 the resultof a 9.15% increase in average interest bearing liabilities and a decrease of19 basis points in the average rate paid. The average interest rate on loans decreased 94 basis points while theaverage rate on investment securities decreased 259 basis points.

 

The following table shows the components of the Bank’snet interest income, setting forth, for each of the three years ended December31, 2002, 2001 and 2000 (i) average assets, liabilities and investments, (ii)interest income earned on interest-earning assets and interest expense paid oninterest-bearing liabilities, (iii) average yields earned on interest-earningassets and average rates paid on interest-bearing liabilities, (iv) the netinterest spread (i.e., the average yield earned on interest-earning assets lessthe average rate paid on interest-bearing liabilities) and (v) the net interestyield on average interest-earning assets (i. e., net interest income divided byaverage interest-earning assets). Yields are computed on a tax-equivalent basis, resulting in adjustmentsto interest earned on non-taxable securities of $16,500 and $253,700 in 2001and 2000 respectively.  Non-accrualloans and overdrafts are included in average loan balances.  Average loans are presented net of unearnedincome.

 

21

----

 

**INTERESTSPREAD ANALYSIS:**

** **
|                                  |   | **2002**      | ** ** | **2001**              | ** ** | **2000**          |       |
|---------------------------------------|--------|---------------|------------|-----------------------|------------|-------------------|------------|
|                                  |   | **Avg   Bal** | ** ** | **Int   Earn   Paid** | ** ** | **Avg  %   Rate** | ** ** | **Avg   Bal** | ** ** | **Int   Earn   Paid** | ** ** | **Avg   %   Rate** | ** ** | **Avg   Bal** | ** ** | **Int   Earn   Paid** | ** ** | **Avg   %   Rate** |   |
|                                  |   | ** **    |       | ** **            |       | ** **        |       | ** ** | ** ** |   |
|                                  |   | ** **    | ** ** | ** **            | ** ** | ** **        | ** ** | ** ** | ** ** |   |
|                                  |   |          |       |                  | ** ** |              | ** ** | **(Dollars in thousands)** | ** ** |   | ** ** |   | ** ** |   |   |
| Interest  Earning Assets:             |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Int-bearing  deposits at other banks  |   | 88            |       | 3                     |       | 3.30              |       | 178 |   | 12 |   | 6.99 |   | 164 |   | 10 |   | 6.36 |   |
| Invest  securities - Taxable          |   | 7,490         |       | 387                   |       | 5.17              |       | 7,444 |   | 469 |   | 6.30 |   | 5,553 |   | 396 |   | 7.12 |   |
| Invest  securities - Non-Taxable      |   | 0             |       | 0                     |       | N/A               |       | 377 |   | 25 |   | 6.65 |   | 9,325 |   | 746 |   | 8.00 |   |
| Federal  funds sold                   |   | 7,063         |       | 115                   |       | 1.63              |       | 10,310 |   | 363 |   | 3.52 |   | 4,776 |   | 303 |   | 6.35 |   |
|                                  |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  investments                    |   | 14,641        |       | 505                   |       | 3.45              |       | 18,308 |   | 870 |   | 4.75 |   | 19,818 |   | 1455 |   | 7.34 |   |
|                                  |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                 |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Construction                          |   | 2,870         |       | 272                   |       | 9.46              |       | 2,209 |   | 227 |   | 10.29 |   | 3,147 |   | 329 |   | 10.45 |   |
| Real  estate                          |   | 37,729        |       | 2,846                 |       | 7.54              |       | 31,258 |   | 2,805 |   | 8.97 |   | 25,211 |   | 2,451 |   | 9.72 |   |
| Installment                           |   | 704           |       | 57                    |       | 8.12              |       | 767 |   | 90 |   | 11.67 |   | 511 |   | 68 |   | 13.30 |   |
| Commercial                            |   | 15,454        |       | 1,191                 |       | 7.71              |       | 14,335 |   | 1,454 |   | 10.15 |   | 12,643 |   | 1,451 |   | 11.48 |   |
|                                  |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  loans                          |   | 56,758        |       | 4,365                 |       | 7.69              |       | 48,570 |   | 4,576 |   | 9.42 |   | 41,512 |   | 4,299 |   | 10.36 |   |
|                                  |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  Interest earning assets        |   | 71,399        |       | 4,870                 |       | 6.82              |       | 66,878 |   | 5,446 |   | 8.14 |   | 61,330 |   | 5,754 |   | 9.38 |   |
|                                  |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest  Bearing Liabilities:        |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Int-bearing  demand                   |   | 10,960        |       | 73                    |       | 0.67              |       | 9,422 |   | 93 |   | 0.99 |   | 8,917 |   | 89 |   | 1.00 |   |
| Money  market savings                 |   | 2,021         |       | 21                    |       | 1.04              |       | 1,328 |   | 22 |   | 1.66 |   | 1,428 |   | 26 |   | 1.84 |   |
| Savings  deposits                     |   | 4,199         |       | 54                    |       | 1.29              |       | 3,885 |   | 71 |   | 1.82 |   | 3,185 |   | 63 |   | 1.98 |   |
| Time  deposits >$100M              |   | 16,059        |       | 610                   |       | 3.80              |       | 15,216 |   | 833 |   | 5.47 |   | 13,019 |   | 764 |   | 5.87 |   |
| Time  deposits <$100M              |   | 20,371        |       | 815                   |       | 4.00              |       | 20,263 |   | 1,126 |   | 5.56 |   | 19,049 |   | 1,105 |   | 5.80 |   |
| Other  Borrowing                      |   | 5,402         |       | 306                   |       | 5.67              |       | 4,460 |   | 293 |   | 6.56 |   | 4,402 |   | 280 |   | 6.36 |   |
|                                  |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest bearing liabilities   |   | 59,012        |       | 1,880                 |       | 3.19              |       | 54,574 |   | 2,437 |   | 4.47 |   | 49,998 |   | 2,328 |   | 4.66 |   |
|                                  |   |          |       |                  |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  interest income                  |   |          |       | 2,990                 |       |              |       |   |   | 3,009 |   |   |   |   |   | 3,426 |   |   |   |
| Net  interest spread                  |   |          |       |                  |       | 3.64              |       |   |   |   |   | 3.68 |   |   |   |   |   | 4.73 |   |
| Net  yield on interest earning assets |   |          |       |                  |       | 4.19              |       |   |   |   |   | 4.50 |   |   |   |   |   | 5.59 |   |

 

22

----

 
|                                   |                                   | **2002 vs 2001** |   | **2001 vs 2000** |   |
|----------------------------------------|----------------------------------------|------------------|--------|------------------|--------|
| **Increase(Decrease)  Due to changes** | **Increase(Decrease)  Due to Changes** |
|                                   |                                   | **Avg  Volume**  |   | **Avg  Rate**    |   | **Total** |   | **Avg  Volume** |   | **Avg  Rate** |   | **Total** |   |
|                                   |                                   |             |   |             |   | **(Dollars in thousands)** |   |   |   |   |   |
| Interest  Earning Assets:              |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Int-bearing  deposits at other banks   |                                   | (6               | )      | (3               | )      | (9 | ) | 1 |   | 1 |   | 2 |   |
| Invest  securities - Taxable           |                                   | 3                |   | (85              | )      | (82 | ) | 135 |   | (61 | ) | 74 |   |
| Invest  securities - Non-Taxable       |                                   | (25              | )      | 0                |   | (25 | ) | (716 | ) | (5 | ) | (721 | ) |
| Federal  funds sold                    |                                   | (114             | )      | (134             | )      | (249 | ) | 352 |   | (292 | ) | 60 |   |
|                                   |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Total  investments                     |                                   | (143             | )      | (222             | )      | (365 | ) | (228 | ) | (357 | ) | (585 | ) |
|                                   |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Loans                                  |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Construction                           |                                   | 68               |   | (24              | )      | 44 |   | (98 | ) | (4 | ) | (102 | ) |
| Real  estate                           |                                   | 581              |   | (540             | )      | 41 |   | 588 |   | (234 | ) | 354 |   |
| Installment                            |                                   | (7               | )      | (25              | )      | (32 | ) | 34 |   | (12 | ) | 22 |   |
| Commercial                             |                                   | 114              |   | (377             | )      | (264 | ) | 194 |   | (191 | ) | 3 |   |
|                                   |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Total  loans                           |                                   | 755              |   | (966             | )      | (211 | ) | 718 |   | (441 | ) | 277 |   |
|                                   |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Total  Interest Earning Assets         |                                   | 612              |   | (1188            | )      | (576 | ) | 490 |   | (798 | ) | (308 | ) |
|                                   |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Interest  Bearing Deposits:            |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
|                                   |                                   |             |   |             |   |   |   |   |   |   |   |   |   |
| Int-bearing  demand                    |                                   | 15               |   | (35              | )      | (20 | ) | 5 |   | (1 | ) | 4 |   |
| Money  market savings                  |                                   | 11               |   | (12              | )      | (1 | ) | (2 | ) | (2 | ) | (4 | ) |
| Savings  deposits                      |                                   | 6                |   | (22              | )      | (16 | ) | 14 |   | (6 | ) | 8 |   |
| Time  deposits >$100M               |                                   | 46               |   | (269             | )      | (223 | ) | 129 |   | (60 | ) | 69 |   |
| Time  deposits <$100M               |                                   | 6                |   | (317             | )      | (311 | ) | 70 |   | (50 | ) | 20 |   |
| Other  Borrowing                       |                                   | 62               |   | (48              | )      | 14 |   | 4 |   | 9 |   | 13 |   |
| Total  interest bearing deposits       |                                   | 146              |   | (703             | )      | (557 | ) | 220 |   | (110 | ) | 110 |   |
| Net  change in net interest            |                                   | 466              |   | (485             | )      | (19 | ) | 270 |   | (688 | ) | (418 | ) |

 

23

----

 

**Provision and Allowance for Loan Losses**

 

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

 

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

 

| **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                   |   | 0.15          | %      |
| Loans  to Individuals                         |   | 2.00          | %      |
| Commercial                                    |   | 2.00          | %      |
| SBA  Loans – Unguaranteed portion        |   | 2.00          | %      |
| Unfunded  Loan Commitments                    |   | .25           | %      |
| Concentration  Risk Factor – Real Estate |   | .10           | %      |
| Economic  Risk Factor                         |   | .25           | %      |
| SBA  Loans - Guaranteed portion               |   | 0.00          | %      |
| Cash  Secured Loans                           |   | 0.00          | %      |

 

Although no assurance can be given that actual losseswill not exceed the amount provided for in the allowance, Management believesthat the allowance is adequate to provide for all estimated credit losses inlight of all known relevant factors.  Atthe end of 2002, 2001 and 2000, the Bank’s allowance stood at 1.04 percent,1.06 percent, and 1.05 percent of gross loans, respectively.  Provisions were made to the allowance forloan losses in 2002, 2001 and 2000 of $117,000, $185,000, and $130,000, respectively.  Loans charged off totaled $59,700 in 2002,$88,900 in 2001, and $68,900 in 2000. Recoveries for these same periods were $13,300, $1,800, and $7,400.

 

24

----

 

The Bank’s non-performing (delinquent 90 days or moreand non-accrual) loans as a percentage of total loans were .06 percent .70percent and .03 percent as of the end of 2002, 2001 and 2000, respectively.

 

Based upon statistics released by Federal and statebanking authorities regarding banks of similar size or otherwise located inCalifornia, Management believes that the Bank’s ratios of delinquent and nonperforming loans to total loans 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, noassurance can be given that the Bank’s loan portfolio will continue to measurewell against its peers on these ratios and quality measures, or that losseswill not otherwise occur in the future. 

 

**Non-Interest Income**

 

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

 
|                                                     |                        | **Years Ended December 31,** |     |
|----------------------------------------------------------|-----------------------------|------------------------------|----------|
|                                                     | **2002**                    |                         | **2001** |   | **2000** |   |
|                                                     | **(Dollars  in thousands)** |                         |
| Service  charges on deposit accounts                     |                        | 508                          |     | 494 |   | 418 |   |
| Other  service charges, commissions commissions and fees |                        | 771                          |     | 489 |   | 633 |   |
| Income  from sales and servicing of SBA loans            |                        | 526                          |     | 513 |   | 394 |   |
| Total  non-interest Income                               |                        | 1,805                        |     | 1,496 |   | 1,445 |   |

 

Total non-interest income increased $309,400 (20.69%)in 2002 when compared with 2001. Service charges on deposit accounts increased$14,100, income from sales and servicing of SBA loans increased $13,300 andother service charges, commissions and fees increased $282,000.

 

Total non-interest income increased $50,400 (3.48%) in2001 when compared with 2000. Service charges on deposit accounts increased$76,000, income from sales and servicing of SBA loans increased $118,700; whileother service charges, commissions and fees decreased $80,400.  Merchant credit card processing incomeincreased by $64,400 during 2001 compared to 2000.

 

Total non-interest income increased $191,300 (15.26%)in 2000 when compared with 1999. Service charges on deposit accounts increased$29,100 and other service charges, commissions and fees increased $193,300;while income from sales and servicing of SBA loans decreased $31,000.

 

25

----

 

The sale of Small Business Administration (SBA)guaranteed loans is a significant contributor to the Bank’s income.  SBA guaranteed loans yield up to 3 3/4% overthe New York prime rate, and the guaranteed portions can be sold at premiumswhich vary with market conditions.  SBAloans are guaranteed by the full faith of the United States Government from 70to 80 percent of the principal amount. The guaranteed portion has risks comparable for an investor to a U. S.Government security and can usually be sold in the secondary financial market,either at a premium or at a yield which allows the Bank to maintain asignificant spread for itself.

 

There can be no assurance that the gains on sale willcontinue at, or above, the levels realized in the past three years.  In addition, increasing competition amonglenders for qualified SBA borrowers makes it difficult for the Bank tocontinually expand its program in this area, and may limit the level of premiumthat can be earned with regard thereto. Furthermore, the SBA recently began requiring lenders to share a portionof premiums in excess of 10% earned on the sale of the guaranteed portions.

 

The following table presents a summary of the activityin SBA loans for the years ended 2002, 2001 and 2000:

 
|                  |   | **2002** |      | **2001** |   | **2000**  |   |
|-----------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                  |   |     |      |     |   |      |   |
| SBA  loans authorized |   | $        | 5,916,900 |     | $      | 5,141,000 |   | $ | 8,125,000 |   |
| SBA  loans sold       |   | $        | 4,689,300 |     | $      | 5,264,300 |   | $ | 4,205,300 |   |

 

Summaryof Income from sales andServicing of SBA Loans

 
|                                                |   | **2002** |    | **2001** |   | **2000** |   |
|-----------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Income  from premium                                |   | $        | 332,800 |     | $      | 363,800  |   | $ | 245,000 |   |
| Income  from servicing                              |   | 193,200  |    | 148,900  |   | 150,000  |   |
| Less  loan origination expense                      |   | 0        |    | 0        |   | (1,000   | )      |
| Total  income from sales and servicing of SBA loans |   | $        | 526,000 |     | $      | 512,700  |   | $ | 394,000 |   |

 

26

----

 

**Non-Interest Expense**

 

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

 
|                             |                        | **Years  Ended   December 31,** |     |
|----------------------------------|-----------------------------|-------------------------------------------|----------|
|                             | **2002**                    |                                      | **2001** |   | **2000** |   |
|                             | **(Dollars  in thousands)** |                                      |
| Salaries  and benefits           |                        | 2,201                                     |     | 2,153 |   | 1,927 |   |
| Occupancy  and equipment expense |                        | 372                                       |     | 326 |   | 304 |   |
| Professional  fees               |                        | 84                                        |     | 107 |   | 91 |   |
| Data  Processing                 |                        | 364                                       |     | 244 |   | 249 |   |
| Other  expenses                  |                        | 733                                       |     | 803 |   | 737 |   |
| Total  other Expenses            |                        | 3,754                                     |     | 3,633 |   | 3,309 |   |

 

Salary expense increased $47,000 in 2002 as the resultof adding a business development officer and three full time equivalentpositions to staff the new Carmel-By-The-Sea Branch; these increased werepartially offset by not replacing the President when he left the Bank inFebruary. Salary expense increased $226,800 in 2001 as a result of the additionof an individual as President, employee merit increases and bonus payments.Salary expense increased $184,800 in 2000 as a result of the addition of threefull time equivalent staff positions, merit increases and bonus payments.

 

Occupancy and equipment expenses increased $46,000 in2002, due primarily to expenses related to opening the Carmel-By-The-SeaBranch.  Occupancy and equipmentexpenses increased $21,900 in 2001, with increases of $15,100 in rent expense,$4,000 in depreciation, property taxes $17,600 while utilities decreased $3,700and repair and maintenance decreased $10,000. Occupancy and equipment expenses increased $7,300 in 2000 due toadditional premises rental expense. Occupancy and equipment expenses increased $15,600 in 1999, withincreases of $10,400 in premises rent, $3,900 in depreciation and $3,700 inequipment rental; while utilities decreased $3,000 and net merchant terminalexpense decreased $4,600.

 

Data processing expense increased $120,100 in 2002 dueto expense associated with the development of an internet website, softwarelicense fees for an information management reporting program and increasednumbers of accounts and transaction activity. Data processing expense decreased $5,200 in 2001.  Data processing expense increased $47,100 in2000 as the result of increases in the number of accounts and transactionvolumes and the implementation of a debit card program.

 

In 2002 professional fees decreased $22,400 withaccounting fees increasing $7,100, while legal fees decreased $29,600.  In 2001 professional fees increased $15,600with accounting and audit fees increasing $2,300 and legal fees increasing$13,300.  In 2000 professional feesincreased $17,100 due to accounting fees related to the quarterly review of theCompany’s Form 10-QSB filings and third party loan reviews.

 

27

----

 

Other expenses for 2002 totaled $732,600 compared with$802,500 in 2001, and decrease of $69,900. Significant changes occurred in the following categories with increasesATM expense $4,300, business development $5,200, director fees $3,100,insurance expense $26,000, prepaid card expense $5,200, messenger & freight$20,100, stationary/supply expense $11,500 and telephone expense $5,200; whiledecreases occurred in auto allowance/expense $8,300, security $15,600, collectionsexpense $24,400, miscellaneous expense $8,900, postage $13,300, donations$10,900, entertainment/meals $3,800, FDIC & State assessments $5,800, loanexpense $3,800,  operations losses$55,200, postage $13,300 and bank security $15,600.

 

Other expenses for 2001 totaled $808,200 compared with$737,400 in 2000, and increase of $70,300. Significant changes occurred in the following categories with increasesATM expense $6,400, auto allowance/expense $8,000, bank fees $17,600,collections expense $16,600, donations $5,400, entertainment/meals $5,300, FDIC& State assessments $10,100, loan expense $5,900, messenger & freight$4,700, miscellaneous expense $17,800, postage $4,100, security $14,400 andshareholder expense $4,500; while decreases occurred in business development$2,600, operations losses $28,500, subscriptions/publications $5,300 and travel$12,200.

 

Other expenses for 2000 totaled $737,400 compared with$671,000 for 1999, an increase of $64,300. Significant changes occurred in the following categories with inincreases advertising $32,500, director fees $5,500, entertainment/meals$23,200, donations $6,800, FDIC & State assessments $14,300, bank fees$3,600, ATM expense $3,200, messenger & freight $3,100, postage $4,300,operations losses $11,400; while decreases occurred in collection expense$11,300, stationary & supplies $12,000, insurance $18,100.

** **

**IncomeTaxes**

 

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

 

28

----

 

Allocation of federal and state income taxes betweencurrent and deferred portions is as follows:

 
|                               |   | **Years Ended December 31,** |    |
|------------------------------------|--------|------------------------------|---------|
|                               |   | **2002**                     |    | **2001** |   | **2000** |   |
| Current tax  provision:            |   |                         |    |   |   |   |   |
| Federal                            |   | $                            | 216,400 |   | $ | 228,300 |   | $ | 168,000 |   |
| State                              |   | 81,300                       |    | 82,900 |   | 115,600 |   |
|                               |   | 297,700                      |    | 311,200 |   | 283,600 |   |
| Deferred tax  provision (benefit): |   |                         |    |   |   |   |   |
| Federal                            |   | 45,000                       |    | (63,900 | ) | 63,400 |   |
| State                              |   | 11,300                       |    | (16,000 | ) | 14,900 |   |
|                               |   | 56,300                       |    | (79,900 | ) | 78,300 |   |
|                               |   | $                            | 354,000 |   | $ | 231,300 |   | $ | 361,900 |   |

 

The reasons for the differences between the statutoryfederal income tax rate and the effective tax rates are summarized as follows:

 
|                                     |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Statutory  federal tax rate              |   | 34.00    | %      | 34.00    | %      | 34.00    | %      |
| State taxes,  net of federal tax benefit |   | 7.20     |   | 7.20     |   | 7.20     |   |
| Other, net                               |   | (0.16    | )      | (2.20    | )      | (8.25    | )      |
| Effective tax  rates                     |   | 41.04    | %      | 39.00    | %      | 32.95    | %      |

 

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: 

 
|                    |   | **2002** |    | **2001** |   |
|-------------------------|--------|----------|---------|----------|--------|
| Deferred  tax asset     |   |     |    |     |   |
| Federal                 |   | $        | 217,700 |     | $      | 262,900 |   |
| State                   |   | 61,000   |    | 68,000   |   |
| Net  deferred tax asset |   | $        | 278,700 |     | $      | 330,900 |   |

 

29

----

 

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

 
|                                      |   | **2002** |    | **2001** |   |
|-------------------------------------------|--------|----------|---------|----------|--------|
| Deferred  tax asset (liabilities)         |   |     |    |     |   |
| Investments:                              |   |     |    |     |   |
| Net  unrealized (gain) loss on securities |   | $        | 66,300  |     | $      | 103,800 |   |
| State  franchise tax                      |   | 48,400   |    | 51,300   |   |
| Allowance  for loan losses                |   | 236,500  |    | 209,300  |   |
| Depreciation                              |   | (72,500  | )       | (33,500  | )      |
| Net  deferred tax asset                   |   | $        | 278,700 |     | $      | 330,900 |   |

 

As of December 31, 2002and 2001, management expects all temporary differences to be offset againstfuture taxable income, and no valuation reserve was deemed necessary.

 

**LOANS**

 

Loans, the largestcomponent of earning assets, represented 79.49% of average earning assets, and75.49% of average total assets during 2002, compared with 69.93% and 72.62%,respectively during 2001.  In 2002,average loans increased 16.86% from $48,569,600 in 2001 to $56,757,700.  Average real estate loans increased$6,470,900 (20.70%), average construction loans decreased $661,000 (29.92%) andaverage commercial loans increased $1,119,100 (7.81%); while averageinstallment loans decreased $62,900 (8.20%).

 

Loan policies andprocedures provide the overall direction to the administration of the loanportfolio.  The Bank’s loan underwritingprocess is intended to encourage sound and consistent credit decisions aremade.  Emphasis is placed upon creditquality, the borrower’s ability to repay through cash flow, secondary, and(occasionally, tertiary) repayment sources, and the value of collateral.

 

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

 

The Bank is therecognized leader for Small Business Administration lending in Monterey County,and holds SBA’s coveted Preferred Lender Status.  Generally, SBA loans are guaranteed by the SBA for 70 to 80percent of their principal amount, which can be retained in portfolio or soldto investors.  Such loans are made atfloating interest rates, but generally for longer terms (up to 25 years) thanare available on a conventional basis to small businesses. The

 

30

----

 

unguaranteed portion of the loans, although generally supported bycollateral, is considered to be more risky than conventional commercial loansbecause they may be based upon credit standards the Bank would not otherwiseapply, such as lower cash flow coverage, or longer repayment terms.

 

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

 

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

 

Consumer loans are madefor the purpose of financing the purchase of various types of consumer goods,home improvement loans, auto loans and other personal loans.  Consumer installment loans generally providefor monthly payments of principal and interest, at a fixed rate.  Most of the Bank’s consumer installmentloans are generally secured by the personal property being purchased.  The Bank generally makes consumer loans tothose customers with a prior banking relationship with the Bank.

 

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

 
|                                   |   | **Years  Ended December 31,** |   |
|----------------------------------------|--------|-------------------------------|--------|
|                                   |   | **2002**                      |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                   |   | **(Dollars in thousands)**    |   |
| Commercial  and industrial             |   | 14,432                        |   | 14,469 |   | 12,988 |   | 11,441 |   | 12,084 |   |
| Real  estate, construction             |   | 4,066                         |   | 1,896 |   | 2,314 |   | 3,459 |   | 356 |   |
| Real  estate, mortgage                 |   | 42,000                        |   | 36,010 |   | 27,802 |   | 23,788 |   | 15,294 |   |
| Installment                            |   | 462                           |   | 703 |   | 518 |   | 435 |   | 390 |   |
| Government  guaranteed loans purchased |   | 63                            |   | 130 |   | 139 |   | 145 |   | 159 |   |
|                                   |   | 61,024                        |   | 53,207 |   | 43,760 |   | 39,267 |   | 28,282 |   |
| Less:                                  |   |                          |   |   |   |   |   |   |   |   |   |
| Allowance  for possible loan losses    |   | (637                          | )      | (566 | ) | (468 | ) | (400 | ) | (336 | ) |
| Deferred  origination fees, net        |   | (130                          | )      | (79 | ) | (41 | ) | (49 | ) | (32 | ) |
| Net  Loans                             |   | 60,257                        |   | 52,562 |   | 43,251 |   | 38,817 |   | 27,914 |   |

 

31

----

 

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

 

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

 

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

 
|                                                          |   | **As of  December 31,**     |   |
|---------------------------------------------------------------|--------|-----------------------------|--------|
|                                                          |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                          |   | **(Dollars  in thousands)** |   |
| Accruing,                                                     |   |                        |   |   |   |   |   |   |   |   |   |
| past  due 90 days or more:                                    |   |                        |   |   |   |   |   |   |   |   |   |
|                                                          |   |                        |   |   |   |   |   |   |   |   |   |
| Real  Estate                                                  |   | 0                           |   | 0 |   | 0 |   | 63 |   | 63 |   |
| Commercial                                                    |   | 0                           |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Installment                                                   |   | 0                           |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Total  accruing                                               |   | 0                           |   | 0 |   | 0 |   | 63 |   | 63 |   |
|                                                          |   |                        |   |   |   |   |   |   |   |   |   |
| Nonaccrual  Loans:                                            |   |                        |   |   |   |   |   |   |   |   |   |
|                                                          |   |                        |   |   |   |   |   |   |   |   |   |
| Real  Estate                                                  |   | 0                           |   | 320 |   | 0 |   | 0 |   | 0 |   |
| Commercial                                                    |   | 24                          |   | 50 |   | 15 |   | 125 |   | 57 |   |
| Installment                                                   |   | 10                          |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Total  nonaccrual                                             |   | 34                          |   | 370 |   | 15 |   | 125 |   | 57 |   |
|                                                          |   |                        |   |   |   |   |   |   |   |   |   |
| Total  nonperforming                                          |   | 34                          |   | 370 |   | 15 |   | 188 |   | 120 |   |
|                                                          |   |                        |   |   |   |   |   |   |   |   |   |
| Total  loans end of period                                    |   | 61,024                      |   | 53,207 |   | 43,760 |   | 39,267 |   | 28,282 |   |
|                                                          |   |                        |   |   |   |   |   |   |   |   |   |
| Ratio  of nonperforming loans to total loans at end of period |   | 0.06                        | %      | 0.70 | % | 0.03 | % | 0.48 | % | 0.42 | % |

 

The low level of non-performing loans is the result ofunderwriting criteria intended to be conservative, frequent review of new anddelinquent loans and a firm collection policy (with the assistance of outsidelegal counsel).  The Bank does not haveany foreign loans or loans for highly leveraged transactions.

 

32

----

 

**Summary of Loan Loss Experience**

 
| ** **                                                                     |                        | **For the  Years ended December 31,** |     |
|--------------------------------------------------------------------------------|-----------------------------|---------------------------------------|----------|
|                                                                           | **2002**                    |                                  | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                           | **(Dollars  in thousands)** |                                  |
| Average  loans outstanding                                                     |                        | 56,758                                |     | 48,570 |   | 41,512 |   | 34,115 |   | 27,414 |   |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Allowance,  beginning of period                                                |                        | 566                                   |     | 468 |   | 400 |   | 336 |   | 269 |   |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Loans  charged off during period:                                              |                        |                                  |     |   |   |   |   |   |   |   |   |
| Commercial                                                                     |                        | 58                                    |     | 80 |   | 67 |   | 128 |   | 69 |   |
| Installment                                                                    |                        | 1                                     |     | 9 |   | 2 |   | 0 |   | 5 |   |
| Real  Estate                                                                   |                        | 1                                     |     | 0 |   | 0 |   | 0 |   | 2 |   |
| Other                                                                          |                        | 0                                     |     | 0 |   | 0 |   | 1 |   | 0 |   |
| Total  charge offs                                                             |                        | 60                                    |     | 89 |   | 69 |   | 129 |   | 75 |   |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Recoveries  during period:                                                     |                        |                                  |     |   |   |   |   |   |   |   |   |
| Commercial                                                                     |                        | 13                                    |     | 1 |   | 7 |   | 13 |   | 12 |   |
| Installment                                                                    |                        | 0                                     |     | 1 |   | 0 |   | 5 |   | 1 |   |
| Other                                                                          |                        | 0                                     |     | 0 |   | 0 |   | 0 |   | 0 |   |
| Total  recoveries                                                              |                        | 13                                    |     | 2 |   | 7 |   | 18 |   | 13 |   |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Net  Loans charged off during the period                                       |                        | 46                                    |     | 87 |   | 62 |   | 111 |   | 63 |   |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Additions  to allowance for possible loan losses                               |                        | 117                                   |     | 185 |   | 130 |   | 174 |   | 130 |   |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Allowance,  end of period                                                      |                        | 637                                   |     | 566 |   | 468 |   | 400 |   | 336 |   |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Ratio  of net loans charged off to average Loans outstanding during the period |                        | 0.08                                  | %        | 0.18 | % | 0.15 | % | 0.32 | % | 0.23 | % |
|                                                                           |                        |                                  |     |   |   |   |   |   |   |   |   |
| Ratio  of allowance to total at end of period                                  |                        | 1.04                                  | %        | 1.06 | % | 1.05 | % | 1.01 | % | 1.18 | % |

 

**Funding Sources**

 

Average deposits increased 6.43% to $68,093,900 in2002 from $63,979,700 in 2001.  In 2002average certificates of deposit increased 2.68%, average demand depositsincreased 4.46% and average interest checking, money market and savingsaccounts as a group increased 17.39%. Average certificates of deposit represented 53.50% of average depositsin 2002 compared with 55.45% in 2001. Average interest checking, money market and savings accounts as a groupwere 

 

33

----

 

25.23% of averagedeposits in 2002 compared with 22.87% in 2001. Average demand deposits represented 21.67% of average deposits in 2002compared with 21.67% in 2001.

 

The Corporation borrowed $1,000,000 on an unsecuredbasis from United Security Bank, Fresno, California on June 28, 2001.  The rate of interest is the United SecurityBank Reference Rate (the “Index”) plus .750 percentage points over theIndex.  The note requires monthlyinterest payments beginning August 5, 2001 and quarterly principal and interestpayments beginning October 5, 2002 through April 5, 2011 and a final payment ofprincipal and interest on July 5, 2011. The proceeds from the borrowing wereused to payoff an $800,000 term loan and to pay down the $200,000 line ofcredit with Pacific Coast Bankers’ Bank. The Corporation renewed the $200,000 revolving line of credit for oneyear, with interest due monthly.  Thecredit line is secured by 93,069 shares of Monterey County Bank stock.  The rate of interest on the credit line isthe prime rate as published in the Wall Street Journal (the “Index”) plus .750percentage points over the Index, with floor rate of 6.50%.  At December 31, 2002, the interest rate onthe term note was 5.00% and the interest rate on the line of credit was6.50%.  The outstanding principalbalances on the term note and line of credit were $972,200 and $200,000,respectively.

 

The Bank has lines of credit from the Federal HomeLoan Bank of San Francisco and Pacific Coast Bankers’ Bank with maximumborrowing limits on December 31, 2002 of $6,898,200 and $2,500,000,respectively.  The Federal Home LoanBank line of credit is secured by certain of the Bank’s real estate securedloans and securities at December 31, 2002 the total principal balances ofpledged loans was $12,840,400 and securities of $4,553,300.  The following table provides information onseven (7) advances totaling $10,750,000 outstanding at December 31, 2002.

 

| **Advance  Amount** |   | **Interest  Rate** |   | **Funding  Date** |   | **Maturity  Date** |   |
|---------------------|--------|--------------------|--------|-------------------|--------|--------------------|--------|
| 1,000,000           |   | 4.83               | %      | 10/6/1998         |   | 10/6/2003          |   |
| 1,000,000           |   | 6.81               | %      | 6/3/1997          |   | 6/3/2004           |   |
| 1,000,000           |   | 6.86               | %      | 8/10/2000         |   | 8/10/2005          |   |
| 2,750,000           |   | 3.44               | %      | 9/27/2002         |   | 9/27/2007          |   |
| 2,750,000           |   | 3.44               | %      | 9/27/2002         |   | 9/27/2007          |   |
| 100,000             |   | 2.89               | %      | 10/29/2002        |   | 10/31/2005         |   |
| 3,900,000           |   | 2.83               | %      | 10/29/2002        |   | 10/31/2005         |   |

 

The Pacific CoastBankers’ Bank line of credit is unsecured. The Bank did not utilize any overnight borrowings in 2002, 2001 or 2000.

** **

**LoanGuarantee**

 

The Corporation guaranteed a loan for CommunityBankers’ Insurance Agency, LLC.  TheCorporation’s liability under the guarantee agreement, which matured September14, 2002, is limited to $20,000.  Theloan for Community Bankers’ Insurance Agency, LLC was paid off September 14,2002; therefore the Corporation has no further liability under the guaranteeagreement.

 

34

----

 

**Capital Resources**

 

The Corporation maintainscapital to comply with legal requirements, to provide a margin of safety forits depositors and stockholders, and to provide for future growth and theability to pay dividends.  At December31, 2002, stockholders’ equity was $5,638,900 versus $5,086,900 at December 31,2001.  The Corporation issued 10% stockdividends in 2002, 2001 and 2000.  TheBank paid cash dividends totaling $75,000, $200,000, and $100,000, to theCorporation in 2002, 2001 and 2000, respectively.

 

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

 

In general, therisk-based capital guidelines provide detailed definitions of which obligationswill be treated as capital, and assign different weights to various assets andoff-balance sheet items, depending upon the perceived degree of credit riskassociated with each asset.  Each assetis assigned to one of four risk-weighted categories.  For example, 0 percent for cash and unconditionally guaranteedgovernment securities; 20 percent for deposits with other banks and fed funds;50 percent for state bonds and certain residential real estate loans; and 100percent for commercial loans and other assets. Capital is categorized as either Tier 1 capital, consisting of commonstock and retained earnings (or deficit), or Tier 2 capital, which includeslimited-life preferred stock and allowance for loan losses (subject to certainlimitations).  The guidelines alsodefine and set minimum capital requirements (risk-based capital ratios), whichincreased over a transition period, ended December 31, 1992.  Under the final 1992 rules, all banks wererequired to maintain Tier 1 capital of at least 4 percent and total capital of8.0% of risk-adjusted assets. The Bank had a Tier 1 capital ratio of 9.40% and9.32% at December 31, 2002 and 2001, respectively, and a total risk-basedcapital ratio of 10.24% and 10.24% at December 31, 2002 and 2001, respectively.

 

The leverage capitalratio guidelines require a minimum leverage capital ratio of 3% of Tier 1capital to total assets less goodwill. The Bank had a leverage capital ratio of 7.24% and 7.52% at December 31,2002 and 2001, respectively.

 

The Company is in theprocess of establishing a Delaware statutory trust for sole purpose of issuingtrust preferred stock for sale into a trust preferred pool with Bear, Stearns& Co. Inc acting as Placement Agent. The trust preferred stock will be treated as Tier 1 capital for theCompany; since it will have a thirty (30) year maturity, is deeply subordinatedto other debt, is not callable in less than five (5) years and provides fordeferral of interest payments for up to sixty (60) months in certaincircumstances.  The trust preferredstock will bear interest at the average three month LIBOR rate plus 3.25% andwill adjust quarterly.  The cost,approximately $115,800, associated with the trust preferred stock issuance willbe amortized over thirty (30) year term. The Company anticipates the transaction will be completed in the firstquarter of 2003.

 

36

----

 

**Liquidity**

 

Liquidity represents abank’s ability to provide sufficient cash flows or cash resources in a mannerthat enables it to meet obligations in a timely fashion and adequately providesfor anticipated future cash needs.  Forthe Bank, 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 the Bank’s business, funds are generated fromthe repayment of loans, maturities within the investment securities portfolioand the acquisition of deposit balances and short-term borrowings.  In addition, the Bank has lines of creditfrom the Federal Home Loan Bank of San Francisco of approximately $11,563,600and a $2,500,000 federal funds line of credit with the Pacific Coast Bankers’Bank to meet temporary liquidity requirements.

 

As a matter of policy,the Bank seeks to maintain a level of liquid assets, including marketableinvestment securities, equal to a least 15 percent of total assets (“primaryliquidity”), while maintaining sources of secondary liquidity (borrowing linesfrom other institutions) equal to at least an additional 10 percent ofassets.  In addition, it seeks togenerally limit loans to not more than 90 percent of deposits.  Withinthese ratios, the Bank generally has excess funds available to sell as federalfunds on a daily basis, and is able to fund its own liquidity needs without theneed of short-term borrowing.  TheBank’s primary liquidity at December 31, 2002, 2001 and 2000 was 22.22 percent,25.79 percent, and 27.88 percent respectively, while its average loan todeposit ratio for such years was 83.35 percent, 75.91 percent and 70.09 percentrespectively.  On December 29, 2000the Bank received wire transfers totaling $10,030,000 for credit to twodemand deposit accounts.  These depositswere temporary in nature, remaining on deposit until January 12, 2001.  These temporary deposits inflated the Bank’sprimary liquidity ratio, adjusting for these deposits the Bank’s primaryliquidity ratio would have been 18.03%.

 

Brokered deposits aredeposit instruments, such as certificates of deposit, deposit notes, bankinvestment contracts and certain municipal investment contracts that are issuedthrough brokers and dealers who then offer and/or sell these depositinstruments to one or more investors. Additionally, deposits on which a financial institution pays an interestrate significantly higher than prevailing rates are considered to be brokereddeposits.  Federal law and regulationrestricts banks from soliciting or accepting brokered deposits, unless the bankis well capitalized under Federal guidelines. The Bank does not have any brokered deposits.

 

Management of interestrate sensitivity (asset/liability management) involves matching and repricingrates of interest-earning assets with interest-bearing liabilities in a mannerdesigned to optimize net interest income within the constraints imposed byregulatory authorities, liquidity determinations and capitalconsiderations.  The Bank institutedformal asset/liability policies at the end of 1989.

 

The purpose forasset/liability management is to provide stable net interest income growth byprotecting the Bank’s earnings from undue interest rate risk.  The Bank expects to generate earnings fromincreasing loan volume, appropriate loan pricing and expense control and notfrom trying to accurately forecast interest rates.  Another important function of asset/liability management ismanaging the risk/return relationships between interest rate risk, liquidity,market risk and capital adequacy.  TheBank gives priority to liquidity concerns followed by capital adequacy, theninterest rate risk and market risk in the investment portfolio.  The policy of the

 

37

----

 

Bank will be to controlthe exposure of the Bank’s earnings to changing interest rates by generallymaintaining a position within a narrow range around an “earnings neutralposition.” An earnings neutral position is defined as the mix of assets andliabilities that generate a net interest margin that is not affected byinterest rate changes.  However,Management does not believe that the Bank can maintain a totally earningsneutral position.  Further, the actualtiming of repricing of assets and liabilities does not always correspond to thetiming assumed by the Bank for analytical purposes.  Therefore, changes in market rates of interest will generallyimpact on the Bank’s net interest income and net interest margin for long orshort periods of time.

 

The Bank monitors itsinterest rate risk on a quarterly basis through the use of a model which calculatesthe effect on earnings of changes in the fed funds rate.  The model converts a fed funds rate changeinto rate changes for each major class of asset and liability, then simulatesthe bank’s net interest margin based on the bank’s actual repricing over a oneyear period, assuming that maturities are reinvested in instruments identicalto those maturing during the period.  AtDecember 31, 2002 the affect of a 2% increase in the fed funds rate, expressed,as a percentage of equity was a positive 7.3%. At December 31, 2002 the fedfunds target rate was 1.25%; therefore, the model assumed a 1% decrease in thefed funds rate resulting in negative affect on capital of 5.6% .

 

The Corporation’s sourcesof revenues and liquidity are the dividends, tax equalization payments ormanagement fees from the Bank, gains on securities held in a trading accountand the line of credit from the Pacific Coast Bankers’ Bank.  The ability of the Bank to pay such items tothe Corporation is subject to limitations under state and Federal law.

 

38

----

 

**Investment Securities**

 

The Corporation maintainsa trading account, at fair value, consisting of marketable securities.  At December 31, 2002 the account value was$82,200.  In addition the Corporationhas a $25,000 investment in Mission Valley Bank stock and a $204,200 investmentin AT Service LLC.  In 2001 theCorporation took a charge to earnings of $40,000 representing its investment inthe Community Bank Insurance Agency, LLC.

 

The following table setsforth the book and market value of the Bank’s investment securities as ofDecember 31, 2002 and 2001:

 
|                                      |   | **INVESTMENT PORTFOLIO MIX** |   |
|-------------------------------------------|--------|------------------------------|--------|
|                                      |   | **(Dollars in thousands)**   |   |
|                                      |   | **2002**                     |   | **2001** |   |
|                                      |   | **Book  value**              |   | **Market  value** |   | **Book  value** |   | **Market  value** |   |
| Available  for sale:                      |   |                         |   |   |   |   |   |   |   |
| Corporate  Debt Securities                |   | 1,508                        |   | 1,487 |   | 3,495 |   | 3,470 |   |
| Government  National Mortgage Association |   | 4,560                        |   | 4,553 |   | — |   | — |   |
| U.S.  Government Agencies                 |   | —                       |   | — |   | 6,000 |   | 6,008 |   |
| Total                                     |   | 6,068                        |   | 6,040 |   | 9,495 |   | 9,478 |   |
|                                      |   |                         |   |   |   |   |   |   |   |
| Other  Securities:                        |   |                         |   |   |   |   |   |   |   |
| Federal  Home Loan Bank Stock             |   | 541                          |   | 541 |   | 286 |   | 286 |   |
| Pacific  Coast Bankers’ Bank Stock   |   | 440                          |   | 440 |   | 440 |   | 440 |   |
| Total                                     |   | 981                          |   | 981 |   | 726 |   | 726 |   |

 

The following table summarizes the maturity of theBank’s investment securities at December 31, 2002:

 
|                            |   | **INVESTMENT PORTFOLIO MATURITIES** |   |
|---------------------------------|--------|-------------------------------------|--------|
|                            |   | **(Dollars in thousands)**          |   |
|                            |   | **Available  for Sale**             |   |
|                            |   | **Amortized  Cost**                 |   | **Fair  Value** |   |
| Due  between one and five years |   | 758,400                             |   | 747,800 |   |
| Due  between five and ten years |   | —                              |   | — |   |
| Over  ten years                 |   | 5,309,900                           |   | 5,292,000 |   |
|                            |   | 6,068,300                           |   | 6,039,800 |   |

 

39

----

 

**ITEM7. FINANCIAL STATEMENTS**

 

The following consolidated financial statementsincluded in the Consolidated Financial Report issued by Hutchinson andBloodgood LLP, Certified Public Accountants at the pages indicated areincorporated herein by reference:

 
| Independent Auditors’  Report on the Financial Statements                                                                      |
|-------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                |
| Consolidated Balance Sheets  at December 31, 2002 and 2001                                                                          |
|                                                                                                                                |
| Consolidated  Statements of Operations for each of the three years in the period ended  December 31, 2002                           |
|                                                                                                                                |
| Consolidated  Statements of Changes in Stockholders’ Equity for each of the three years in  the period ended December 31, 2002 |
|                                                                                                                                |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2002                           |
|                                                                                                                                |
| Notes to  Consolidated Financial Statements                                                                                         |

 

**ITEM8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE**

 

The Company had no disagreements with its independentaccountants on any matter of accounting principles, practices or financialstatement disclosure during 2002, 2001 or 2000.

 

40

----

 

**PARTIII**

 

**ITEM9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCEWITH SECTION 16(a) OF THE EXCHANGE ACT**

 

The name, age, title and five-year business backgroundof each director, executive officers and significant employees of theCorporation (including the Bank) as of December 31, 2002, 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 |   | 61      |   | Chairman of the Board  & Chief Executive Officer Monterey County Bank since 3/87                                                                                                                                                     |
|                                                                                                     |   |    |   |                                                                                                                                                                                                                                     |
| Sandra  G. Chrietzberg  Director, 1988 to 1994 and  since 1995                                           |   | 59      |   | Formerly President and  CEO Queen of Chardonnay, Inc., dba La Reina Winery 8/84-12/93                                                                                                                                                    |
|                                                                                                     |   |    |   |                                                                                                                                                                                                                                     |
| Peter  J. Coniglio, Esq.  Director since 1976                                                            |   | 73      |   | Partner - Hudson,  Martin, Ferrante & Street, Monterey                                                                                                                                                                               |
|                                                                                                     |   |    |   |                                                                                                                                                                                                                                     |
| Carla  S. Hudson, CPA  Director since 1994                                                               |   | 49      |   | Partner - Huey and  Hudson, Certified Public Accountants                                                                                                                                                                                 |
|                                                                                                     |   |    |   |                                                                                                                                                                                                                                     |
| John  M. Lotz  Director since 1991                                                                       |   | 61      |   | 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.                                        |
|                                                                                                     |   |    |   |                                                                                                                                                                                                                                     |
| Bruce  N. Warner  Executive Vice President,  Chief Financial Officer  and Chief Operating Officer        |   | 55      |   | 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. |

 

41

----

 
| Andre  G. Herrera  Vice President          |   | 38     |   | 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; Vice President, Manager Management Information Systems and  Merchant Services since 2/94. |
|--------------------------------------------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                       |   |   |   |                                                                                                                                                                                                                                                                                         |
| Mary  Ellen Stanton  Senior Vice President |   | 65     |   | Senior Vice President,  Loan Administration, Monterey County Since 10/98.                                                                                                                                                                                                                    |
|                                       |   |   |   | Vice President, Loan  Administration, Monterey County Bank 10/88.                                                                                                                                                                                                                            |

 

Directors of the Corporation serve in similarcapacities with the Bank.  Executiveofficers of the Bank serve in similar capacities with the Corporation, althoughthe limited operations of the Corporation do not require significant amounts oftheir time.  There are no familyrelationships among the persons listed above, except that Mr. and Mrs. Chrietzbergare spouses.

 

Based solely upon a review of the relevant formsfurnished to the Bank and the Corporation, except as disclosed below, theCorporation believes that all officers, directors and principal shareholdersfiled appropriate forms as required by Section 16(a) of the Exchange Act, and relatedregulations, during 2002.

 

42

----

 

**ITEM10. EXECUTIVE COMPENSATION**

 

The following tables sets forth certain informationregarding the compensation paid to the officers of the Corporation/Bank whosesalary and bonus exceeded $100,000 for 2001.

 
|                               |   | **Annual Compensation** |   | **Long Term Compensation Awards** |    |
|------------------------------------|--------|-------------------------|--------|-----------------------------------|---------|
| **Name &  Principal Position** |   | **Salary**              |   | **Bonus**                         |    | **Other  AnnualCompensation** |   | **Restricted  StockAwards** |   | **Securities  UnderlyingOptions/SARs** |   | **All OtherCompensation** |   |
|                               |   |                    |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Charles  T. Chrietzberg, Jr.       |   | 2002                    |   | $                                 | 190,914 |   | $ | 161,000 |   | $ | 3,274 | (1) | None |   | 30,000 |   | $ | 0 | (2) |
| Chairman  & CEO                |   | 2001                    |   | $                                 | 181,296 |   | $ | 160,800 |   | $ | 3,420 | (1) | None |   | None |   | $ | 572 | (2) |
|                               |   | 2000                    |   | $                                 | 187,713 |   | $ | 160,000 |   | $ | 2,670 | (1) | None |   | 10,000 |   | $ | 11,541 | (2) |
|                               |   |                    |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Bruce  N. Warner                   |   | 2002                    |   | $                                 | 99,379  |   | $ | 26,605 |   | None |   | None |   | 10,000 |   | None |   |
| Senior  Vice President,            |   | 2001                    |   | $                                 | 90,773  |   | $ | 23,400 |   | None |   | None |   | None |   | None |   |
| Chief  Financial Officer           |   | 2000                    |   | $                                 | 86,461  |   | $ | 49,317 |   | None |   | None |   | 7,000 |   | None |   |
| Chief  Operating Officer           |   |                    |   |                              |    |   |   |   |   |   |   |   |   |   |   |
|                               |   |                    |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Andre  G. Herrera                  |   | 2002                    |   | $                                 | 99,405  |   | $ | 18,459 |   | None |   | None |   | 2,000 |   | None |   |
| Vice  President,                   |   | 2001                    |   | $                                 | 94,110  |   | $ | 6,571 |   | None |   | None |   | None |   | None |   |
| Chief  Information Officer         |   | 2000                    |   | $                                 | 94,606  |   | $ | 19,726 |   | None |   | None |   | 5,000 |   | None |   |

 

----

(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.

 

The Bank leases an automobile for the use of its ChiefExecutive Officer (the value of his personal use of the automobile is includedabove).  The Bank furnishes, on anon-discriminatory basis, to the employees: (i) insurance benefits; and  (ii) other benefits.  The value of these benefits (excludingnon-discriminatory plan benefits) was less than the lesser of $50,000 or tenpercent of the compensation shown above for the respective persons or group, andis not included in the table.

 

The Board of Directors authorized the Bank to enterinto a three year employment contract with Mr. Chrietzberg, effective January1, 2003.  It provides for a base salaryof $180,000 per year, a Bank furnished automobile or automobile allowance, anda bonus based on profits.  The bonus,not to exceed $220,000 annually, will equal $10,000 for each 0.1 percent thatthe Bank’s profits exceed 1.0 percent return on average assets plus $10,000 foreach 1 percent that the Bank’s return on equity exceeds 10.0 percent.  Under the terms of the contract, if Mr.Chrietzberg is terminated other than for cause (as defined in the contract), heis entitled to severance compensation for his monthly salary plus a pro ratedincentive bonus for the greater of 24 months or the remaining term of hiscontract (which ends in December, 2005); however, if the termination followswithin twelve (12) months after a change in control transaction (as defined inthe contract), he is entitled to such severance compensation for the greater of24 months or the remainder of the term of the contract.

 

43

----

 

The following tables set forth certain informationregarding the long term incentive plan provided for Mr. Chrietzberg.

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

 

In December, 1993, the Board of Directors approved aSalary Continuation Agreement for the benefit of Mr. Chrietzberg that providedfor payments of $75,000 per year, for 15 years, if he remains with the Bankuntil normal retirement, commencing age 65. After consideration of the impact of such an agreement on the Bank’sincome, the Bank amended the Agreement to provide for one half the originalbenefit amounts, but adopted Surviving Income Agreements which provide benefitsupon the death of the executive to his beneficiary in a single payment, in anamount equal to the retirement benefit. The Salary Continuation Agreement provides for lesser payments in theevent of early retirement, generally designated to coincide with increases inthe anticipated surrender value for the life insurance policies describedbelow.

 

In August, 2001, the Board of Directors amended theSalary Continuation Agreement for the benefit of Mr. Chrietzberg which wasapproved in December, 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.Chrietzberg die before his sixty-fifth (65th) birthday; hisbeneficiary(ies) shall be entitled to an amount equal to $2,940,000 or the netat risk insurance portion of the proceeds, whichever amount is less.  The net at risk insurance portion is thetotal proceeds less the cash value of the policy.  Should Mr. Chrietzberg die on or subsequent to his sixty-fifth(65th) birthday, his beneficiary(ies) shall be entitled to an amountequal to $1,000,000 plus the present value of the remaining retirement benefitsdue to Mr. Chrietzberg or the net at risk insurance portion of the proceeds,whichever is less, and the Bank shall be entitled to the remainder of suchproceeds.

 

The Bank’s obligations under the Salary ContinuationAgreement are not secured by any segregated amounts, but are informally fundedby the purchase of single-premium life insurance policies.  The salary continuation expense accrued netof earnings on life insurance policies in 2002, 2001 and 2000 was $0, $600, and$11,500, respectively.  Based upon thecurrent projected earnings of the insurance used to informally fund the Bank’sobligations under the Agreement, and the anticipated salary continuationexpense to be booked, net of tax benefits, the Bank anticipates (based uponcurrent tax laws and assumptions regarding the yield on alternativeinvestment(s) that the cost of the benefits to be provided under the agreementwill not have a material adverse impact on the Bank’s net income after taxes inthe future, although no assurance can be given in this regard.  The Surviving Income Agreement wasterminated upon adoption of the amended Salary Continuation Agreement.

 

44

----

 

The following table sets forth certain informationconcerning the grant of stock options under the Corporation’s’ 1998 AmendedStock Option Plan to the named executive officer during the year ended December31, 2002.

 

Option/SAR Grantsin Last fiscal Year

 
| **Name**                     |   | **Number ofSecurities  Underlying  Options/Sars  granted (#)** |   | **Percent oftotal options/  SARs granted  to employees  in fiscal year** |   | **Exercise or  base price  ($/Sh)** |   | **Expiration  date** |   |
|------------------------------|--------|----------------------------------------------------------------|--------|--------------------------------------------------------------------------|--------|-------------------------------------|--------|----------------------|--------|
| Charles  T. Chrietzberg, Jr. |   | 30,000                                                         |   | 45.45                                                                    | %      | 3.30                                |   | 2/23/07              |   |
| Bruce  N. Warner             |   | 10,000                                                         |   | 15.15                                                                    | %      | 3.00                                |   | 2/23/07              |   |

 

The following table sets forth the number of shares ofCommon Stock acquired by each of the named executive officers upon exercise ofstock options during 2002, the net value realized upon exercise, the number ofshares of Common Stock represented by outstanding stock options held by each ofthe named executive officers as of December 31, 2002 and the value of suchoptions based on the last transaction in 2002, which the Corporation hasknowledge of, and certain information concerning unexercised options under the1998 Amended Stock Option Plan.

 

AggregatedOption/Sar Exercises in Last Fiscal Yearand FY-End Options/Sar Values

 
|                        |   | **Shares  Acquired********on** |   | **Value**        |   | **Number of  Unexercised  Options/SARs at  FY-End(#)** |   | **Value of  Unexercised  in-the-Money  Options/SARs at  FY-End ($)** |   |
|-----------------------------|--------|--------------------------------|--------|------------------|--------|--------------------------------------------------------|--------|----------------------------------------------------------------------|--------|
| **Name**                    |   | **Exercise (#)**               |   | **Received ($)** |   | **Exercisable**                                        |   | **Unexercisable**                                                    |   | **Exercisable** |   | **Unexercisable** |   |
| Charles T. Chrietzberg, Jr. |   | None                           |   | None             |   | 86,573                                                 |   | None                                                                 |   | 52,719 |   | None |   |
| Bruce N. Warner             |   | 14,641                         |   | 16,423           |   | 28,370                                                 |   | None                                                                 |   | 19,110 |   | None |   |

 

In 2002, each director received a standard fee of $500per regular board meeting attended and $150 for each committee meetingattended.  The Chair of the AuditCommittee received a fee of $300 for each committee meeting attended.

 

45

----

 

**ITEM11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

To the knowledge of the management of the Company, thefollowing shareholders own more than five percent (5%) of the outstandingcommon stock of the Company, its only class of voting securities.

 
| **Name and  Address**        |   | **Amount and Nature of  Beneficial Ownership** |   | **Percent of  Class** |   |
|------------------------------|--------|------------------------------------------------|--------|-----------------------|--------|
| Charles T. Chrietzberg,  Jr. |   | 673,876                                        | (1)    | 42.64                 |   |
| P.O. Box 1344                |   |                                           |   |                  |   |
| Carmel,  CA  93921      |   |                                           |   |                  |   |
|                         |   |                                           |   |                  |   |
| David  S. Lewis, Trust       |   | 153,863                                        |   | 10.30                 |   |
| 30500  Aurora del Mar        |   |                                           |   |                  |   |
| Carmel,  CA  93923      |   |                                           |   |                  |   |

 

----

(1)              Includes 86,573shares subject to employee stock options and 18,416 shares held beneficiallyfor Mr. Chrietzberg and Mrs. Chrietzberg in Individual Retirement Accountswhere voting power is shared with the custodian of the account.  316,000 shares of the Common Stock owned byMr. Chrietzberg are pledged to secure a loan from an unaffiliated bank.

 

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

 
| **Name**                                         |   | **Amount and  Nature of  Beneficial  Ownership** |      | **Percent of  Class** |   | **Shares  Subject to  Purchase  Options** |   | **Percent of  Class without  Option Shares** |   |
|--------------------------------------------------|--------|--------------------------------------------------|-----------|-----------------------|--------|-------------------------------------------|--------|----------------------------------------------|--------|
| Charles  T. Chrietzberg, Jr.                     |   | 673,876                                          | (1)(2)(3) | 42.64                 | %      | 86,573                                    |   | 39.32                                        | %      |
| Sandra  G. Chrietzberg                           |   | 673,876                                          | (2)(3)    | 42.64                 | %      | 86,573                                    |   | 39.32                                        | %      |
| Peter  J. Coniglio                               |   | 75,355                                           | (4)(5)    | 4.96                  | %      | 24,267                                    |   | 3.42                                         | %      |
| Carla  S. Hudson                                 |   | 34,898                                           | (6)       | 2.29                  | %      | 28,293                                    |   | 0.44                                         |   |
| John  M. Lotz                                    |   | 5,500                                            |      | 0.37                  | %      | 5,500                                     |   | 0.00                                         | %      |
| All  Directors and Executive Officers as a group |   | 863,393                                          | (7)       | 51.80                 |   | 173,003                                   | %      | 46.58                                        | %      |

 

----

(1)                  Includes 86,573 shares subject to hisemployee stock options.  316,000 sharesof the Common Stock owned by Mr. Chrietzberg are pledged to secure a loan froman unaffiliated bank. Should he default under such credit, the shares could beacquired by the lender, or sold pursuant to applicable terms of the UniformCommercial Code, in a transaction that could result in a change of control ofthe Corporation.  Such transaction mayrequire approval under provisions of Federal and California change in bankcontrol laws.

 

46

----

 

(2)       The shares include an aggregate of 18,416shares held beneficially by Mr. Chrietzberg and Mrs. Chrietzberg in IndividualRetirement Accounts, where voting power is also shared with the custodian ofthe account.

 

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

 

(4)       Sole voting power.

 

(5)       Includes 24,267 shares subject to therespective director’s stock options.  Ofthe remaining shares 16,105 are held by Mr. Coniglio, 26,530 are held in afamily trust controlled by Mr. Coniglio, as to which he has sole voting andinvestment power, while 8,453 shares are held by Hudson, Martin, Ferrante &Street, a partnership of which Mr. Coniglio is the managing partner, withvoting and investment power.

 

(6)       Includes 28,293 shares subject to therespective director’s stock options. The remaining  shares are heldjointly with family members, other than 1,610 shares held in a corporatepension, as to which Ms. Hudson has voting and investment power.

 

(7)                      Includes73,764 shares held by an executive officer who is not also a director, 28,370shares are subject to employee stock options.

 

47

----

 

**ITEM12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

The Bank has had, and expects to have in the future,banking transactions in the ordinary course of its business with directors,officers, principal shareholders and their associates.  Management of the Bank believes that thesetransactions have been (and those in the future are intended to be) onsubstantially the same terms, including interest rates, collateral and repaymentterms on extensions of credit, as those prevailing at the same time forcomparable transactions with others and did not involve more than the normalrisk 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 on extensions ofcredit to directors and to directors, principal shareholders and officers.

 
|                       |   | **Maximum** |   | **Outstanding as of  December 31, 2002** |   |
|----------------------------|--------|-------------|--------|------------------------------------------|--------|
| **Name**                   |   | **Amount**  |   | **Percent of  Equity  Capital**          |   | **Amount** |   | **Percent of  EquityCapital** |   |
| Peter  J. Coniglio         |   | 1,166,600   | (1)    | 21.47                                    | %      | 1,162,700 | (1)  | 20.62 | % |
| John  M. Lotz              |   | 27,500      |   | 0.49                                     | %      | 26,868 |   | 0.47 | % |
|                       |   |        |   |                                     |   |   |   |   |   |
| Directors,  Principal      |   |        |   |                                     |   |   |   |   |   |
| Shareholder,  and Officers |   |        |   |                                     |   |   |   |   |   |
| as a  Group (6 in number)  |   | 1,192,900   |   | 21.95                                    | %      | 1,189,400 |   | 21.09 | % |

 

----

(1)       Included in the extensions of credit toMr. Coniglio is a loan to the Coniglio Family Partnership, which had anoutstanding balance of  $1,084,700 onDecember 31, 2002.

 

48

----

 

**Item13. 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                                                                                                                                                                                                           |
| 10 (ii) A |   | (1)  Employment Contract of Charles T. Chrietzberg,  Jr., dated January 1, 2003                                                                                                                                                                         |
|      |   | (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                                                                                                                                                                                                                                                 |
|      |   |                                                                                                                                                                                                                                                         |
|      |   |                                                                                                                                                                                                                                                         |
| B.        |   | REPORTS                                                                                                                                                                                                                                                      |
|      |   |                                                                                                                                                                                                                                                         |
|      |   | None                                                                                                                                                                                                                                                         |

 

49

----

 

**SIGNATURES**

 

In accordance withSection 13 or 15(d) of the Exchange Act, the registrant caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

 
|   |           |   |   | NORTHERN CALIFORNIA  BANCORP, INC. |
|--------|----------------|--------|--------|------------------------------------|
|   |           |   |   |                               |
| Date:  | March 20, 2003 |   |   | By:                                |   /s/ | Charles T. Chrietzberg,  Jr. |
|   |           |   |   |                               | Charles T. Chrietzberg, Jr. |
|   |           |   |   |                               | Chief Executive Officer and President |
|   |           |   |   |                               |
|   |           |   |   |                               |
| Date:  | March 20, 2003 |   |   | By:                                |   /s/ | Bruce N. Warner |
|   |           |   |   |                               | Bruce N. Warner |
|   |           |   |   |                               | Chief Financial Officer |
|   |           |   |   |                               | and Principal Accounting Officer |

 

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

 
| **Name**                         |   | **Position** |   | **Date**       |
|----------------------------------|--------|--------------|--------|----------------|
|                             |   |         |   |           |
| /s/ Charles T.  Chrietzberg, Jr. |   |         |   | March 20, 2003 |
| Charles T. Chrietzberg,  Jr.     |   |         |   |           |
| Director                         |   |         |   |           |
|                             |   |         |   |           |
| /s/ Sandra G.  Chrietzberg       |   |         |   | March 20, 2003 |
| Sandra G. Chrietzberg            |   |         |   |           |
| Director                         |   |         |   |           |
|                             |   |         |   |           |
| /s/ Peter J. Coniglio            |   |         |   | March 20, 2003 |
| Peter J. Coniglio                |   |         |   |           |
| Director                         |   |         |   |           |
|                             |   |         |   |           |
| /s/ Carla S. Hudson              |   |         |   | March 20, 2003 |
| Carla S. Hudson                  |   |         |   |           |
| Director                         |   |         |   |           |
|                             |   |         |   |           |
| /s/ John M. Lotz                 |   |         |   | March 20, 2003 |
| John M. Lotz                     |   |         |   |           |
| Director                         |   |         |   |           |

 

50

----

 

CERTIFICATIONS

 

I, Charles T.Chrietzberg, Jr. certify that:

 

1.   I have read this annual report on Form 10-KSBof Northern California Bancorp, Inc.;

 

2.   Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.   Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.   The registrant’s other certifying officer andI are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisannual report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filling date of this annual report (the“Evaluation Date”); and

 

c)              presented in thisannual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.   The registrant’s other certifying officer andI have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee or registrant’s board of directors ( orpersons performing the equivalent functions):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.   The registrant’s other certifying officer andI have indicated in this annual report whether there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: March 20, 2003 |   |   |                                  |
|----------------------|--------|--------|---------------------------------------|
|                 |   |   |  /s/ Charles T. Chrietzberg, Jr. |   |
|                 |   |   | Charles T. Chrietzberg,  Jr.          |
|                 |   |   | Chairman of the Board  &          |
|                 |   |   | Chief Executive Officer               |

 

51

----

 

CERTIFICATIONS

 

I, Bruce N. Warnercertify that:

 

1.   1. I have read this annual report on Form10-KSB of Northern California Bancorp, Inc.;

 

2.   Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of the circumstancesunder which such statements were made, not misleading with respect to theperiod covered by this annual report;

 

3.   Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.   The registrant’s other certifying officer andI are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

d)             designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisannual report is being prepared;

 

e)              evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filling date of this annual report (the“Evaluation Date”); and

 

f)                presented in thisannual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.   The registrant’s other certifying officer andI have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee or registrant’s board of directors ( orpersons performing the equivalent functions):

 

c)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

d)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.   The registrant’s other certifying officer andI have indicated in this annual report whether there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

 
| Date: March 20, 2003 |   |   |                           |
|----------------------|--------|--------|--------------------------------|
|                 |   |   | /s/ Bruce N. Warner            |   |
|                 |   |   | Bruce N. Warner                |
|                 |   |   | Chief Financial Officer  & |
|                 |   |   | Principal Accounting  Officer  |

 

52

----

 

CERTIFICATION UNDER SECTION 906

OF THE SARBANES-OXLEY ACT OF 2002

 

Pursuant to Section 906 of the Sabanes-Oxley Act of2002, each of the undersigned certifies that this periodic report fullycomplies with the requirements of section 13(a) or 15(d) of the SecuritiesExchange Act of 1934 and that information contained in this periodic reportfairly presents, in all material respects, the financial condition and resultsof operations of Northern California Bancorp, Inc.

 

 
| Date: March 20, 2003 |   |   | /s/ Charles T.  Chrietzberg, Jr.                           |   |
|----------------------|--------|--------|------------------------------------------------------------|--------|
|                 |   |   | Charles T. Chrietzberg,  Jr.                               |   |
|                 |   |   | Chief Executive Officer  and President                     |   |
|                 |   |   |                                                       |   |
|                 |   |   |                                                       |   |
| Date: March 20, 2003 |   |   | /s/ Bruce N. Warner                                        |   |
|                 |   |   | Bruce N. Warner                                            |   |
|                 |   |   | Chief Financial Officer  and  Principal Accounting Officer |   |

 

53

----

 

**NORTHERN CALIFORNIA BANCORP, INC.**

**AND SUBSIDIARY**

 

**CONSOLIDATED FINANCIAL REPORT**

 

**December31, 2002 and 2001**

 

----

 

**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 ofDirectors

NorthernCalifornia Bancorp, Inc.

Monterey,California

 

We have auditedthe accompanying consolidated balance sheets of Northern California Bancorp,Inc. and its wholly owned subsidiary, Monterey County Bank, as of December 31,2002 and 2001 and the related consolidated statements of operations, changes inshareholders’ equity, and cash flows for each of the years in the three-yearperiod ended December 31, 2002.  Theseconsolidated financial statements are the responsibility of the Corporation’smanagement.  Our responsibility is toexpress an opinion on these consolidated financial statements based on our audits.

 

We conducted ouraudits in accordance with auditing standards generally accepted in the UnitedStates of America.  Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made by management,as well 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 above present fairly, in allmaterial respects, the financial position of Northern California Bancorp, Inc.and its wholly owned subsidiary, as of December 31, 2002 and 2001, and theresults of their operations and their cash flows for each of the years in thethree-year period ended December 31, 2002 in conformity with accountingprinciples generally accepted in the United States of America.

 

 

# February26, 2003

 

1

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATED BALANCE SHEETS**

**December 31, 2002 and 2001**

** **
|                                                                                                                                             |   | **2002**   |       | **2001**   |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|
| **ASSETS**                                                                                                                                       |   |       |       |       |   |
|                                                                                                                                             |   |       |       |       |   |
| Cash and due  from banks (Note 2)                                                                                                                |   | $          | 13,017,100 |       | $      | 11,392,900 |   |
| Time deposits  with other financial institutions                                                                                                 |   | —     |       | 100,000    |   |
| Trading assets  (Note 3)                                                                                                                         |   | 82,200     |       | 173,000    |   |
| Securities available  for sale (Note 4)                                                                                                          |   | 6,039,800  |       | 9,478,400  |   |
| Other  investments (Note 4)                                                                                                                      |   | 1,210,500  |       | 950,600    |   |
| Loans held for  sale                                                                                                                             |   | 982,500    |       | 605,600    |   |
| Loans, net  (Notes 6 and 15)                                                                                                                     |   | 59,274,400 |       | 51,956,300 |   |
| Bank premises  and equipment, net (Note 7)                                                                                                       |   | 2,243,700  |       | 1,804,700  |   |
| Cash surrender  value of life insurance                                                                                                          |   | 2,160,400  |       | 2,000,700  |   |
| Interest  receivable and other assets                                                                                                            |   | 1,268,700  |       | 1,272,700  |   |
|                                                                                                                                             |   |       |       |       |   |
| Total assets                                                                                                                                     |   | $          | 86,279,300 |       | $      | 79,734,900 |   |
|                                                                                                                                             |   |       |       |       |   |
| **LIABILITIES AND SHAREHOLDERS'  EQUITY**                                                                                                        |   |       |       |       |   |
|                                                                                                                                             |   |       |       |       |   |
| Deposits                                                                                                                                         |   |       |       |       |   |
| Non  interest-bearing demand                                                                                                                     |   | $          | 15,023,700 |       | $      | 14,525,800 |   |
| Interest-bearing  demand                                                                                                                         |   | 12,653,400 |       | 12,014,500 |   |
| Savings                                                                                                                                          |   | 4,667,900  |       | 3,849,000  |   |
| Time                                                                                                                                             |   | 19,143,900 |       | 21,434,500 |   |
| Time in  denominations of $100,000 or more                                                                                                       |   | 16,127,500 |       | 16,508,600 |   |
|                                                                                                                                             |   |       |       |       |   |
| Total deposits                                                                                                                                   |   | 67,616,400 |       | 68,332,400 |   |
|                                                                                                                                             |   |       |       |       |   |
| Short-term  borrowing (Note 9)                                                                                                                   |   | 200,000    |       | 200,000    |   |
| Long-term debt  (Note 9)                                                                                                                         |   | 972,200    |       | 1,000,000  |   |
| Federal Home  Loan Bank borrowed funds (Note 10)                                                                                                 |   | 10,750,000 |       | 4,000,000  |   |
| Interest payable  and other liabilities                                                                                                          |   | 1,101,800  |       | 1,115,600  |   |
|                                                                                                                                             |   |       |       |       |   |
| Total  liabilities                                                                                                                               |   | 80,640,400 |       | 74,648,000 |   |
|                                                                                                                                             |   |       |       |       |   |
| Commitments and  contingencies (Note 12)                                                                                                         |   |       |       |       |   |
|                                                                                                                                             |   |       |       |       |   |
| Shareholders'  equity (Notes 13 and 14)                                                                                                          |   |       |       |       |   |
| Common stock, no  stated par value, authorized: 2,500,000 shares, issued and outstanding:  1,493,816 shares in 2002 and 1,328,207 shares in 2001 |   | 4,500,400  |       | 4,040,600  |   |
| Retained  earnings                                                                                                                               |   | 1,120,900  |       | 1,038,000  |   |
| Accumulated  other comprehensive income (Note 1)                                                                                                 |   | 17,600     |       | 8,300      |   |
|                                                                                                                                             |   |       |       |       |   |
| Total  shareholders' equity                                                                                                                      |   | 5,638,900  |       | 5,086,900  |   |
|                                                                                                                                             |   |       |       |       |   |
| Total  liabilities and shareholders' equity                                                                                                      |   | $          | 86,279,300 |       | $      | 79,734,900 |   |

** **

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

 

2

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**YearsEnded December 31, 2002, 2001, and 2000**

 
|                                                  |   | **2002**  |      | **2001**  |   | **2000**  |   |
|-------------------------------------------------------|--------|-----------|-----------|-----------|--------|-----------|--------|
|                                                  |   |      |      |      |   |      |   |
| Interest income                                       |   |      |      |      |   |      |   |
| Loans                                                 |   | $         | 4,365,300 |      | $      | 4,576,300 |   | $ | 4,284,800 |   |
| Time deposits  with other financial institutions      |   | 2,900     |      | 12,400    |   | 10,500    |   |
| Investment  securities                                |   | 392,800   |      | 487,500   |   | 902,700   |   |
| Federal funds  sold                                   |   | 114,800   |      | 363,400   |   | 303,300   |   |
| Total interest  income                                |   | 4,875,800 |      | 5,439,600 |   | 5,501,300 |   |
|                                                  |   |      |      |      |   |      |   |
| Interest expense                                      |   |      |      |      |   |      |   |
| Interest-bearing  transaction accounts                |   | 94,500    |      | 115,100   |   | 115,600   |   |
| Savings and time  deposit accounts                    |   | 869,000   |      | 1,196,500 |   | 1,168,300 |   |
| Time deposits in  denominations of $100,000 or more   |   | 610,400   |      | 833,000   |   | 763,900   |   |
| Notes payable  and other                              |   | 373,800   |      | 381,100   |   | 361,800   |   |
| Total interest  expense                               |   | 1,947,700 |      | 2,525,700 |   | 2,409,600 |   |
|                                                  |   |      |      |      |   |      |   |
| Net interest  income                                  |   | 2,928,100 |      | 2,913,900 |   | 3,091,700 |   |
| Provision for  loan losses (Note 6)                   |   | 117,000   |      | 185,000   |   | 130,000   |   |
| Net interest  income, after provision for loan losses |   | 2,811,100 |      | 2,728,900 |   | 2,961,700 |   |
|                                                  |   |      |      |      |   |      |   |
| Other income                                          |   |      |      |      |   |      |   |
| Service charges  on deposit accounts                  |   | 508,100   |      | 494,000   |   | 418,000   |   |
| Income from  sales and servicing of Small             |   |      |      |      |   |      |   |
| Business  Administration loans (Note 5)               |   | 526,000   |      | 512,700   |   | 394,000   |   |
| Other income                                          |   | 771,000   |      | 489,000   |   | 633,300   |   |
| Total other  income                                   |   | 1,805,100 |      | 1,495,700 |   | 1,445,300 |   |
|                                                  |   |      |      |      |   |      |   |
| Operating  expense                                    |   |      |      |      |   |      |   |
| Salaries and  employee benefits                       |   | 2,200,500 |      | 2,153,500 |   | 1,926,700 |   |
| Occupancy and  equipment expense                      |   | 372,300   |      | 326,300   |   | 304,400   |   |
| Professional  fees                                    |   | 84,200    |      | 106,600   |   | 91,200    |   |
| Data processing                                       |   | 364,000   |      | 243,900   |   | 249,100   |   |
| Other general  and administrative                     |   | 732,600   |      | 802,500   |   | 737,400   |   |
| Total operating  expenses                             |   | 3,753,600 |      | 3,632,800 |   | 3,308,800 |   |
|                                                  |   |      |      |      |   |      |   |
| Income before  tax provision                          |   | 862,600   |      | 591,800   |   | 1,098,200 |   |
| Income tax  provision (Note 11)                       |   | 354,000   |      | 231,300   |   | 361,900   |   |
|                                                  |   |      |      |      |   |      |   |
| Net income                                            |   | $         | 508,600   |      | $      | 360,500   |   | $ | 736,300 |   |
|                                                  |   |      |      |      |   |      |   |
| Earnings per  common share                            |   |      |      |      |   |      |   |
|                                                  |   |      |      |      |   |      |   |
| Basic                                                 |   | $         | 0.34      |      | $      | 0.25      |   | $ | 0.50 |   |
|                                                  |   |      |      |      |   |      |   |
| Diluted                                               |   | $         | 0.29      |      | $      | 0.21      |   | $ | 0.44 |   |

 

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

 

3

----

 

**NORTHERNCALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY**

**YearsEnded December 31, 2002, 2001, and 2000**

 
|                                                                             |   | **Number of  Shares** |   | **Common  Stock** |      | **Retained  Earnings** |   | **Accumulated  Other Compre-  hensive Income  (Loss)** |   | **Total** |    |
|----------------------------------------------------------------------------------|--------|-----------------------|--------|-------------------|-----------|------------------------|--------|--------------------------------------------------------|--------|-----------|---------|
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Balance at  December 31, 1999                                                    |   | 1,112,641             |   | $                 | 3,395,400 |                   | $      | 659,600                                                |   | $         | (62,000 | ) | $ | 3,993,000 |   |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Comprehensive  income:                                                           |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Net income for  the year                                                         |   | —                |   | —            |      | 736,300                |   | —                                                 |   | 736,300   |    |
| Change in net  unrealized loss on securities and other assets net of tax effects |   | —                |   | —            |      | —                 |   | 152,000                                                |   | 152,000   |    |
| Total  comprehensive income                                                      |   |                  |   |              |      |                   |   |                                                   |   | 888,300   |    |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| 10% common stock  dividend                                                       |   | 110,784               |   | 332,300           |      | (332,900               | )      | —                                                 |   | (600      | )       |
| Repurchase of  common stock                                                      |   | (3,754                | )      | (11,000           | )         | —                 |   | —                                                 |   | (11,000   | )       |
| Repurchase of  stock options                                                     |   | —                |   | —            |      | (8,400                 | )      | —                                                 |   | (8,400    | )       |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Balance at  December 31, 2000                                                    |   | 1,219,671             |   | 3,716,700         |      | 1,054,600              |   | 90,000                                                 |   | 4,861,300 |    |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Comprehensive  income:                                                           |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Net income for  the year                                                         |   | —                |   | —            |      | 360,500                |   | —                                                 |   | 360,500   |    |
| Change in net  unrealized gain on securities and other assets net of tax effects |   | —                |   | —            |      | —                 |   | (81,700                                                | )      | (81,700   | )       |
| Total  comprehensive income                                                      |   |                  |   |              |      |                   |   |                                                   |   | 278,800   |    |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| 10% common stock  dividend                                                       |   | 120,516               |   | 361,600           |      | (362,300               | )      | —                                                 |   | (700      | )       |
| Repurchase of  common stock                                                      |   | (11,980               | )      | (37,700           | )         | —                 |   | —                                                 |   | (37,700   | )       |
| Repurchase of  stock options                                                     |   | —                |   | —            |      | (14,800                | )      | —                                                 |   | (14,800   | )       |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Balance at  December 31, 2001                                                    |   | 1,328,207             |   | 4,040,600         |      | 1,038,000              |   | 8,300                                                  |   | 5,086,900 |    |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Comprehensive  income:                                                           |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Net income for  the year                                                         |   | —                |   | —            |      | 508,600                |   | —                                                 |   | 508,600   |    |
| Change in net  unrealized gain on securities and other assets net of tax effects |   | —                |   | —            |      | —                 |   | 9,300                                                  |   | 9,300     |    |
| Total  comprehensive income                                                      |   |                  |   |              |      |                   |   |                                                   |   | 517,900   |    |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| 10% common stock  dividend                                                       |   | 135,637               |   | 406,900           |      | (407,400               | )      | —                                                 |   | (500      | )       |
| Repurchase of  common stock                                                      |   | (774                  | )      | (2,300            | )         | —                 |   | —                                                 |   | (2,300    | )       |
| Exercise of  stock options                                                       |   | 30,746                |   | 55,200            |      | —                 |   | —                                                 |   | 55,200    |    |
| Repurchase of  stock options                                                     |   | —                |   | —            |      | (18,300                | )      | —                                                 |   | (18,300   | )       |
|                                                                             |   |                  |   |              |      |                   |   |                                                   |   |      |    |
| Balance at  December 31, 2002                                                    |   | 1,493,816             |   | $                 | 4,500,400 |                   | $      | 1,120,900                                              |   | $         | 17,600  |   | $ | 5,638,900 |   |

 

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

 

4

----

 

**NORTHERNCALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2002, 2001, and 2000**

 
|                                                                               |   | **2002**    |       | **2001**    |   | **2000**    |   |
|------------------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|-------------|--------|
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                          |   |        |       |        |   |        |   |
| Net income                                                                         |   | $           | 508,600    |        | $      | 360,500     |   | $ | 736,300 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |        |       |        |   |        |   |
| Depreciation and  amortization expense                                             |   | 120,700     |       | 121,000     |   | 126,900     |   |
| Amortization of  discounts on investment securities                                |   | (11,800     | )          | 3,800       |   | (700        | )      |
| Loss on sale of  equipment                                                         |   | 2,900       |       | —      |   | —      |   |
| Provision for  loan losses                                                         |   | 117,000     |       | 185,000     |   | 130,000     |   |
| Amortization of  deferred servicing premium                                        |   | —      |       | —      |   | 7,400       |   |
| Amortization of  deferred gains on Small Business Administration loans             |   | —      |       | (1,500      | )      | (1,600      | )      |
| Increase  (decrease) in trading assets                                             |   | 90,800      |       | (5,000      | )      | (33,000     | )      |
| Increase  (decrease) in other liabilities                                          |   | 147,000     |       | 209,500     |   | (55,800     | )      |
| Increase in  other assets                                                          |   | (207,200    | )          | (739,100    | )      | (174,300    | )      |
| (Increase)  decrease in deferred tax asset                                         |   | 52,200      |       | (140,000    | )      | 41,200      |   |
| (Increase)  decrease in interest payable                                           |   | (160,800    | )          | (10,800     | )      | 63,900      |   |
| (Increase)  decrease in interest receivable                                        |   | (700        | )          | 291,400     |   | (164,400    | )      |
| Net cash  provided by operating activities                                         |   | 658,700     |       | 274,800     |   | 675,900     |   |
|                                                                               |   |        |       |        |   |        |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                          |   |        |       |        |   |        |   |
| Decrease in time  deposits                                                         |   | 100,000     |       | 100,000     |   | —      |   |
| Proceeds from  maturity of investment securities                                   |   | 15,310,900  |       | 32,908,600  |   | 6,246,500   |   |
| Purchase of  investments                                                           |   | (12,122,900 | )          | (24,982,400 | )      | (13,587,700 | )      |
| Net increase in  loans                                                             |   | (7,423,300  | )          | (11,441,600 | )      | (2,549,800  | )      |
| (Increase)  decrease in loans held for sale                                        |   | (376,900    | )          | 1,943,900   |   | (1,884,200  | )      |
| Proceeds from  sale of equipment                                                   |   | 3,000       |       | —      |   | —      |   |
| Additions to  bank premises and equipment                                          |   | (565,600    | )          | (152,500    | )      | (50,300     | )      |
| Net cash used by  investing activities                                             |   | (5,074,800  | )          | (1,624,000  | )      | (11,825,500 | )      |
|                                                                               |   |        |       |        |   |        |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                                          |   |        |       |        |   |        |   |
| Net increase  (decrease) in deposits                                               |   | (716,000    | )          | (3,885,900  | )      | 16,655,700  |   |
| Proceeds from  borrowings, net                                                     |   | 6,750,000   |       | —      |   | 1,124,900   |   |
| Repayments of  borrowings, net                                                     |   | (27,800     | )          | (675,000    | )      | —      |   |
| Proceeds from  exercise of stock options                                           |   | 55,200      |       | —      |   | —      |   |
| Repurchase of  common stock and stock options                                      |   | (20,600     | )          | (52,500     | )      | (19,400     | )      |
| Cash dividends  paid on common stock                                               |   | (500        | )          | (700        | )      | (600        | )      |
| Net cash  provided (used) by financing activities                                  |   | 6,040,300   |       | (4,614,100  | )      | 17,760,600  |   |
|                                                                               |   |        |       |        |   |        |   |
| Net increase  (decrease) in cash and cash equivalents                              |   | 1,624,200   |       | (5,963,300  | )      | 6,611,000   |   |
|                                                                               |   |        |       |        |   |        |   |
| **CASH  AND CASH EQUIVALENTS, BEGINNING**                                          |   | 11,392,900  |       | 17,356,200  |   | 10,745,200  |   |
|                                                                               |   |        |       |        |   |        |   |
| **CASH  AND CASH EQUIVALENTS, ENDING**                                             |   | $           | 13,017,100 |        | $      | 11,392,900  |   | $ | 17,356,200 |   |

 

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

 

5

----

 

**NORTHERNCALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2002, 2001, and 2000**

 
|                             |   | **2002** |      | **2001** |   | **2000**  |   |
|----------------------------------|--------|----------|-----------|----------|--------|-----------|--------|
| **OTHER  CASH FLOW INFORMATION** |   |     |      |     |   |      |   |
|                             |   |     |      |     |   |      |   |
| Interest paid                    |   | $        | 2,108,600 |     | $      | 2,536,700 |   | $ | 2,163,300 |   |
|                             |   |     |      |     |   |      |   |
| Income taxes  paid               |   | $        | 363,000   |     | $      | 353,200   |   | $ | 325,200 |   |

 

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

 

6

----

 

#### **NOTESTO CONDOLIDATED FINANCIAL STATEMENTS**

**December31, 2002 and 2001**

 

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

 

***Basis of Presentation and Consolidation***

 

The consolidated financial statements include theaccounts of Northern California Bancorp, Inc. (the “Corporation”) and itswholly owned subsidiary, Monterey County Bank (the “Bank”).  All****significant inter-company balances andtransactions have been eliminated in consolidation.

 

***Use of Estimates***

 

In preparing consolidated financial statements inconformity with accounting principles generally accepted in the United Statesof America, management is required to make estimates and assumptions thataffect the reported amounts of assets and liabilities as of the date of thebalance sheet and reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.  Materialestimates that are particularly susceptible to significant change in the nearterm relate to the determination of the allowance for loan losses, and thevaluation of deferred tax assets.

 

***Business***

 

The Bank provides a variety of financial services toindividuals and small businesses through its four offices on the MontereyPeninsula.  Its primary deposit productsare demand and term certificate accounts. Its primary lending products are residential, commercial, and Small BusinessAdministration (SBA) loans.

 

***Cash and Cash Equivalents***

 

For purposes of the consolidated statements of cashflows, cash and cash equivalents include cash and balances due from banks, allof which mature within ninety days.

 

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

 

Interest-bearing deposits in banks mature within oneyear and are carried at cost.

 

7

----

 

***Trading Activities***

 

The Corporation engages in trading activities for itsown account.  Securities that are heldprincipally for resale in the near term are recorded in the trading assetsaccount at fair value with changes in fair value recorded in earnings.  Interest and dividends are included in netinterest income.

 

Quoted market prices, when available, are used todetermine the fair value of trading instruments.  If quoted market prices are not available, then fair values areestimated using pricing models, quoted prices of instruments with similarcharacteristics, or discounted cash flows.

 

***Investment Securities***

 

Investments in debt securities that management has thepositive intent and ability to hold to maturity are classified as “held tomaturity” and reflected at cost, adjusted for amortization of premiums andaccretion of discounts, which are recognized as adjustments to interestincome.  Other marketable securities areclassified as “available for sale” and are reflected at fair value, withunrealized gains and losses excluded from earnings and reported in othercomprehensive income. Gains and losses on disposition are generally recognizedon the trade date, based on the net proceeds and the adjusted carrying amountof the securities sold using the specific identification method.  Purchase premiums and discounts arerecognized in interest income using methods approximating the interest methodover the terms of the securities.

 

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

 

The Bank originates loans to customers under the SmallBusiness Administration (SBA) program that generally provides for SBAguarantees of 70% to 80% of each loan. The Bank generally sells the guaranteed portion of each loan to a thirdparty and retains only the non-guaranteed portion in its own portfolio.  A gain is recognized on these loans throughcollection on sale of a premium over the adjusted carrying value, or through retentionof an ongoing rate differential, less a normal service fee between the ratepaid by the borrower to the Bank and the rate paid by the Bank to the purchaser(excess servicing fee).  In calculatingthe gain, the Bank assumes that the loans sold will be outstanding for one-halfof their contractual lives.

#### ** **

8

----

 

The Bank’s investment in an SBA loan is allocatedamong the retained portion of the loan, excess servicing retained, and the soldportion of the loan, based on the relative fair market value of each portion atthe time of loan 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 loansthat are guaranteed by the SBA and are carried at the lower of cost ormarket.  Market value for loansguaranteed by the SBA is generally determined based on the price at which theloans were committed to be sold on the trade date.  Direct loan origination costs are recorded at settlement as anadjustment to gain or loss on sale.

 

***Loans and Loan Fees***

 

The Bank grants mortgage, commercial, and consumerloans to customers.  A substantialportion of the loan portfolio is represented by mortgage loans on the MontereyPeninsula.  The ability of the Bank’sdebtors to honor their contracts is dependent upon the real estate and generaleconomic sectors in the area.

 

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

#### ** **

9

----

 

***Allowance for Loan Losses***

 

The allowance for loan losses is established through aprovision for loan losses charged to earnings and is maintained at a levelconsidered adequate to provide for reasonably foreseeable loan losses.

 

The provision and the level of the allowance areevaluated on a regular basis by management and are based upon management’speriodic review of the collectibility of the loans in light of historicalexperience, known and inherent risks in the nature and volume of the loanportfolio, adverse situations that may affect the borrower’s ability to repay,estimated value of any underlying collateral, and prevailing economicconditions.  This evaluation isinherently subjective as it requires estimates that are susceptible tosignificant change.  In addition,various regulatory agencies, as an integral part of their examination process,periodically review the Bank’s allowance for losses on loans and other realestate owned.

 

Such agencies may require the Bank to recognizeadditions to the allowance based on their judgment of information available tothem at the time of their examination. Ultimately, losses may vary from current estimates and future additionsto the allowance may be necessary.

 

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

 

A loan is considered impaired when, based on currentinformation and events, it is probable that a creditor will be unable tocollect the scheduled payments of principal or interest when due according tothe contractual terms of the loan agreement. Factors considered by management in determining impairment includepayment status, collateral value, and the probability of collecting scheduledprincipal and interest payments when due. Loans that experience insignificant payment delays and paymentshortfalls generally are not classified as impaired.  Management determines the significance of payment delays andpayment shortfalls on a case-by-case basis, taking into consideration all ofthe circumstances surrounding the loan and the borrower, including the lengthof the delay, the reasons for the delay, the borrower’s prior payment record,and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loanbasis by either the present value of expected future cash flows discounted atthe loan’s effective interest rate, the loan’s obtainable market price, or thefair value of the collateral if the loan is collateral dependent.  Substantially, all of the Bank’s loans thathave been identified as impaired have been measured by the fair value ofexisting collateral.

 

10

----

 

Large groups of smaller balance homogeneous loans arecollectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumerloans for impairment disclosures.

 

***Loan Servicing***

 

The Bank has adopted Statement of Financial AccountingStandards (“SFAS”) No. 122, “Accounting for Mortgage Servicing Rights,” assuperseded by SFAS No. 125, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities,” whereby rights to serviceloans for others are capitalized as separate assets, whether acquired throughpurchase or origination, if such loans are sold or securitized with servicingrights retained.  Accordingly, the totalcost of the loan is allocated to the related servicing right and to the loanbased on the relative fair values if it is practicable to estimate those fairvalues.

 

The Bank estimates fair value based on the presentvalue of estimated expected future cash flows using prepayment speeds anddiscount rates commensurate with the risks involved, and servicing costsdetermined on an incremental cost basis. Prior to the adoption of SFAS No. 122, the capitalization of originatedmortgage servicing rights was not allowed under accounting principles generallyaccepted in the United States of America.

 

Capitalized mortgage servicing rights are amortized toservicing revenue in proportion to, and over the period of, estimated netservicing revenues.  Impairment ofmortgage servicing rights is assessed based on the fair value of those rights.  For purposes of measuring impairment, therights are stratified based on the following predominant risk characteristicsof the underlying loans: loan type, size, note rate, date of origination, term,and geographic location.  Impairment isrecognized through a valuation allowance for an individual stratum, to theextent that fair value is less than the capitalized amount for the stratum.

#### ** **

11

----

 

***Banking Premises and Equipment***

 

Land is carried atcost.  Buildings and equipment arecarried at cost, less accumulated depreciation computed on the straight-linemethod over the estimated useful lives of the assets.

 

It is general practice tocharge the cost of****maintenance and repairs to earnings whenincurred; major expenditures for betterments are capitalized and depreciated.

 

***Income Taxes***

 

Deferred tax assets andliabilities are reflected at currently enacted income tax rates applicable tothe period in which the deferred tax assets or liabilities are expected to berealized or settled.  As changes in taxlaws or rates are enacted, deferred tax assets and liabilities are adjustedaccordingly through the provision for income taxes.

 

***Stock Option Plan***

 

Under the Corporation’sStock Option Plan, the Bank may grant incentive stock options and non-qualifiedstock options to directors, officers, and employees of the Corporation and it’ssubsidiary, so long as the Corporation owns a majority of the equity interestof such subsidiary.  Incentive StockOptions may be granted at prices not lower than 100% of the fair market valueof the common stock on the date of grant. However, an incentive stock option granted to an individual owning 10%or more of the Corporation’s stock after such grant must have an exercise priceof at least 110%****of such fair market value and an exercise period of not morethan five years.  Non-qualified stockoptions may be granted at prices not lower than 85% of the fair market value ofthe common stock on the date of grant. The Board of Directors is authorized to determine when options becomeexercisable within a period not extending 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, 2002, 243,130 options wereoutstanding.  During 2002, 81,000options were granted.

#### ** **

12

----

 

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

 

The Corporation applies APB Opinion 25 and relatedInterpretations in accounting for the plan. Accordingly, no compensation cost has been recognized.  Had compensation cost for the Corporation’sstock-based compensation plan been determined based on the fair value at thegrant date for awards under the plan consistent with the method prescribed bySFAS No. 123, the Corporation’s net income and basic earnings per share wouldhave been adjusted to the pro forma amounts indicated below:

 
|                  |   | **2002** |    | **2001** |   | **2000** |   |
|-----------------------|--------|----------|---------|----------|--------|----------|--------|
| Net income:           |   |     |    |     |   |     |   |
| As reported           |   | $        | 508,600 |     | $      | 360,500  |   | $ | 736,300 |   |
| Pro forma             |   | $        | 471,300 |     | $      | 360,500  |   | $ | 712,400 |   |
|                  |   |     |    |     |   |     |   |
| Earnings per share:   |   |     |    |     |   |     |   |
| Basic - as reported   |   | $        | 0.34    |     | $      | 0.25     |   | $ | 0.50 |   |
| Basic - pro forma     |   | $        | 0.32    |     | $      | 0.25     |   | $ | 0.48 |   |
|                  |   |     |    |     |   |     |   |
| Diluted - as reported |   | $        | 0.29    |     | $      | 0.21     |   | $ | 0.44 |   |
| Diluted - pro forma   |   | $        | 0.27    |     | $      | 0.21     |   | $ | 0.42 |   |

 

The fair value of theseoptions was estimated at the grant date using the Black-Scholes option pricingmodel with the following weighted-average assumptions for 2002 and 2000:risk-free interest rate of 4.5 percent; dividend yield of 0 percent; expectedoption life of 5.6 years; and volatility of 30 percent.

 

13

----

 

***Earnings per share***

 

Basic earnings per sharerepresents income available to common shareholders divided by theweighted-average number of common shares outstanding during the period.  Diluted earnings per share reflectsadditional common shares that would have been outstanding if dilutive potentialcommon shares had been issued, as well as any adjustment to income that wouldresult from the assumed issuance. Potential common shares that may be issued by the Corporation relatesolely to outstanding stock options, and are determined using the treasurystock method.  The weighted averagenumber of shares used in the computation of basic earnings per share was1,483,493 for 2002, 1,469,489 for 2001, and 1,479,520 for 2000.  The weighted average number of shares usedin the computation of earnings per share assuming dilution of stock options was1,744,082 for 2002, 1,701,827 for 2001, and 1,705,258 for 2000.  The 10% stock dividend was retroactivelyreflected in the 2001 and 2000 weighted shares.

 

# ***Accounting Changes***

#  

The Corporation adopted SFAS No. 142, “Goodwill andOther Intangible Assets, effective January 1, 2002.  Accordingly, goodwill is no longer subject to amortization overits estimated useful life, but is subject to at least an annual assessment forimpairment by applying a fair value based test.  Additionally, under SFAS No. 142, acquired intangible assets(such as core deposit intangibles) are separately recognized if the benefit ofthe intangible asset is obtained through contractual or other legal rights, orif the intangible asset can be sold, transferred, licensed, rented, orexchanged, and amortized over their useful life.  Branch acquisition transactions were outside the scope of SFASNo. 142 and, accordingly, intangible assets related to such transactionscontinued to amortize upon the adoption of SFAS No. 142.  On October 31, 2002, the Corporation adoptedSFAS No. 147, “Acquisitions of Certain Financial Institutions.”  This Statement amends (except fortransactions between two or more mutual enterprises) previous interpretiveguidance on the application of the purchase method of accounting toacquisitions of financial institutions, and requires the application of SFASNo. 141, “Business Combinations”, and SFAS No. 142 to branch acquisitions ifsuch transactions meet the definition of a business combination.  This Statement amends SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets”, to include inits scope core deposit intangibles of financial institutions.  Accordingly, such intangibles are subject toa recoverability test based on undiscounted cash flows, and to the impairmentrecognition and measurement provisions that are required for other long-livedassets that are held and used.

 

14

----

 

In December 2002, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation – Transition andDisclosure,” which provides for transition methods for companies electing torecord compensation expense associated with stock options, as well as enhanceddisclosures for companies that elect to retain the intrinsic value method ofaccounting as prescribed by APB No. 25. The provisions of this Statement are effective for fiscal years endingafter December 31, 2002.

 

The adoption of SFAS No.141, 142, 147, and 148 did not have a material impact on the Corporation’sconsolidated financial statements.

#  

# ***Comprehensive Income***

 

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

 

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

 
|                                                                                      |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Unrealized holding gains  (losses) on available for sale securities and other assets, net |   | $        | 16,900 |     | $      | (194,600 | )      | $ | 277,900 |   |
| Tax effect                                                                                |   | (7,600   | )      | 112,900  |   | (125,900 | )      |
|                                                                                      |   |     |   |     |   |     |   |
| Net-of-tax amount                                                                         |   | $        | 9,300  |     | $      | (81,700  | )      | $ | 152,000 |   |

 

15

----

 

The components ofaccumulated other comprehensive income and related tax effects are as follows:

 
|                                                                             |   | **2002** |   | **2001** |   |
|----------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Unrealized holding gains  on available for sale securities and other assets, net |   | $        | 32,000 |     | $      | 15,100 |   |
| Tax effect                                                                       |   | (14,400  | )      | (6,800   | )      |
|                                                                             |   |     |   |     |   |
| Net-of-tax amount                                                                |   | $        | 17,600 |     | $      | 8,300 |   |

 

***Advertising Costs***

 

Advertising costs arecharged to operations when incurred.

 

***Reclassification***

 

Certain amounts have beenreclassified in the 2001 and 2000 financial statements to conform to the 2002presentation.

 

**Note 2. CASH AND DUEFROM BANKS**

 

Aggregate reserves (inthe form of cash and deposits with the Federal Reserve Bank) of $455,000 weremaintained to satisfy federal regulatory requirements at December 31, 2002.

 

**Note 3. TRADING ASSETS**

 

At December 31, 2002 and2001, trading assets, at fair value, consisted of marketable equity securitiesin the amount of $82,200 and $173,000, respectively.

 

16

----

 

**Note 4. INVESTMENTSECURITIES AND OTHER INVESTMENTS**

 

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

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

 

17

----

 

 
|                                      |   | **Amortized   Cost**   |      | **Gross   Unrealized    Gains** |   | **Gross   Unrealized   Losses** |   | **Fair   Value** |   |
|-------------------------------------------|--------|------------------------|-----------|--------------------------------------|--------|---------------------------------|--------|------------------|--------|
|                                      |   | **December  31, 2001** |      |
| Securities Available for  Sale            |   |                   |      |                                 |   |                            |   |             |   |
| U.S. Government Agencies                  |   | $                      | 6,000,000 |                                 | $      | 8,000                           |   | $                | — |   | $ | 6,008,000 |   |
| Corporate Debt Securities                 |   | 3,495,300              |      | —                               |   | 24,900                          |   | 3,470,400        |   |
|                                      |   |                   |      |                                 |   |                            |   |             |   |
| Total securities available  for sale      |   | $                      | 9,495,300 |                                 | $      | 8,000                           |   | $                | 24,900 |   | $ | 9,478,400 |   |
|                                      |   |                   |      |                                 |   |                            |   |             |   |
| Other Investments, at cost                |   |                   |      |                                 |   |                            |   |             |   |
| AT Services LLC                           |   | $                      | 200,000   |                                 | $      | —                          |   | $                | — |   | $ | 200,000 |   |
| Mission Valley Bank                       |   | 25,000                 |      | —                               |   | —                          |   | 25,000           |   |
| Federal Home Loan Bank,  stock restricted |   | 285,700                |      | —                               |   | —                          |   | 285,700          |   |
| Pacific Coast Banker’s  Bank Stock   |   | 439,900                |      | —                               |   | —                          |   | 439,900          |   |
|                                      |   |                   |      |                                 |   |                            |   |             |   |
| Total other investments                   |   | $                      | 950,600   |                                 | $      | —                          |   | $                | — |   | $ | 950,600 |   |

 

18

----

 

The amortized cost andfair value of debt securities by contractual maturity at December 31, 2002 areshown below.  Expected maturities willdiffer from contractual maturities because borrowers may have the right to callor prepay obligations with or without call or prepayment penalties.

 
|                               |   | **Amortized   Cost** |      | **Fair   Value** |   |
|------------------------------------|--------|----------------------|-----------|------------------|--------|
|                               |   |                 |      |             |   |
| Due between one and five  years    |   | $                    | 758,400   |             | $      | 747,800 |   |
| Due in over ten years              |   | 750,000              |      | 738,700          |   |
| GNMA - Mortgage Backed  Securities |   | 4,559,900            |      | 4,553,300        |   |
|                               |   |                 |      |             |   |
|                               |   | $                    | 6,068,300 |             | $      | 6,039,800 |   |

 

Proceeds from maturityand sales of investment securities during 2002 and 2001, respectively, were$15,310,900 and $32,908,600.  Realizedgains during 2002 and 2001, respectively, were $93,400 and $59,700.

 

**Note 5. SALES ANDSERVICING OF SBA LOANS**

 

A summary of the activityof SBA loans follows:

 
|                 |   | **2002** |      | **2001** |   | **2000**  |   |
|----------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                 |   |     |      |     |   |      |   |
| SBA loans originated |   | $        | 5,916,900 |     | $      | 5,141,000 |   | $ | 8,125,000 |   |
|                 |   |     |      |     |   |      |   |
| SBA loans sold       |   | $        | 4,689,300 |     | $      | 5,264,300 |   | $ | 4,205,300 |   |

 

19

----

 

A summary of income fromSBA loans sold is as follows:

 
|                                  |   | **2002** |    | **2001** |   | **2000** |   |
|---------------------------------------|--------|----------|---------|----------|--------|----------|--------|
|                                  |   |     |    |     |   |     |   |
| Income from premiums                  |   | $        | 332,800 |     | $      | 363,800  |   | $ | 244,900 |   |
| Income from servicing                 |   | 193,200  |    | 148,900  |   | 150,100  |   |
| Less loan origination  expense        |   | —   |    | —   |   | (1,000   | )      |
|                                  |   |     |    |     |   |     |   |
| Total SBA sales and  servicing income |   | $        | 526,000 |     | $      | 512,700  |   | $ | 394,000 |   |

 

**Note 6. LOANS ANDALLOWANCE FOR LOAN LOSSES**

 

A summary of loanbalances follows:

 
|                                   |   | **2002**   |       | **2001**   |   |
|----------------------------------------|--------|------------|------------|------------|--------|
|                                   |   |       |       |       |   |
| Commercial and industrial              |   | $          | 13,449,900 |       | $      | 13,863,200 |   |
| Construction                           |   | 4,066,300  |       | 1,896,000  |   |
| Real estate, mortgage                  |   | 41,999,800 |       | 36,009,500 |   |
| Installment                            |   | 461,900    |       | 702,600    |   |
| Government guaranteed  loans purchased |   | 63,400     |       | 130,100    |   |
|                                   |   | 60,041,300 |       | 52,601,400 |   |
| Allowance for loan losses              |   | (636,900   | )          | (566,300   | )      |
| Deferred origination fees,  net        |   | (130,000   | )          | (78,800    | )      |
|                                   |   |       |       |       |   |
| Loans, net                             |   | $          | 59,274,400 |       | $      | 51,956,300 |   |

 

20

----

 

An analysis of theallowance for loan losses follows:

 
|                      |   | **2002** |    | **2001** |   | **2000** |   |
|---------------------------|--------|----------|---------|----------|--------|----------|--------|
|                      |   |     |    |     |   |     |   |
| Beginning balance         |   | $        | 566,300 |     | $      | 468,500  |   | $ | 400,000 |   |
| Recoveries                |   | 13,300   |    | 1,700    |   | 7,400    |   |
| Loans charged off         |   | (59,700  | )       | (88,900  | )      | (68,900  | )      |
| Provision for loan losses |   | 117,000  |    | 185,000  |   | 130,000  |   |
|                      |   |     |    |     |   |     |   |
| Ending balance            |   | $        | 636,900 |     | $      | 566,300  |   | $ | 468,500 |   |

 

As of December 31, 2002and 2001 the recorded investment in impaired loans totaled $328,400 and$1,187,800 with corresponding valuation allowances of $27,500 and $78,600,respectively.  No additional amounts arecommitted to be advanced in connection with impaired loans.

 

As of December 31, 2002,2001, and 2000 the average recorded investment in impaired loans amounted toapproximately $1,218,500, $984,200, and $409,700, respectively.  Non-accrual loans totaled $34,200 and$370,300 at December 31, 2002 and 2001, respectively.  If interest on non-accrual loans had been accrued, such incomewould have approximated $3,000, $21,300, and $1,100 for 2002, 2001, and 2000,respectively.

 

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

 

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

 
|                     |   | **2002**   |      | **2001**   |   | **Useful  Lives** |   |
|--------------------------|--------|------------|-----------|------------|--------|-------------------|--------|
|                     |   |       |      |       |   |              |   |
| Building and land        |   | $          | 915,400   |       | $      | 915,400           |   | 40 years |   |
| Building improvements    |   | 423,700    |      | 408,500    |   | 40 years          |   |
| Leasehold improvements   |   | 710,900    |      | 500,100    |   | Lease term        |   |
| Furniture and equipment  |   | 1,640,600  |      | 1,395,700  |   | 3-8 years         |   |
|                     |   | 3,690,600  |      | 3,219,700  |   |              |   |
| Accumulated depreciation |   | (1,446,900 | )         | (1,415,000 | )      |              |   |
|                     |   |       |      |       |   |              |   |
|                     |   | $          | 2,243,700 |       | $      | 1,804,700         |   |   |   |

## ** **

21

----

 

Depreciation expense of$120,700, $121,000, and $126,900 was included****in occupancy and equipmentexpense for the years ended December 31, 2002, 2001, and 2000, respectively.

 

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

 

At December 31, 2002, thescheduled maturities of time deposits are as follows:

 

| 2003       |   | $         | 24,380,300 |   |
|------------|--------|-----------|------------|--------|
| 2004       |   | 3,520,000 |       |
| 2005       |   | 4,750,200 |       |
| 2006       |   | 777,000   |       |
| 2007       |   | 1,572,300 |       |
| Thereafter |   | 271,600   |       |
|       |   |      |       |
|       |   | $         | 35,271,400 |   |

 

#### **Note 9.   SHORT-TERM BORROWING AND LONG-TERM DEBT**

 

The Corporation borrowed$1,000,000 on an unsecured basis from United Security Bank, Fresno, Californiaon June 28, 2001.  The rate of interestis the United Security Bank Reference Rate (the “Index”) plus .750 percentagepoints over the Index.  The noterequires monthly interest payments beginning August 5, 2001, quarterlyprincipal and interest payments beginning October 5, 2002 through April 5,2011, and a final payment of principal and interest on July 5, 2011.  The proceeds from the borrowing were used topayoff an $800,000 term loan and to pay down the $200,000 line of credit withPacific Coast Bankers’ Bank.  TheCorporation renewed the $200,000 revolving line of credit for one year, withinterest due monthly.  The credit lineis secured by 93,069 shares of Monterey County Bank common stock.  The rate of interest on the credit line isthe prime rate as published in the Wall Street Journal (the “Index”) plus .750percentage points over the Index, with floor rate of 6.50%.  At December 31, 2002, the interest rate onthe term note was 5.00% and the interest rate on the line of credit was6.50%.  The outstanding principalbalances at December 31, 2002 on the term note and line of credit were $972,200and $200,000, respectively.

#### ** **

22

----

 

The following tableprovides information on the repayment schedule of the term loan.

 

| 2003       |   | $       | 111,100 |   |
|------------|--------|---------|---------|--------|
| 2004       |   | 111,100 |    |
| 2005       |   | 111,100 |    |
| 2006       |   | 111,100 |    |
| 2007       |   | 111,100 |    |
| Thereafter |   | 416,700 |    |
|       |   |    |    |
|       |   | $       | 972,200 |   |

 

#### **Note 10.  FEDERAL HOME LOAN BANK BORROWED FUNDS**

 

The Bank entered into anadvance and security agreement with the Federal Home Loan Bank of San Franciscoon January 21, 1993.  The followingtable provides information on the seven (7) advances totaling $10,750,000 outstandingat December 31, 2002.

 

| **Advance   Amount** |   | **Fixed   Interest   Rate** |   | **Funding   Date** |   | **Maturity   Date** |   |
|----------------------|--------|-----------------------------|--------|--------------------|--------|---------------------|--------|
| 1,000,000            |   | 4.83                        | %      | 10/6/98            |   | 10/6/03             |   |
| 1,000,000            |   | 6.81                        | %      | 6/3/97             |   | 6/3/04              |   |
| 1,000,000            |   | 6.86                        | %      | 8/10/00            |   | 8/10/05             |   |
| 2,750,000            |   | 3.44                        | %      | 9/27/02            |   | 9/27/07             |   |
| 1,000,000            |   | 7.71                        | %      | 6/1/00             |   | 6/3/30              |   |
| 100,000              |   | 2.89                        | %      | 10/29/02           |   | 10/31/05            |   |
| 3,900,000            |   | 2.83                        | %      | 10/29/02           |   | 10/31/05            |   |

 

The advances are securedby pledged loan principal in the amount of $12,840,400 and a security in theamount of $4,553,300.

 

23

----

 

#### **Note11.  INCOME TAXES**

 

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

 
|                               |   | **2002** |    | **2001** |   | **2000** |   |
|------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Current tax provision:             |   |     |    |     |   |     |   |
| Federal                            |   | $        | 216,400 |     | $      | 228,300  |   | $ | 168,000 |   |
| California                         |   | 81,300   |    | 82,900   |   | 115,600  |   |
|                               |   | 297,700  |    | 311,200  |   | 283,600  |   |
|                               |   |     |    |     |   |     |   |
| Deferred tax provision  (benefit): |   |     |    |     |   |     |   |
| Federal                            |   | 45,000   |    | (63,900  | )      | 63,400   |   |
| California                         |   | 11,300   |    | (16,000  | )      | 14,900   |   |
|                               |   | 56,300   |    | (79,900  | )      | 78,300   |   |
|                               |   |     |    |     |   |     |   |
|                               |   | $        | 354,000 |     | $      | 231,300  |   | $ | 361,900 |   |

 

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

 
|                                          |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                          |   |     |   |     |   |     |   |
| 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                                    |   | (0.16    | )      | (2.20    | )      | (8.25    | )      |
|                                          |   |     |   |     |   |     |   |
| Effective tax rates                           |   | 41.04    | %      | 39.00    | %      | 32.95    | %      |

 

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

 

24

----

 

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

 
|                   |   | **2002** |    | **2001** |   |
|------------------------|--------|----------|---------|----------|--------|
| Deferred tax asset     |   |     |    |     |   |
| Federal                |   | $        | 217,700 |     | $      | 262,900 |   |
| California             |   | 61,000   |    | 68,000   |   |
|                   |   |     |    |     |   |
| Net deferred tax asset |   | $        | 278,700 |     | $      | 330,900 |   |

 

The tax effects of each typeof income and expense item that give rise to deferred taxes are as follows:

 
|                                            |   | **2002** |    | **2001** | ** ** |
|-------------------------------------------------|--------|----------|---------|----------|------------|
| Deferred tax assets  (liabilities) Investments: |   |     |    |     |       |
| Net unrealized loss on  securities              |   | $        | 66,300  |     | $          | 103,800 |   |
| California franchise tax                        |   | 48,400   |    | 51,300   |       |
| Allowance for loan losses                       |   | 236,500  |    | 209,300  |       |
| Depreciation                                    |   | (72,500  | )       | (33,500  | )          |
|                                            |   |     |    |     |       |
| Net deferred tax asset                          |   | $        | 278,700 |     | $          | 330,900 |   |

 

As of December 31, 2002 and 2001, management expectsall temporary differences to be offset against future taxable income, and novaluation reserve was deemed necessary.

 

25

----

 

#### **Note12.****    ****COMMITMENTS AND CONTINGENCIES**

 

In the normal course of business, there areoutstanding commitments and contingencies that are not reflected in theconsolidated financial statements.

 

***Operating lease commitments***

 

The Bank leases its branch buildings in Carmel By-The-Sea,Carmel Valley, and Pacific Grove.  TheCarmel By-The-Sea office has a five and one half year lease with four, fiveyear options and commenced in April 2002. The Carmel building has a twenty-five year lease which commenced inMarch 1981 and may be adjusted annually for changes in the Consumer PriceIndex.  The Pacific Grove building has afive-year lease with five, five-year options and commenced in April 1997.  The Bank also leases certain equipment usedin the normal course of business.

 

Rent expense for operating leases is included inoccupancy and equipment expense and amounted to approximately $170,400,$113,500, and $80,200 in 2002, 2001, and 2000, respectively.

 

At December 31, 2002, approximate future minimumrental commitments for all non-cancelable operating leases are as follows:

 

| 2003   |   | $       | 272,900   |   |
|--------|--------|---------|-----------|--------|
| 2004   |   | 267,600 |      |
| 2005   |   | 251,900 |      |
| 2006   |   | 165,000 |      |
| 2007   |   | 102,100 |      |
|   |   | $       | 1,059,500 |   |

 

***Loan commitments***

 

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

 

The Bank’s exposure to credit loss is represented by the contractualamount of these commitments.  The Bankuses the same credit policies in making commitments as it does foron-balance-sheet instruments.

 

26

----

 

At December 31, 2002 and 2001, such commitments toextend credit were approximately $7,804,400 and $7,968,500, respectively, ofundisbursed lines of credit and undisbursed loans in process.

 

#### **Note13.****    ****SHAREHOLDERS’ EQUITY**

 

***Minimum regulatory requirements***

 

The Corporation (on a consolidated basis) and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Corporation’s and Bank’s financialstatements.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCorporation and the Bank must meet specific capital guidelines that involvequantitative measures of their assets, liabilities, and certainoff-balance-sheet items as calculated under regulatory accounting practices.  The capital amounts and classifications arealso subject to qualitative judgments by the regulators about components, riskweightings, and other factors.  Promptcorrective action provisions are not applicable to bank holding companies.

 

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) andof Tier 1 capital (as defined) to average assets (as defined).  Management believes, as of December 31, 2002and 2001, that the Corporation and the Bank met all capital adequacyrequirements to which they are subject.

 

27

----

 

As of December 31, 2002, the most recent notificationfrom the Federal Deposit Insurance Corporation categorized the Bank as wellcapitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, aninstitution must maintain minimum total risk-based, Tier 1 risk-based, and Tier1 leverage ratios as set forth in the following tables.  There are no conditions or events since thenotification that management believes have changed the Bank’s category.  The Corporation’s and the Bank’s actualcapital amounts and ratios as of December 31, 2002 and 2001 are also presentedin the tables.

 

**December 31, 2002**

 
|                                     |   | **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                             |   | $                              | 6,056  |                              | 9.1    | %                                                                                 | $      | 5,347 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | 6,866                          |   | 10.4                              | %      | 5,312                                                                             |   | 8.0 | % | $ | 6,640 |   | 10.0 | % |
|                                     |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Risk  Weighted Assets: |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |
| Consolidated                             |   | 5,419                          |   | 8.1                               | %      | 2,674                                                                             |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | 6,229                          |   | 9.4                               | %      | 2,656                                                                             |   | 4.0 | % | 3,984 |   | 6.0 | % |
|                                     |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |
| Tier 1 Capital to Average  Assets:       |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |
| Consolidated                             |   | 5,639                          |   | 7.7                               | %      | 3,240                                                                             |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | 6,380                          |   | 8.6                               | %      | 3,221                                                                             |   | 4.0 | % | 4,027 |   | 5.0 | % |
|                                          |        |                                |        |                                   |        |                                                                                   |        |  |  |  |  |  |  |  |  |  |

 

28

----

 

**December31, 2001**

 
|                                     |   | **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                             |   | $                              | 5,656  |                              | 9.1    | %                                                                                 | $      | 4,984 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | 6,333                          |   | 10.3                              | %      | 4,943                                                                             |   | 8.0 | % | $ | 6,179 |   | 10.0 | % |
|                                     |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Risk  Weighted Assets: |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |
| Consolidated                             |   | 5,087                          |   | 8.2                               | %      | 2,488                                                                             |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | 5,767                          |   | 9.3                               | %      | 2,468                                                                             |   | 4.0 | % | 3,707 |   | 6.0 | % |
|                                     |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |
| Tier 1 Capital to Average  Assets:       |   |                           |   |                              |   |                                                                              |   |   |   |   |   |   |   |
| Consolidated                             |   | 5,087                          |   | 6.6                               | %      | 3,085                                                                             |   | 4.0 | % | N/A |   | N/A |   |
| Monterey County Bank                     |   | 5,767                          |   | 7.5                               | %      | 3,065                                                                             |   | 4.0 | % | 3,831 |   | 5.0 | % |
|                                          |        |                                |        |                                   |        |                                                                                   |        |  |  |  |  |  |  |  |  |  |

 

29

----

 

#### **Note 14.  STOCK OPTIONS AND STOCK DIVIDENDS**

 

At December 31, 2002, options for the purchase of243,130 shares of the Corporation’s common stock were outstanding andexercisable at prices ranging from $1.55 to $3.00.  The status of all optioned shares is as follows:

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

 

30

----

 

#### **Note 15.  RELATED PARTY TRANSACTIONS**

 

The Corporation has, and expects to have in the future,banking transactions in the ordinary course of its business with directors,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,  2000 |   | $         | 919,000   |   |
|----------------------------------|--------|-----------|-----------|--------|
| New loans                        |   | 268,600   |      |
| Repayments                       |   | (47,500   | )         |
|                             |   |      |      |
| Balance as of December 31,  2001 |   | 1,140,100 |      |
| New loans                        |   | 86,700    |      |
| Repayments                       |   | (37,400   | )         |
|                             |   |      |      |
| Balance as of December 31,  2002 |   | $         | 1,189,400 |   |

 

Related party deposits totaled approximately $165,700and $186,700 at December 31, 2002 and 2001, respectively.

 

#### **Note 16.  EMPLOYEE BENEFIT PLANS**

 

During 1995, the Corporation established an employeestock ownership plan (ESOP) to invest in the Corporation’s common stock for thebenefit of eligible employees.  TheBoard of Directors determines the Corporation’s contribution to the plan.  Shares in the plan generally vest afterseven years.  The Corporation did notcontribute to the ESOP trust in 2002, 2001, or 2000.  There were no shares in the plan as of December 31, 2002.

 

The Bank has a salary reduction plan under Section401(k) of the Internal Revenue Code. The plan covers substantially all full-time employees who have completedone year of service with the Bank. Employees are allowed to defer up to 15% of their compensation subjectto certain limits based on federal tax laws. Under the provisions of the plan, the Bank’s contribution policy isdiscretionary.  The Bank initiated amatching contribution in 2001 of 100% of each employee’s contribution up to 6%of the employee’s compensation.  TheBank’s matching contributions in 2002 and 2001 totaled $65,800 and $52,500,respectively.  No contributions weremade in 2000.

 

31

----

 

#### **Note 17.  REGULATORY MATTERS**

 

The Corporation is subject to regulation by the Boardof Governors of the Federal Reserve System under the Bank Holding CorporationAct.  The Bank is subject to regulation,supervision, and regular examination by the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation.  The regulations of these agencies affectmost aspects of the Corporation’s business and prescribe permissible types ofloans and investments, the amount of required reserves, requirements for branchoffices, the permissible scope of the Corporation’s activities, and variousother requirements.  The Corporation isalso subject to certain regulations of the Federal Reserve Bank dealing primarilywith check clearing activities, establishment of banking reserves,Truth-in-Lending (Regulation Z), and Equal Credit Opportunity (Regulation B).

 

#### **Note 18.  FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

SFAS No. 107, “Disclosures about Fair Value ofFinancial Instruments” requires disclosure of estimated fair values of allfinancial instruments where it is practicable to estimate such values.  In cases where quoted market prices are notavailable, fair values are based on estimates using present value or other valuationtechniques.  Those techniques aresignificantly affected by the assumptions used, including the discount rate andestimates of future cash flows. Accordingly, the derived fair value estimates cannot be substantiated bycomparison to independent markets and, in many cases, could not be realized inimmediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and allnon-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amountspresented do not represent the underlying value of the Corporation.

 

The Corporation in estimating fair value disclosuresfor financial instruments used the following methods and assumptions:

 

**Cash and cash equivalents:** The carryingamounts of cash and short-term instruments approximate fair values.

 

**Investment securities:** Fair values forinvestment securities, excluding Federal Home Loan Bank stock and Pacific CoastBanker’s Bank stock, are basedon quoted market prices.  The carryingvalue of Federal Home Loan Bank stock approximates fair value based on theredemption provisions of the Federal Home Loan Bank.

 

32

----

 

**Loans:**For variable-rate loans thatreprice frequently and with no significant change in credit risk, fair valuesare based on carrying values.  The fairvalue of performing fixed-rate loans is estimated by discounting future cashflows using the Corporation’s current offering rate for loans with similarcharacteristics.  The fair value of performingadjustable-rate loans is considered the same as book value.  The fair value of non-performing loans isestimated at the fair value of the related collateral or, when in management’sopinion foreclosure upon the collateral is unlikely, by discounting future cashflows using rates which take into account management’s estimate of credit risk.

 

**Commitments to Extend Credit and Standby Letters of Credit:**The Corporation does not generally enter into long-term fixed rate commitmentsor letters of credit.  These commitmentsare generally priced at current prevailing rates.  These rates are generally variable and, therefore, there is nointerest rate exposure.  Accordingly,the fair market value of these instruments is equal to the carrying valueamount of their net deferred fees.  Thenet deferred fees associated with these instruments are not material.  The Corporation has no unusual credit riskassociated with these instruments.

 

**Deposit liabilities:** The fair valuesdisclosed for demand deposits (e.g., interest and non-interest checking,savings, and certain types of money market accounts) are, by definition, equalto the amount payable on demand at the reporting date (i.e., their carryingamounts).  Fair values for fixed-ratecertificates of deposit are estimated using a discounted cash flow calculationthat applies interest rates currently being offered on certificates to aschedule of aggregated expected monthly maturities on time deposits.

 

**Accrued interest:** The carrying amountsof accrued interest approximate fair value.

 

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

 

33

----

 

The estimated fair values, and related carryingamounts, of the Corporation’s financial instruments as of December 31, 2002 and2001 are as follows:

 
|                            |   | **2002**             |       | **2001**        |   |
|---------------------------------|--------|----------------------|------------|-----------------|--------|
|                            |   | **Carrying  Amount** |       | **Fair  Value** |   | **Carrying  Amount** |   | **Fair  Value** |   |
| Financial Assets:               |   |                 |       |            |   |   |   |   |   |
| Cash and cash equivalents       |   | $                    | 13,017,100 |            | $      | 13,017,100 |   | $ | 11,392,900 |   | $ | 11,392,900 |   |
| Time deposits                   |   | —               |       | —          |   | 100,000 |   | 100,000 |   |
| Trading assets                  |   | 82,200               |       | 82,200          |   | 173,000 |   | 173,000 |   |
| Securities, available for  sale |   | 6,039,800            |       | 6,039,800       |   | 9,478,400 |   | 9,478,400 |   |
| Other investments               |   | 1,210,500            |       | 1,210,500       |   | 950,600 |   | 950,600 |   |
| Loans, held for sale            |   | 982,500              |       | 982,500         |   | 605,600 |   | 605,600 |   |
| Loans, net                      |   | 59,274,400           |       | 60,006,400      |   | 51,956,300 |   | 53,328,200 |   |
| Accrued interest  receivable    |   | 313,500              |       | 313,500         |   | 312,300 |   | 312,300 |   |
|                            |   |                 |       |            |   |   |   |   |   |
| Financial Liabilities:          |   |                 |       |            |   |   |   |   |   |
| Deposits                        |   | 67,616,400           |       | 67,699,200      |   | 68,332,400 |   | 68,639,900 |   |
| Short-term borrowings           |   | 200,000              |       | 200,000         |   | 200,000 |   | 200,000 |   |
| Long-term debt                  |   | 11,722,200           |       | 11,753,300      |   | 5,000,000 |   | 5,004,000 |   |
| Accrued interest payable        |   | 366,900              |       | 366,900         |   | 522,800 |   | 522,800 |   |
|                                 |        |                      |            |                 |        |  |  |  |  |  |  |  |  |

 

#### **Note 19.  SUBSEQUENT EVENTS**

 

The Corporation has appliedto be included in a Trust Preferred Securities Pool.  The Corporation would issue $3,000,000 to $5,000,000 in TrustPreferred Securities.  The proceeds ofthe issuance will be used to retire the Corporation’s current debt, injectcapital into the subsidiary, and for working capital.  Expenses related to the issuance would be recognized over thelife (30 years) of the securities.

 

34

----

 

#### **Note 20.  NORTHERN CALIFORNIA BANCORP, INC. (PARENTCORPORATION ONLY)**

 

The following are the financial statements of NorthernCalifornia Bancorp, Inc. (Parent Corporation only) as of December 31, 2002 and2001:

 

**Balance Sheets**

 
|                                             |   | **2002**  |      | **2001**  |   |
|--------------------------------------------------|--------|-----------|-----------|-----------|--------|
| Assets                                           |   |      |      |      |   |
| Cash and due from banks                          |   | $         | 17,100    |      | $      | 8,600 |   |
| Investment securities -  trading account         |   | 82,200    |      | 173,000   |   |
| Investment in Mission  Valley Bank Stock         |   | 25,000    |      | 25,000    |   |
| Investment in AT Services  LLC Acquisition Corp. |   | 204,200   |      | 200,000   |   |
| Deferred tax asset                               |   | 87,000    |      | 119,800   |   |
| Prepaid trust preferred  offering expense        |   | 10,000    |      | —    |   |
| Accounts receivable                              |   | 10,000    |      | —    |   |
| Investment in common stock  of                   |   |      |      |      |   |
| Monterey County Bank                             |   | 6,380,200 |      | 5,766,700 |   |
|                                             |   |      |      |      |   |
|                                             |   | $         | 6,815,700 |      | $      | 6,293,100 |   |
|                                             |   |      |      |      |   |
| Liabilities and  Shareholders’ Equity       |   |      |      |      |   |
| Accounts payable and  accrued expenses           |   | $         | 3,600     |      | $      | 4,900 |   |
| Dividend payable                                 |   | 1,000     |      | 1,300     |   |
| Notes payable                                    |   | 1,172,200 |      | 1,200,000 |   |
| Total liabilities                                |   | 1,176,800 |      | 1,206,200 |   |
| Shareholders’ equity                        |   | 5,638,900 |      | 5,086,900 |   |
|                                             |   |      |      |      |   |
|                                             |   | $         | 6,815,700 |      | $      | 6,293,100 |   |

 

35

----

 

 
| **Statements  of Operations**                     |   | **2002** |    | **2001** |   | **2000** |   |
|---------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
|                                              |   |     |    |     |   |     |   |
| Equity in income of  subsidiary                   |   | $        | 629,100 |     | $      | 663,300  |   | $ | 780,900 |   |
| Investment income from AT  Services LLC           |   | 24,200   |    | —   |   | —   |   |
| Gain (loss) on sale of  securities                |   | 5,400    |    | (27,800  | )      | 34,000   |   |
| Loss on trading asset                             |   | (173,800 | )       | (199,400 | )      | —   |   |
| Loss on Community Bankers’  Insurance Agency |   | —   |    | (40,000  | )      | —   |   |
| Dividend income                                   |   | 5,500    |    | —   |   | —   |   |
| Miscellaneous income                              |   | —   |    | 2,200    |   | 4,000    |   |
| Operating expenses                                |   | (85,600  | )       | (118,800 | )      | (118,300 | )      |
| Applicable tax benefit                            |   | 103,800  |    | 81,000   |   | 35,700   |   |
|                                              |   |     |    |     |   |     |   |
| Net income                                        |   | $        | 508,600 |     | $      | 360,500  |   | $ | 736,300 |   |

 

36

----

 
| **Statements  of Cash Flows**                                                  |   | **2002** |    | **2001** |   | **2000** |   |
|--------------------------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Cash flows from operating  activities:                                         |   |     |    |     |   |     |   |
| Net income                                                                     |   | $        | 508,600 |     | $      | 360,500  |   | $ | 736,300 |   |
| Adjustments to reconcile  net income to net cash used by operating activities: |   |     |    |     |   |     |   |
| Equity in undistributed  income of Monterey County Bank                        |   | (629,100 | )       | (663,300 | )      | (780,900 | )      |
| (Increase) decrease in  trading securities                                     |   | 90,800   |    | (5,000   | )      | (33,000  | )      |
| (Increase) decrease in  other assets                                           |   | 12,700   |    | (46,100  | )      | (61,100  | )      |
| Increase (decrease) in  accrued expenses                                       |   | (1,300   | )       | (4,000   | )      | 8,600    |   |
| Increase (decrease) in  other liabilities                                      |   | (300     | )       | (1,400   | )      | 600      |   |
| Net cash used by operating  activities                                         |   | (18,600  | )       | (359,300 | )      | (129,500 | )      |
| Cash flows from investing  activities:                                         |   |     |    |     |   |     |   |
| Cash dividends received  from subsidiary                                       |   | 75,000   |    | 200,000  |   | 100,000  |   |
| Increase in investments                                                        |   | (54,200  | )       | (154,800 | )      | (74,400  | )      |
| Net cash provided by  investing activities                                     |   | 20,800   |    | 45,200   |   | 25,600   |   |
| Cash flows from financing  activities:                                         |   |     |    |     |   |     |   |
| Increase (decrease) in  borrowed funds                                         |   | (27,800  | )       | 325,000  |   | 125,000  |   |
| Cash dividends paid on  common stock                                           |   | (500     | )       | (700     | )      | (600     | )      |
| Exercise of stock options                                                      |   | 55,200   |    | —   |   | —   |   |
| Stock repurchase                                                               |   | (20,600  | )       | (52,500  | )      | (19,400  | )      |
| Net cash provided by  financing activities                                     |   | 6,300    |    | 271,800  |   | 105,000  |   |
| Net increase (decrease) in  cash and cash equivalents                          |   | 8,500    |    | (42,300  | )      | 1,100    |   |
|                                                                           |   |     |    |     |   |     |   |
| Cash and cash equivalents,  beginning of year                                  |   | 8,600    |    | 50,900   |   | 49,800   |   |
|                                                                           |   |     |    |     |   |     |   |
| Cash and cash equivalents,  end of year                                        |   | $        | 17,100  |     | $      | 8,600    |   | $ | 50,900 |   |

 

The ability of the Corporation to pay dividends willlargely depend upon the dividends paid to it by the Bank.  There are legal limitations on the abilityof the Bank to provide funds to the Corporation in the form of loans, advances,or dividends.

 

37

----