** **

**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, 2005**                                                                                                                                                                                                                                     |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                                                           |
| **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**

 

**NORTHERN CALIFORNIA BANCORP, INC.**

(Name of Small Business Issuer in its Charter)

 

**Incorporated in the State ofCalifornia**

**IRS Employer IdentificationNumber 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) ofthe Securities Exchange Act during the past 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes   ý       No  o

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined is Rule 12b-2 of theExchange Act). Yes  o  No  ý

 

Revenues for the yearended December 31, 2005; $ 15,052,800.

 

Asof March 1, 2006, the Corporation had 1,631,439 shares of common stockout-standing. The aggregate market value of voting stock held by non-affiliatesof the Corporation was $7,354,300, based on the most recent sale at $10.00 pershare on February 24, 2006.

 

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

 

1.     Portionsof the Independent Auditor’s Report for the fiscal year ended December 31,2005 are incorporated by reference in Part II Item 7.

 

 

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FORM 10-KSBCROSS REFERENCE INDEX

 
| ** **        | ** **                                                                                                                               | **PAGE**   | ** ** |
|-------------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **        | ** **                                                                                                                               | ** ** | ** ** |
| **PART I**   | ** **                                                                                                                               | ** ** | ** ** |
| ITEM 1            | Business                                                                                                                                 | 3          |       |
| ITEM 2            | Properties                                                                                                                               | 18         |       |
| ITEM 3            | Legal Proceedings                                                                                                                        | 19         |       |
| ITEM 4            | Submission of Matters to a  Vote of Security Holders                                                                                     | 19         |       |
|              |                                                                                                                                     |       |       |
| **PART II**  | ** **                                                                                                                               | ** ** | ** ** |
| ITEM 5            | Market for the Corporation’s  Common stock and Related Stockholder Matters                                                          | 19         |       |
| ITEM 6            | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                              | 22         |       |
| ITEM 7            | Financial Statements  and Supplementary Data                                                                                             | 46         |       |
|              | Independent Auditors’  Report on the Financial Statements                                                                           | FS 1       |       |
|              | Consolidated Balance  Sheets at December 31, 2004 and 2003                                                                          | FS 2       |       |
|              | Consolidated  Statements of Operations for each of the three years in the period ended December 31,  2004                           | FS 3       |       |
|              | Consolidated  Statements of Changes in Stockholders’ Equity for each of the three years in  the period ended December 31, 2004 | FS 4       |       |
|              | Consolidated  Statements of Cash Flows for each of the three years in the period ended December 31,  2004                           | FD 5-6     |       |
|              | Notes to  Consolidated Financial Statements                                                                                              | FS 7-48    |       |
| ITEM 8            | Changes in  and Disagreements with Accountants and Financial Disclosure                                                                  | 46         |       |
| ITEM 8A           | Controls and  Procedures                                                                                                                 | 46         |       |
| ITEM 8B           | Not Applicable                                                                                                                           | 47         |       |
|              |                                                                                                                                     |       |       |
| **PART III** | ** **                                                                                                                               | ** ** | ** ** |
| ITEM 9            | Directors,  Executive Officers, Promoters and Control Persons:  Compliance with Section 16(a) of the Exchange Act              | 48         |       |
| ITEM 10           | Executive  Compensation                                                                                                                  | 50         |       |
| ITEM 11           | Security  Ownership of Certain Beneficial Owners and Management, and  Related Stockholder Matters                                        | 53         |       |
| ITEM 12           | Certain  Relationships and Related Transactions                                                                                          | 54         |       |
| ITEM 13           | Exhibits and Reports                                                                                                                     | 55         |       |
| ITEM 14           | Principal  Accountant Fees and Services                                                                                                  | 56         |       |
|              | Signatures                                                                                                                               | 57         |       |

 

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**PART I**

 

Certainmatters discussed or incorporated by reference in this Annual Report of Form 10-Kincluding, but not limited to, those described in “Item 6 - Management’sDiscussion and Analysis of Financial Condition and Results of Operations”, areforward-looking statements that are subject to risks and uncertainties thatcould cause actual results to differ materially from those projected in theforward-looking statements. Such risks and uncertainties include, among others,(1) competitive pressure in the banking industry increasing significantly;(2) changes in the interest rate environment reduces margins; (3) generaleconomic conditions, either nationally or regionally, are less favorable thanexpected, resulting in, among other things, a deterioration in credit quality; (4) changesin the regulatory environment; (5) changes in business conditions andinflation; and (6) changes in securities markets. Therefore, theinformation set forth therein should be carefully considered when evaluatingthe business prospects of the Corporation.

 

**ITEM 1. BUSINESS**

 

**GENERAL**

 

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

 

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

 

**BANKSUBSIDIARY**

 

MontereyCounty Bank, an independent, California chartered commercial banking corporationwas chartered by the State of California 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. The Bank offers its customers a widevariety of the normal personal, consumer and commercial services expected of alocally owned, independently operated bank. The Bank’s deposits are insured bythe Federal Deposit Insurance Corporation “FDIC”, and, as such, the Bank issubject to regulations by that federal agency and to periodic audits of itsoperations and documentary compliance by “FDIC” 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.

 

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

 

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At December 31,2005 the Bank had total assets, deposits and shareholders’ equity ofapproximately $162,645,100, $118,120,100 and $8,930,900, respectively.

 

**NorthernCalifornia Bancorp, Inc. Trust I**

 

On March 27, 2003,Northern California Bancorp, Inc. Trust I, a newly formed Delawarestatutory business trust and a wholly owned subsidiary of the Company (theTrust), issued an aggregate of $3.0 million of principal amount of FloatingRate TRUPSâ (Capital TrustPass-through Securities of the Trust) (the Trust Preferred Securities). BearStearns & Co., Inc. acted as placement agent in connection withthe offering of the Trust Preferred Securities. The securities issued by theTrust are fully guaranteed by the Company with respect to distributions andamounts payable upon liquidation, redemption or repayment. The entire proceedsto the Trust from the sale of the Trust Preferred Securities were used by theTrust in order to purchase $3.0 million in principal amount of the FloatingRate Junior Subordinated Deferrable Interest Debentures due 2033 issued by theCompany (the Subordinated Debt Securities).

 

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

#  

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

 

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

 

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

 

**EMPLOYEES**

 

At December 31,2005 the Northern California Bancorp, Inc. and its subsidiary MontereyCounty Bank employed a total of 47 full time equivalent persons.

 

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**COMPETITION**

 

Allphases of the Bank’s business have been, since inception, and will continue tobe subject to significant competitive forces. Although the Bank has increasingrecognition in its primary service area and Monterey County, it neverthelesshas to compete with other independent local banking institutions, includingcommercial banks and savings and loan associations, as well as branch officesof regional commercial banks, some of which have assets, capital and lendinglimits substantially larger than the Bank, as well as wider geographic markets,more support services and larger media advertising capabilities. The Bank willalso compete with respect to its lending activities, as well as in attractingdemand deposits, with savings banks, savings and loan associations, insurancecompanies, regulated small loan companies and credit unions, as well assecurities brokerage offices which can issue commercial paper and othersecurities (such as shares in money market funds).

 

Amongthe advantages such institutions have over the Bank are their ability tofinance wide ranging advertising campaigns and to allocate their investmentassets to regions of highest yields and demand. Many institutions offer certainservices, such as trust services and international banking, which the Bank doesnot currently offer or plan to offer. By virtue of their greater total capital,such institutions have substantially higher lending limits than the Bank (legallending limits to an individual customer being limited to a percentage of abank’s total capital accounts). These competitors may intensify theiradvertising and marketing activities to counter any efforts by the Bank tofurther attract new business as a commercial bank. In addition, as a result oflegislation enacted earlier in the decade, there is increased competitionbetween banks, savings and loan associations and credit unions for the depositand loan business of individuals. These activities may hinder the Bank’sability to capture a significant market share.

 

Tocompete with the financial institutions in its primary service area, the Bankintends to use the flexibility, which its independent status will permit. Itsactivities in this regard include an ability and intention to respond quicklyto changes in the interest rates paid on time and savings deposits and chargedon loans, and to charges imposed on depository accounts, so as to remaincompetitive in the market place. It also will continue to emphasize specializedservices for the small business person and professional and personal contactsby the Bank’s officers, directors and employees. If there are customers whoseloan demands exceed the Bank’s lending limits, the Bank has the ability toarrange for such loans on a participation basis with other financialinstitutions. No assurance can be given, however, that the Bank’s efforts tocompete with other financial institutions in its primary service area will besuccessful.

 

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

 

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

 

TheBank entered into an agreement with Genesis Financial Solutions, a purchaser ofcharged-off consumer credit card balances, to market a MasterCard credit cardprogram. The Bank will be issuing the cards, but the credit card balances willbe 100 percent owned by Genesis Financial Solutions. The program wasimplemented in the first quarter of 2005 with the initial card solicitationsbeing mailed in February 2005; 14,741 active cards were on file at December 31,2005. The Bank’s 2005 revenues from the program were $95,400. Genesis FinancialSolutions maintains 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.

 

TheBank entered into an agreement in February 2006 with GC Acquisitions,LLC (“GCA”), the owner of a portfolio of consumercredit card contracts and receivables, under which the Bank will offerMasterCard® credit cards to qualifying GCA credit card contract holders. GCA will, through its affiliates, agents and vendors, establish new credit cardaccounts with the Bank for certain of its existing credit card contractholders, service the credit card accounts and own the receivables generatedfrom the accounts. GCA will maintain reserve deposits with the Bank based oncardholder activity and available credit. The initial card issuance isprojected to begin in April 2006 with the number of cards to be issuedestimated at approximately two hundred fifty thousand (250,000). The Bank’srevenues from the program will be dependent on the number of cards in theportfolio and the amount of reserve deposits maintained.

 

TheBank has implemented a pre-paid debit card program. The program is marketed bythird parties through employer payroll programs and check cashing facilities,through Internet websites for purchasers of the websites’ products and services.Holders of the pre-paid cards will be able to have additional funds added tothe card balance, make point of sale purchases and withdraw cash throughautomated teller machines. The Bank will be issuing the pre-paid cards andmaintaining the funds held on the cards. The Bank’s revenues from the programwill be in the form of transaction fees and earnings from investing thefunds held on the cards. Revenues from the program were $13,800, $8,300 and$2,100 in 2005, 2004 and 2003, respectively.

 

TheBank depends largely on rate differentials. In general, the difference betweenthe interest rate paid by the Bank on its deposits and its other borrowings,and the interest rate received by the Bank on loans extended to its customersand securities held in the Bank’s portfolio, comprise the major portion of theBank’s earnings. These rates are highly sensitive to many factors that arebeyond the control of the Bank. Accordingly, the earnings and growth of theBank are subject to the influence of domestic and foreign economic conditions,including inflation, recession and unemployment.

 

Monetaryand fiscal policies of the federal government and the policies of regulatoryagencies, particularly the Federal Reserve Board, also impact on the Bank’sbusiness. The Federal Reserve Board implements national monetary policies (withobjectives such as curbing inflation and combating recession) by its open-marketoperations in U.S. Government securities, by adjusting the

 

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required level ofreserves for financial intermediaries subject to its reserve requirements andby varying the discount rates applicable to borrowings by depositoryinstitutions. The actions of the Federal Reserve Board in these areas influencethe growth of bank loans, investments and deposits and also affect interestrates charged on loans and paid on deposits. The nature and impact of anyfuture changes in monetary policies cannot be predicted.

 

**SUPERVISIONAND REGULATION**

 

**TheCorporation**

 

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

 

On December 29,1995, after receipt of appropriate approvals, and/or passage of notice periodswithout objection, from the California Superintendent of Banks, the FederalDeposit Insurance Corporation, the Board of Governors of the Federal ReserveSystem and the shareholders of the Bank, the Corporation acquired the Bankthrough a reverse triangular merger (the “Merger”). As a result, by operationof law, each outstanding share of common stock of the Bank prior to the Mergerwas converted into a share of common stock of the Corporation, while theCorporation became the sole owner of the newly issued shares of common stock ofthe Bank.

 

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

 

A bankholding company is generally prohibited from engaging in, or acquiring director indirect control of more than 5% of the voting shares of any company engagedin non-banking activities unless the FRB, by order or regulation, has foundsuch activities to be so closely related to banking or managing or controllingbanks as to be a proper incident thereto. In making such determinations, theFRB considers whether the performance of such activities by a bank holdingcompany would offer advantages to the public, which outweigh possible adverseeffects.

 

TheFRB’s Regulation “Y” sets out the non-banking activities that are permissiblefor bank holding companies under the law, subject to the FRB’s approval inindividual cases. Most of these activities are now permitted for Californiabanks that are well-capitalized.  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 Presidentand 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 allows

 

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subsidiaries of banks toengage in a broad range of financial activities that are not permitted forbanks themselves. Management cannot predict what effect these changes will haveon the Bank or the Corporation.

 

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

 

TheCorporation and any subsidiaries which it may acquire or organize afterthe reorganization will be deemed affiliates of the Bank within the meaning ofthe Federal Reserve Act. Pursuant thereto, loans by the Bank to affiliates,investments by the Bank in affiliates’ stock, and taking affiliates’ stock by theBank as collateral 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 placeother limitations on transactions between the Bank and its affiliates designedto ensure that the Bank receives treatment in such transactions comparable tothat available from unaffiliated third parties.

 

TheCorporation and its subsidiaries are prohibited from engaging in certain tie-inarrangements in connection with any extension of credit, sale or lease ofproperty or furnishing of services. For example, with certain exceptions, theBank may not condition an extension of credit on a customer’s obtainingother services provided by it, the Corporation or any other subsidiary, or on apromise from its customer not to obtain other services from a competitor.

 

**Sarbanes-OxleyAct**

 

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

 

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

•      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 and realtime 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.

•      Providesfor mandated internal control report and assessment with the annual report andan attestation and a report on such report by the company’s auditor.

 

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The effect of theAct upon corporations is uncertain; however, it is likely that compliance costsmay increase as corporations modify procedures if required to conform tothe provisions of the Act. The Company does not currently anticipate thatcompliance with the Act will have a material effect upon its financial positionor results or its operations or its cash flows.

 

**SubsidiaryBank**

 

Bothfederal and state laws provide extensive regulation of the banking business. Stateand federal statutes and regulations apply to many aspects of the Bank’soperations, including minimum capital requirements, reserves against deposits,interest rates payable on deposits, loans, investments, mergers andacquisitions, borrowings, dividends and locations of branch offices. TheCalifornia Superintendent of Banks and the FDIC provide primary supervision,periodic examination and regulation of the Bank.

 

TheFDIC, through its Bank Insurance Fund (the “BIF”) insures the Bank’s deposits,currently up to a maximum of $100,000 per depositor. 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 nota member of the Federal Reserve System, certain regulations of the FederalReserve Board also apply to its operations.

 

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

 

Federallaw imposes restrictions on banks with regard to transactions with affiliates,including any extensions of credit to, or the issuance of a guarantee or letterof credit on behalf of, its affiliates, as well as the purchase of orinvestments in stock or other securities thereof, or the taking of suchsecurities as collateral for loans, and the purchase of assets of fromaffiliates. These restrictions have the effect of preventing affiliates (suchas the Corporation) from borrowing from the Bank unless the loans are securedby marketable obligations of designated amounts. Secured loans and investmentsby the Bank are limited to 10% of the Bank’s capital and surplus (as defined byfederal regulations) in the case of any one affiliate, and 20% thereof in thecase of all affiliates. California law also imposes certain restrictions withrespect to transactions involving other controlling persons of the Bank.

 

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

 

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**Capital Adequacy Standards**

 

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

 

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

 

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

 

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

 

A bankingorganization’s qualifying total capital consists of two components: Tier Icapital (core capital) and Tier 2 capital (supplementary capital). Tier Icapital consists primarily of common stock, related surplus and retainedearnings, qualifying noncumulative perpetual preferred stock and minorityinterests in the equity accounts of consolidated subsidiaries. Trust preferredsecurities qualify as Tier 1 capital up to a maximum of 25% of capital. Anyadditional portion will qualify as Tier 2 capital. Intangibles, such asgoodwill, are generally deducted from Tier 1 capital; however, purchasedmortgage servicing rights and purchased credit card relationships may beincluded, subject to certain limitations. At least 50% of the bankingorganization’s total regulatory capital must consist of Tier 1 capital.

 

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

 

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

 

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

 

Forcapital adequacy purposes, deferred tax assets that can be realized from taxespaid in prior carry-back years, and from the future reversal of temporarydifferences, are generally unlimited. However, deferred tax assets that canonly be realized through future taxable earnings, including the implementationof a tax planning strategy, count toward regulatory capital purposes only up tothe lesser of (i) the amount that can be realized within one year of thequarter-end report date or (ii) 10% of Tier I capital. The amount ofdeferred taxes in excess of this limit, if any, would be deducted from Tier Icapital and total assets in regulatory capital calculations.

 

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

 

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

 

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

 

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**Prompt Corrective Action and Other EnforcementMechanisms**

 

Under Section 38of the FDIA, as added by the Federal Deposit Insurance Corporation ImprovementAct of 1991 (“FDICIA”), each federal banking agency is required to implement asystem of prompt corrective action for institutions which it regulates. Thefederal banking agencies have promulgated substantially similar regulations toimplement this system of prompt corrective action. Under the regulations, aninstitution shall generally be deemed to be: (i) ”well capitalized” if ithas a total risk-based capital ratio of 10.0% or more, has a Tier I risk-basedcapital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0%or more and is not subject to specified requirements to meet and maintain aspecific capital level for any capital measure; (ii) ”adequatelycapitalized” if it has a total risk-based capital ratio of 8.0% or more, aTier I risk-based capital ratio of 4.0% or more and a Tier I leveragecapital ratio of 4.0% or more (3.0% under certain circumstances) and does not meetthe definition of “well capitalized;” (iii) ”undercapitalized” if it has atotal risk-based capital ratio that is less than 8.0%, a Tier I risk-basedcapital ratio that is less than 4.0% or a Tier I leverage capital ratiothat is less than 4.0% (3.0% under certain circumstances); (iv) ”significantlyundercapitalized” if it has a total risk-based capital ratio that is less than6.0%, a Tier I risk-based capital ratio that is less than 3.0% or aTier I leverage capital ratio that is less than 3.0%; and (v) ”criticallyundercapitalized” if it has a ratio of tangible equity to total assets that isequal to or less than 2.0%.

 

Section 38of the FDIA and the implementing regulations also provide that a federalbanking agency may, after notice and an opportunity for a hearing, reclassify awell capitalized institution as adequately capitalized and may require anadequately capitalized institution or an undercapitalized institution to complywith supervisory actions as if it were in the next lower category if theinstitution is in an unsafe or unsound condition or engaging in an unsafe orunsound practice. (The FDIC may not, however, reclassify a significantlyundercapitalized institution as critically undercapitalized.)

 

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

 

At December 31,2005, the Bank met the tests to be categorized as “well capitalized” under theprompt corrective action regulations of the FDIC.

 

**Safety and Soundness Standards**

 

Federallaw requires the federal banking regulatory agencies to prescribe, byregulation, standards for all insured depository institutions relating to: (i) internalcontrols, information systems and internal audit systems; (ii) loandocumentation; (iii) credit underwriting; (iv) interest rate riskexposure; (v) asset growth; and (vi) compensation, fees and benefits.The federal banking agencies recently adopted final regulations and InteragencyGuidelines Prescribing Standards for Safety and Soundness (“Guidelines”) toimplement safety and soundness standards required by the FDIA. The

 

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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 also proposed asset quality and earningsstandards which, if adopted in final, would be added to the Guidelines. Underthe final regulations, if the FDIC determines that the Bank fails to meet anystandard prescribed by the Guidelines, the agency may require the Bank tosubmit to the agency an acceptable plan to achieve compliance with thestandard, as required by the FDIA. The final regulations establish deadlinesfor the submission and review of such safety and soundness compliance plans.

 

**Premiums for Deposit Insurance**

 

TheFDIC adopted regulations implementing a risk-based premium system required byfederal law. Under the regulations which cover the assessment periods commencingon and after January 1, 1994, insured depository institutions are requiredto pay insurance premiums within a range of $.23 cents per $100 of deposits to$.31 cents per $100 of deposits depending on their risk classification. TheFDIC, effective September 30, 1995, lowered assessments from their ratesof $.23 to $.31 per $100 of insured deposits to rates of $.04 to $.31,depending on the health of the bank, as a result of the re-capitalization ofthe BIF. The FDIC may alter the existing assessment rate structure fordeposit insurance and may change the base assessment rate (currently, 4 to31 basis points per year) by rulemaking with notice and comment. Without noticeor comment, the FDIC may increase or decrease the current rate schedule uniformlyby as much as 5 basis points, as deemed necessary to maintain the targetdesignated reserve ratio 1.25 percent (fund balance to estimated insureddeposits). The insured deposit rates for 2005 were $.00 to $.27. These ratesare projected to continue through the first half of 2006.

 

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

 

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

 

TheFICO assessment rate is adjusted quarterly to reflect changes in the assessmentbasis of the respective funds based on the quarterly Call Report and the ThriftFinancial Report submissions. The FICO quarterly rates for 2005 were 1.44, 1.44,1.34 and 1.34. The FICO quarterly rate for the first quarter of 2006 is 1.32.

 

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**Interstate Banking and Branching**

 

On September 29,1994, the President signed into law the Riegle-Neal Interstate Banking andBranching Efficiency Act of 1994 (the “Interstate Act”). Under the InterstateAct, beginning one year after the date of enactment, a bank holding companythat is adequately capitalized and managed may obtain regulatory approvalto acquire an existing bank located in another state without regard to statelaw. A bank holding company would not be permitted to make such an acquisitionif, upon consummation, it would control (a) more than 10% of the totalamount of deposits of insured depository institutions in the United States or (b) 30%or more of the deposits in the state in which the bank is located. A state may limitthe percentage of total deposits that may be held in that state by any onebank or bank holding company if application of such limitation does not discriminateagainst out-of-state banks. An out-of-state bank holding company may notacquire a state bank in existence for less than a minimum length of time that may beprescribed by state law except that a state may not impose more than afive year existence requirement.

 

TheInterstate Act also permitted affective June 1, 1997, mergers of insuredbanks located in different states and conversion of the branches of theacquired bank into branches of the resulting bank. Each state may permitsuch combinations earlier than June 1, 1997, and may adoptlegislation to prohibit interstate mergers after that date in that state or inother states by that state’s banks. The same concentration limits discussed inthe preceding paragraph apply. The Interstate Act also permits a national orstate bank to establish branches in a state other than its home state ifpermitted by the laws of that state, subject to the same requirement andconditions as for a merger transaction.

 

TheInterstate Act is likely to increase competition in the Bank’s market areasespecially from larger financial institutions and their holding companies. Itis difficult to asses the impact such likely increased competition will have onthe Bank’ operations.

 

OnOctober 2, 1995, the “California Interstate Banking and Branching Act of1995” (the “1995 Act”) became effective. The 1995 Act generally allowsout-of-state banks to enter California by merging with, or purchasing, aCalifornia bank or industrial loan company which is at least five years old. Also,the 1995 Act repeals the California Interstate (National) Banking Act of 1986,which previously regulated the acquisition of California banks by out-of-statebank holding companies. In addition, the 1995 Act permits California statebanks, with the approval of the Superintendent of Banks, to establish agencyrelationships with FDIC-insured banks and savings associations. Finally, the1995 Act provides for regulatory relief, including (i) authorization forthe Superintendent to exempt banks from the requirement of obtaining approvalbefore establishing or relocating a branch office or place of business, (ii) repealof the requirement of directors’ oaths (Financial Code Section 682), and (iii) repealof the aggregate limit on real estate loans (Financial Code Section 1230).

 

**Community Reinvestment Act andFair Lending Developments**

 

TheBank is subject to certain fair lending requirements, reporting obligationsinvolving home mortgage lending operations and Community Reinvestment Act (the “CRA”).The CRA generally requires the federal banking agencies to evaluate the recordof financial institutions in meeting the credit needs of their local community,including low and moderate income neighborhoods. In addition to substantialpenalties and corrective measures that may be required for

 

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a violation of certainfair lending laws, the federal banking agencies may take compliance withsuch laws and CRA into account when regulating and supervising otheractivities.

 

InMay, 1995, the federal banking agencies issued final regulations which changethe manner in which they measure a bank’s compliance with its CRA obligations. Thefinal regulations adopt a performance-based evaluation system which bases CRAratings on an institution’s actual lending service and investment performancerather than the extent to which the institution conducts needs assessments,documents community outreach or complies with other procedural requirements. InMarch 1994, the Federal Interagency Task Force on Fair Lending issued apolicy statement on discrimination in lending. The policy statement describesthe three methods that federal agencies will use to prove discrimination: overtevidence of discrimination, evidence of disparate treatment and evidence ofdisparate impact. Management of the Bank believes that the Bank is insubstantial compliance with all requirements under these provisions. Followingthe Bank’s most recent CRA examination, the Bank’s rating was “satisfactory”.

 

**Other Regulations and Policies**

 

Thefederal regulatory agencies have adopted regulations that implement Section 304of FDICIA which requires federal banking agencies to adopt uniform regulationsprescribing standards for real estate lending. Each insured depository institutionmust adopt and maintain a comprehensive written real estate lending policy,developed in conformance with prescribed guidelines, and each agency hasspecified loan-to-value limits in guidelines concerning various categories ofreal estate loans.

 

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

 

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

 

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**Financial Modernization Act**

 

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

 

The Gramm-Leach-BlileyAct defines “financial in nature” to include securities underwriting, dealingand market making; sponsoring mutual funds and investment companies; insuranceunderwriting and agencies; merchant banking activities; and activities that theFederal Reserve Board has determined to be closely related to banking. Anational bank (and therefore, a state bank as well) may also engage,subject to limitations on investment, in activities that are financial innature, other than insurance underwriting, insurance company portfolioinvestment, real estate development and real estate investment, through afinancial subsidiary of the bank, if the bank is well capitalized, well managedand has at least a satisfactory Community Reinvestment Act rating. Subsidiarybanks of a financial holding company or national banks with financialsubsidiaries must continue to be well capitalized and well managed in order tocontinue to engage in activities that are financial in nature withoutregulatory actions or restrictions, which could include divestiture of thefinancial in nature subsidiary or subsidiaries. In addition, a financialholding company or a bank may not acquire a company that is engaged inactivities that are financial in nature unless each of the subsidiary banks ofthe financial holding company or the bank has a Community Reinvestment Act ratingof satisfactory or better.

 

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

** **

**USA Patriot Act of 2001**

 

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

 

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

 

•              standardsfor verifying customer identification at account opening; and

 

•              rules topromote cooperation among financial institutions, regulators, and lawenforcement entities in identifying parties that may be involved interrorism or money laundering.

 

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

 

# **Regulatory Enforcement Powers**

 

Commercialbanking organizations, such as the Bank, may be subject to enforcementactions by the FDIC and the Superintendent for engaging in unsafe or unsoundpractices in the conduct of their businesses or for violations of any law,rule, regulation or any condition imposed in writing by the agency or anywritten 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 money penalties, the issuance of directivesto increase capital, the issuance of formal and informal agreements, theissuance of removal and prohibition orders against institution-affiliatedparties and the imposition of restrictions and sanctions under the promptcorrective action provisions of the FDICIA.

 

# **California and Federal Banking Law**

 

 The Federal 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 federal regulatory agencyhas been given 60 days’ prior written notice of such proposed acquisition and,within that time period, has not issued a notice disapproving the proposedacquisition or extending for up to another 30 days the period during which sucha disapproval may be issued. An acquisition may be made prior to theexpiration of the disapproval period if the agency issues written notice of itsintent not to disapprove the action. The acquisition of more than 10% of a class ofvoting stock of a bank (or holding company) with a class of securitiesregistered under Section 12 of the Securities Exchange Act of 1934, asamended (such as the Common stock), is generally presumed, subject to rebuttal.to constitute the acquisition of control.

 

Underthe California Financial Code, no person shall, directly or indirectly, acquirecontrol of a California licensed bank or a bank holding company unless theSuperintendent has approved such acquisition of control. A person would bedeemed to have acquired control of the Corporation under this state law if suchperson, directly or indirectly, has the power (i) to vote 25% or more ofthe voting power of the Corporation or (ii) to direct or cause thedirection of the management and policies of the Corporation. For purposes ofthis law, a person who directly or indirectly owns or controls 10% or more ofthe Common stock would be presumed to control the Corporation, subject torebuttal.

 

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Inaddition, any “company” would be required to obtain the approval of the FederalReserve under the Bank Holding Company Act of 1956, as amended (the “BHC Act”),before acquiring 25% (5% in the case of an acquirer that is, or is deemed tobe, a bank holding company) or more of the outstanding Common stock of, or suchlesser number of shares as constitute control over, the Bank or theCorporation.

 

TheCommunity Reinvestment Act of 1977 (“CRA”) and the related Regulations of theComptroller of the Currency, the Board of Governors of the Federal Reserve andthe Federal Deposit Insurance Corporation (“FDIC”) are intended to encourageregulated financial institutions to help meet the credit needs of their localcommunity or communities, including low and moderate income neighborhoods,consistent with the safe and sound operation of such financial institutions. TheCRA and 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 examinations are made public and are takeninto account upon the filing of any application to establish a domestic branch,to merge or to acquire the assets or assume the liabilities of a bank. In thecase of a bank holding company, the CRA performance record of the subsidiarybank(s) involved in the transaction is reviewed in connection with the filingof an application to acquire ownership or control of shares or assets of a bankor to merge with any other bank holding company. An unsatisfactory record cansubstantially delay or block the transaction.

 

**RESEARCH**

 

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

 

**DEPENDENCEUPON A SINGLE CUSTOMER**

 

Neither theCorporation nor the Bank is dependent upon a single customer or very fewcustomers. The Bank’s business is concentrated in, and largely dependent uponthe strength of the local economy in, the Monterey Peninsula area of NorthernCalifornia. The local economy is affected by both national trends and by localfactors. Tourism and the activities at the former Fort Ord military base areamong the major contributors to the local economy.

 

**ITEM 2. PROPERTIES**

 

The main office ofthe Bank, which also serves as the principal office of the Corporation, islocated at 601 Munras Ave., Monterey, California 93940. This facility containsa lobby, executive and customer service offices, teller stations, safe depositboxes and related non-vault area, vault, operations area, lounge andmiscellaneous areas. A drive-through facility and adequate paved parking arealso on the premises. Both the land and all improvements thereto are owned bythe Bank**.**The Bank currently operates three branchoffices in Carmel-By-The-Sea, Carmel Valley and Pacific Grove, California, allwithin approximately 10 miles from the Bank’s main office. The Bank also has a loanproduction office located in Monterey, California. The land and improvementsdedicated to the Carmel-By-The-Sea, Carmel Valley and Pacific Grove branchoffices and the loan production office are leased. See Footnote 12 to theCorporation’s financial statements included

 

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herewith. In March 2005the Bank purchased a building located at 565 Abrego St., Monterey, CA 93940. Thisfacility located within a city block of the Bank’s main office will be utilizedfor additional office space.

 

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

 

**ITEM 3. LEGAL PROCEEDINGS**

 

None

 

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

 

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

 

**PART II**

 

**ITEM 5. MARKET FOR THECORPORATION’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.**

 

The Corporation’sstock, which is held by approximately 530 persons, began trading on the NationalAssociation of Securities DealersAutomated Quotations (NASDAQ) system in May 2005.  In addition to the limited trading on theNASDAQ, stock symbol NRLB; the Corporation also has knowledge of a limitednumber of transactions conducted between individual shareholders.

 

The Corporationrepurchased 3,795 shares of common stock at $4.00 per share in 2005 and 5,368at $4.00 in 2003; no shares were repurchased in 2004.

 

The followingtable sets forth, according to information known to the Corporation, the pricepaid per share in, and volume of, transactions in the Corporation’s stockduring the quarters ended March 31, 2003 to December 31, 2005.

 
| **Quarter/Year**    | ** ** | **Price** | ** ** | **Volume****(1)** | ** ** |
|---------------------|------------|-----------|------------|-------------------|------------|
|                |       |      |       |              |       |
| 1st quarter of 2003 |       | 3.00      |       | 46                |       |
| 2nd quarter of 2003 |       | 3.00-4.00 |       | 1,273             |       |
| 3rd quarter of 2003 |       | 3.00-4.00 |       | 45,948            |       |
| 4th quarter of 2003 |       | 3.00      |       | 504               |       |
|                |       |      |       |              |       |
| 1st quarter of 2004 |       | 3.00      |       | 1,438             |       |
| 2nd quarter of 2004 |       | 3.00-4.00 |       | 3,795             |       |
| 3rd quarter of 2004 |       | 3.00      |       | 166               |       |
| 4th quarter of 2004 |       | —    |       | —            |       |
|                |       |      |       |              |       |
| 1st quarter of 2005 |       | —    |       | —            |       |
| 2nd quarter of 2005 |       | 3.00-6.75 |       | 2,913             |       |
| 3rd quarter of 2005 |       | 4.00-5.35 |       | 6,873             |       |
| 4th quarter of 2005 |       | 4.00-8.15 |       | 8,083             |       |

 

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

 

The principal sourceof cash flow of the Corporation, including cash flow to pay dividends on itsstock or principal and interest on debt, is interest and dividends oninvestments and tax payments and dividends from the Bank. There are statutoryand regulatory limitations on the payment of dividends by the Bank to theCorporation, as well as by the Corporation to its shareholders.

 

If in the opinionof the applicable federal and/or state regulatory authority, a depositoryinstitution or holding company is engaged in or is about to engage in an unsafeor unsound practice (which, depending on the financial condition of thedepository institution or holding company, could include the payment ofdividends), such authority may require, after notice and hearing (exceptin the case of an emergency proceeding where there is in no notice or hearing),that such institution or holding company cease and desist from such practice. Moreover,the Federal Reserve and the FDIC have issued policy statements which providethat bank holding companies and insured depository institutions generallyshould only pay dividends out of current operating earnings.

 

Under the FederalDeposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), an FDICinsured depository institution may not pay any dividend if payment wouldcause it to become undercapitalized or once it is undercapitalized.

 

The Bank’s paymentof dividends, as a California chartered commercial banking corporation, isregulated by the California Financial Code. Under the California FinancialCode, funds available for cash dividend payments by the Bank are restricted tothe lessor of: (i) retained earnings; or (ii) the Bank’s net incomefor its last three fiscal years (less any distributions to the stockholdersmade during such period). As of December 31, 2005 the Bank had $7,478,900in retained earnings. The Bank’s net income for the last three fiscal yearsless distributions to stockholders was $4,746,000.

 

InDecember 2005, 2004 and 2003 the Corporation paid cash dividends of $0.20,$0.165 and $0.15 per share, respectively. The Bank paid cash dividends totaling$50,000 to the Corporation during 2003; no dividends were paid in 2004 or 2005.

 

**Recent Sales of UnregisteredSecurities**

 

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

 

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On March 27, 2003, the Company’s wholly ownedspecial-purpose trust subsidiary, Northern California Bancorp, Inc. TrustI (the “Trust”) issued $3,000,000 of principal amount of Floating Rate TRUPSâ (Capital Trust Pass-through Securities) (the“Trust Preferred Securities”). Bear Stearns & Co. acted as placementagent in connection with the offering of the Trust Preferred Securities withaggregate commission of approximately $90,000 paid to Bear Stearns &Co. by Northern California Bancorp, Inc. Trust I in connection with suchplacement services. The securities bear a floating rate of interest of 3.25%over the three month LIBOR rate (4.15% + 3.250% = 7.40% at December 31,2005), payable quarterly. Concurrent with the issuance of the Trust PreferredSecurities, the Trust used the proceeds from the Trust Preferred Securitiesoffering to purchase a like amount of Junior Subordinated Debentures of theCompany. The Subordinated Debentures are the sole assets of the Trust. TheCompany will pay interest on the Junior Subordinated Debentures to the Trust,which represents the sole revenue and sole source of dividend distributions tothe holders of the Trust Preferred Securities. The Company has the right,assuming no default has occurred, to defer payments of interest on the JuniorSubordinated Debentures at any time for a period not to exceed 20 consecutivequarters. The Trust Preferred Securities will mature on April 7, 2033, butcan be redeemed under certain circumstances at a premium prior to April 7,2008, and can be redeemed, in whole or in part, on any January 7, April 7,July 7 or October 7 occurring on or after April 7, 2008 at par. TheCompany fully and unconditionally guarantees the obligations of the Trust, on asubordinated basis. The Companyreceived $2.91 million from the Trust upon issuance of the Junior SubordinatedDebentures, of which $1 million was contributed by the Company to the Bank toincrease its capital, $1.14 million was used to retire existing Company debtand the remainder held as working capital. The Subordinated DebtSecurities were not registered under the Securities Act in reliance on theexemption set forth in Section 4(2) thereof.

 

Thesale of the Trust Preferred Securities was part of a larger transactionarranged by Bear Stearns & Co., Inc. pursuant to which the TrustPreferred Securities were deposited into a special purpose vehicle along withsimilar securities issued by a number of other banks and the special purposevehicle then issued its securities to the public (the “Pooled TRUPSâ“). The Pooled TRUPSâ were sold by Bear Stearns & Co., Inc.only (i) to those entities Bear Stearns & Co., Inc.reasonably believed were qualified institutional buyers (as defined in Rule 144Aunder the Securities Act), (ii) to “accredited investors” (as defined in Rule 501(a)(1),(2), (3) or (7) or Regulation D promulgated under the Securities Act)or (iii) in offshore transactions in compliance with Rule 903 ofRegulation S under the Securities Act. The Trust Preferred Securities were notregistered under the Securities Act in reliance on exemptions set forth in Rule 144A,Regulation D and Regulation S, as applicable.

 

On November 13, 2003, the Company’s whollyowned special-purpose trust subsidiary, Northern California Bancorp, Inc.Trust II (the “Trust”) issued $5,000,000 ofprincipal amount of Floating Rate TRUPSâ(Capital Trust Pass-through Securities) (the “Trust Preferred Securities”). Citigroup Global Markets, Inc.acted as placement agent in connection with the offering of the Trust PreferredSecurities with aggregate commission of approximately $40,000 paid to CitigroupGlobal Markets, Inc. by Northern California Bancorp, Inc. Trust II inconnection with such placement services. The securities bear a floating rate of interest of 2.85% over the threemonth LIBOR rate (4.25% + 2.85% = 7.10% at December 31, 2005), payable quarterly. Concurrent with theissuance of the Trust Preferred Securities, the Trust used the proceeds fromthe Trust Preferred Securities offering to purchase a like amount of JuniorSubordinated Debentures of the Company. The Subordinated Debentures are thesole assets of the Trust and are eliminated, along with the related incomestatement effects, in the consolidated financial statements. The Company willpay interest

 

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on the Junior Subordinated Debentures to the Trust, which represents thesole revenue and sole source of dividend distributions to the holders of theTrust Preferred Securities. The Company has the right, assuming no default hasoccurred, to defer payments of interest on the Junior Subordinated Debenturesat any time for a period not to exceed 20 consecutive quarters. The TrustPreferred Securities will mature on November 8, 2033, but can be redeemedunder certain circumstances at a premium prior to August 8, 2008, and canbe redeemed, in whole or in part, on any February 8, May 8, August 8or November 8 occurring on or after August 8, 2008 at par. TheCompany fully and unconditionally guarantees the obligations of the Trust, on asubordinated basis. The Company received $4.96 million from the Trust uponissuance of the Junior Subordinated Debentures, of which $2.5 million wascontributed by the Company to the Bank to increase its capital and theremainder held as working capital.

 

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

 

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

 

**Statements Regarding Forward-Looking Information**

 

Exceptfor historical information contained herein, the matters discussed orincorporated by reference in this report contain forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, asamended (the “Securities Act”), and Section 21E of the Securities ExchangeAct of 1934 (the “Exchange Act”), that involve substantial risks anduncertainties. When used in this report, or in the documents incorporated byreference herein, the words “anticipate,” “believe,” “estimate,” “may,” “intend,”“expect,” and similar expressions identify certain of such forward-lookingstatements. Actual results of Monterey County Bank could differ materially fromsuch forward-looking statements contained herein. Factors that could causefuture results to vary from current expectations include, but are not limitedto, the following: changes in economic conditions (both generally and morespecifically in the markets in which the Bank operates); changes in interestrates, deposit flows, loan demand, real estate values and competition; changesin accounting principles, policies or guidelines and in government legislationand regulation (which change from time to time and over which the Bank has nocontrol); other factors affecting the Bank’s operations, markets, products andservices; and other risks detailed in this Form 10-KSB and in the Bank’sother reports filed with the Comptroller of the Currency pursuant to the rules andregulations of the Securities and Exchange Commission. Readers are cautionednot to place undue reliance on these forward-looking statements, which reflectmanagement’s analysis only as of the

 

22

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date hereof. TheBank undertakes no obligation to publicly revise these forward-lookingstatements to reflect events or circumstances that arise after the datethereof.

 

**OVERVIEW**

 

The followingdiscussion reviews and analyzes the operating results and financial conditionof the Corporation, focusing on the Bank. It should be read in conjunction withthe financial statements and the other financial data presented elsewhereherein.

 

Net income foreach of the last three years was $1,929,300 in 2005, $1,065,200 in 2004, and $839,800in 2003. The primary net income per share for each of the last three years was$1.20, $.68, and $.55 respectively. The diluted net income per share for thesame time periods was $1.00, $.56 and $.47, respectively. Return on averageshareholders’ equity was 24.15%, 15.35% and 13.84% in 2005, 2004 and 2003,respectively. Return on average assets was 1.24%, 0.88%, and 0.88% in 2005, 2004and 2003, respectively.

 

The increase inearnings in 2005 was due to increases of $2,134,500 in net interest incomeafter provision for loan losses, $135,200 in non-interest income, $696,800 in non-interestexpense and $708,800 in income tax expense.

 

The increase inearnings in 2004 was due to increases of $1,240,700 in net interest incomeafter provision for loan losses; partially offset by a decrease of $131,700 innon-interest income and increases of $761,500 in non-interest expense and$122,100 in income tax expense.

 

The increase inearnings in 2003 was due to increases of $682,800 in net interest income afterprovision for loan losses and $717,300 in non-interest income; partially offsetby increases of $764,400 in non-interest expense and $304,500 in income taxexpense.

 

23

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

 
| ** **                                         | ** ** | **As of and for the years Ended December 31,**   | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands except per share data)** | ** ** |
| Summary of  Operating Results:                     |       |                                             |       |   |   |   |   |   |   |   |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Total interest  income                             |       | $                                                | 10,691     |   | $ | 7,355 |   | $ | 5,569 |   | $ | 4,876 |   | $ | 5,440 |   |
| Total interest  expense                            |       | 3,672                                            |       | 2,435 |   | 1,920 |   | 1,948 |   | 2,526 |   |
| Net interest  income                               |       | 7,019                                            |       | 4,920 |   | 3,649 |   | 2,928 |   | 2,914 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Provision for  possible loan losses                |       | 150                                              |       | 185 |   | 155 |   | 117 |   | 185 |   |
| Net interest  income after provision for loan loss |       | 6,869                                            |       | 4,735 |   | 3,494 |   | 2,811 |   | 2,729 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Total other  income                                |       | 4,362                                            |       | 2,222 |   | 2,403 |   | 1,805 |   | 1,496 |   |
| Total other  expense                               |       | 7,813                                            |       | 5,111 |   | 4,399 |   | 3,754 |   | 3,633 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Income (loss)  before taxes                        |       | 3,419                                            |       | 1,846 |   | 1,498 |   | 863 |   | 592 |   |
| Provision for  income tax                          |       | 1,489                                            |       | 781 |   | 659 |   | 354 |   | 231 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Net income  (loss)                                 |       | 1,929                                            |       | 1,065 |   | 840 |   | 509 |   | 361 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Per Common Share  Data:                            |       |                                             |       |   |   |   |   |   |   |   |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Net income -  Primary (1)                          |       | $                                                | 1.195      |   | $ | 0.676 |   | $ | 0.550 |   | $ | 0.343 |   | $ | 0.246 |   |
| Net income -  Diluted (2)                          |       | $                                                | 1.003      |   | $ | 0.555 |   | $ | 0.480 |   | $ | 0.292 |   | $ | 0.212 |   |
| Book value, end  of period (3)                     |       | $                                                | 5.55       |   | $ | 4.55 |   | $ | 4.09 |   | $ | 3.77 |   | $ | 3.48 |   |
| Avg shares  outstanding (4)                        |       | 1,576,589                                        |       | 1,576,589 |   | 1,528,268 |   | 1,483,493 |   | 1,469,489 |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Balance Sheet  Data:                               |       |                                             |       |   |   |   |   |   |   |   |   |
|                                               |       |                                             |       |   |   |   |   |   |   |   |   |
| Total loans, net  of unearned income (5)           |       | $                                                | 107,300    |   | $ | 95,036 |   | $ | 76,908 |   | $ | 60,257 |   | $ | 52,562 |   |
| Total assets                                       |       | 162,645                                          |       | 134,039 |   | 107,872 |   | 86,279 |   | 79,735 |   |
| Total deposits                                     |       | 118,120                                          |       | 97,263 |   | 78,132 |   | 67,616 |   | 68,332 |   |
| Stockholders’  equity (6)                     |       | 8,931                                            |       | 7,321 |   | 6,411 |   | 5,639 |   | 5,087 |   |

 

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| ** **                                           | ** ** | **As of and for the Years Ended December 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Selected  Financial Ratios:                          |       |                                           |       |   |   |   |   |   |   |   |   |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Return on  average assets (5)                        |       | 1.24                                           | %          | 0.88 | % | 0.88 | % | 0.63 | % | 0.48 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Return on  average stockholders’ equity (5)     |       | 24.15                                          | %          | 15.35 | % | 13.84 | % | 10.49 | % | 7.87 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Net interest  spread                                 |       | 4.31                                           | %          | 4.02 | % | 3.92 | % | 3.22 | % | 3.57 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Net interest  margin                                 |       | 4.88                                           | %          | 4.47 | % | 4.30 | % | 3.88 | % | 4.37 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Avg  shareholders’ equity to average assets     |       | 5.15                                           | %          | 5.75 | % | 6.35 | % | 5.99 | % | 6.09 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Risked-Based  capital ratios                         |       |                                           |       |   |   |   |   |   |   |   |   |
| Tier 1                                               |       | 8.70                                           | %          | 8.56 | % | 9.00 | % | 8.10 | % | 8.20 | % |
| Total                                                |       | 14.30                                          | %          | 15.30 | % | 17.30 | % | 9.10 | % | 9.10 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Total loans to  total deposits at end of period      |       | 90.84                                          | %          | 97.71 | % | 98.43 | % | 89.12 | % | 76.92 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Allowance to  total loans at end of period           |       | 1.02                                           | %          | 1.00 | % | 1.00 | % | 1.04 | % | 1.06 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Nonperforming  loans to total loans at end of period |       | 0.00                                           | %          | 0.04 | % | 0.04 | % | 0.06 | % | 0.70 | % |
|                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Net charge-offs  to average loans                    |       | 0.01                                           | %          | 0.00 | % | 0.03 | % | 0.18 | % | 0.18 | % |

 

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(1)           Basicearnings per share amounts were computed on the basis of the weighted averagenumber of shares of common stock during the year. The weighted average numberof shares used for this computation was 1,614,196 for 2005, 1,576,589 for 2004,1,528,268 for 2003, 1,483,493 for 2002 and 1,469,489 for 2001.

 

(2)           Fullydiluted earnings per share amounts were computed on the basis of the weightedaverage number of shares of common stock and common stock equivalentsoutstanding during the year. Common stock equivalents include employee stockoptions. The weighted average number of shares used for this computation was 1,923,532,1,919,512, 1,796,859, 1,744,082 and 1,701,827 in 2005, 2004, 2003, 2002 and 2001,respectively.

 

(3)           Weighted average commonshares.

 

(4)           Includes loans beingheld for sale.

 

(5)           Averages are of dailybalances.

 

**Critical Accounting Policies**

 

The preparation of financialstatements in accordance with accounting principles generally accepted in theUnited States of America requires management to make a number of judgments,estimates and assumptions that affect the reported amount of assets,liabilities, income and expenses in the Bank’s financial statements andaccompanying notes.  Management believes that the

 

25

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judgments, estimates and assumptions used inpreparation of the Bank’s financial statements are appropriate given thefactual circumstances as of December 31, 2005.

 

Various elements of the Bank’saccounting policies, by their nature, are inherently subject to estimationtechniques, valuation assumptions and other subjective assessments. Critical accounting policies are those that involve the most complex andsubjective decisions and assessments and have the greatest potential impact ofthe Bank’s results of operation.  In particular, management has identifiedone accounting policy that, due to judgments, estimates and assumptionsinherent in this policy, and the sensitivity of the Bank’s financial statementsto those judgments, estimates and assumptions, are critical to an understandingof the Bank’s financial statements.  This policy relates to themethodology that determines the allowance for loan and lease losses. Management has discussed the development and selection of this criticalaccounting policy with the Audit Committee of the Board of Directors. Although Management believes the level of the allowance at December 31, 2005 isadequate to absorb losses inherent in the loan portfolio, a decline in theregional economy may result in increasing losses that cannot reasonably bepredicted at this time.   For further information regarding theallowance for loan losses see “Provision and Allowance for Loan Losses,” andNote 6 to the Bank’s audited financial statements included elsewhere herein.

 

**Recently Issued AccountingStandards**

 

Refer to Note 1 to theFinancial Statements – “Accounting Policies” for discussion of the recentlyissued accounting standards.

 

**NET INTEREST INCOME**

 

Net interestincome, the difference between (a) interest and fees earned on interest-earningassets and (b) interest paid on interest-bearing liabilities, is the mostsignificant component of the Bank’s earnings. Changes in net interest incomefrom period to period result from increases or decreases in the averagebalances of interest earning assets portfolio, the availability of particularsources of funds and changes in prevailing interest rates.

 

The following table summarizes theCorporation’s net interest income. Yields are computed on a tax-equivalentbasis, no tax-exempt securities were held during the year ended December 31,2003.

#  

| ** **           | ** ** | **Years Ended  December 31,** | ** ** | **Increase (Decrease)  From Prior Year** | ** ** |
|----------------------|------------|-------------------------------|------------|------------------------------------------|------------|
| ** **           | ** ** | **2005**                      | ** ** | **2004**                                 | ** ** | **2003** | ** ** | **2005/2004** | ** ** | **2004/2003** | ** ** |
| ** **           | ** ** | ** **                    | ** ** | ** **                               | ** ** | ** ** | ** ** | **Amt** | ** ** | **%** | ** ** | **Amt** | ** ** | **%** | ** ** |
| ** **           | ** ** | **(Dollars in thousands)**    | ** ** |
| Interest Income      |       | $                             | 10,691     |                                     | $          | 7,355 |   | $ | 5,570 |   | $ | 3,336 |   | 45.36 |   | $ | 1,785 |   | 32.04 |   |
| Interest Expense     |       | 3,672                         |       | 2,435                                    |       | 1,920 |   | 1,237 |   | 50.78 |   | 515 |   | 26.85 |   |
| Net Interest  Income |       | $                             | 7,019      |                                     | $          | 4,920 |   | $ | 3,649 |   | $ | 2,099 |   | 42.07 |   | $ | 1,270 |   | 34.78 |   |

 

26

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Net interest income increased $2,099,500 or42.07% from 2004 to 2005. Average interest bearing assets increased 28.21%,while the average rate earned increased 72 basis points, resulting in anincrease of $3,335,900 in total interest income. Interest expense increased $1,236,400the result of a 29.72% increase in average interest bearing liabilities, whilethe average rate paid increased 43 basis points.

 

Net interest income increased $1,270,000 or34.78% from 2003 to 2004. Average interest bearing assets increased 29.06%,while the average rate earned increased 10 basis points, resulting in anincrease of $1,785,400 in total interest income. Interest expense increased$514,700 the result of a 26.94% increase in average interest bearingliabilities, while the average rate paid remained the same.

 

The following table showsthe components of net interest income, setting forth, for each of the threeyears ended December 31, 2005, 2004 and 2003 (i) average assets, liabilitiesand investments, (ii) interest income earned on interest-earning assets andinterest expense paid on interest-bearing liabilities, (iii) average yieldsearned on interest-earning assets and average rates paid on interest-bearingliabilities, (iv) the net interest spread (i.e., the average yield earned oninterest-earning assets less the average rate paid on interest-bearingliabilities) and (v) the net interest yield on average interest-earning assets(i.e., net interest income divided by average interest-earning assets). Yieldsare computed on a tax-equivalent basis, resulting in adjustments to interestearned on non-taxable securities of $137,900 and $70,200 in 2005 and 2004,respectively; no tax-exempt securities were held in 2003. Non-accrual loans andoverdrafts are included in average loan balances. Average loans are presentednet of unearned income.

 

27

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**INTERESTSPREAD ANALYSIS:**

** **
| ** **                            | ** ** | **2005**                   | ** ** | **2004**            | ** ** | **2003**         | ** ** |
|---------------------------------------|------------|----------------------------|------------|---------------------|------------|------------------|------------|
| ** **                            | ** ** | **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:             |       |                       |       |                |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Time deposits  financial institutions |       | $                          | 1,000      |                | $          | 29               |       | 2.92 |   | $ | — |   | $ | — |   | — |   | $ | — |   | $ | — |   | — |   |
| Invest securities  - Taxable          |       | 13,237                     |       | 441                 |       | 3.33             |       | 10,755 |   | 301 |   | 2.80 |   | 8,113 |   | 299 |   | 3.69 |   |
| Invest securities  - Non-Taxable      |       | 7,026                      |       | 445                 |       | 6.33             |       | 3,456 |   | 226 |   | 6.55 |   | — |   | — |   | — |   |
| Federal funds  sold                   |       | 10,481                     |       | 352                 |       | 3.36             |       | 10,479 |   | 141 |   | 1.35 |   | 8,891 |   | 97 |   | 1.09 |   |
| Total investments                     |       | 31,744                     |       | 1267                |       | 3.99             |       | 24,691 |   | 669 |   | 2.71 |   | 17,004 |   | 396 |   | 2.33 |   |
|                                  |       |                       |       |                |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                 |       |                       |       |                |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Construction                          |       | 9,952                      |       | 1,269               |       | 12.75            |       | 7,384 |   | 794 |   | 10.76 |   | 3,847 |   | 369 |   | 9.59 |   |
| Real estate                           |       | 72,608                     |       | 5,935               |       | 8.17             |       | 59,393 |   | 4,500 |   | 7.58 |   | 47,264 |   | 3,585 |   | 7.59 |   |
| Installment                           |       | 853                        |       | 56                  |       | 6.57             |       | 548 |   | 40 |   | 7.38 |   | 494 |   | 38 |   | 7.62 |   |
| Commercial                            |       | 25,550                     |       | 2,302               |       | 9.01             |       | 19,545 |   | 1,421 |   | 7.27 |   | 16,344 |   | 1,182 |   | 7.23 |   |
| Total loans                           |       | 108,963                    |       | 9,561               |       | 8.77             |       | 86,870 |   | 6,756 |   | 7.78 |   | 67,949 |   | 5,174 |   | 7.61 |   |
|                                  |       |                       |       |                |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Interest earning  assets        |       | 140,707                    |       | 10,828              |       | 7.70             |       | 111,561 |   | 7,425 |   | 6.66 |   | 84,953 |   | 5,570 |   | 6.56 |   |
|                                  |       |                       |       |                |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Bearing  Liabilities:        |       |                       |       |                |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Int-bearing  demand                   |       | $                          | 12,584     |                | $          | 32               |       | 0.26 |   | $ | 13,099 |   | $ | 33 |   | 0.25 |   | $ | 10,892 |   | $ | 27 |   | 0.25 |   |
| Money market  savings                 |       | 4,818                      |       | 32                  |       | 0.66             |       | 3,894 |   | 32 |   | 0.81 |   | 2,592 |   | 22 |   | 0.86 |   |
| Savings deposits                      |       | 7,476                      |       | 80                  |       | 1.07             |       | 7,924 |   | 81 |   | 1.02 |   | 6,011 |   | 62 |   | 1.03 |   |
| Time deposits  >$100M              |       | 29,908                     |       | 990                 |       | 3.31             |       | 18,795 |   | 562 |   | 2.99 |   | 16,378 |   | 511 |   | 3.12 |   |
| Time deposits  <$100M              |       | 31,981                     |       | 971                 |       | 3.04             |       | 24,264 |   | 711 |   | 2.93 |   | 20,074 |   | 618 |   | 3.08 |   |
| Other borrowing                       |       | 32,998                     |       | 1,567               |       | 4.75             |       | 24,347 |   | 1,018 |   | 4.18 |   | 16,781 |   | 680 |   | 4.05 |   |
| Total interest bearing  liabilities   |       | $                          | 119,765    |                | $          | 3,672            |       | 3.07 |   | $ | 92,324 |   | $ | 2,436 |   | 2.64 |   | $ | 72,729 |   | $ | 1,920 |   | 2.64 |   |
| Net interest  income                  |       |                       |       | $                   | 7,156      |             |       |   |   |   | $ | 4,989 |   |   |   |   |   | $ | 3,649 |   |   |   |
| Net interest  spread                  |       |                       |       |                |       | 4.63             |       |   |   |   |   | 4.02 |   |   |   |   |   | 3.92 |   |
| Net yield on  interest earning assets |       |                       |       |                |       | 5.09             |       |   |   |   |   | 4.47 |   |   |   |   |   | 4.30 |   |
|                                  |       |                       |       |                |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |

 

28

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| ** **                            | ** ** | **2005 vs 2004**                        | ** ** | **2004 vs 2003**                        | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                            | ** ** | **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:             |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Time deposits  financial institutions |       | $                                       | 29         |                                    | $          | — |   | $ | 29 |   | $ | — |   | $ | — |   | $ | — |   |
| Invest  securities - Taxable          |       | 266                                     |       | (127                                    | )          | 139 |   | 97 |   | (95 | ) | 2 |   |
| Invest  securities - Tax Free         |       | 221                                     |       | (15                                     | )          | 206 |   | — |   | 226 |   | 226 |   |
| Federal funds  sold                   |       | 0                                       |       | 211                                     |       | 211 |   | 17 |   | 27 |   | 44 |   |
| Total  investments                    |       | 516                                     |       | 69                                      |       | 585 |   | 115 |   | 158 |   | 273 |   |
|                                  |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Loans                                 |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Construction                          |       | 276                                     |       | 198                                     |       | 474 |   | 339 |   | 86 |   | 425 |   |
| Real estate                           |       | 1,001                                   |       | 433                                     |       | 1,434 |   | 923 |   | (8 | ) | 915 |   |
| Installment                           |       | 22                                      |       | (7                                      | )          | 15 |   | 3 |   | (1 | ) | 2 |   |
| Commercial                            |       | 437                                     |       | 444                                     |       | 881 |   | 231 |   | 8 |   | 239 |   |
| Total loans                           |       | 1,737                                   |       | 1,068                                   |       | 2,805 |   | 1,496 |   | 84 |   | 1,581 |   |
|                                  |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Total interest  earning assets        |       | 2,253                                   |       | 1,137                                   |       | 3,390 |   | 1,610 |   | 242 |   | 1,854 |   |
|                                  |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest Bearing  Deposits:           |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Int-bearing  demand                   |       | $                                       | (1         | )                                       | $          | 1 |   | $ | — |   | $ | 6 |   | $ | — |   | $ | 6 |   |
| Money market  savings                 |       | 7                                       |       | (7                                      | )          | — |   | 11 |   | (2 | ) | 9 |   |
| Savings deposits                      |       | (4                                      | )          | 4                                       |       | — |   | 20 |   | (1 | ) | 19 |   |
| Time deposits  >$100M              |       | 332                                     |       | 96                                      |       | 427 |   | 75 |   | (24 | ) | 51 |   |
| Time deposits  <$100M              |       | 226                                     |       | 34                                      |       | 260 |   | 129 |   | (36 | ) | 93 |   |
| Other Borrowing                       |       | 362                                     |       | 187                                     |       | 549 |   | 306 |   | 32 |   | 338 |   |
|                                  |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Total interest  bearing deposits      |       | 922                                     |       | 315                                     |       | 1,236 |   | 547 |   | (32 | ) | 516 |   |
|                                  |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Net change in  net interest           |       | $                                       | 1,331      |                                    | $          | 822 |   | $ | 2,154 |   | $ | 1,063 |   | $ | 274 |   | $ | 1,338 |   |

 

29

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**Provisionand Allowance for Loan Losses**

 

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

 

The allowance for loanlosses reflects management’s ongoing evaluation of the risks inherent in theloan portfolio both generally and with respect to specific loans, the state ofthe economy, and the level of net loan losses experienced in the past. Managementand the Board of Directors review the results of the State Banking Departmentand FDIC examinations, independent accountants’ observations, and the Bank’sinternal review as additional indicators to determine if the amount in theallowance for loan losses is adequate to protect against estimated futurelosses. It is the Bank’s current practice, which could change in accordancewith the factors mentioned above, to maintain an allowance which is at leastequal to the sum of the following percentage of loan balances by loan category.

 

| **Loan Category**                        | ** ** | **Reserve %** | ** ** |
|-----------------------------------------------|------------|---------------|------------|
|                                          |       |          |       |
| Classified  Loans:                            |       |          |       |
| Loans classified  loss                        |       | 100.00        | %          |
| Loans classified  doubtful                    |       | 50.00         | %          |
| Loans classified  substandard                 |       |          |       |
| Real Estate  Secured                          |       | 5.00          | %          |
| Non Real Estate  Secured                      |       | 20.00         | %          |
|                                          |       |          |       |
| Unclassified  Loans:                          |       |          |       |
| Real Estate -  Loan to value 80% or less      |       | 0.10          | %          |
| Real Estate -  Loan to value over 80%         |       | 0.70          | %          |
| Real Estate -  Construction                   |       | 0.25          | %          |
| Loans to  Individuals                         |       | 3.00          | %          |
| Commercial                                    |       | 2.00          | %          |
| SBA Loans –  Unguaranteed portion        |       | 2.00          | %          |
| Unfunded Loan  Commitments                    |       | .25           | %          |
| Concentration  Risk Factor – Real Estate |       | .10           | %          |
| Economic Risk  Factor                         |       | .20           | %          |
| SBA Loans -  Guaranteed portion               |       | 0.00          | %          |
| Cash Secured  Loans                           |       | 0.00          | %          |

 

Although no assurance canbe given that actual losses will not exceed the amount provided for in theallowance, Management believes that the allowance is adequate to provide forall estimated credit losses in light of all known relevant factors. At the endof 2005, 2004 and 2003, the Bank’s allowance stood at 1.02 percent, 1.00percent, and 1.00 percent of gross loans, respectively. Provisions were made tothe allowance for loan losses in 2005, 2004 and 2003 of $150,000, $185,000, and$155,000, respectively. Loans charged off in 2005 totaled $14,200, no loanswere charged off in 2004 and $18,400 was charged off in 2003. Recoveries forthese same periods were $1,900, $3,200, and $1,300.

 

30

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The Bank’snon-performing (delinquent 90 days or more and on non-accrual) loans as apercentage of total loans were 0.00 percent 0.04 percent and 0.06 percent as ofthe end of 2005, 2004 and 2003, respectively.

 

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

 

**Non-InterestIncome**

 

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

 
| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)**   | ** ** |
| Service charges  on deposit accounts          |       | $                            | 564        |   | $ | 517 |   | $ | 506 |   |
| Other service  charges, commissions and fees  |       | 2,807                        |       | 2,994 |   | 3,192 |   |
| Income from  sales and servicing of SBA loans |       | 991                          |       | 716 |   | 661 |   |
|                                          |       |                         |       |   |   |   |   |
| Total  non-interest income                    |       | $                            | 4,362      |   | $ | 4,227 |   | $ | 4,359 |   |

 

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

 

Total non-interest incomedecreased $131,700 or 3.03% in 2004 when compared with 2003. Income from salesand servicing of SBA loans increased $55,800 and service charges on depositaccounts increased $10,800; while other income decreased $198,300. The decreasein other income was due primarily to decreases of $265,400 in commercialbanking origination fees.

 

Total non-interest incomeincreased $717,200 or 19.69% in 2003 when compared with 2002. Other incomeincreased $580,200, income from sales and servicing of SBA loans increased$134,600; while service charges on deposit accounts decreased $2,600. Theincrease in other income was due primarily to increases of $348,000 incommercial banking origination fees, $183,500 in merchant discount fees and$48,700 in net income from merchant credit card processing.

 

31

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The sale of SmallBusiness Administration (SBA) guaranteed loans is a significant contributor tothe Bank’s income. SBA guaranteed loans yield up to 3 3/4% over the New Yorkprime rate, and the guaranteed portions can be sold at premiums which vary withmarket conditions. SBA loans are guaranteed by the full faith of the UnitedStates Government up to 85 percent of the principal amount. The guaranteedportion has risks comparable for an investor to a U. S. Government security andcan usually be sold in the secondary financial market, either at a premium orat a yield which allows the Bank to maintain a significant spread for itself.

 

There can be noassurance that the gains on sale will continue at, or above, the levelsrealized in the past three years. The Small Business Administration hasrecently increased the guarantee fees borrowers must pay. Increasingcompetition among lenders for qualified SBA borrowers makes it difficult forthe Bank to continually expand its program in this area, and may limit thelevel of premium that can be earned with regard thereto.

 

The followingtable presents a summary of the activity in SBA loans for the years ended 2005,2004 and 2003:

 
| ** **            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**   | ** ** |
|-----------------------|------------|----------|------------|----------|------------|------------|------------|
|                  |       |     |       |     |       |       |       |
| SBA loans  authorized |       | $        | 6,274,000  |     | $          | 15,844,000 |       | $ | 8,882,900 |   |
| SBA loans sold        |       | $        | 7,944,900  |     | $          | 4,669,100  |       | $ | 4,994,100 |   |

 

Summary of Income from sales and Servicing of SBALoans

 
| ** **                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income from  premium                                |       | $        | 665,400    |     | $          | 412,400  |       | $ | 440,000 |   |
| Income from  servicing                              |       | 326,000  |       | 304,000  |       | 220,600  |       |
| Total income  from sales and servicing of SBA loans |       | $        | 991,400    |     | $          | 716,400  |       | $ | 660,600 |   |

 

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**Non-InterestExpense**

 

The following tablepresents a summary of the Bank’s other non-interest expense:

 
| ** **                       | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------|------------|------------------------------|------------|
| ** **                       | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)**   | ** ** |
| Salaries and  benefits           |       | $                            | 3,282      |   | $ | 3,003 |   | $ | 2,566 |   |
| Occupancy and  equipment expense |       | 664                          |       | 597 |   | 511 |   |
| Professional  fees               |       | 141                          |       | 113 |   | 89 |   |
| Data processing                  |       | 356                          |       | 364 |   | 357 |   |
| Other expenses                   |       | 3,370                        |       | 3,038 |   | 2,831 |   |
| Income Tax  Expense              |       | 1,489                        |       | 781 |   | 659 |   |
| Total other  expenses            |       | $                            | 9,302      |   | $ | 7,896 |   | $ | 7,013 |   |

 

Salary and benefitsexpense increased $278,200 in 2005 as a result merit increases and bonus payments.Salary and benefits expense increased $437,600 in 2004 as a result of the firstfull year of salary expense related to the hiring of an Executive VicePresident/Chief Lending Officer during the fourth quarter of 2003, meritincreases and bonus payments. Salary and benefits expense increased $365,500 in2003 as a result of the first full year of salary expense related to theCarmel-by-the Sea branch office, the hiring of an Executive VicePresident/Chief Lending Officer during the fourth quarter, merit increases andbonus payments.

 

Occupancy andequipment expenses increased $67,800 in 2005, with significant increases of $48,300in depreciation expense, $18,000 in property taxes, $11,100 in premises rent,premises expense other $10,000 and $8,800 in janitorial expense; while netmerchant terminal decreased $30,800. Occupancy and equipment expenses increased$86,000 in 2004, with significant increases of $19,800 in depreciation expense,$22,700 in merchant terminal expense, $14,100 in repairs and maintenanceexpense, $7,800 in janitorial expense and $4,700 in premises rent. Occupancyand equipment expenses increased $138,400 in 2003, with significant increasesof $65,700 in premises rent net of sublease income, $46,100 in depreciation,$9,200 in repairs and maintenance expense, $3,800 in property taxes and $3,300in merchant terminal.

 

Data processingexpense decreased $8,100 in 2005, the result of renegotiation of the dataservices contract during the fourth quarter of 2004. Data processing expenseincreased $6,800 in 2004. Data processing expense decreased $6,900 in 2003.

 

In 2005,professional fees increased $27,000 due to accounting/audit fees increasing $21,600while legal fees increased $5,400. In 2004, professional fees increased $24,400due to accounting/audit fees increasing $19,500 while legal fees increased$4,900. In 2003, professional fees increased $4,900 due to accounting feesincreasing $8,500 while legal fees decreased $3,600.

 

Other expenses for2005 totaled $3,369,900 compared with $3,038,000 for 2004, an increase of $331,900.Significant changes occurred in the following categories with the establishmentof provision for debt securities losses $119,500 and provision for lossunfunded loan commitments $52,000; increases in director fees $53,400, donations$49,900, merchant processing expense $44,500 telephone expense $17,200,entertainment and meals $16,100, bank fees $15,200,

 

33

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stationary/supplies$14,900, advertising $13,600, insurance $10,900, miscellaneous expense $8,800, subscription/publicationexpense $8,600, dues and memberships $8,600; while decreases occurred in loanexpense $41,300, operational losses $30,600, collection expense $21,300,postage expense $9,100 and business development $9,000.

 

Other expenses for2004 totaled $3,038,000 compared with $2,831,300 for 2003, an increase of $206,700.Significant changes occurred in the following categories with in increasesoperational losses $35,200, business development $31,700, insurance $23,200,advertising $13,800, collection expense $20,700, telephone expense $12,600,entertainment and meals $11,500, donations $9,700, postage expense $8,300, andamortization trust preferred offering expense $5,700; while decreases occurredin stationary & supplies $13,800, loan expense $12,000 and autoallowance/expense $6,300.

 

Other expenses for2003 totaled $2,831,300 compared with $2,567,600 for 2002, an increase of $261,900.Significant changes occurred in the following categories with in increasesmerchant credit card processing expense $118,400, operational losses $68,000,insurance $20,400, advertising $13,300, FDIC and State assessments $10,400,bank fees $10,100, director fees $10,000, business development $8,800,telephone expense $8,300, stationary & supplies $7,800 and subscriptions$5.600; while decreases occurred in donations $8,100, travel expense $6,500,prepaid card program expense $5,200, entertainment/meals $5,000 and poppyaccount expense $5,000.

 

**LOANS**

 

Loans, the largestcomponent of earning assets, represented 77.46% of average earning assets, and 70.53%of average total assets during 2005, compared with 79.17% and 72.32%,respectively during 2004. In 2005, average loans increased 25.43% from $86,870,200in 2004 to $108,962,800. Average real estate loans increased $13,215,000 or 22.25%,average commercial loans increased $6,005,200 or 30.73%, average constructionloans increased $2,567,500 or 34.77% and average installment loans decreased $305,000or 55.63%.

 

Loan policies and procedures provide the overalldirection to the administration of the loan portfolio. The Bank’s loanunderwriting process is intended to encourage sound and consistent creditdecisions are made. Emphasis is placed upon credit quality, the borrower’sability to repay through cash flow, secondary, and (occasionally tertiary)repayment sources, and the value of collateral.

 

The Bank’scommercial and industrial loans are generally made for the purpose of providingworking capital, financing the purchase of equipment or inventory, and otherbusiness purposes. Such loans generally have maturities ranging from one yearto several years. Short-term business loans are generally intended to financecurrent transactions and typically provide for monthly interest payments withprincipal being payable at maturity or at 90-day intervals. Term loans (usuallyfor a term of two to five years) normally provide for monthly installments ofprincipal and interest. The Bank from time to time utilizes accounts receivableand inventory as security for loans.

 

34

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The Bank is therecognized leader for Small Business Administration lending in Monterey County,and holds SBA’s coveted Preferred Lender Status. Generally, SBA loans areguaranteed by the SBA for up to 85 percent of their principal amount, which canbe retained in portfolio or sold to investors. Such loans are made at floatinginterest rates, but generally for longer terms (up to 25 years) than areavailable on a conventional basis to small businesses.  The unguaranteedportion of the loans, although generally supported by collateral, is consideredto be more risky than conventional commercial loans because they may be basedupon credit standards the Bank would not otherwise apply, such as lower cashflow coverage, or longer repayment terms.

 

The Bank’s realestate loan portfolio consists both of real estate construction loans and realestate mortgage loans. The Bank has initiated a program to generate morecommercial and industrial real estate loans, which generally yield higherreturns than normal commercial loans. The Bank has also developed a brokerprogram for generating residential real estate loans. The Bank does not makereal estate development loans.  Real estate construction loans are madefor a much shorter term, and often at higher interest rates, than conventionalsingle-family residential real estate loans. The cost of administering suchloans is often higher than for other real estate loans, as principal is drawnon periodically as construction progresses.

 

The Bank alsomakes real estate loans secured by a first deed of trust on single familyresidential properties and commercial and industrial real estate. Californiacommercial banks are permitted, depending on the type and maturity of the loan,to lend up to 90 percent of the fair market value of real property (or more ifthe loan is insured either by private mortgage insurers or governmentalagencies). In certain instances, the appraised value may exceed the actual amountwhich could be realized on foreclosure, or declines in market value subsequentto making the loan can impair the Bank’s security.

 

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

 

35

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The followingtable presents the composition of the loan portfolio, including loans held forsale, at December 31 for the last five years.

 
| ** **                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                             | ** ** | **(Dollars in thousands)**   | ** ** |
| Commercial and  industrial             |       | $                            | 26,236     |   | $ | 23,854 |   | $ | 18,607 |   | $ | 14,432 |   | $ | 14,469 |   |
| Real estate,  construction             |       | 10,456                       |       | 7,373 |   | 5,934 |   | 4,066 |   | 1,896 |   |
| Real estate,  mortgage                 |       | 71,006                       |       | 64,339 |   | 52,698 |   | 42,000 |   | 36,010 |   |
| Installment                            |       | 942                          |       | 622 |   | 580 |   | 462 |   | 703 |   |
| Government  guaranteed loans purchased |       | 45                           |       | 51 |   | 57 |   | 63 |   | 130 |   |
|                                   |       | 108,685                      |       | 96,239 |   | 77,876 |   | 61,024 |   | 53,208 |   |
| Less:                                  |       |                         |       |   |   |   |   |   |   |   |   |
| Allowance for  possible loan losses    |       | (1,101                       | )          | (963 | ) | (775 | ) | (637 | ) | (566 | ) |
| Deferred  origination fees, net        |       | (284                         | )          | (240 | ) | (193 | ) | (130 | ) | (79 | ) |
| Net Loans                              |       | $                            | 107,300    |   | $ | 95,036 |   | $ | 76,908 |   | $ | 60,257 |   | $ | 52,562 |   |

 

36

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**Non-performingand Non-accrual Loans**

 

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

 

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

 
| ** **                                                                  | ** ** | **As of December 31,**     | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                  | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Accruing,                                                                   |       |                       |       |   |   |   |   |   |   |   |   |
| past due 90 days  or more:                                                  |       |                       |       |   |   |   |   |   |   |   |   |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Real Estate                                                                 |       | $                          | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial                                                                  |       | —                     |       | — |   | — |   | — |   | — |   |
| Installment                                                                 |       | —                     |       | — |   | — |   | — |   | — |   |
| Total accruing                                                              |       | —                     |       | — |   | — |   | — |   | — |   |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Nonaccrual  Loans:                                                          |       |                       |       |   |   |   |   |   |   |   |   |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Real Estate                                                                 |       | $                          | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 320 |   |
| Commercial                                                                  |       | —                     |       | 43 |   | 28 |   | 24 |   | 50 |   |
| Installment                                                                 |       | —                     |       | — |   | — |   | 10 |   | — |   |
| Total nonaccrual                                                            |       | —                     |       | 43 |   | 28 |   | 34 |   | 370 |   |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Total  nonperforming                                                        |       | $                          | —     |   | $ | 43 |   | $ | 28 |   | $ | 34 |   | $ | 370 |   |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Total loans end  of period                                                  |       | $                          | 108,685    |   | $ | 96,239 |   | $ | 77,876 |   | $ | 61,024 |   | $ | 53,207 |   |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Ratio of  nonperforming loans to total loans at end of period               |       | 0.00                       | %          | 0.04 | % | 0.04 | % | 0.06 | % | 0.70 | % |
| Ratio of  nonperforming loans to allowance for loan losses at end of period |       | N/A                        |       | 2259.14 | % | 4421.35 | % | 1862.78 | % | 152.9 | % |

 

The low level of non-performing loans isthe result of underwriting criteria intended to be conservative, frequentreview of new and delinquent loans and a firm collection policy (with theassistance of outside legal counsel). The Bank does not have any foreign loansor loans for highly leveraged transactions.

 

37

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**Summary of Loan Loss Experience**

 
| ** **                                                                     | ** ** | **For the Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)**           | ** ** |
| Average loans  outstanding                                                     |       | $                                    | 108,963    |   | $ | 86,870 |   | $ | 67,949 |   | $ | 11,192 |   | $ | 48,265 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Allowance,  beginning of period                                                |       | 963                                  |       | 775 |   | 637 |   | 566 |   | 468 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Loans charged  off during period:                                              |       |                                 |       |   |   |   |   |   |   |   |   |
| Real Estate                                                                    |       | 0                                    |       | 0 |   | 0 |   | 58 |   | 80 |   |
| Commercial                                                                     |       | 14                                   |       | 0 |   | 18 |   | 1 |   | 9 |   |
| Installment                                                                    |       | 0                                    |       | 0 |   | 0 |   | 1 |   | 0 |   |
| Other                                                                          |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total charge  offs                                                             |       | 14                                   |       | 0 |   | 18 |   | 60 |   | 89 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Recoveries  during period:                                                     |       |                                 |       |   |   |   |   |   |   |   |   |
| Real Estate                                                                    |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Commercial                                                                     |       | 2                                    |       | 3 |   | 1 |   | 13 |   | 1 |   |
| Installment                                                                    |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 1 |   |
| Other                                                                          |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total recoveries                                                               |       | 2                                    |       | 3 |   | 1 |   | 13 |   | 2 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Net Loans  charged off during the period                                       |       | 12                                   |       | (3 | ) | 17 |   | 47 |   | 87 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Additions to  allowance for possible loan losses                               |       | 150                                  |       | 185 |   | 155 |   | 117 |   | 185 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Allowance, end  of period                                                      |       | 1,101                                |       | 963 |   | 775 |   | 636 |   | 566 |   |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Ratio of net  loans charged off to average Loans outstanding during the period |       | 0.01                                 | %          | 0.00 | % | 0.03 | % | 0.42 | % | 0.18 | % |
|                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |
| Ratio of  allowance to total loans at end of period                            |       | 1.01                                 | %          | 1.00 | % | 1.00 | % | 1.01 | % | 1.06 | % |
|                                                                                |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

38

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**Funding Sources**

 

Average depositsincreased 25.79% to $110,699,800 in 2005 from $88,005,600 in 2004. In 2005average demand deposits increased 19.49% and average certificates of depositincreased 43.73% while average interest checking, money market and savingsaccounts as a group decreased 0.16%. Average certificates of depositrepresented 55.91% of average deposits in 2005 compared with 48.93% in 2004. Averageinterest checking, money market and savings accounts as a group were 22.47% ofaverage deposits in 2005 compared with 28.31% in 2004. Average demand depositsrepresented 21.62% of average deposits in 2005 compared with 22.76% in 2004.

 

The following table setsforth the scheduled maturities of the Company’s time deposits in denominationsof $100,000 or greater at December 31, 2005:

 

| 2006       |   | $         | 48,723,000 |   |
|------------|--------|-----------|------------|--------|
| 2007       |   | 9,037,500 |       |
| 2008       |   | 1,952,100 |       |
| 2009       |   | 1,112,900 |       |
| 2010       |   | 961,000   |       |
| Thereafter |   | 34,900    |       |
|       |   |      |       |
|       |   | $         | 61,821,400 |   |

 

The Corporation borrowed$1,000,000 on an unsecured basis from United Security Bank, Fresno, Californiaon June 28, 2001. The rate of interest is the United Security Bank ReferenceRate (the “Index”) plus .750 percentage points over the Index. The note requiresmonthly interest payments beginning August 5, 2001, quarterly principal andinterest payments beginning October 5, 2002 through April 5, 2011, and a finalpayment of principal and interest on July 5, 2011. The proceeds from theborrowing were used to payoff an $800,000 term loan and to pay down the$200,000 line of credit with Pacific Coast Bankers’ Bank. The Corporationrenewed the $200,000 revolving line of credit for one year, with interest duemonthly. The credit line is secured by 93,069 shares of Monterey County Bank commonstock. The rate of interest on the credit line is the prime rate as publishedin the Wall Street Journal (the “Index”) plus .750 percentage points over theIndex, with floor rate of 6.50%. The Corporation paid off both the term noteand line of credit with proceeds from its March 27, 2003 Trust PreferredSecurities issuance.

 

The Bank has lines ofcredit from the Federal Home Loan Bank of San Francisco, Bank of the West,Pacific Coast Bankers’ Bank and The Independent Bank with available borrowingcapacity on December 31, 2005 of $4,402,400, $4,500,000, $6,000,000 and$5,000,000, respectively. The Federal Home Loan Bank line of credit has amaximum borrowing capacity of twenty five percent (25%) of the Bank’s totalassets, adjusted quarterly. The Federal Home Loan Bank line of credit issecured by a portion of the Bank’s real estate secured loans and securities atDecember 31, 2005. The total principal balances of pledged loans was$31,100,400 and securities of $10,423,000. The following table providesinformation on nine (9) advances totaling $24,750,000 outstanding at December31, 2005.

 

39

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| **Advance  Amount** | ** ** | **Fixed  Interest  Rate** | ** ** | **Funding  Date** | ** ** | **Maturity  Date** | ** ** |
|---------------------|------------|---------------------------|------------|-------------------|------------|--------------------|------------|
| 1,000,000           |       | 2.54                      | %          | 2/4/03            |       | 2/6/06             |       |
| 1,000,000           |       | 1.77                      | %          | 3/9/04            |       | 3/9/06             |       |
| 2,750,000           |       | 3.44                      | %          | 9/27/02           |       | 9/27/07            |       |
| 3,000,000           |       | 4.30                      | %          | 6/17/05           |       | 6/17/10            |       |
| 5,000,000           |       | 4.96                      | %          | 11/14/05          |       | 11/15/10           |       |
| 1,000,000           |       | 7.72                      | %          | 6/1/00            |       | 6/3/30             |       |
| 4,000,000           |       | 5.96                      | %          | 8/2/04            |       | 7/28/34            |       |
| 5,000,000           |       | 5.63                      | %          | 12/24/04          |       | 12/22/34           |       |
| 2,000,000           |       | 5.13                      | %          | 5/4/05            |       | 5/1/35             |       |

 

The Bank of the West,Pacific Coast Bankers’ Bank and The Independent Bank lines of credit are unsecured. The Bank did not utilize any overnightborrowings in 2005, 2004 or 2003.

 

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

 

**Capital Resources**

 

The Corporation maintainscapital to comply with legal requirements, to provide a margin of safety forits depositors and stockholders, and to provide for future growth and theability to pay dividends. At December 31, 2005, stockholders’ equity was $8,930,900versus $7,321,100 at December 31, 2004. The Corporation paid cash dividends of$0.20, $0.165 and $0.15 per share in 2005, 2004 and 2003, respectively. TheBank paid no cash dividends to the Corporation in 2005, and 2004; $50,000 waspaid in 2003.

 

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

 

In general, the risk-based capital guidelines providedetailed definitions of which obligations will be treated as capital, andassign different weights to various assets and off-balance sheet items,depending upon the perceived degree of credit risk associated with each asset. Eachasset is assigned to one of four risk-weighted categories. For example, 0percent for cash and unconditionally guaranteed government securities; 20percent for deposits with other banks and fed funds; 50 percent for state bondsand certain residential real estate loans; and 100 percent for commercial loansand other assets. Capital is categorized as either Tier 1 capital, consistingof common stock and retained earnings (or deficit), or Tier 2 capital, whichincludes limited-life preferred stock and allowance for loan losses (subject tocertain limitations). The guidelines also define and set minimum capitalrequirements (risk-based capital ratios), which increased over a transitionperiod, 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

 

40

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Bank had a Tier 1 capital ratio of 12.07% and 11.58% at December 31,2005 and 2004, respectively, and a total risk-based capital ratio of 13.06% and12.48% at December 31, 2005 and 2004, respectively.

 

The Tier 1 leverage capital ratio guidelines require aminimum leverage capital ratio of 3% of Tier 1 capital to total assets lessgoodwill. The Bank had a leverage capital ratio of 9.60% and 9.37% at December31, 2005 and 2004, respectively.

 

The significant increase in each of the Bank’srisk-based capital ratios from December 31, 2002 to December 31, 2003 was theresult of $4,000,000 in capital contributions from the Corporation. TheCorporation utilized a portion of the proceeds from two trust preferredsecurity issuances to make the capital contributions.

 

On March 27, 2003, the Company’s wholly ownedspecial-purpose trust subsidiary, Northern California Bancorp, Inc. Trust I(the “Trust”) issued $3 million in cumulative Trust Preferred Securities. Thesecurities bear a floating rate of interest of 3.25% over the three month LIBORrate, payable quarterly. Concurrent with the issuance of the Trust PreferredSecurities, the Trust used the proceeds from the Trust Preferred Securitiesoffering to purchase a like amount of Junior Subordinated Debentures of theCompany. The Subordinated Debentures are the sole assets of the Trust and areeliminated, along with the related income statement effects, in theconsolidated financial statements. The Company will pay interest on the JuniorSubordinated Debentures to the Trust, which represents the sole revenue andsole source of dividend distributions to the holders of the Trust PreferredSecurities. The Company has the right, assuming no default has occurred, todefer payments of interest on the Junior Subordinated Debentures at any timefor a period not to exceed 20 consecutive quarters. The Trust PreferredSecurities will mature on April 7, 2033, but can be redeemed under certaincircumstances at a premium prior to April 7, 2008, and can be redeemed, inwhole or in part, on any January 7, April 7, July 7 or October 7 on or after April7, 2008 at par. The Company fully and unconditionally guarantees theobligations of the Trust, on a subordinated basis.

 

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

 

On November 13, 2003, the Company’s wholly owned special-purpose trustsubsidiary, Northern California Bancorp, Inc. Trust II (the “Trust”) issued $5million in cumulative Trust Preferred Securities. The securities bear afloating rate of interest of 2.85% over the three month LIBOR rate, payablequarterly. Concurrent with the issuance of the Trust Preferred Securities, theTrust used the proceeds from the Trust Preferred Securities offering topurchase a like amount of Junior Subordinated Debentures of the Company. TheSubordinated Debentures are the sole assets of the Trust and are eliminated,along with the related income statement effects, in the consolidated financialstatements. The Company will pay interest on the Junior Subordinated Debenturesto the Trust, which represents the sole revenue and sole source of dividenddistributions to the holders of the Trust Preferred Securities. The Company hasthe right, assuming no default has occurred, to defer payments of interest onthe Junior Subordinated Debentures at any time for a period not to exceed 20consecutive quarters. The Trust Preferred Securities will mature on August 8,2033, but can be redeemed under certain circumstances at a premium prior to August8, 2008, and can be

 

41

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

 

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

 

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

 

**Liquidity**

 

Liquidityrepresents a bank’s ability to provide sufficient cash flows or cash resourcesin a manner that enables it to meet obligations in a timely fashion andadequately provides for anticipated future cash needs. For the Bank, liquidityconsiderations involve the capacity to meet expected and potential requirementsof depositors seeking access to balances and to provide for the credit demandsof borrowing customers. In the ordinary course of the Bank’s business, fundsare generated from the repayment of loans, maturities within the investmentsecurities portfolio and the acquisition of deposit balances and short-termborrowings. In addition, the Bank has lines of credit from the Federal HomeLoan Bank of San Francisco of approximately $29,257,400, subject to pledging ofacceptable collateral, and unsecured federal funds lines of credit with Bank of the West $4,500,000, Pacific CoastBankers’ Bank $6,000,000 and The Independent Bank $5,000,000 to meettemporary liquidity requirements. Availableborrowing capacities on December 31, 2005 were $4,402,400, $4,500,000,$6,000,000 and $5,000,000, respectively.

 

As a matter of policy,the Bank seeks to maintain a level of liquid assets, including marketableinvestment securities, equal to a least 15 percent of total assets (“primaryliquidity”), while maintaining sources of secondary liquidity (borrowing linesfrom other institutions) equal to at least an additional 10 percent of assets. Inaddition, it seeks to generally limit loans to not more than 90 percent ofdeposits.  Within these ratios, the Bank generally has excess fundsavailable to sell as federal funds on a daily basis, and is able to fund itsown liquidity needs without the need of short-term borrowing. The Bank’s totalliquidity at December 31, 2005, 2004 and 2003 was 27.09 percent, 22.70 percent,and 20.84 percent respectively, while its average loan to deposit ratio forsuch years was 90.84 percent, 97.71 percent and 98.43 percent respectively.

 

Brokered deposits are deposit instruments, such ascertificates of deposit, deposit notes, bank investment contracts and certainmunicipal investment contracts that are issued through brokers and dealers whothen offer and/or sell these deposit instruments to one or more investors. Additionally,deposits on which a financial institution pays an interest rate significantlyhigher than prevailing rates are considered to be brokered deposits. Federallaw and regulation restricts banks from soliciting or accepting brokered deposits,unless the bank is well capitalized under Federal guidelines. The Bank’sbrokered deposits totaled approximately $12,849,300 or 10.82% at December 31,2005, $14,385,800 or 14.54% at December 31, 2004 and $5,995,000 or 7.53% oftotal deposits at December 31, 2003. None of the Bank’s brokered deposits paidan interest rate significantly higher than prevailing rates.

 

42

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Managementof interest rate sensitivity (asset/liability management) involves matching andrepricing rates of interest-earning assets with interest-bearing liabilities ina manner designed to optimize net interest income within the constraintsimposed by regulatory authorities, liquidity determinations and capitalconsiderations. The Bank instituted formal asset/liability policies at the endof 1989.

 

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

 

The Bank monitors its interest rate risk on a quarterlybasis through the use of a model which calculates the effect on earnings ofchanges in the fed funds rate. The model converts a fed funds rate change intorate changes for each major class of asset and liability, then simulates thebank’s net interest margin based on the bank’s actual repricing over a one yearperiod, assuming that maturities are reinvested in instruments identical tothose maturing during the period. The following table shows the affect on netinterest income of a 100 and a 200 basis point rate shock at December 31, 2005.

 
| **Rate Shock Increase(Decrease)  in Basis Points** | ** ** | **Percent Increase(Decrease) in  Net Interest Income** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| 100                                                                    |       | 5.6                                                                        | %          |
| (100)                                                                  |       | (5.6                                                                       | )%         |
| 200                                                                    |       | 11.2                                                                       | %          |
| (200)                                                                  |       | (11.2                                                                      | )%         |

 

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

 

43

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**InvestmentSecurities**

 

The Corporation maintains a trading account, at fairvalue, consisting of marketable securities. At December 31, 2005 the accountvalue was $1,027,500. The Corporation has investments of $40,000 in AT ServiceLLC, which provides title insurance services for commercial, industrial andresidential properties, as well as other real estate related financial andinformational services, including escrow, real estate information, trustee saleguarantees and real estate tax exchanges, $10,000 in Metrocities Mortgage, LLCand $100,000 in Pan Pacific Bank. In addition the Corporation has investmentsin Northern California Bancorp Trust I ($93,000) and Northern CaliforniaBancorp Trust II ($155,000), these are special-purpose trust subsidiaries whichwere formed to facilitate the issuance of trust preferred securities.

 

The following table sets forth the book and marketvalue of the Bank’s investment securities as of December 31, 2005 and 2004:

 
| ** **                                  | ** ** | **INVESTMENT PORTFOLIO MIX** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **(Dollars in thousands)**   | ** ** |
| ** **                                  | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **Book  value**              | ** ** | **Market  value** | ** ** | **Book  value** | ** ** | **Market  value** | ** ** |
| Available for  sale:                        |       |                         |       |   |   |   |   |   |   |
| Corporate Debt  Securities                  |       | $                            | 631        |   | $ | 631 |   | $ | 750 |   | $ | 752 |   |
| Government  National Mortgage Association   |       | 857                          |       | 837 |   | 1,400 |   | 1,377 |   |
| U.S. Government  Agencies                   |       | 9,714                        |       | 9,597 |   | 4,704 |   | 4,706 |   |
| Total                                       |       | 11,202                       |       | 11,065 |   | 6,854 |   | 6,834 |   |
|                                        |       |                         |       |   |   |   |   |   |   |
| Held to  maturity:                          |       |                         |       |   |   |   |   |   |   |
| State/Local  Agency Securities              |       | 7,025                        |       | 7,162 |   | 6,219 |   | 6,300 |   |
|                                        |       |                         |       |   |   |   |   |   |   |
| Other  Securities:                          |       |                         |       |   |   |   |   |   |   |
| Federal Home  Loan Bank Stock               |       | 1,183                        |       | 1,183 |   | 924 |   | 924 |   |
| Pacific Coast  Bankers’ Bank Stock     |       | 440                          |       | 440 |   | 440 |   | 440 |   |
| AT Services, LLC                            |       | 40                           |       | 40 |   | 202 |   | 202 |   |
| Metrocities  Mortgage, LLC                  |       | 10                           |       | 10 |   | — |   | — |   |
| Pan Pacific Bank                            |       | 100                          |       | 100 |   | — |   | — |   |
| Northern  California Bancorp, Inc. Trust I  |       | 93                           |       | 93 |   | 93 |   | 93 |   |
| Northern  California Bancorp, Inc. Trust II |       | 155                          |       | 155 |   | 155 |   | 155 |   |
| Total                                       |       | $                            | 2,021      |   | $ | 2,021 |   | $ | 1,668 |   | $ | 1,668 |   |

 

The followingtables summarize the maturity of the Bank’s investment securities at December31, 2005:

 

44

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| ** **                        | ** ** | **INVESTMENT PORTFOLIO MATURITIES** | ** ** |
|-----------------------------------|------------|-------------------------------------|------------|
| ** **                        | ** ** | **(Dollars in thousands)**          | ** ** |
| ** **                        | ** ** | **Available for Sale**              | ** ** |
| ** **                        | ** ** | **Amortized  Cost**                 | ** ** | **Fair  Value** | ** ** |
| Due within one year               |       | $                                   | 3,000,000  |   | $ | 2,986,800 |   |
| Due between one and five years    |       | 4,713,900                           |       | 4,636,800 |   |
| Due between five and ten years    |       | 2,630,600                           |       | 2,603,800 |   |
| GNMA - Mortgage Backed Securities |       | 857,400                             |       | 837,900 |   |
|                              |       | $                                   | 11,201,900 |   | $ | 11,065,300 |   |

 
| ** **            | ** ** | **Held to Maturity** | ** ** |
|-----------------------|------------|--------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**            | ** ** | **Fair  Value** | ** ** |
| Due in over ten years |       | $                              | 7,025,000  |   | 7,169,100 |   |
|                       |            |                                |            |  |  |  |

 

45

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**ITEM 7. FINANCIAL STATEMENTS**

 

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

 
| Independent Auditors’ Report on the  Financial Statements                                                                      | 1      |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                |   |
| Consolidated Balance Sheets at December  31, 2005 and 2004                                                                          | 2      |
|                                                                                                                                |   |
| Consolidated Statements of  Operations for each of the three years in the period ended December 31, 2005                            | 3      |
|                                                                                                                                |   |
| Consolidated  Statements of Changes in Stockholders’ Equity for each of the three years in  the period ended December 31, 2005 | 4      |
|                                                                                                                                |   |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2005                           | 5      |
|                                                                                                                                |   |
| Notes to Consolidated  Financial Statements                                                                                         | 7-48   |

 

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

** **

The Company had no disagreements with its independent accountants onany matter of accounting principles, practices or financial statementdisclosure during 2005, 2004 or 2003.

 

**ITEM8A. CONTROLS AND PROCEDURES**

 

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

** **

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

 

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, 

 

46

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

 

(b)           **Changes inInternal Controls**

 

Therewere no significant changes in Northern California Bancorp, Inc.’s internalcontrols or in other factors that could significantly affect NorthernCalifornia Bancorp, Inc.’s internal controls subsequent to the Evaluation Date,nor any significant deficiencies or material weaknesses in such controlsrequiring corrective actions.  As aresult, no corrective actions were taken.

 

**ITEM 8B. OTHERINFORMATION**

** **

Not Applicable

 

47

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** **

**PART III**

 

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

 

**Code of Ethics**

 

The Bank has adopted a code of ethics applicable to all of its officers,directors and employees, including its principal executive officer, principalfinancial officer, principal accounting officer and persons performing similarfunctions.

 

The name, age, title and five-year business background of eachdirector, executive officers and significant employees of the Corporation(including the Bank) as of December 31, 2005, are as follows:

 
| **Name & Position with Bank** | ** ** | **Age** | ** ** | **Principal Occupation During Past Five Years**    | ** ** |
|-------------------------------------------------------|------------|---------|------------|-----------------------------------------------------------------------------|------------|
|                                                  |       |    |       |                                                                        |       |
| Charles T. Chrietzberg, Jr.                           |       | 64      |       | Chairman of the Board & Chief Executive Officer                         |       |
| Director since  1985,                                 |       |    |       | Monterey County Bank since 3/87                                             |       |
| Chairman of the  Board &                          |       |    |       |                                                                        |       |
| Chief Executive  Officer                              |       |    |       |                                                                        |       |
|                                                  |       |    |       |                                                                        |       |
| Sandra G. Chrietzberg                                 |       | 62      |       | Formerly President and CEO Queen of Chardonnay,  Inc.,                      |       |
| Director, 1988  to 1994 and                           |       |    |       | dba La Reina Winery 8/84-12/93                                              |       |
| since 1995                                            |       |    |       |                                                                        |       |
|                                                  |       |    |       |                                                                        |       |
| Peter J. Coniglio, Esq.                               |       | 76      |       | Partner - Hudson, Martin, Ferrante & Street,  Monterey                  |       |
| Director since  1976                                  |       |    |       |                                                                        |       |
|                                                  |       |    |       |                                                                        |       |
| Carla S. Hudson, CPA                                  |       | 52      |       | Partner – Bianchi, Lorinez, Huey, Hudson and  Company, LLP             |       |
| Director since  1994                                  |       |    |       |                                                                        |       |
|                                                  |       |    |       |                                                                        |       |
| John M. Lotz                                          |       | 64      |       | Chairman, Chief Executive Officer & President  Del Monte Aviation, Inc. |       |
| Director since  1991                                  |       |    |       | dba. Monterey Bay Aviation, President and Chief  Executive Officer,         |       |
|                                                  |       |    |       | of Couroc of Monterey 1996-2001.                                            |       |
|                                                  |       |    |       |                                                                        |       |
| Timothy M. Leveque                                    |       | 62      |       | Executive Vice President, Chief Lending Officer of  Monterey                |       |
| Executive Vice  President                             |       |    |       | County Bank since 11/03, Senior Executive Vice  President,                  |       |
| Chief Lending  Officer                                |       |    |       | Chief Lending Officer, Pacific Coast Bankers’ Bank  1997-2003          |       |
|                                                  |       |    |       |                                                                        |       |
| Bruce N. Warner                                       |       | 58      |       | Executive Vice President, Chief Financial Officer  and Chief                |       |
| Executive Vice  President,                            |       |    |       | Operating Officer of Monterey County Bank since  2002;                      |       |
| Chief Financial  Officer                              |       |    |       | Senior Vice President, Chief Financial Officer and  Chief                   |       |
| and Chief  Operating Officer                          |       |    |       | Operating Officer of Monterey County Bank since  1993-2002.                 |       |
|                                                  |       |    |       |                                                                        |       |
| Virginia L. Cooper                                    |       | 61      |       | Senior Vice President, Manager SBA Loan Department  11/02.                  |       |
| Senior Vice  President                                |       |    |       | Vice President SBA Loan Department 3/98.                                    |       |
|                                                  |       |    |       |                                                                        |       |
| Mary Ellen Stanton                                    |       | 68      |       | Senior Vice President, Loan Administration, Monterey  County                |       |
| Senior Vice  President                                |       |    |       | Bank Since 10/98.                                                           |       |
|                                                  |       |    |       |                                                                        |       |
| Andre G. Herrera                                      |       | 40      |       | Senior Vice President, Chief Information Officer,  BankCard                 |       |
| Senior Vice  President                                |       |    |       | Service 12/04, Vice President, Chief Information  Officer 11/01.            |       |

 

48

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Directors of the Corporation serve in similar capacities with theBank.  The Chairman of the Board, ChiefExecutive Officer and Executive Vice President, Chief Financial Officer of theCorporation serve in similar capacities with the Bank, although the limitedoperations of the Corporation do not requiresignificant amounts of their time.  Thereare no family relationships among the persons listed above, except that Mr. andMrs. Chrietzberg are spouses.

 

Based solely upon a review of the relevant forms furnished to the Bankand the Corporation, except as disclosed below, the Corporation believes thatall officers, directors and principal shareholders filed appropriate forms asrequired by Section 16(a) of the Exchange Act, and related regulations, during2005.

 

49

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**ITEM10. EXECUTIVE COMPENSATION**

 

The following table sets forth certain information regarding thecompensation paid to the Chief Executive Officer, Executive Officers and thenext two highest compensated officer of the Corporation/Bank whose salary andbonus exceeded $100,000 for 2005.

 
| ** **                        | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Long Term Compensation Awards** | ** ** |
|-----------------------------------|------------|------------|------------|------------------------------|------------|--------------------------------------------------|------------|
| **Name & Principal Position** | ** ** | ** ** | ** ** | **Salary**                   | ** ** | **Bonus**                                        | ** ** | **Other  Annual  Compensation** | ** ** | **Restricted  Stock  Awards** | ** ** | **Securities  Underlying  Options/SARs** | ** ** | **All Other  Compensation** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Charles T.  Chrietzberg, Jr.      |       | 2005       |       | $                            | 243,262    |                                             | $          | 250,000 |   | $ | 3,137 | (1) | None |   | 0 |   | $ | 47,241 | (2) |
| Chairman &  CEO               |       | 2004       |       | $                            | 180,437    |                                             | $          | 221,700 |   | $ | 2,199 | (1) | None |   | 25,000 |   | $ | 76,806 | (2) |
|                              |       | 2003       |       | $                            | 184,069    |                                             | $          | 221,000 |   | $ | 2,557 | (1) | None |   | 30,000 |   | $ | 26,298 | (2) |
|                              |       |       |       |                         |       |                                             |       |   |   |   |   |   |   |   |   |
| Timothy M.  Leveque               |       | 2005       |       | $                            | 156,140    |                                             | $          | 75,200 |   | $ | 6,000 | (3) | None |   | 0 |   | None |   |
| Executive Vice  President,        |       | 2004       |       | $                            | 137,356    |                                             | $          | 60,150 |   | $ | 12,000 | (3) | None |   | 60,000 |   | None |   |
| Chief Lending  Officer            |       | 2003       |       | $                            | 16,925     |                                             | —     |   | $ | 750 | (3) | None |   | None |   | None |   |
|                              |       |       |       |                         |       |                                             |       |   |   |   |   |   |   |   |   |
| Bruce N. Warner                   |       | 2005       |       | $                            | 144,658    |                                             | $          | 51,200 |   | None |   | None |   | 10,000 |   | None |   |
| Executive Vice  President,        |       | 2004       |       | $                            | 137,024    |                                             | $          | 51,100 |   | None |   | None |   | 25,000 |   | None |   |
| Chief Financial  Officer          |       | 2003       |       | $                            | 104,899    |                                             | $          | 45,601 |   | None |   | None |   | 5,000 |   | None |   |
| Chief Operating  Officer          |       |       |       |                         |       |                                             |       |   |   |   |   |   |   |   |   |
|                              |       |       |       |                         |       |                                             |       |   |   |   |   |   |   |   |   |
| Andre G. Herrera                  |       | 2005       |       | $                            | 115,760    |                                             | $          | 20,000 |   | None |   | None |   | 0 |   | None |   |
| Senior Vice  President,           |       | 2004       |       | $                            | 105,092    |                                             | $          | 15,258 |   | None |   | None |   | 2,200 |   | None |   |
| Chief  Information Officer        |       | 2003       |       | $                            | 103,975    |                                             | $          | 13,743 |   | None |   | None |   | 2,500 |   | None |   |
|                              |       |       |       |                         |       |                                             |       |   |   |   |   |   |   |   |   |
| Viginia L.  Cooper                |       | 2005       |       | $                            | 81,981     |                                             | $          | 40,800 |   | None |   | None |   | 0 |   | None |   |
| Senior Vice  President,           |       | 2004       |       | $                            | 74,645     |                                             | $          | 25,700 |   | None |   | None |   | 2,500 |   | None |   |
| Manager Small  Business           |       | 2003       |       | $                            | 81,340     |                                             | $          | 20,500 |   | None |   | None |   | 1,500 |   | None |   |
| Admin. Loan  Dept.                |       |       |       |                         |       |                                             |       |   |   |   |   |   |   |   |   |

 

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(1)                                  Representspersonal use of company automobile.

 

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

 

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

 

The Bank owns an automobile for the use of its Chief Executive Officer(the value of his personal use of the automobile is included above).  The Bank furnishes, on a non-discriminatorybasis, to the employees: (i) insurance benefits; and (ii) 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,and is not included in the table.

 

The Board of Directors authorized the Bank to enter into a three yearemployment contract with Mr. Chrietzberg, effective January 1, 2005.  It provides for a base salary of $240,000 peryear, a Bank furnished automobile or automobile allowance, and a bonus based onprofits.  The bonus, not to exceed$250,000 annually, will equal $10,000 for each 0.1 percent that the Bank’sprofits

 

50

----

 

exceed 1.0 percent return on average assets plus$10,000 for each 1 percent that the Bank’s return on equity exceeds 10.0percent.  Under the terms of thecontract, if Mr. Chrietzberg is terminated other than for cause (as defined inthe contract), he is entitled to severance compensation for his monthly salaryplus a pro rated incentive bonus for the greater of 24 months or the remainingterm of his contract (which ends in December, 2008); however, if thetermination follows within twelve (12) months after a change in controltransaction (as defined in the contract), he is entitled to such severancecompensation for the greater of 24 months or the remainder of the term of thecontract.

 

The Board of Directors authorized the Bank to execute Addendum 1 to thethree year employment contract with Mr. Chrietzberg effective January 1, 2006.  Addendum 1 provides for a base salary of $300,000 and a bonus not toexceed $300,000.  All other terms of theemployment contract remain the same.

 

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

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

 

In December 1993, the Board of Directors approved a Salary ContinuationAgreement for the benefit of Mr. Chrietzberg that provided for payments of$75,000 per year, for 15 years, if he remains with the Bank until normal retirement,commencing age 65.  After considerationof the impact of such an agreement on the Bank’s income, the Bank amended theAgreement to provide for one half the original benefit amounts, but adoptedSurviving Income Agreements which provide benefits upon the death of theexecutive to his beneficiary in a single payment, in an amount equal to theretirement benefit.  The SalaryContinuation Agreement provides for lesser payments in the event of earlyretirement, generally designated to coincide with increases in the anticipatedsurrender value for the life insurance policies described below.

 

In August, 2001, the Board of Directors amended the Salary ContinuationAgreement for the benefit of Mr. Chrietzberg which was approved in December,1993 and amended in August 1999.   Theamended Salary Continuation Agreement provides for payments of $90,000 peryear, for Mr. Chrietzberg’s lifetime. The amended Salary Continuation Agreement provides the following withregard to the division of death proceeds should Mr. Chrietzberg die before hissixty-fifth (65th) birthday; his beneficiary(ies) shall be entitledto an amount equal to $2,940,000 or the net at risk insurance portion of theproceeds, whichever amount is less.  Thenet at risk insurance portion is the total proceeds less the cash value of thepolicy.  Should Mr. Chrietzberg die on orsubsequent to his sixty-fifth (65th) birthday, his beneficiary(ies)shall be entitled to an amount equal to $1,000,000 plus the present value ofthe remaining retirement benefits due to Mr. Chrietzberg or the net at riskinsurance portion of the proceeds, whichever is less, and the Bank shall beentitled to the remainder of such proceeds.

 

51

----

 

The Bank’s obligations under the Salary Continuation Agreement are notsecured by any segregated amounts, but are informally funded by the purchase ofsingle-premium life insurance policies. The salary continuation expense accrued net of earnings on lifeinsurance policies in 2005, 2004 and 2003 was $47,200, $76,800, and $26,300,respectively.  Based upon the currentprojected earnings of the insurance used to informally fund the Bank’sobligations under the Agreement, and the anticipated salary continuationexpense to be booked, net of tax benefits, the Bank anticipates (based uponcurrent tax laws and assumptions regarding the yield on alternativeinvestment(s)) that the cost of the benefits to be provided under the agreementwill not have a material adverse impact on the Bank’s net income after taxes inthe future, although no assurance can be given in this regard.  The Surviving Income Agreement was terminatedupon adoption of the amended Salary Continuation Agreement.

 

The following table sets forth certain information concerning the grantof stock options under the Corporation’s’ 1998 Amended Stock Option Plan to thenamed executive officer during the year ended December 31, 2005.

 

Option Grants inLast Fiscal Year

 
| **Name**        | ** ** | **Number of  Securities  Underlying  Options  granted (#)** | ** ** | **Percent of  total options  granted  to employees  in fiscal year** | ** ** | **Exercise or  base price  ($/Sh)** | ** ** | **Expiration  date** | ** ** |
|-----------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------|------------|
| Bruce N. Warner |       | 10,000                                                                |       | 100.00                                                                                        | %          | 4.00                                          |       | 6/16/10              |       |

 

The following table sets forth the number of shares of Common stockacquired by each of the named executive officers upon exercise of stock optionsduring 2005, the net value realized upon exercise, the number of shares ofCommon stock represented by outstanding stock options held by each of the namedexecutive officers as of December 31, 2005 and the value of such options basedon the last transaction in 2005, which the Corporation has knowledge of, andcertain information concerning unexercised options under the 1998 Amended StockOption Plan.

 

Aggregated OptionExercises in Last Fiscal Year

and FY-End OptionValues

 
| ** **                  | ** ** | **Shares  Acquired on** | ** ** | **Value**             | ** ** | **Number of  Unexercised  Options at  FY-End(#)** | ** ** | **Value of  Unexercised  in-the-Money  Options at  FY-End ($)** | ** ** |
|-----------------------------|------------|------------------------------|------------|-----------------------|------------|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| **Name**                    | ** ** | **Exercise (#)**        | ** ** | **Received ($)** | ** ** | **Exercisable**                                             | ** ** | **Unexercisable**                                                              | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Charles T. Chrietzberg, Jr. |       | None                         |       | None                  |       | 88,000                                                      |       | None                                                                           |       | $ | 352,000 |   | $ | None |   |
| Timothy M. Leveque          |       | None                         |       | None                  |       | 40,000                                                      |       | 20,000                                                                         |       | 140,000 |   | 70,000 |   |
| Bruce N. Warner             |       | 16,000                       |       | 35,000                |       | 35,000                                                      |       | None                                                                           |       | 122,500 |   | None |   |
|                             |            |                              |            |                       |            |                                                             |            |                                                                                |            |  |  |  |  |  |  |

 

In 2005, each director received a $13,000 retainer and a 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.

 

52

----

 

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

 

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

 
| **Name and Address**        | ** ** | **Amount and Nature of   Beneficial Ownership** | ** ** | **Percent of  Class** | ** ** |
|-----------------------------|------------|-------------------------------------------------|------------|-----------------------|------------|
| ** **                  |
| Charles T. Chrietzberg, Jr. |       | 768,874                                         | (1)        | 44.72                 |       |
| P.O. Box 1344               |       |                                            |       |                  |       |
| Carmel, CA   93921     |       |                                            |       |                  |       |
|                        |       |                                            |       |                  |       |
| David S. Lewis, Trust       |       | 153,863                                         |       | 9.43                  |       |
| 30500 Aurora del Mar        |       |                                            |       |                  |       |
| Carmel, CA   93923     |       |                                            |       |                  |       |

 

----

(1)               Includes 88,000shares subject to employee stock options and 18,414 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 information regarding thebeneficial ownership, both by numerical holding and percentage interest of eachof the Company’s directors and all of its directors and executive officers as agroup.  All addresses are in care of theCorporation at 601 Munras Ave. Monterey, CA 93940.

 
| **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.                      |       | 768,874                                          | (1) (2) (3) | 44.72                 | %          | 88,000                                    |       | 41.73                                        | %          |
| Sandra G. Chrietzberg                            |       | 768,874                                          | (2) (3)     | 44.72                 | %          | 88,000                                    |       | 41.73                                        | %          |
| Peter J. Coniglio                                |       | 80,355                                           | (4) (5)     | 4.85                  | %          | 25,241                                    |       | 3.38                                         | %          |
| Carla S. Hudson                                  |       | 39,899                                           | (6)         | 2.43                  | %          | 10,500                                    |       | 1.80                                         | %          |
| John M. Lotz                                     |       | 11,395                                           |        | 0.69                  | %          | 10,500                                    |       | 0.05                                         | %          |
| All Directors  and Executive Officers as a group |       | 1,067,064                                        | (7)         | 57.66                 | %          | 219,241                                   |       | 51.97                                        | %          |

 

----

(1)               Includes88,000 shares subject to his employee stock options.  316,000 shares of the Common stock owned byMr. Chrietzberg are pledged to secure a loan from an unaffiliated bank. Shouldhe default under such credit, the shares could be acquired by the lender, orsold pursuant to applicable terms of the Uniform Commercial Code, in atransaction that could result in a change of control of the Corporation.  Such transaction may require approval underprovisions of Federal and California change in bank control laws.

 

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

 

(3)               Includes shares ofspouse pursuant to California’s community property laws.

 

(4)               Sole voting power.

 

53

----

 

(5)               Includes 25,241shares subject to the respective director’s stock options.  Of the remaining shares 20,131 are held byMr. Coniglio, 25,241 are held in a family trust controlled by Mr. Coniglio, asto which he has sole voting and investment power, while 8,453 shares are heldby Hudson, Martin, Ferrante & Street, a partnership of which Mr. Conigliois the managing partner, with voting and investment power.

 

(6)               Includes 10,500shares subject to the respective director’s stock options.  The remaining shares are held jointly withfamily members, other than 1,610 shares held in a corporate pension, as towhich Ms. Hudson has voting and investment power.

 

(7)               Includes 166,541shares held by executive officers who are not also directors, 85,000 shares aresubject to employee stock options.

 

**ITEM12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

** **

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

 
| ** **                                                               | ** ** | **Maximum** | ** ** | ** **                      | ** ** | **Outstanding as of  December 31, 2005** | ** ** |
|--------------------------------------------------------------------------|------------|-------------|------------|---------------------------------|------------|------------------------------------------|------------|
| **Name**                                                                 | ** ** | **Amount**  | ** ** | **Percent of  Equity  Capital** | ** ** | **Amount**                               | ** ** | **Percent of  Equity  Capital** | ** ** |
| Peter J.  Coniglio                                                       |       | 1,305,200   | (1)        | 17.57                           | %          | 1,068,100                                | (1)        | 11.96 | % |
| Carla S. Hudson                                                          |       | 137,300     | (2)        | 2.15                            | %          | 105,600                                  | (2)        | 1.18 | % |
| John M. Lotz                                                             |       | 2,500       |       | 0.04                            | %          | 2,500                                    |       | 0.03 | % |
|                                                                     |       |        |       |                            |       |                                     |       |   |   |
| Directors,  Principal Shareholder, and Officers as a Group (7 in number) |       | 1,176,200   |       | 13.17                           | %          | 1,445,100                                |       | 22.65 | % |

 

----

(1)     Includedin the extensions of credit to Mr. Coniglio is a loan to the Coniglio FamilyPartnership, which had an outstanding balance of $1,024,800 on December 31,2005.

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

 

54

----

** **

**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                                                                                                                                                                                                         |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  2002.                                                                                                                                                                                                    |       |
|      |       | (3)  Lease  agreement 301 Webster Street, Monterey, CA   93924                                                                                                                                                                                    |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  2004.                                                                                                                                                                                                    |       |
| 10 (ii) A |       | (1)  First Addendum to Employment Contract of Charles T.  Chrietzberg, Jr.                                                                                                                                                                        |       |
|      |       | (2)   Employment Contract of Charles T. Chrietzberg, Jr., dated January 1,  2005                                                                                                                                                                       |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  2004.                                                                                                                                                                                                    |       |
|      |       | (3)  Deferred  Compensation Agreement, dated December 31, 1993                                                                                                                                                                                         |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  1995.                                                                                                                                                                                                    |       |
|      |       | (4)  Northern  California Bancorp, Inc. 1998 Stock Option Plan and Stock Option Agreements                                                                                                                                                             |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  1998.                                                                                                                                                                                                    |       |
|      |       | (5)  Amendment  to the Salary Continuation Agreement Dated December 31, 1993                                                                                                                                                                           |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  1999.                                                                                                                                                                                                    |       |
|      |       | (6) Life Insurance Endorsement Method Split Dollar  Plan Agreement                                                                                                                                                                                          |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  1999.                                                                                                                                                                                                    |       |
|      |       | (7) Amendment to the Life Insurance Endorsement  Method Split Dollar Plan Agreement Dated January 5, 2000                                                                                                                                                   |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  2001                                                                                                                                                                                                     |       |
|      |       | (8) Amendment to the Life Insurance Endorsement  Method Split Dollar Plan                                                                                                                                                                              |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  2001                                                                                                                                                                                                     |       |
|      |       | (9) Amendment to the Salary Continuation Agreement  Dated December 31, 1993                                                                                                                                                                                 |       |
|      |       | Filed as exhibit to Form 10KSB dated December 31,  2001                                                                                                                                                                                                     |       |
| 11        |       | Statement Reference Computation of Per Share  Earnings                                                                                                                                                                                                      |       |
| 21        |       | Subsidiaries                                                                                                                                                                                                                                                |       |
| 23.1      |       | Consent  of Hutchinson and Bloodgood, LLP                                                                                                                                                                                                                   |       |
| 31.1      |       | Certification of the Chief  Executive Officer of Northern California Bancorp, Inc. pursuant to Section  302 of the Sarbannes-Oxley Act of 2002.                                                                                                             |       |
| 31.2      |       | Certification  of the Chief Financial Officer of   Northern California Bancorp, Inc. pursuant to Section 302 of the  Sarbannes-Oxley Act of 2002.                                                                                                      |       |
| 32.1      |       | Certification  of the Chief Executive Officer of Northern California Bancorp, Inc. pursuant  to                                                                                                                                                             |       |

 

55

----

 
|   |   | Section  906 of  the Sarbannes-Oxley Act of 2002.                                                                                                       |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.2   |   | Certification  of the Chief Financial Officer of   Northern California Bancorp, Inc.   pursuant to Section 906 of the Sarbannes-Oxley Act of 2002. |

** **

B.            REPORTS

 

None

 

**ITEM14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

**Fees**

**Audit Fees.**Aggregate fees billed by Hutchinson and Bloodgood for professionalservices rendered in connection with the audit of the Bank’s annual financialstatements for the fiscal year ended December 31, 2005 and for the requiredreview of the Bank’s financial statements included in its Form 10-QSB’sfor that same year totaled $68,500.

 

**Financial Information System Design and ImplementationFees.**No fees werepaid to Hutchinson and Bloodgood for financial information system design andimplementation services rendered for the 2005 fiscal year.

 

**All Other Fees.**$2,800 was paid to Hutchinson & Bloodgoodfor all tax services rendered for the 2005 fiscal year.

 

56

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** **

**SIGNATURES**

 

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

 
|   |           | NORTHERN CALIFORNIA BANCORP, INC. |
|--------|----------------|-----------------------------------|
|   |           |                              |
| Date:  | March 23, 2006 | By:                               | /s/ | Charles T. Chrietzberg,  Jr. |   |
|   |           |                              | Charles T. Chrietzberg, Jr. |
|   |           |                              | Chief Executive Officer |
|   |           |                              | and President |
|   |           |                              |   |
| Date:  | March 23, 2006 | By:                               | /s/ | Bruce N. Warner |   |
|   |           |                              | Bruce N. Warner |
|   |           |                              | Chief Financial Officer |
|   |           |                              | and Principal  Accounting Officer |

 

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

 
| **Name**                         | ** ** | **Position** | ** ** | **Date**       |
|----------------------------------|------------|--------------|------------|----------------|
|                             |       |         |       |           |
|                             |       |         |       |           |
| /s/ Charles T.  Chrietzberg, Jr. |       |         |       | March 23, 2006 |
| Charles T.  Chrietzberg, Jr.     |       | Director     |       |           |
|                             |       |         |       |           |
| /s/ Sandra G. Chrietzberg        |       |         |       | March 23, 2006 |
| Sandra G. Chrietzberg            |       | Director     |       |           |
|                             |       |         |       |           |
| /s/ Peter J. Coniglio            |       |         |       | March 23, 2006 |
| Peter J. Coniglio                |       | Director     |       |           |
|                             |       |         |       |           |
| /s/ Carls S. Hudson              |       |         |       | March 23, 2006 |
| Carla S. Hudson                  |       | Director     |       |           |
|                             |       |         |       |           |
| /s/ John M. Lotz                 |       |         |       | March 23, 2006 |
| John M. Lotz                     |       | Director     |       |           |

 

57

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**NORTHERN CALIFORNIA BANCORP, INC.**

**AND SUBSIDIARY**

** **

**CONSOLIDATED FINANCIAL REPORT**

 

**Years Ended December 31, 2005 and2004**

 

----

 

**TABLE OF CONTENTS**

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

 

----

 

**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 31,2005 and 2004 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, 2005.  Theseconsolidated financial statements are the responsibility of the Corporation’smanagement.  Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

 

We conducted ouraudits in accordance with standards of the Public Company Accounting OversightBoard (United States).  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 test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable 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, 2005 and 2004, and theresults of their operations and their cash flows for each of the years in thethree-year period ended December 31, 2005 in conformity with accountingprinciples generally accepted in the United States of America.

 

 

Watsonville,California

# February9, 2006

 

1

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

** **

**CONSOLIDATEDBALANCE SHEETS**

**December31, 2005 and 2004**

 

 
| ** **                                                                                                                                                            | ** **                                       | **2005**    | ** **  | **2004**    | ** **  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------|-------------|-------------|-------------|-------------|
| **ASSETS**                                                                                                                                                            |                                             |        |        |        |        |
| ** **                                                                                                                                                            |                                             |        |        |        |        |
| Cash and due  from banks                                                                                                                                              |                                             | $           | 5,830,600   |        | $           | 5,614,000 |   |
| Federal funds  sold                                                                                                                                                   |                                             | 18,300,000  |        | 11,195,000  |        |
| Total cash and  cash equivalents                                                                                                                                      |                                             | 24,130,600  |        | 16,809,000  |        |
| Time deposits  with other financial institutions                                                                                                                      |                                             | 1,000,000   |        | —      |        |
| Trading assets                                                                                                                                                        |                                             | 1,027,500   |        | 803,700     |        |
| Investment  securities available for sale                                                                                                                             |                                             | 11,065,300  |        | 6,834,900   |        |
| Investment  securities held to maturity, at cost (fair value approximates $7,161,900 in  2005; $6,299,700 in 2004)                                                    |                                             | 7,025,000   |        | 6,219,100   |        |
| Other  investments                                                                                                                                                    |                                             | 2,020,500   |        | 1,813,500   |        |
| Loans held for  sale                                                                                                                                                  |                                             | 5,315,000   |        | 4,539,500   |        |
| Loans, net of  allowance for loan losses of   $1,100,700 in 2005; $963,000 in 2004                                                                               |                                             | 101,985,000 |        | 90,496,300  |        |
| Bank premises  and equipment, net                                                                                                                                     |                                             | 4,362,300   |        | 2,217,600   |        |
| Cash surrender  value of life insurance                                                                                                                               |                                             | 2,466,700   |        | 2,391,900   |        |
| Interest  receivable and other assets                                                                                                                                 |                                             | 2,247,200   |        | 1,913,800   |        |
|                                                                                                                                                                  |                                             |        |        |        |        |
|                                                                                                                                                                  | Total assets                                     |        | $           | 162,645,100 |        | $ | 134,039,300 |   |
|                                                                                                                                                                  |                                             |        |        |        |        |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                         |                                             |        |        |        |        |
|                                                                                                                                                                  |                                             |        |        |        |        |
| Deposits:                                                                                                                                                             |                                             |        |        |        |        |
| Non  interest-bearing demand                                                                                                                                          |                                             | $           | 30,814,900  |        | $           | 22,840,000 |   |
| Interest-bearing  demand                                                                                                                                              |                                             | 17,824,500  |        | 16,787,900  |        |
| Savings                                                                                                                                                               |                                             | 7,659,300   |        | 6,792,800   |        |
| Time less than  $100,000                                                                                                                                              |                                             | 32,143,200  |        | 26,574,700  |        |
| Time in  denominations of $100,000 or more                                                                                                                            |                                             | 29,678,200  |        | 24,267,800  |        |
|                                                                                                                                                                  |                                             |        |        |        |        |
|                                                                                                                                                                  | Total deposits                                   |        | 118,120,100 |        | 97,263,200  |   |
|                                                                                                                                                                  |                                             |        |        |        |        |
| Federal Home  Loan Bank borrowed funds                                                                                                                                |                                             | 24,750,000  |        | 19,650,000  |        |
| Junior  subordinated debt securities                                                                                                                                  |                                             | 8,248,000   |        | 8,248,000   |        |
| Interest payable  and other liabilities                                                                                                                               |                                             | 2,596,100   |        | 1,557,000   |        |
|                                                                                                                                                                  |                                             |        |        |        |        |
|                                                                                                                                                                  | Total liabilities                                |        | 153,714,200 |        | 126,718,200 |   |
|                                                                                                                                                                  |                                             |        |        |        |        |
| Commitments  (Note 12)                                                                                                                                                |                                             |        |        |        |        |
|                                                                                                                                                                  |                                             |        |        |        |        |
| Shareholders’  equity                                                                                                                                            |                                             |        |        |        |        |
| Common stock, no  stated par value, authorized: 2,500,000 shares, issued and outstanding:  1,631,439 and 1,608,019 shares at December 31, 2005 and 2004, respectively |                                             | 4,771,800   |        | 4,719,900   |        |
| Retained  earnings                                                                                                                                                    |                                             | 4,128,600   |        | 2,525,600   |        |
| Accumulated  other comprehensive income                                                                                                                               |                                             | 30,500      |        | 75,600      |        |
|                                                                                                                                                                  |                                             |        |        |        |        |
|                                                                                                                                                                  | Total  shareholders’ equity                 |        | 8,930,900   |        | 7,321,100   |   |
|                                                                                                                                                                  |                                             |        |        |        |        |
|                                                                                                                                                                  | Total  liabilities and shareholders’ equity |        | $           | 162,645,100 |        | $ | 134,039,300 |   |

 

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

 

2

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**YearsEnded December 31, 2005, 2004, and 2003**

 
| ** **                                                              | ** ** | **2005**   | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|
|                                                                    |       |       |       |      |       |      |       |
| Interest income                                                         |       |       |       |      |       |      |       |
| Loans                                                                   |       | $          | 9,561,100  |      | $          | 6,756,100 |       | $ | 5,173,400 |   |
| Time deposits  with other financial institutions                        |       | 29,200     |       | —    |       | —    |       |
| Investment  securities                                                  |       | 748,100    |       | 457,500   |       | 299,400   |       |
| Federal funds  sold                                                     |       | 352,400    |       | 141,300   |       | 96,700    |       |
| Total interest  income                                                  |       | 10,690,800 |       | 7,354,900 |       | 5,569,500 |       |
|                                                                    |       |       |       |      |       |      |       |
| Interest expense                                                        |       |       |       |      |       |      |       |
| Interest-bearing  transaction accounts                                  |       | 64,400     |       | 64,400    |       | 49,300    |       |
| Savings and time  deposit accounts                                      |       | 1,050,500  |       | 791,300   |       | 680,200   |       |
| Time deposits in  denominations of $100,000 or more                     |       | 989,900    |       | 561,600   |       | 510,500   |       |
| Notes payable  and other                                                |       | 1,566,800  |       | 1,017,900 |       | 680,500   |       |
| Total interest  expense                                                 |       | 3,671,600  |       | 2,435,200 |       | 1,920,500 |       |
|                                                                    |       |       |       |      |       |      |       |
| Net interest  income                                                    |       | 7,019,200  |       | 4,919,700 |       | 3,649,000 |       |
| Provision for loan losses                                               |       | 150,000    |       | 185,000   |       | 155,000   |       |
| Net interest  income, after provision for loan losses                   |       | 6,869,200  |       | 4,734,700 |       | 3,494,000 |       |
|                                                                    |       |       |       |      |       |      |       |
| Other income                                                            |       |       |       |      |       |      |       |
| Service charges  on deposit accounts                                    |       | 563,800    |       | 516,500   |       | 505,700   |       |
| Income from  sales and servicing of Small Business Administration loans |       | 991,400    |       | 716,400   |       | 660,600   |       |
| Other income                                                            |       | 2,806,800  |       | 2,993,900 |       | 3,192,200 |       |
| Total other  income                                                     |       | 4,362,000  |       | 4,226,800 |       | 4,358,500 |       |
|                                                                    |       |       |       |      |       |      |       |
| Operating expense                                                       |       |       |       |      |       |      |       |
| Salaries and  employee benefits                                         |       | 3,281,800  |       | 3,003,600 |       | 2,566,000 |       |
| Occupancy and  equipment expense                                        |       | 664,500    |       | 596,700   |       | 510,700   |       |
| Professional  fees                                                      |       | 140,500    |       | 113,500   |       | 89,100    |       |
| Data processing                                                         |       | 355,800    |       | 363,900   |       | 357,100   |       |
| Other general  and administrative                                       |       | 3,369,900  |       | 3,038,000 |       | 2,831,300 |       |
| Total operating  expenses                                               |       | 7,812,500  |       | 7,115,700 |       | 6,354,200 |       |
|                                                                    |       |       |       |      |       |      |       |
| Income before tax provision                                             |       | 3,418,700  |       | 1,845,800 |       | 1,498,300 |       |
| Income tax  provision                                                   |       | 1,489,400  |       | 780,600   |       | 658,500   |       |
|                                                                    |       |       |       |      |       |      |       |
| Net income                                                              |       | $          | 1,929,300  |      | $          | 1,065,200 |       | $ | 839,800 |   |
|                                                                    |       |       |       |      |       |      |       |
| Earnings per common share                                               |       |       |       |      |       |      |       |
|                                                                    |       |       |       |      |       |      |       |
| Basic                                                                   |       | $          | 1.20       |      | $          | 0.68      |       | $ | 0.55 |   |
|                                                                    |       |       |       |      |       |      |       |
| Diluted                                                                 |       | $          | 1.00       |      | $          | 0.56      |       | $ | 0.47 |   |

 

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, 2005, 2004, and 2003**

 
| ** **                                                                       | ** ** | ** **                 | ** ** | ** **        | ** ** | ** **             | ** ** | **Accumulated**                             | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------|------------|------------------------|------------|---------------------------------------------|------------|------------|------------|
| ** **                                                                       | ** ** | **Number of  Shares** | ** ** | **Common  Stock** | ** ** | **Retained  Earnings** | ** ** | **Other Compre-  hensive Income** | ** ** | **Total**  | ** ** |
| ** **                                                                       | ** ** | ** **                 | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                                  | ** ** | ** ** | ** ** |
| Balance at December 31, 2002                                                     |       | 1,493,816                  |       | $                 | 4,500,400  |                   | $          | 1,120,900                                   |       | $          | 17,600     |   | $ | 5,638,900 |   |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Comprehensive  income:                                                           |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Net income for  the year                                                         |       | —                     |       | —            |       | 839,800                |       | —                                      |       | 839,800    |       |
| Change in net  unrealized gain on securities and other assets, net of tax effect |       | —                     |       | —            |       | —                 |       | 36,300                                      |       | 36,300     |       |
| Total  comprehensive income                                                      |       |                       |       |              |       |                   |       |                                        |       | 876,100    |       |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| $.15 per share  cash dividend                                                    |       | —                     |       | —            |       | (235,000               | )          | —                                      |       | (235,000   | )          |
| Exercise of  stock options                                                       |       | 78,210                     |       | 152,000           |       | —                 |       | —                                      |       | 152,000    |       |
| Repurchase of  stock options                                                     |       | (5,368                     | )          | (21,500           | )          | —                 |       | —                                      |       | (21,500    | )          |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Balance at December 31, 2003                                                     |       | 1,566,658                  |       | 4,630,900         |       | 1,725,700              |       | 53,900                                      |       | 6,410,500  |       |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Comprehensive  income:                                                           |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Net income for  the year                                                         |       | —                     |       | —            |       | 1,065,200              |       | —                                      |       | 1,065,200  |       |
| Change in net  unrealized gain on securities and other assets, net of tax effect |       | —                     |       | —            |       | —                 |       | 21,700                                      |       | 21,700     |       |
| Total  comprehensive income                                                      |       |                       |       |              |       |                   |       |                                        |       | 1,086,900  |       |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| $.165 per share  cash dividend                                                   |       | —                     |       | —            |       | (265,300               | )          | —                                      |       | (265,300   | )          |
| Exercise of  stock options                                                       |       | 41,361                     |       | 89,000            |       | —                 |       | —                                      |       | 89,000     |       |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Balance at December 31, 2004                                                     |       | 1,608,019                  |       | 4,719,900         |       | 2,525,600              |       | 75,600                                      |       | 7,321,100  |       |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Comprehensive  income:                                                           |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Net income for  the year                                                         |       | —                     |       | —            |       | 1,929,300              |       | —                                      |       | 1,929,300  |       |
| Change in net  unrealized gain on securities and other assets, net of tax effect |       | —                     |       | —            |       | —                 |       | (45,100                                     | )          | (45,100    | )          |
| Total  comprehensive income                                                      |       |                       |       |              |       |                   |       |                                        |       | 1,884,200  |       |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| $.20 per share  cash dividend                                                    |       | —                     |       | —            |       | (326,300               | )          | —                                      |       | (326,300   | )          |
| Repurchase of  stock options                                                     |       | (3,795                     | )          | (15,200           | )          | —                 |       | —                                      |       | (15,200    | )          |
| Exercise of  stock options                                                       |       | 27,215                     |       | 67,100            |       | —                 |       | —                                      |       | 67,100     |       |
|                                                                             |       |                       |       |              |       |                   |       |                                        |       |       |       |
| Balance at December 31, 2005                                                     |       | 1,631,439                  |       | $                 | 4,771,800  |                   | $          | 4,128,600                                   |       | $          | 30,500     |   | $ | 8,930,900 |   |

 

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

 

4

----

 

**NORTHERNCALIFORNIA BANCORP, INC.**

**ANDSUBSIDIARY**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2005, 2004, and 2003**

 
| ** **                                                                                   | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                     |       |        |       |        |       |        |       |
| Net income                                                                                   |       | $           | 1,929,300  |        | $          | 1,065,200   |       | $ | 839,800 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |        |       |        |       |        |       |
| Depreciation and  amortization expense                                                       |       | 240,700     |       | 208,500     |       | 169,800     |       |
| Realized gain  (loss) on sales of available-for-sale securities, net                         |       | 91,800      |       | (50,600     | )          | (21,300     | )          |
| Amortization of  deferred loan costs                                                         |       | 224,000     |       | 126,300     |       | 108,500     |       |
| Amortization of  discounts and premiums on investment securities                             |       | 7,300       |       | 28,100      |       | 85,400      |       |
| (Gain) loss on  sale of equipment                                                            |       | (800        | )          | (2,100      | )          | 100         |       |
| Provision for  loan losses                                                                   |       | 150,000     |       | 185,000     |       | 155,000     |       |
| Change in  deferred tax asset                                                                |       | (178,800    | )          | (75,900     | )          | 104,900     |       |
| Increase in  trading assets                                                                  |       | (223,800    | )          | (640,400    | )          | (81,100     | )          |
| Increase in  loans held for sale                                                             |       | (775,500    | )          | (2,191,700  | )          | (1,365,300  | )          |
| Increase in interest  receivable                                                             |       | (209,700    | )          | (175,300    | )          | (78,600     | )          |
| (Increase)  decrease in other assets                                                         |       | 9,200       |       | (388,600    | )          | (154,600    | )          |
| Increase  (decrease) in interest payable                                                     |       | 376,000     |       | 24,100      |       | (9,300      | )          |
| Increase in  other liabilities                                                               |       | 663,100     |       | 201,800     |       | 238,600     |       |
| Net cash  provided by (used in) operating activities                                         |       | 2,302,800   |       | (1,685,600  | )          | (8,100      | )          |
|                                                                                         |       |        |       |        |       |        |       |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                                     |       |        |       |        |       |        |       |
| Net change in  time deposits with other financial institutions                               |       | (1,000,000  | )          | —      |       | —      |       |
| Proceeds from  maturity of investment securities                                             |       | 597,300     |       | 8,557,800   |       | 2,974,400   |       |
| Purchase of  investments                                                                     |       | (6,020,000  | )          | (15,643,400 | )          | (3,607,000  | )          |
| Net increase in  loans                                                                       |       | (60,466,800 | )          | (35,517,000 | )          | (6,228,700  | )          |
| Loan purchases                                                                               |       | (13,448,200 | )          | (11,043,300 | )          | (12,546,000 | )          |
| Proceeds from  loan sales                                                                    |       | 62,052,300  |       | 30,313,300  |       | 3,225,000   |       |
| Proceeds from  sale of equipment                                                             |       | 500         |       | 3,200       |       | 1,900       |       |
| Additions to  bank premises and equipment                                                    |       | (2,378,800  | )          | (223,600    | )          | (122,800    | )          |
| Net cash used by  investing activities                                                       |       | (20,663,700 | )          | (23,553,000 | )          | (16,303,200 | )          |
|                                                                                         |       |        |       |        |       |        |       |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                                     |       |        |       |        |       |        |       |
| Net increase in  deposits                                                                    |       | 20,856,900  |       | 19,130,800  |       | 10,516,000  |       |
| Proceeds from  FHLB borrowings                                                               |       | 10,000,000  |       | 13,900,000  |       | 11,248,000  |       |
| Repayments of  FHLB borrowings                                                               |       | (4,900,000  | )          | (8,000,000  | )          | (1,172,200  | )          |
| Proceeds from  exercise of stock options                                                     |       | 67,100      |       | 89,000      |       | 152,000     |       |
| Repurchase of  common stock and stock options                                                |       | (15,200     | )          | —      |       | (21,500     | )          |
| Cash dividends  paid on common stock                                                         |       | (326,300    | )          | (265,300    | )          | (235,000    | )          |
| Net cash  provided by financing activities                                                   |       | 25,682,500  |       | 24,854,500  |       | 20,487,300  |       |
|                                                                                         |       |        |       |        |       |        |       |
| Net increase  (decrease) in cash and cash equivalents                                        |       | 7,321,600   |       | (384,100    | )          | 4,176,000   |       |
|                                                                                         |       |        |       |        |       |        |       |
| **CASH AND CASH EQUIVALENTS, BEGINNING**                                                     |       | 16,809,000  |       | 17,193,100  |       | 13,017,100  |       |
|                                                                                         |       |        |       |        |       |        |       |
| **CASH AND CASH EQUIVALENTS, ENDING**                                                        |       | $           | 24,130,600 |        | $          | 16,809,000  |       | $ | 17,193,100 |   |

 

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

 

5

----

 
| ** **                      | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **OTHER CASH FLOW INFORMATION** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                            |       |       |       |       |       |       |       |
| Interest paid                   |       | $          | 3,295,600  |       | $          | 2,411,500  |       | $ | 1,738,100 |   |
|                            |       |       |       |       |       |       |       |
| Income taxes  paid              |       | $          | 1,519,500  |       | $          | 815,400    |       | $ | 363,000 |   |

 

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

 

6

----

 

**NORTHERNCALIFORNIA BANCORP, INC. AND SUBSIDIARY**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**YearsEnded December 31, 2005 and 2004**

 

**Note 1.        SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

***Natureof Business***

 

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

 

***Basisof 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 and transactions havebeen eliminated in consolidation.

 

The Corporation determines whether it has acontrolling financial interest in an entity by first evaluating whether theentity is a voting interest entity or a variable interest entity underaccounting principles generally accepted in the United States of America.Voting interest entities are entities in which the total equity investment atrisk is sufficient to enable the entity to finance itself independently andprovides the equity holders with the obligation to absorb losses, the right toreceive residual returns and the right to make decisions about the entity’sactivities. The Corporation consolidates voting interest entities in which ithas all, or at least a majority of, the voting interest.  As defined inapplicable accounting standards, variable interest entities (VIEs) are entitiesthat lack one or more of the characteristics of a voting interest entity. A controlling financial interest in an entity is present when an enterprise hasa variable interest, or a combination of variable interests, that will absorb amajority of the entity’s expected losses, receive a majority of the entity’sexpected residual returns, or both.  The enterprise with a controllingfinancial interest, known as the primary beneficiary, consolidates theVIE.  The Corporation’s wholly owned subsidiaries, Northern CaliforniaBancorp, Inc. Trust I and Northern California Bancorp, Inc. Trust II, are VIEsfor which the Corporation is not the primary beneficiary.  Accordingly,the accounts of these entities are not included in the Corporation’sconsolidated financial statements at December 31, 2005.

 

7

----

 

***Useof Estimates***

 

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

 

***Cashand Cash Equivalents***

 

For purposes of reportingcash flows, cash and cash equivalents include cash, amounts due from banks andFederal funds sold on a daily basis.

 

***TimeDeposits with Other Financial Institutions***

 

Interest-bearing depositsin banks mature within one year and are carried at cost.

 

***TradingActivities***

 

The Corporation engagesin trading activities for its own account. Securities that are held principallyfor resale in the near term are recorded in the trading assets account at fairvalue with changes in fair value recorded in earnings. Interest and dividendsare included in net interest income.

 

Quoted market prices,when available, are used to determine the fair value of trading instruments. Ifquoted market prices are not available, then fair values are estimated usingpricing models, quoted prices of instruments with similar characteristics, ordiscounted cash flows.

 

8

----

#### ** **

***InvestmentSecurities***

 

Investments in debtsecurities that management has the positive intent and ability to hold tomaturity are classified as “held to maturity” and reflected at cost, adjustedfor amortization of premiums and accretion of discounts, which are recognizedas adjustments to interest income. Other marketable securities are classifiedas “available for sale” and are reflected at fair value, with unrealized gainsand losses excluded from earnings and reported in other comprehensive income. Inestimating other-than-temporary impairment losses, management considers (1) thelength of time and the extent to which the fair value has been less than cost,(2) the financial condition and near-term prospects of the issuer, and (3) theintent and ability of the Bank to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in fair value. Gainsand losses on disposition are generally recognized on the trade date, based onthe net proceeds and the adjusted carrying amount of the securities sold usingthe specific identification method. Purchase premiums and discounts arerecognized in interest income using methods approximating the interest methodover the terms of the securities.

 

***Salesand Servicing of SBA Loans***

 

The Bank originates loansto customers under the Small Business Administration (SBA) program thatgenerally provides for SBA guarantees of 70% to 85% of each loan. The Bankgenerally sells the guaranteed portion of each loan to a third party and retainsonly the non-guaranteed portion in its own portfolio. A gain is recognized onthese loans through collection on sale of a premium over the adjusted carryingvalue, or through retention of an ongoing rate differential, less a normalservice fee between the rate paid by the borrower to the Bank and the rate paidby the Bank to the purchaser (excess servicing fee). In calculating the gain,the Bank assumes that the loans sold will be outstanding for one-half of theircontractual lives.

 

9

----

 

The Bank’s investment inan SBA loan is allocated among the retained portion of the loan, excessservicing retained, and the sold portion of the loan, based on the relativefair market value of each portion at the time of loan origination, adjusted forpayments and other activities. Since the portion retained does not carry an SBAguarantee, 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 are reflected as an asset which is amortized overan assumed half life; in the event future prepayments are significant andfuture expected cash flows are inadequate to cover the unamortized excessservicing asset, additional amortization is recognized.

 

***LoansHeld for Sale***

 

Loans held for saleconsist of the portion of loans that are guaranteed by the SBA and are carriedat the lower of cost or market. Market value for loans guaranteed by the SBA isgenerally determined based on the price at which the loans were committed to besold on the trade date. Direct loan origination costs are recorded atsettlement as an adjustment to gain or loss on sale.

 

***Loansand Loan Fees***

 

The Bank grants mortgage,commercial, construction, and consumer loans to customers. A substantialportion of the loan portfolio is represented by****mortgageloans on the Monterey Peninsula. The ability of the Bank’s debtors to honortheir contracts is dependent upon the real estate and general economic sectorsin the area.

 

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

 

Loans that management hasthe intent and ability to hold for the foreseeable future or until maturity orpay-off generally are reported at their outstanding unpaid principal balancesadjusted for charge-offs, the allowance for loan losses, and any deferred feesor cost on originated loans. Interest income is accrued on the unpaid principalbalance. Loan origination fees, net of certain direct origination costs, aredeferred and recognized as an adjustment of the related loan yield using theinterest method.

 

10

----

 

The accrual of intereston mortgage and commercial loans is discontinued at the time the loan is 90days past due unless the credit is well-secured and in process of collection. Creditcard loans and other personal loans are typically charged off no later than 180days past due. Past due status is based on contractual terms of the loan. Inall cases, loans are placed on nonaccrual or charged-off at an earlier date ifcollection of principal or interest is considered doubtful.

 

All interest accrued butnot collected for loans that are placed on nonaccrual or charged off isreversed against interest income. The interest on these loans is accounted foron the cash-basis or cost-recovery method, until qualifying for return toaccrual. Loans are returned to accrual status when all the principal andinterest amounts contractually due are brought current and future payments arereasonably assured.

 

***Allowancefor Loan Losses***

 

The allowance for loanlosses is established through a provision for loan losses charged to earningsand is maintained at a level considered adequate to provide for reasonablyforeseeable loan losses.

 

The provision and thelevel of the allowance are evaluated on a regular basis by management and arebased upon management’s periodic review of the collectibility of the loans inlight of historical experience, known and inherent risks in the nature andvolume of the loan portfolio, adverse situations that may affect the borrower’sability to repay, estimated value of any underlying collateral, and prevailingeconomic conditions. This evaluation is inherently subjective as it requiresestimates that are susceptible to significant change. In addition, variousregulatory 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 requirethe Bank to recognize additions to the allowance based on their judgment ofinformation available to them at the time of their examination. Ultimately,losses may vary from current estimates and future additions to the allowancemay be necessary.

 

Loan losses are chargedagainst the allowance when management believes the collectibility of the loanbalance is unlikely. Subsequent recoveries, if any, are credited to theallowance.

 

11

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The allowance consists ofspecific, general and unallocated components. The specific component relates toloans that are classified as either doubtful, substandard or special mention. Forsuch loans that are also classified as impaired, an allowance is establishedwhen the discounted cash flows (or collateral value or observable market price)of the impaired loan is lower than that of the carrying value of that loan. Thegeneral component covers non-classified loans and is based on historical loss experienceadjusted for qualitative factors. An unallocated component is maintained tocover uncertainties that could affect management’s estimate of probable losses.The unallocated component of the allowance reflects the margin of imprecisioninherent in the underlying assumptions used in the methodologies for estimatingspecific and general losses in the portfolio.

 

A loan is consideredimpaired when, based on current information and events, it is probable that acreditor will be unable to collect the scheduled payments of principal orinterest when due according to the contractual terms of the loan agreement. Factorsconsidered by management in determining impairment include payment status,collateral value, and the probability of collecting scheduled principal andinterest payments when due. Loans that experience insignificant payment delaysand payment shortfalls generally are not classified as impaired. Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed. Impairment ismeasured on a loan-by-loan basis by either the present value of expected futurecash flows discounted at the loan’s effective interest rate, the loan’sobtainable market price, or the fair value of the collateral if the loan iscollateral dependent. Substantially, all of the Bank’s loans that have beenidentified as impaired have been measured by the fair value of existingcollateral.

 

Large groups of smallerbalance homogeneous loans are collectively evaluated for impairment. Accordingly,the Bank does not separately identify individual consumer loans for impairmentdisclosures.

 

12

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***LoanServicing***

 

Rights to service loansfor others are capitalized as separate assets, whether acquired throughpurchase or origination, if such loans are sold or securitized with servicingrights retained. Accordingly, the total cost of the loan is allocated to therelated servicing right and to the loan based on the relative fair values if itis practicable to estimate those fair values.

 

The Bank estimates fairvalue based on the present value of estimated expected future cash flows usingprepayment speeds and discount rates commensurate with the risks involved, andservicing costs determined on an incremental cost basis.

 

Capitalized mortgageservicing rights are reported in other assets and amortized to servicingrevenue in proportion to, and over the period of, estimated net servicingrevenues. Impairment of mortgage servicing rights is assessed based on the fairvalue of those rights. For purposes of measuring impairment, the rights arestratified based on the following predominant risk characteristics of theunderlying loans: loan type, size, note rate, date of origination, term, andgeographic location. Impairment is recognized through a valuation allowance foran individual stratum, to the extent that fair value is less than thecapitalized amount for the stratum.

 

***BankingPremises and Equipment***

 

Land is carried at cost. Buildingsand equipment are carried at cost, less accumulated depreciation computed onthe straight-line method over the estimated useful lives of the assets.

 

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

 

13

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#### ** **

***IncomeTaxes***

 

Deferredincome taxes are recognized for estimated future tax effects attributable toincome tax carry forwards as well as temporary differences between income tax and financial reportingpurposes. Valuation allowances are established when necessary to reduce thedeferred tax asset to the amount expected to be realized.  Deferred taxassets and liabilities are reflected at currently enacted income tax ratesapplicable to the period in which the deferred tax assets or liabilities areexpected to be realized or settled. As changes in tax laws or rates areenacted, deferred tax assets and liabilities are adjusted accordingly throughthe provision for income taxes.

 

***Transfers of Financial Assets***

 

Transfers of financialassets are accounted for as sales when control over the assets has beensurrendered. Control over transferred assets is deemed to be surrendered when1) the assets have been isolated from the Bank, 2) the transferee (buyer)obtains the right to pledge or exchange the transferred assets, free ofconditions that would constrain it from taking advantage of that right, and 3)the Bank does not maintain effective control over the transferred assetsthrough an agreement to repurchase them before their maturity.

 

***StockOption 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 Stock Options are granted at fair value of thecommon stock on the date of grant. However, an incentive stock option grantedto an individual owning 10% or more of the Corporation’s stock after such grantmust have an exercise price of at least 110%****ofsuch fair market value and an exercise period of not more than five years. Non-qualifiedstock options may be granted at prices not lower than 85% of the fair marketvalue of the common stock on the date of grant. The Board of Directors isauthorized to determine when options become exercisable within a period not exceeding10 years from the date of grant. Under the Plan, 301,357 shares of common stockhave been reserved for the granting of these options. At December 31, 2005, 293,141options were outstanding. During 2005, 10,000 options were granted, and 27,215 optionswere exercised by officers, employees, and board members.

 

14

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Statement of FinancialAccounting Standards (“SFAS”) No. 123, “Accounting for Stock-BasedCompensation,” as amended by SFAS No. 148 “Accounting for Stock-BasedCompensation –Transition and Disclosure,” encourages all entities to adopt afair value based method of accounting for employee stock compensation plans,whereby compensation cost is measured at the grant date based on the value ofthe award and is recognized over the service period, which is usually the vestingperiod. However, it also allows an entity to continue to measure compensationcost for those plans using the intrinsic value based method of accounting prescribedby Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” whereby compensation cost is the excess, if any, of thequoted market price of the stock at the grant date (or other measurement date)over the amount an employee must pay to acquire the stock. Stock options issuedunder the Corporation’s stock option plan have no intrinsic value at the grantdate, and under Opinion No. 25 no compensation cost is recognized for them.

 

Had compensation cost forthe Corporation’s stock-based compensation plan been determined based on thefair value at the grant date for awards under the plan consistent with themethod prescribed by SFAS No. 123 as amended by SFAS 148, the Corporation’s netincome and earnings per share would have been adjusted by the compensation costnet of taxes to the pro forma amounts indicated below:

 
| ** **                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**  | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Net income:                      |       |     |       |     |       |      |       |
| As reported                      |       | $        | 1,929,300  |     | $          | 1,065,200 |       | $ | 839,800 |   |
| Compensation  cost, net of taxes |       | 5,100    |       | 102,700  |       | 29,900    |       |
|                             |       |     |       |     |       |      |       |
| Pro forma                        |       | $        | 1,924,200  |     | $          | 962,500   |       | $ | 809,900 |   |
|                             |       |     |       |     |       |      |       |
| Basic earnings  per share:       |       |     |       |     |       |      |       |
| As reported                      |       | $        | 1.20       |     | $          | 0.68      |       | $ | 0.55 |   |
| Pro forma                        |       | $        | 1.19       |     | $          | 0.61      |       | $ | 0.53 |   |
|                             |       |     |       |     |       |      |       |
| Diluted earnings  per share:     |       |     |       |     |       |      |       |
| As reported                      |       | $        | 1.00       |     | $          | 0.56      |       | $ | 0.47 |   |
| Pro forma                        |       | $        | 1.00       |     | $          | 0.50      |       | $ | 0.45 |   |

 

15

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The fair value of theseoptions was estimated at the grant date using the Black-Scholes option pricingmodel with the following weighted-average assumptions for 2005, 2004, and 2003:risk-free interest rate of 4.6%, 4.8%, and 5.1%, respectively; dividend yieldof 1.3%, 1.0%, and 1.7%, respectively; expected option life of 4 years, 8 years,and 5.4 years, respectively ; and volatility of 20%, 20%, and 20%, respectively.

 

Inaccordance with Statement of Financial Accounting Standards No. 123R, beginningin 2006 the Bank will be required to record compensation cost for stock optionsprovided to employees, directors and others in return for service to the Bank.The cost is measured at the fair value of the options when granted, and thiscost is expensed over the service period, which is normally the vesting periodof the options. This will apply to awards that vest after January 1, 2006, thedate of adoption of SFAS No. 123R. The effect on results of operations willdepend in part on the level of future option grants and the calculation of thefair value of the options granted at such future date, as well as the vestingperiods provided, and so cannot currently be predicted.

 

Notwithstandingoptions granted in the future, management has evaluated the pro forma cost ofthe options granted in 2005. The Bank will record compensation costs for stock options granted in 2005beginning on January 1, 2006. The estimated after tax cost of these options foreach of the next five fiscal years ending December 31 is as follows:

 
| 2006 |   | $      | 16,700 |   |
|------|--------|--------|--------|--------|
| 2007 |   | — |   |
| 2008 |   | — |   |
| 2009 |   | — |   |
| 2010 |   | — |   |

 

Althoughstock option expense will reduce future reported earnings, there will be nosignificant effect on the Bank’s financial position for options that vest afterthe adoption date, as total equity will not change.

 

16

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***Earningsper share***

 

Basic earnings per sharerepresents income available to common shareholders divided by theweighted-average number of common shares outstanding during the period. Dilutedearnings per share reflects additional common shares that would have beenoutstanding if dilutive potential common shares had been issued, as well as anyadjustment to income that would result from the assumed issuance. Potentialcommon shares that may be issued by the Corporation relate solely tooutstanding stock options, and are determined using the treasury stock method. Theweighted average number of shares used in the computation of basic earnings pershare was 1,614,196for 2005, 1,576,589 for 2004, and 1,528,268 for 2003. The weighted averagenumber of shares used in the computation of earnings per share assumingdilution of stock options was 1,923,532for 2005, 1,919,512 for 2004, and 1,796,859 for 2003. The Corporationpaid cash dividends of $.20, $.165, and $.15 per share in 2005, 2004 and 2003,respectively.

 

***AccountingChanges***

# *** ***

InMarch 2004, Securities and Exchange Commission (“SEC”) Staff AccountingBulletin No. 105 (“SAB 105”) was issued, which provides guidance regarding loancommitments that are accounted for as derivative instruments under FASB No. 133(as amended), Accounting forDerivative Instruments and Hedging Activities. In this Bulletin, the SECruled that the amount of the expected servicing rights should not be includedwhen determining the fair value of derivative interest rate lock commitments. Thisguidance must be applied to rate locks initiated after March 31, 2004. The adoption of SAB 105 didnot have a material impact on the Company’s consolidated financial statements.

 

17

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In March 2004, theFinancial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) reached consensuson several issues being addressed in EITF Issue No. 03-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*. The consensus providesguidance for evaluating whether an investment is other-than-temporarilyimpaired and was effective for other-than-temporary impairment evaluations madein reporting periods beginning after June 15, 2004. The disclosure provisionsof EITF 03-1 continue to be effective for the Bank’s financial statements forthe year ended December 31, 2005.

 

OnNovember 3, 2005, the FASB issued FASB Staff Position (“FSP”) Nos. FAS 115-1and FAS 124-1, *The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments*.This FSP addresses the determination as to when an investment is consideredimpaired, whether that impairment is other than temporary, and the measurementof an impairment loss. This FSP also includes accounting considerationssubsequent to the recognition of an other-than-temporary impairment andrequires certain disclosures about unrealized losses that have not been recognizedas other-than-temporary impairments.

 

ThisFSP nullifies certain requirements of EITF Issue 03-1, and supersedes EITFTopic No. D-44, *Recognition ofOther-Than-Temporary Impairment upon the Planned Sale of a Security Whose CostExceeds Fair Value*. The guidance in this FSP amends FASB StatementNo. 115, *Accounting for Certain Investmentsin Debt and Equity Securities*. The FSP is effective for reportingperiods beginning after December 15, 2005. The Bank does not anticipate anymaterial impact to its financial condition or results of operations as a resultof the adoption of this guidance.

 

InDecember 2004, the FASB issued Statement of Financial Accounting StandardsNo. 123R, *Share Based Payment*(SFAS 123R), effective for the first reporting period that begins afterJune 15, 2005. SFAS 123R is a revision of SFAS 123, *Accounting for Stock-Based Compensation*.SFAS 123R eliminates the alternative to apply the Accounting Principles Board (“APB”)Opinion No. 25, *Accounting for StockIssued to Employees* intrinsic value method of accounting for thecost of employee services received in exchange for an award of equityinstruments. SFAS 123R provides for the initial measurement of the cost ofemployee services received in exchange for an award of equity instruments basedon the grant-date fair value of the award. The effective date of the standardunder these new rules for the Bank’s financial statements is January 1, 2006.See “Stock Option Plan” above for management’s estimate of the futurecompensation expense related to the adoption of this Statement.

 

18

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InDecember 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets – An Amendment of APB OpinionNo. 29, Accounting for Nonmonetary Transactions* (SFAS 153).SFAS 153 eliminates the exception from fair value measurement for nonmonetaryexchanges of similar productive assets in paragraph 21(b) of APB OpinionNo. 29, *Accounting for NonmonetaryTransactions*, and replaces it with an exception for exchanges thatdo not have commercial substance. SFAS 153 specifies that a nonmonetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange. This standard waseffective for fiscal periods beginning after June 15, 2005. Managementbelieves that the adoption of SFAS 153 will not have an impact on the Bank’sfinancial statements.

 

InMay 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections - A Replacement of APB Opinion No. 20 and FASBStatement No. 3*. SFAS 154 replaces APB Opinion 20, *Accounting Changes*, and FASB Statement 3, *Reporting Accounting Changes in Interim FinancialStatements*, and changes the accounting and reporting requirementsfor a change in accounting principle. SFAS 154 applies to all voluntary changesin an accounting principle, as well as to changes required by a new accountingpronouncement in the unusual instance that the pronouncement does not includespecific transition provisions. SFAS 154 is effective for accounting changesand error corrections made in fiscal years beginning after December 15, 2005and requires retrospective application to prior periods’ financial statementsfor most voluntary changes in an accounting principle, unless it isimpracticable to do so. SFAS 154 did not change the guidance for reportingcorrections of errors, changes in estimates or for justification of a change inaccounting principle on the basis of preferability. The Bank does notanticipate any material impact to its financial condition or results ofoperations as a result of the adoption of SFAS No. 154.

 

19

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***ComprehensiveIncome***

# *** ***

Accounting principlesgenerally require that recognized revenue, expenses, gains, and losses beincluded in net income. Although certain changes in assets and liabilities,such as unrealized gains and losses on available-for-sale securities, arereported as a separate component of the equity section of the balance sheet,such items, along with net income, are components of comprehensive income.

 

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

 
| ** **                                                                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unrealized  holding gains on available for sale securities and other assets, net |       | $        | (81,900    | )        | $          | 39,300   |       | $ | 66,100 |   |
| Tax effect                                                                       |       | 36,800   |       | (17,600  | )          | (29,800  | )          |
|                                                                             |       |     |       |     |       |     |       |
| Net-of-tax  amount                                                               |       | $        | (45,100    | )        | $          | 21,700   |       | $ | 36,300 |   |
|                                                                                  |            |          |            |          |            |          |            |  |  |  |  |

 

20

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

 
| ** **                                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Unrealized  holding losses on available for sale securities            |       | $        | (136,600   | )        | $          | (19,300 | ) |
| Unrealized  holding gains on available for sale asset strip receivable |       | 192,000  |       | 156,700  |       |
| Tax effect                                                             |       | (24,900  | )          | (61,800  | )          |
|                                                                   |       |     |       |     |       |
| Net-of-tax  amount                                                     |       | $        | 30,500     |     | $          | 75,600 |   |

*** ***

***AdvertisingCosts***

 

Advertising costs arecharged to operations when incurred. The amount expensed for advertising as ofDecember 31, 2005, 2004, and 2003 was $140,900, $127,500, and $113,500,respectively.

 

***Reclassification***

 

Certain amounts have been reclassified in the 2004 and2003 financial statements to conform to the 2005 presentation.

 

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

 

The Corporation is required to maintain aggregatereserves (in the form of cash and deposits with the Federal Reserve Bank) tosatisfy federal regulatory requirements. At December 2005 and 2004, thesereserve balances amounted to $800,000 and $766,000, respectively.

 

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

 

At December 31, 2005 and2004, trading assets, at fair value, consisted of marketable equity securitiesin the amount of $1,027,500 and $803,700, respectively.

 

21

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

 

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

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

 

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| ** **                                  | ** ** | **Amortized  Cost**   | ** ** | **Gross  Unrealized  Gains  (Losses)** | ** ** | **Fair  Value** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|----------------------------------------|------------|-----------------|------------|
| ** **                                  | ** ** | **December 31, 2004** | ** ** |
| **Securities  Available for Sale**          |       |                  |       |                                   |       |            |       |
| GNMA - Mortgage  Backed Securities          |       | $                     | 1,399,900  |                                   | $          | (22,800         | )          | $ | 1,377,100 |   |
| Government  Agency Securities               |       | 4,704,300             |       | 1,800                                  |       | 4,706,100       |       |
| Corporate Debt  Securities                  |       | 750,000               |       | 1,700                                  |       | 751,700         |       |
|                                        |       |                  |       |                                   |       |            |       |
| Total securities  available for sale        |       | $                     | 6,854,200  |                                   | $          | (19,300         | )          | $ | 6,834,900 |   |
|                                        |       |                  |       |                                   |       |            |       |
| **Securities  Held to Maturity**            |       |                  |       |                                   |       |            |       |
| State/Local  Agency Securities              |       | $                     | 6,219,100  |                                   | $          | 80,600          |       | $ | 6,299,700 |   |
|                                        |       |                  |       |                                   |       |            |       |
| **Other  Investments, at cost**             |       |                  |       |                                   |       |            |       |
| AT Services LLC                             |       | $                     | 202,000    |                                   | $          | —          |       | $ | 202,000 |   |
| Federal Home  Loan Bank stock, restricted   |       | 923,600               |       | —                                 |       | 923,600         |       |
| Northern  California Bancorp, Inc. Trust I  |       | 93,000                |       | —                                 |       | 93,000          |       |
| Northern  California Bancorp, Inc. Trust II |       | 155,000               |       | —                                 |       | 155,000         |       |
| Pacific Coast  Banker’s Bank Stock     |       | 439,900               |       | 891,700                                |       | 1,331,600       |       |
|                                        |       |                  |       |                                   |       |            |       |
| Total other  investments                    |       | $                     | 1,813,500  |                                   | $          | 891,700         |       | $ | 2,705,200 |   |

 

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The amortized cost andfair value of debt securities by contractual maturity at December 31, 2005 areshown below. Expected maturities will differ from contractual maturitiesbecause borrowers may have the right to call or prepay obligations with orwithout call or prepayment penalties.

 
| ** **                              | ** ** | **Available for Sale** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **Amortized  Cost**    | ** ** | **Fair  Value** | ** ** |
|                                    |       |                   |       |   |   |
| Due within one  year                    |       | $                      | 3,000,000  |   | $ | 2,986,800 |   |
| Due after one  year through five years  |       | 4,713,900              |       | 4,636,800 |   |
| Due after five  years through ten years |       | 2,630,600              |       | 2,603,800 |   |
| GNMA - Mortgage  Backed Securities      |       | 857,400                |       | 837,900 |   |
|                                    |       |                   |       |   |   |
|                                    |       | $                      | 11,201,900 |   | $ | 11,065,300 |   |

 
| ** **           | ** ** | **Held to Maturity** | ** ** |
|----------------------|------------|----------------------|------------|
| ** **           | ** ** | **Amortized  Cost**  | ** ** | **Fair  Value** | ** ** |
|                 |       |                 |       |   |   |
| Due after ten  years |       | $                    | 7,025,000  |   | $ | 7,161,900 |   |
|                      |            |                      |            |  |  |  |  |

 

Proceeds from maturityand sales of investment securities during 2005 and 2004, respectively, were $70,200and $8,557,800. Realized gains (losses) during 2005 and 2004, respectively,were $(91,800) and $50,600.

 

Asa member of the Federal Home Loan Bank (FHLB) system, the Bank is required tomaintain an investment in FHLB stock in an amount equal to the greater of 1% ofits outstanding mortgage loans or 5% of advances from the FHLB. As of December31, 2005 and 2004, the Bank had advances from the FHLB totaling $24,750,000 and$19,650,000, respectively. No ready market exists for FHLB stock, and it has noquoted market value. FHLB stock is evaluated for impairment based on anestimate of the ultimate recoverability of par value.

 

24

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Information pertaining to securities with grossunrealized losses at December 31, 2005, aggregated by investment category andlength of time that individual securities have been in a continuous lossposition follows:

 
| ** **                       | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**            | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------------|------------|
| ** **                       | ** ** | **Carrying  Amount**    | ** ** | **Unrealized  Loss**  | ** ** | **Carrying  Amount** | ** ** | **Unrealized  Loss** | ** ** | **Carrying  Amount** | ** ** | **Unrealized  Loss** | ** ** |
| Securities  Available-for-Sale   |       |                    |       |                  |       |                 |       |   |   |   |   |   |   |
| Government  Agencies             |       | $                       | 8,715,000  |                  | $          | (95,800              | )          | $ | 999,100 |   | $ | (21,300 | ) | $ | 9,714,100 |   | $ | (117,100 | ) |
| GNMA - Mortgage  Backed Security |       | 857,300                 |       | (19,500               | )          |                 |       |   |   | 857,300 |   | (19,500 | ) |
| Corporate Debt  Security         |       | 750,000                 |       | (119,500              | )          |                 |       |   |   | 750,000 |   | (119,500 | ) |
|                             |       |                    |       |                  |       |                 |       |   |   |   |   |   |   |
| Securities  Held-to-Maturity     |       |                    |       |                  |       |                 |       |   |   |   |   |   |   |
| State/Local  Agency Securities   |       | 604,700                 |       | (14,600               | )          |                 |       |   |   | 604,700 |   | (14,600 | ) |
|                                  |            |                         |            |                       |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

The corporate debtsecurity is considered to be impaired due to its credit rating being lowered bynational credit rating agencies. Management has established a reserve forpossible loss which is adjusted quarterly based on the current market value ofthe security.

 

OnDecember 31, 2005, 8 securities have an unrealized loss with aggregatedepreciation of 1.3% from the Bank’s amortized cost basis. The unrealizedlosses relate to a mortgage backed security issued by federally sponsoredagencies, which are fully secured by conforming residential loans andsecurities issued by agencies of the United States. Since the Bank has theability to hold these securities until estimated maturity, no decline is deemedto be other than temporary.

 

25

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OnJanuary 31, 2006, Monterey County Bank, a wholly owned subsidiary of NorthernCalifornia Bancorp, Inc., sold its shares of common stock in Pacific CoastBanker’s Bancshares (“PCBB”). The net sales proceeds were $1,757,025. Aftersubtracting the book value of $439,900, the resulting pretax gain was$1,313,426. The after tax gain will approximate $790,000. Monterey County Bankowned 3,699 shares of PCBB that sold for $475.00 per share less a $3,699 salescharge.

 

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

 

A summary of the activityof SBA loans follows:

 
| ** **            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**   | ** ** |
|-----------------------|------------|----------|------------|----------|------------|------------|------------|
|                  |       |     |       |     |       |       |       |
| SBA loans  originated |       | $        | 6,274,000  |     | $          | 15,844,000 |       | $ | 8,882,900 |   |
|                  |       |     |       |     |       |       |       |
| SBA loans sold        |       | $        | 7,944,900  |     | $          | 4,669,100  |       | $ | 4,994,100 |   |

 

A summary of income fromSBA loans sold is as follows:

 
| ** **                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |     |       |
| Income from  premiums                 |       | $        | 665,400    |     | $          | 412,400  |       | $ | 440,000 |   |
| Income from  servicing                |       | 326,000  |       | 304,000  |       | 220,600  |       |
|                                  |       |     |       |     |       |     |       |
| Total SBA sales  and servicing income |       | $        | 991,400    |     | $          | 716,400  |       | $ | 660,600 |   |

 

26

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

 

A summary of loanbalances follows:

 
| ** **                             | ** ** | **2005**    | ** **  | **2004**   | ** ** |
|----------------------------------------|------------|-------------|-------------|------------|------------|
|                                   |       |        |        |       |       |
| Commercial and  industrial             |       | $           | 20,920,900  |       | $          | 19,314,300 |   |
| Construction                           |       | 10,455,900  |        | 7,372,500  |       |
| Real estate,  mortgage                 |       | 71,005,800  |        | 64,339,200 |       |
| Installment                            |       | 942,300     |        | 622,000    |       |
| Government  guaranteed loans purchased |       | 45,300      |        | 51,400     |       |
|                                   |       | 103,370,200 |        | 91,699,400 |       |
| Allowance for  loan losses             |       | (1,100,700  | )           | (963,000   | )          |
| Deferred  origination fees, net        |       | (284,500    | )           | (240,100   | )          |
|                                   |       |        |        |       |       |
| Loans, net                             |       | $           | 101,985,000 |       | $          | 90,496,300 |   |

 

An analysis of theallowance for loan losses follows:

 
| ** **                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |     |       |
| Beginning  balance         |       | $        | 963,000    |     | $          | 774,800  |       | $ | 636,900 |   |
| Recoveries                 |       | 1,900    |       | 3,200    |       | 1,300    |       |
| Loans charged  off         |       | (14,200  | )          | —   |       | (18,400  | )          |
| Provision for  loan losses |       | 150,000  |       | 185,000  |       | 155,000  |       |
|                       |       |     |       |     |       |     |       |
| Ending balance             |       | $        | 1,100,700  |     | $          | 963,000  |       | $ | 774,800 |   |

 

27

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** **

As of December 31, 2005 there were no impaired loans;at December 31, 2004 the recorded investment in impaired loans totaled $42,600 witha corresponding valuation $19,900. No additional amounts are committed to beadvanced in connection with impaired loans.

 

During the years ended December 31, 2005, 2004, and2003 the average recorded investment in impaired loans amounted toapproximately $82,400, $617,100, and $705,000, respectively. At December 31,2005 there were no non-accrual loans; at December 31, 2004 non-accrual loanstotaled $42,600. If interest on non-accrual loans had been accrued, such incomewould have approximated $8,200 and $3,100 for 2004, and 2003, respectively.

 

As of December 31, 2005 and 2004, there were no loans pastdue ninety days or more and still accruing interest.

 

Loans serviced for others are not included in theaccompanying balance sheets. The unpaid principal balance of loans serviced forothers was $85,033,900 and $51,586,800 at December 31, 2005 and 2004,respectively.

 

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

## ** **

A summary of the cost and accumulated depreciation ofbanking premises and equipment and their estimated useful lives follows:

 
| ** **                | ** ** | **2005**   | ** ** | **2004**   | ** ** | **Useful Lives** | ** ** |
|---------------------------|------------|------------|------------|------------|------------|------------------|------------|
|                      |       |       |       |       |       |             |       |
| Land                      |       | $          | 1,173,700  |       | $          | 711,725          |       |   |   |
| Building                  |       | 1,807,800  |       | 203,675    |       | 40 years         |       |
| Building  improvements    |       | 484,500    |       | 466,100    |       | 40 years         |       |
| Leasehold  improvements   |       | 877,300    |       | 826,700    |       | Lease term       |       |
| Furniture and  equipment  |       | 1,787,700  |       | 1,594,700  |       | 3-8 years        |       |
|                      |       | 6,131,000  |       | 3,802,900  |       |             |       |
| Accumulated  depreciation |       | (1,768,700 | )          | (1,585,300 | )          |             |       |
|                      |       | $          | 4,362,300  |       | $          | 2,217,600        |       |   |   |

 

Depreciation and amortization expense for the years ending December 31, 2005, 2004, and 2003amounted to $240,700, $208,500, and $169,800, respectively.

 

28

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

## ** **

At December 31, 2005, the scheduled maturities of timedeposits are as follows:

 
| 2006       |   | $         | 48,723,000 |   |
|------------|--------|-----------|------------|--------|
| 2007       |   | 9,037,500 |       |
| 2008       |   | 1,952,100 |       |
| 2009       |   | 1,112,900 |       |
| 2010       |   | 961,000   |       |
| Thereafter |   | 34,900    |       |
|       |   |      |       |
|       |   | $         | 61,821,400 |   |

 

#### **Note 9.**        JUNIORSUBORDINATED DEBT SECURITIES

#### ** **

On March 27, 2003, theCompany’s wholly owned special-purpose trust subsidiary, Northern CaliforniaBancorp, Inc. Trust I (the “Trust”) issued $3 million in cumulative TrustPreferred Securities. The securities bear a floating rate of interest of 3.25%over the three month LIBOR rate, payable quarterly. Concurrent with theissuance of the Trust Preferred Securities, the Trust used the proceeds fromthe Trust Preferred Securities offering to purchase a like amount of JuniorSubordinated Debentures of the Company. The Company will pay interest on theJunior Subordinated Debentures to the Trust, which represents the sole revenueand sole source of dividend distributions to the holders of the Trust PreferredSecurities. The Company has the right, assuming no default has occurred, todefer payments of interest on the Junior Subordinated Debentures at any timefor a period not to exceed 20 consecutive quarters. The Trust PreferredSecurities will mature on April 7, 2033, but can be redeemed under certaincircumstances at a premium prior to April 7, 2008, and can be redeemed, inwhole or in part, on any January 7, April 7, July 7 or October 7 occurring afterApril 7, 2008 at par. The Company fully and unconditionally guarantees theobligations of the Trust, on a subordinated basis.

 

29

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The Company received $2.91million from the Trust upon issuance of the Junior Subordinated Debentures, ofwhich $1 million was contributed by the Company to the Bank to increase itscapital, $1.14 million was used to retire existing Company debt and the remainder held as workingcapital. Under applicable regulatory guidelines, a portion of the TrustPreferred Securities will qualify as Tier I Capital, and the remainder as TierII Capital.

 

On November 13, 2003, the Company’s wholly ownedspecial-purpose trust subsidiary, Northern California Bancorp, Inc. Trust II(the “Trust”) issued $5 million in cumulative Trust Preferred Securities. The securitiesbear a floating rate of interest of 2.85% over the three month LIBOR rate,payable quarterly. Concurrent with the issuance of the Trust PreferredSecurities, the Trust used the proceeds from the Trust Preferred Securitiesoffering to purchase a like amount of Junior Subordinated Debentures of theCompany. The Company will pay interest on the Junior Subordinated Debentures tothe Trust, which represents the sole revenue and sole source of dividenddistributions to the holders of the Trust Preferred Securities. The Company hasthe right, assuming no default has occurred, to defer payments of interest onthe Junior Subordinated Debentures at any time for a period not to exceed 20consecutive quarters. The Trust Preferred Securities will mature on November 8,2033, but can be redeemed under certain circumstances at a premium prior to November8, 2008, and can be redeemed, in whole or in part, on any February 8, May 8, August8 or November 8 occurring after November 8, 2008 at par. The Company fully and unconditionallyguarantees the obligations of the Trust, on a subordinated basis.

 

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

 

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

 

During the years ended December31, 2005, 2004 and 2003 interest expense on Junior Subordinated Debenturestotaled $526,200, $372,500, and $130,900, respectively. The amortization of the issuance cost totaled$5,700, $5,700 and $3,000 for the years ended December 31, 2005, 2004 and 2003,respectively.

 

30

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#### **Note 10.**      FUNDINGSOURCES

#### ** **

The Bank has lines of credit from the Federal HomeLoan Bank (FHLB) of San Francisco, Bank of the West, Pacific Coast Bankers’Bank and The Independent Bank with available borrowing capacity on December 31,2005 of $4,402,400, $4,500,000, $6,000,000 and $5,000,000, respectively. TheFederal Home Loan Bank line of credit has a maximum borrowing capacity oftwenty five percent (25%) of the Bank’s total assets, adjusted quarterly. TheFederal Home Loan Bank line of credit is secured by a portion of the Bank’sreal estate secured loans and securities at December 31, 2005. The totalprincipal balance of pledged loans was $31,100,400 and securities of $10,423,000.The following table provides information on nine (9) FHLB advances totaling $24,750,000and outstanding at December 31, 2005.

 
| ** **  | ** ** | **Fixed**    | ** ** | ** **  | ** ** | ** **   | ** ** |
|-------------|------------|--------------|------------|-------------|------------|--------------|------------|
| **Advance** | ** ** | **Interest** | ** ** | **Funding** | ** ** | **Maturity** | ** ** |
| **Amount**  | ** ** | **Rate**     | ** ** | **Date**    | ** ** | **Date**     | ** ** |
| 1,000,000   |       | 2.54         | %          | 2/4/03      |       | 2/6/06       |       |
| 1,000,000   |       | 1.77         | %          | 3/9/04      |       | 3/9/06       |       |
| 2,750,000   |       | 3.44         | %          | 9/27/02     |       | 9/27/07      |       |
| 3,000,000   |       | 4.30         | %          | 6/17/05     |       | 6/17/10      |       |
| 5,000,000   |       | 4.96         | %          | 11/14/05    |       | 11/15/10     |       |
| 1,000,000   |       | 7.72         | %          | 6/1/00      |       | 6/3/30       |       |
| 4,000,000   |       | 5.96         | %          | 8/2/04      |       | 7/28/34      |       |
| 5,000,000   |       | 5.63         | %          | 12/24/04    |       | 12/22/34     |       |
| 2,000,000   |       | 5.13         | %          | 5/4/05      |       | 5/1/35       |       |

 

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

 

The Bank hasa $105,000 letter of credit issued by the Federal Home Loan Bank of SanFrancisco to secure the uninsured portion of local agency deposits maintainedwith the Bank. The letter of credit matures April 17, 2006.

 

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#### **Note 11.**      INCOMETAXES

#### ** **

Allocation of federal and California income taxesbetween current and deferred portions is as follows:

 
| ** **                        | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|-----------|------------|----------|------------|----------|------------|
| Current tax provision:            |       |      |       |     |       |     |       |
| Federal                           |       | $         | 1,218,100  |     | $          | 619,800  |       | $ | 410,800 |   |
| California                        |       | 450,100   |       | 236,700  |       | 142,800  |       |
|                              |       | 1,668,200 |       | 856,500  |       | 553,600  |       |
|                              |       |      |       |     |       |     |       |
| Deferred tax provision (benefit): |       |      |       |     |       |     |       |
| Federal                           |       | (212,800  | )          | (146,700 | )          | 61,900   |       |
| California                        |       | (41,000   | )          | (36,200  | )          | (8,600   | )          |
| Increase in  valuation allowance  |       | 75,000    |       | 107,000  |       | 51,600   |       |
|                              |       | (178,800  | )          | (75,900  | )          | 104,900  |       |
|                              |       | $         | 1,489,400  |     | $          | 780,600  |       | $ | 658,500 |   |

 

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

 
| ** **                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |     |       |
| Statutory  federal tax rate                   |       | 34.00    | %          | 34.00    | %          | 34.00    | %          |
| California  taxes, net of federal tax benefit |       | 7.20     |       | 7.20     |       | 7.20     |       |
| Other, net                                    |       | 2.37     |       | 1.10     |       | 2.74     |       |
| Effective tax  rates                          |       | 43.57    | %          | 42.30    | %          | 43.94    | %          |

 

32

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

 
| ** **                | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Deferred tax  asset       |       |     |       |     |       |
| Federal                   |       | $        | 692,900    |     | $          | 480,100 |   |
| California                |       | 172,200  |       | 131,200  |       |
|                      |       |     |       |     |       |
| Total deferred  tax asset |       | 865,100  |       | 611,300  |       |
| Valuation  allowance      |       | (410,000 | )          | (335,000 | )          |
|                      |       |     |       |     |       |
| Net deferred tax  asset   |       | $        | 455,100    |     | $          | 276,300 |   |

 

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

 
| ** **                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets (liabilities)     |       |     |       |     |       |
| Net unrealized  gain on securities     |       | $        | (27,800    | )        | $          | (70,400 | ) |
| California  franchise tax              |       | 211,600  |       | 121,800  |       |
| Allowance for  loan losses             |       | 465,800  |       | 391,000  |       |
| Accrued salary  continuation liability |       | 323,000  |       | 281,400  |       |
| Depreciation                           |       | (107,500 | )          | (112,500 | )          |
|                                   |       |     |       |     |       |
| Total deferred  tax asset              |       | 865,100  |       | 611,300  |       |
| Valuation  allowance                   |       | (410,000 | )          | (335,000 | )          |
|                                   |       |     |       |     |       |
| Net deferred tax  asset                |       | $        | 455,100    |     | $          | 276,300 |   |

 

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

 

33

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#### **Note 12.**      COMMITMENTS

#### ** **

In the normal course ofbusiness, there are outstanding commitments that are not reflected in theconsolidated financial statements.

 

***Operating lease commitments***

 

The Bank leases its branch offices in CarmelBy-The-Sea, Carmel Valley, and Pacific Grove. The Carmel By-The-Sea office hasa five and one half year lease with four, five year options and commenced inApril 2002. The Carmel building has a twenty-five year lease which commenced inMarch 1981 and may be adjusted annually for changes in the Consumer Price Index.The Pacific Grove building has a five-year lease with five, five-year optionsand commenced in April 1997. The Bank leases approximately 1,000 square feet at321 Webster Street, Monterey, CA. The 321 Webster Street lease has a term ofthree years commencing September 2000, with a three-year option. The Bank alsoleases approximately 1500 square feet for a Loan Production Office at 301Webster Street, Monterey, CA. The Webster Street lease has a term of two yearstwo months commencing July 2004, with a five-year option. The Bank also leasescertain equipment used in the normal course of business.

 

Rent expensefor operating leases is included in occupancy and equipment expense andamounted to approximately $286,400, $275,200, and $270,800 in 2005, 2004, and2003, respectively.

 

Effective April1, 2000, the Bank entered into a 5 year sublease agreement to rent one of theunits in the Carmel Valley branch. Sublease rental income for the years ending2005, 2004, and 2003 was approximately $26,500, $37,400, and $39,300,respectively.

 

Effective July1, 2002, the Bank entered into a 5 year and 3 months sublease agreement to rentone of the units in the Carmel-By-The-Sea branch. Sublease rental income forthe year ending 2005, 2004, and 2003 was approximately $40,200, $37,200, and $39,300,respectively.

 

34

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Future minimum rental commitments for allnon-cancelable operating leases are as follows:

 
| **Year Ending** | ** ** | **Minimum Lease** | ** ** | **Sublease** | ** ** | **Net Lease**   | ** ** |
|-----------------|------------|-------------------|------------|--------------|------------|-----------------|------------|
| **December 31** | ** ** | **Commitments**   | ** ** | **Income**   | ** ** | **Commitments** | ** ** |
| 2006            |       | $                 | 261,200    |         | $          | 38,300          |       | $ | 222,900 |   |
| 2007            |       | 182,100           |       | 28,800       |       | 153,300         |       |
| 2008            |       | 108,000           |       | —       |       | 108,000         |       |
| 2009            |       | 108,000           |       | —       |       | 108,000         |       |
| 2010            |       | 108,000           |       | —       |       | 108,000         |       |
| Thereafter      |       | 18,000            |       | —       |       | 18,000          |       |
|            |       |              |       |         |       |            |       |
|            |       | $                 | 785,300    |         | $          | 67,100          |       | $ | 718,200 |   |

 

***Loancommitments***

 

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 include commitments toextend credit. Such commitments involve, to varying degrees, elements of creditand interest rate risk in excess of the amount recognized in the consolidatedbalance sheets.

 

The Bank’s exposure to credit loss is represented bythe contractual amount of these commitments. The Bank uses the same creditpolicies in making commitments as it does for on-balance-sheet instruments.

 

At December 31, 2005 and 2004, such commitments toextend credit were approximately $25,950,100 and $23,971,400, respectively, ofundisbursed lines of credit, undisbursed loans in process, and commitmentletters.

 

35

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#### **Note 13.**      CONCENTRATIONOF RISK

#### ** **

TheBank grants commercial, construction, real estate and installment loans tobusinesses and individuals primarily in the Monterey Peninsula area ofNorthern California. Most loansare secured by business assets, and commercial and residential real estate.Real estate and construction loans held for investment represented 75% of totalloans held for investment at December 31, 2005 and 2004. The Bank has noconcentration of loans with any one customer.

 

TheBank does have concentrations of loans in the real estate and accommodation andfood services industries. Loans held for investment in the real estate industryrepresented 31.13% and 31.26% of total loans held for investment at December31, 2005 and 2004. Loans held for investment in the accommodation and foodservices industry represented 20.57% and 24.21% of total loans held forinvestment at December 31, 2005 and 2004, respectively.

 

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

#### ** **

Other income for theyears ended December 31, 2005, 2004, and 2003 totaled $2,806,800, $2,993,900, and$3,192,200, respectively. Significant categories comprising other income in theyears ending December 31, 2005, 2004, and 2003 were net merchant discount feesof $2,342,600, $2,343,400, and $2,331,700, commercial banking broker fees of $412,200,$274,000, and $539,400, life insurance cash surrender value earnings of $79,900,$65,200, and $89,700, credit card marketing program income of $222,100, $120,000and $49,100, and trading asset activities ($392,400), $53,200 and $91,700.

 

Other general and administrative expensesfor the years ended December 31, 2005, 2004, and 2003 totaled $3,369,900, $3,038,000,and $2,831,300, respectively.

 

Significant categoriescomprising other general and administrative expenses in the years endingDecember 31, 2005, 2004, and 2003 were merchant credit processing expense of $2,049,500, $2,005,000,and $1,955,300, advertising of $140,900, $127,300, and $113,500, and insuranceof $117,300, $106,400, and $84,100.

 

36

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

#### ** **

***Minimumregulatory requirements***

 

The Corporation (on aconsolidated basis) and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies. Failure to meetminimum 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 financial statements.

 

Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCorporation and the Bank must meet specific capital guidelines that involve quantitative measuresof their assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The capital amounts and classificationsare also subject to qualitative judgments by the regulators about components,risk weightings, and other factors. Underapplicable regulatory guidelines, a portion of the Trust Preferred Securitiesqualify as Tier I Capital, and the remainder as Tier II Capital. Promptcorrective action provisions are not applicable to bank holding companies.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Corporationand the Bank to maintain minimum amounts and ratios (set forth in the following table) of totaland Tier 1 capital (as defined in the regulations) to risk-weighted assets (asdefined) and of Tier 1 capital (as defined) to average assets (as defined). Managementbelieves, as of December 31, 2005 and 2004, that the Corporation and the Bankmet all capital adequacy requirements to which they are subject.

 

As of December 31, 2005,the most recent notification from the Federal Deposit Insurance Corporationcategorized the Bank as well capitalized under the regulatory framework forprompt corrective action. To be categorized as well capitalized, an institutionmust maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverageratios as set forth in the following tables. There are no conditions or eventssince the notification that management believes have changed the Bank’scategory. The Corporation’s and the Bank’s actual capital amounts and ratios asof December 31, 2005 and 2004 are also presented in the tables.

 

37

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**December 31, 2005**

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

 

38

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**December 31, 2004**

 
| ** **                               | ** ** | **Actual**                     | ** ** | **Minimum  Capital  Requirement** | ** ** | **Well Capitalized  Under Prompt  Corrective  Action  Provisions** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Amount**                     | ** ** | **Ratio**                         | ** ** | **Amount**                                                         | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                               | ** ** | **(All dollars in thousands)** | ** ** |
| Total Capital to  Risk Weighted Assets:  |       |                           |       |                              |       |                                                               |       |   |   |   |   |   |   |
| Consolidated                             |       | $                              | 15,914     |                              | 15.3       | %                                                                  | $          | 8,204 |   | 8.0 | % | N/A |   | N/A |   |
| Monterey County  Bank                    |       | 13,189                         |       | 12.5                              | %          | 8,492                                                              |       | 8.0 | % | $ | 10,615 |   | 10.0 | % |
|                                     |       |                           |       |                              |       |                                                               |       |   |   |   |   |   |   |
| Tier 1 Capital  to Risk Weighted Assets: |       |                           |       |                              |       |                                                               |       |   |   |   |   |   |   |
| Consolidated                             |       | 8,781                          |       | 8.6                               | %          | 4,102                                                              |       | 4.0 | % | N/A |   | N/A |   |
| Monterey County  Bank                    |       | 12,226                         |       | 11.5                              | %          | 4,246                                                              |       | 4.0 | % | 6,369 |   | 6.0 | % |
|                                     |       |                           |       |                              |       |                                                               |       |   |   |   |   |   |   |
| Tier 1 Capital  to Average Assets:       |       |                           |       |                              |       |                                                               |       |   |   |   |   |   |   |
| Consolidated                             |       | 8,781                          |       | 7.3                               | %          | 4,840                                                              |       | 4.0 | % | N/A |   | N/A |   |
| Monterey County  Bank                    |       | 12,226                         |       | 9.7                               | %          | 5,068                                                              |       | 4.0 | % | 6,334 |   | 5.0 | % |
|                                          |            |                                |            |                                   |            |                                                                    |            |  |  |  |  |  |  |  |  |  |

 

#### **Note 16.**      OTHERREGULATORY MATTERS

#### ** **

The Corporation issubject to regulation by the Board of Governors of the Federal Reserve Systemunder the Bank Holding Corporation Act. The Bank is subject to regulation,supervision, and regular examination by the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation. The regulations ofthese agencies affect most aspects of the Corporation’s business and prescribepermissible types of loans and investments, the amount of required reserves,requirements for branch offices, the permissible scope of the Corporation’sactivities, and various other requirements. The Corporation is also subject tocertain regulations of the Federal Reserve Bank dealing primarily with checkclearing activities, establishment of banking reserves, Truth-in-Lending(Regulation Z), and Equal Credit Opportunity (Regulation B).

 

39

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#### **Note 17.**      STOCKOPTIONS AND STOCK DIVIDENDS

#### ** **

At December 31, 2005, options for thepurchase of 293,141 shares of the Corporation’s common stock were outstandingand exercisable at prices ranging from $1.71 - $ 4.40. The status of alloptioned shares is as follows:

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

 

40

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| ** **                        | ** ** | **Shares** | ** ** | **Exercise Price Range** | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** |
|-----------------------------------|------------|------------|------------|--------------------------|------------|---------------------------------------------------|------------|
|                              |       |       |       |                     |       |                                              |       |
| Outstanding at  December 31, 2003 |       | 221,578    |       | $1.55 - $3.30            |       | 3.8 Years                                         |       |
|                              |       |       |       |                     |       |                                              |       |
| Granted                           |       | 138,500    |       | $4.00 - $4.40            |       |                                              |       |
| Exercised                         |       | (41,361    | )          | $1.55 - $2.48            |       |                                              |       |
|                              |       |       |       |                     |       |                                              |       |
| Outstanding at  December 31, 2004 |       | 318,717    |       | $2.75 - $4.40            |       | 5.1 Years                                         |       |
|                              |       |       |       |                     |       |                                              |       |
| Granted                           |       | 10,000     |       | $4.00                    |       |                                              |       |
| Exercised                         |       | (27,215    | )          | $1.86 - $3.00            |       |                                              |       |
| Cancelled                         |       | (8,362     | )          | $2.25 - $4.00            |       |                                              |       |
|                              |       |       |       |                     |       |                                              |       |
| Outstanding at  December 31, 2005 |       | 293,140    |       |                     |       | 4 Years                                           |       |

 

The weighted averageexercise price was $2.47, $2.15, and $1.84 for the years ending December 31,2005, 2004, and 2003 respectively. The weighted average fair value of optionsgranted during the years ending December 31, 2005, 2004, and 2003 were $4.00, $2.89,and $2.40, respectively. All but 20,000 of the options are exercisable as ofDecember 31, 2005.

 

#### **Note 18.**      RELATEDPARTY TRANSACTIONS

#### ** **

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

 

41

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Aggregate loan transactions with related parties areapproximately as follows:

 
| Balance as of  December 31, 2003  |   | $         | 1,534,800 |   |
|-----------------------------------|--------|-----------|-----------|--------|
| Loan  reclassified to non-related |   | (250,000  | )         |
| Repayments                        |   | (76,900   | )         |
|                              |   |      |      |
| Balance as of  December 31, 2004  |   | 1,207,900 |      |
| Advances on  lines of credit      |   | 11,700    |      |
| Repayments                        |   | (43,400   | )         |
|                              |   |      |      |
| Balance as of  December 31, 2005  |   | $         | 1,176,200 |   |

 

Related party depositstotaled approximately $167,700 and $189,300 at December 31, 2005 and 2004,respectively.

 

#### **Note 19.**      EMPLOYEEBENEFIT PLANS

#### ** **

During 1995, theCorporation established an employee stock ownership plan (ESOP) to invest inthe Corporation’s common stock for the benefit of eligible employees. The Boardof Directors determines the Corporation’s contribution to the plan. Shares inthe plan generally vest after seven years. The Corporation did not contributeto the ESOP trust in 2005, 2004, or 2003. There were no shares in the plan asof December 31, 2005.

 

The Bank has a salary reduction plan underSection 401(k) of the Internal Revenue Code. The plan covers substantially allfull-time employees who have completed one year of service with the Bank. Employeesare allowed to defer up to 15% of their compensation subject to certain limitsbased on federal tax laws. Under the provisions of the plan, the Bank’scontribution policy is discretionary. The Bank initiated a matchingcontribution in 2001 of 100% of each employee’s contribution up to 6% of theemployee’s compensation. The Bank’s matching contributions in 2005, 2004, and2003 totaled $107,200, $87,200, and $71,800, respectively.

 

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

#### ** **

Federal and state bankingregulations place certain restrictions on dividends paid and loans or advancesmade by the Bank to the Corporation. The total amount of dividends which may bepaid at any date is generally limited to the lesser of: (i) retained earnings;or (ii) the Bank’s net income for its last three fiscal years (less anydistributions to the stockholders made during such period), and loan oradvances are limited to 25% of the Bank’s primary capital plus the allowancefor loan losses on a secured basis and 15% on an unsecured basis.

 

#### **Note 21.**      SALARYCONTINUATION PLANS

#### ** **

The Corporation hasestablished salary continuation plans, which provide for payments to a certainofficer at retirement. Included in other liabilities at December 31, 2005 and2004, respectively, is $720,300 and $627,600 of deferred compensation relatedto the continuation plans. The plans are funded through life insurance policiesthat generate value to fund the future benefits.

 

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

#### ** **

SFAS No. 107, “Disclosuresabout Fair Value of Financial Instruments” requires disclosure of estimatedfair values of all financial instruments where it is practicable to estimatesuch values. In cases where quoted market prices are not available, fair valuesare based on estimates using present value or other valuation techniques. Thosetechniques are significantly affected by the assumptions used, including thediscount rate and estimates of future cash flows. Accordingly, the derived fairvalue estimates cannot be substantiated by comparison to independent marketsand, in many cases, could not be realized in immediate settlement of theinstrument. Statement No. 107 excludes certain financial instruments and allnon-financial instruments from its disclosure requirements. Accordingly, theaggregate fair value amounts presented do not represent the underlying value ofthe Corporation.

 

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

 

***Cashand cash equivalents:*** The carrying amounts of cashand short-term instruments approximate fair values.

 

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

 

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***Loans:***For variable-rate loans that reprice frequently and with no significantchange in credit risk, fair values are based on carrying values. The fair valueof performing fixed-rate loans is estimated by discounting future cash flowsusing the Corporation’s current offering rate for loans with similarcharacteristics. The fair value of performing adjustable-rate loans isconsidered 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.

 

***Commitmentsto Extend Credit and Standby Letters of Credit:*****The Corporation does not generally enter into long-termfixed rate commitments or letters of credit. These commitments are generallypriced at current prevailing rates. These rates are generally variable and,therefore, there is no interest rate exposure. Accordingly, the fair marketvalue of these instruments is equal to the carrying value amount of their netdeferred fees. The net deferred fees associated with these instruments are notmaterial. The Corporation has no unusual credit risk associated with theseinstruments.

 

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

 

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

 

***CashSurrender Value of Life Insurance:***The carryingamount of life insurance approximate fair value.

 

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

 

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

 

44

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The estimated fairvalues, and related carrying amounts, of the Corporation’s financialinstruments as of December 31, 2005 and 2004 are as follows:

 
| ** **                                       | ** ** | **2005**     | ** ** | **2004**    | ** ** |
|--------------------------------------------------|------------|--------------|------------|-------------|------------|
| ** **                                       | ** ** | **Carrying** | ** ** | **Fair**    | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                       | ** ** | **Amount**   | ** ** | **Value**   | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial  Assets:                               |       |         |       |        |       |   |   |   |   |
| Cash and cash  equivalents                       |       | $            | 24,130,600 |        | $          | 24,130,600 |   | $ | 16,809,000 |   | $ | 16,809,000 |   |
| Time deposits  with other financial institutions |       | 1,000,000    |       | 1,000,000   |       | — |   | — |   |
| Trading assets                                   |       | 1,027,500    |       | 1,027,500   |       | 803,700 |   | 803,700 |   |
| Securities,  available for sale                  |       | 11,065,300   |       | 11,065,300  |       | 6,834,900 |   | 6,834,900 |   |
| Securities, held  to maturity                    |       | 7,025,000    |       | 7,161,900   |       | 6,219,100 |   | 6,299,700 |   |
| Other  investments                               |       | 2,020,500    |       | 3,337,600   |       | 1,813,500 |   | 2,705,200 |   |
| Loans, held for  sale                            |       | 5,315,000    |       | 5,315,000   |       | 4,539,500 |   | 4,539,500 |   |
| Loans, net                                       |       | 101,985,000  |       | 98,569,000  |       | 90,496,300 |   | 90,456,100 |   |
| Accrued interest  receivable                     |       | 773,900      |       | 773,900     |       | 565,100 |   | 565,100 |   |
|                                             |       |         |       |        |       |   |   |   |   |
| Financial  Liabilities:                          |       |         |       |        |       |   |   |   |   |
| Deposits                                         |       | 118,120,200  |       | 117,890,600 |       | 97,263,200 |   | 97,268,800 |   |
| Long-term debt                                   |       | 32,998,000   |       | 32,460,800  |       | 27,898,000 |   | 27,904,800 |   |
| Accrued interest  payable                        |       | 649,400      |       | 649,400     |       | 380,800 |   | 380,800 |   |
|                                                  |            |              |            |             |            |  |  |  |  |  |  |  |  |

 

45

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

#### ** **

The following are thefinancial statements of Northern California Bancorp, Inc. (Parent Corporationonly) as of December 31, 2005 and 2004:

 
| **Balance Sheets**                                  | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|
| Assets                                              |       |       |       |       |       |
| Cash and due  from banks                            |       | $          | 581,100    |       | $          | 1,657,800 |   |
| Investment  securities - trading account            |       | 1,027,500  |       | 803,700    |       |
| Investment in  Metrocities Mortgage, LLC Stock      |       | 10,000     |       | —     |       |
| Investment in  Pan Pacific Bank Stock               |       | 100,000    |       | —     |       |
| Investment in AT  Services LLC Acquisition Corp.    |       | 40,000     |       | 202,000    |       |
| Northern  California Bancorp, Inc. Trust I          |       | 93,000     |       | 93,000     |       |
| Northern  California Bancorp, Inc. Trust II         |       | 155,000    |       | 155,000    |       |
| Debt issue  costs, net                              |       | 155,600    |       | 161,200    |       |
| Accounts  receivable                                |       | 5,000      |       | 2,300      |       |
| Investment in  common stock of Monterey County Bank |       | 15,139,000 |       | 12,595,800 |       |
|                                                |       |       |       |       |       |
|                                                |       | $          | 17,306,200 |       | $          | 15,670,800 |   |
|                                                |       |       |       |       |       |
| Liabilities and  Shareholders’ Equity          |       |       |       |       |       |
| Accounts payable  and accrued expenses              |       | $          | 108,000    |       | $          | 77,500 |   |
| Dividend payable                                    |       | 16,600     |       | 15,000     |       |
| Deferred tax  liability                             |       | 2,800      |       | 9,200      |       |
| Junior  subordinated debt securities                |       | 8,248,000  |       | 8,248,000  |       |
| Total  liabilities                                  |       | 8,375,400  |       | 8,349,700  |       |
| Shareholders’  equity                          |       | 8,930,800  |       | 7,321,100  |       |
|                                                |       |       |       |       |       |
|                                                |       | $          | 17,306,200 |       | $          | 15,670,800 |   |

 

46

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| **Statements of Operations**                     | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Equity in income  of subsidiary                  |       | $          | 2,588,300  |       | $          | 1,290,100  |       | $ | 917,600 |   |
| Investment  income from AT Services LLC          |       | 100        |       | —     |       | 14,300     |       |
| Gain on sale of  securities                      |       | 34,900     |       | 27,400     |       | 36,200     |       |
| Gain (loss) on  trading asset                    |       | (427,300   | )          | 25,900     |       | 49,700     |       |
| Dividend income                                  |       | 24,000     |       | 13,200     |       | 9,100      |       |
| Interest &  Fees on Loans                    |       | 23,700     |       | —     |       | —     |       |
| Miscellaneous  income                            |       | 300        |       | 100        |       | 100        |       |
| Investment  income from Metrocities Mortgage LLC |       | 59,000     |       | —     |       | —     |       |
| Operating  expenses                              |       | (579,000   | )          | (421,200   | )          | (176,000   | )          |
| Applicable tax  benefit (provision)              |       | 205,300    |       | 129,700    |       | (11,200    | )          |
|                                             |       |       |       |       |       |       |       |
| Net income                                       |       | $          | 1,929,300  |       | $          | 1,065,200  |       | $ | 839,800 |   |

 

47

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| **Statements of Cash Flows**                                                   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                                           |       |       |       |       |       |       |       |
| Cash flows from  operating activities:                                         |       |       |       |       |       |       |       |
| Net income                                                                     |       | $          | 1,929,300  |       | $          | 1,065,200  |       | $ | 839,800 |   |
| Adjustments to  reconcile net income to net cash used by operating activities: |       |       |       |       |       |       |       |
| Equity in  undistributed income of Monterey County Bank                        |       | (2,588,300 | )          | (1,290,100 | )          | (917,600   | )          |
| Increase in  trading securities                                                |       | (223,800   | )          | (640,400   | )          | (81,100    | )          |
| (Increase)  decrease in other assets                                           |       | 2,700      |       | 18,000     |       | (74,500    | )          |
| Increase in  accrued expenses                                                  |       | 30,500     |       | 18,700     |       | 55,300     |       |
| Increase  (decrease) in other liabilities                                      |       | (4,800     | )          | 9,400      |       | 13,800     |       |
| Net cash used by  operating activities                                         |       | (854,400   | )          | (819,200   | )          | (164,300   | )          |
| Cash flows from  investing activities:                                         |       |       |       |       |       |       |       |
| Cash dividends  received from subsidiary                                       |       | —     |       | —     |       | 50,000     |       |
| (Increase)  decrease in investments                                            |       | 52,100     |       | 25,000     |       | (4,245,800 | )          |
| Net cash  provided (used) by investing activities                              |       | 52,100     |       | 25,000     |       | (4,195,800 | )          |
| Cash flows from  financing activities:                                         |       |       |       |       |       |       |       |
| Proceeds from  borrowings                                                      |       | —     |       | —     |       | 8,248,000  |       |
| Repayments on  borrowings                                                      |       | —     |       | —     |       | (1,172,200 | )          |
| Cash dividends  paid on common stock                                           |       | (326,300   | )          | (265,300   | )          | (235,000   | )          |
| Exercise of  stock options                                                     |       | 67,100     |       | 89,000     |       | 152,000    |       |
| Stock repurchase                                                               |       | (15,200    | )          | —     |       | (21,500    | )          |
| Net cash  provided (used) by financing activities                              |       | (274,400   | )          | (176,300   | )          | 6,971,300  |       |
| Net increase  (decrease) in cash and cash equivalents                          |       | (1,076,700 | )          | (970,500   | )          | 2,611,200  |       |
| Cash and cash  equivalents, beginning of year                                  |       | 1,657,800  |       | 2,628,300  |       | 17,100     |       |
| Cash and cash  equivalents, end of year                                        |       | $          | 581,100    |       | $          | 1,657,800  |       | $ | 2,628,300 |   |

 

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