# **FORM10-QSB**

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20429**

**(Mark One)**

**x****     ****QUARTERLY REPORT UNDER SECTION 13OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the quarterly period ended June 30, 2006**

**o****        ****TRANSITION REPORT UNDER SECTION13 OR 15(d) OF THE EXCHANGE ACT**

**For the transition period from               to                 **

**CommissionFile No. 000-32827**

**COAST BANCORP**

(Exact name ofRegistration as Specified in its Charter)

| **California**                            |   | **77-0567091**                     |
|-------------------------------------------|--------|------------------------------------|
| (State of  incorporation or organization) |   | (IRS Employer  Identification No.) |

 

**500 Marsh Street, San LuisObispo, CA 93401**

(Address ofprincipal executive offices)

**(805) 541-0400**

(Registrant’stelephone number, including area code)

**Not applicable**

(Former name, formeraddress and former fiscal year, if changed since last report)

Check whether the issuer(1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.     Yes:     x     No:    o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   Yes: oNo: x

**APPLICABLEONLY TO CORPORATE ISSUERS**

State the number ofshares outstanding of each of the issuer’s classes of common equity, as of thelatest practicable date:

Common Stock – As ofAugust 1, 2006, there were 676,100 shares of the issuer’s common stockoutstanding.

Transitional SmallBusiness Disclosure Format (Check one)                       Yes:    o     No:    x

 

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**FORWARDLOOKING STATEMENTS**

**CERTAINSTATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-QSB INCLUDE FORWARD-LOOKINGINFORMATION WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, ASAMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,AND ARE SUBJECT TO THE “SAFE HARBOR” CREATED BY THOSE SECTIONS.  THESE FORWARD-LOOKING STATEMENTS INVOLVECERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFERMATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS.  SUCH RISKS AND UNCERTAINTIES INCLUDE, BUT ARENOT LIMITED TO, THE FOLLOWING FACTORS: COMPETITIVE PRESSURE IN THE BANKINGINDUSTRY INCREASES SIGNIFICANTLY; CHANGES IN THE INTEREST RATE ENVIRONMENTREDUCE MARGINS; GENERAL ECONOMIC CONDITIONS, EITHER NATIONALLY OR REGIONALLY,ARE LESS FAVORABLE THAN EXPECTED, RESULTING IN, AMONG OTHER THINGS ADETERIORATION IN CREDIT QUALITY AND AN INCREASE IN THE PROVISION FOR POSSIBLELOAN LOSSES; CHANGES IN THE REGULATORY ENVIRONMENT; CHANGES IN BUSINESSCONDITIONS, PARTICULARLY IN SAN LUIS OBISPO COUNTY; VOLATILITY OF RATESENSITIVE DEPOSITS; OPERATIONAL RISKS INCLUDING DATA PROCESSING SYSTEMSFAILURES OR FRAUD; ASSET/LIABILITY MATCHING RISKS AND LIQUIDITY RISKS; CHANGESIN THE SECURITIES MARKETS; THE ABILITY TO SATISFY THE REQUIREMENTS OF THESARBANES-OXLEY ACT AND OTHER REGULATIONS GOVERNING INTERNAL CONTROLS; ANDPOTENTIAL ECONOMIC EFFECT OF THE WAR ON TERRORISM AND THE WAR IN IRAQ ANDAFGHANISTAN .**

**THEREFORE,THE INFORMATION CONTAINED IN THIS DOCUMENT SHOULD BE CAREFULLY CONSIDERED WHENEVALUATING THE BUSINESS PROSPECTS OF COAST BANCORP AND COAST NATIONAL BANK.**

**MOREOVER,WHEREVER PHRASES SUCH AS SIMILAR TO, “IN MANAGEMENT’S OPINION,”“MANAGEMENTBELIEVES,” OR “MANAGEMENT CONSIDERS” ARE USED, SUCH STATEMENTS ARE AS OF, ANDBASED UPON THE KNOWLEDGE OF MANAGEMENT, AT THE TIME MADE AND ARE SUBJECT TOCHANGE BY THE PASSAGE OF TIME AND/OR SUBSEQUENT EVENTS, AND ACCORDINGLY SUCHSTATEMENTS ARE SUBJECT TO THE SAME RISKS AND UNCERTAINTIES NOTED ABOVE WITHRESPECT TO FORWARD-LOOKING STATEMENTS.**

2

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## **COAST BANCORP**

## **INDEX**

| **PART I – FINANCIAL INFORMATION**                                                                   | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** |
| **Item 1 - Financial  Statements**                                                                        | ** ** |
| ** **                                                                                                | ** ** |
| Statements of  Financial Condition                                                                        |       |
| Statements of  Operations                                                                                 |       |
| Statement of  Changes in Stockholders’ Equity                                                        |       |
| Cash Flow  Statement                                                                                      |       |
| Notes to Financial  Statements                                                                            |       |
|                                                                                                      |       |
| **Item 2 -  Management’s Discussion and Analysis of Financial Condition and Results of  Operations** | ** ** |
| ** **                                                                                                | ** ** |
| Overview                                                                                                  |       |
| Net Interest Income                                                                                       |       |
| Non-Interest Income                                                                                       |       |
| Non-Interest Expense                                                                                      |       |
| Income Taxes                                                                                              |       |
| Investment Portfolio                                                                                      |       |
| Loan Portfolio                                                                                            |       |
| Asset Quality                                                                                             |       |
| Provision for Loan Losses                                                                                 |       |
| Funding                                                                                                   |       |
| Return on Equity and  Assets                                                                              |       |
| Capital Resources                                                                                         |       |
| Liquidity                                                                                                 |       |
|                                                                                                      |       |
| **Item 3 – Controls  and Procedures**                                                                |       |
| ** **                                                                                                |       |
| **PART II – OTHER  INFORMATION**                                                                     |       |
|                                                                                                      |       |
| Item 1 – Legal Proceedings                                                                           |       |
| Item 2 –  Unregistered Sales of Securities and Use of Proceeds                                       |       |
| Item 3 –  Defaults upon Senior Securities                                                            |       |
| Item 4 –  Submission of Matters to a Vote of Security Holders                                        |       |
| Item 5 – Other Information                                                                           |       |
| Item 6 – Exhibits                                                                                    |       |
|                                                                                                      |       |
| **SIGNATURES**                                                                                            |       |

 

3

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**COASTBANCORP & SUBSIDIARY**

**CONSOLIDATED BALANCE SHEETS (unaudited)**

**June 31,2006 and December 31, 2005**

**ITEMI - FINANCIAL STATEMENTS**

** **
| ** **                                                                                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In thousands)**                                                                                                     | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                             | ** ** |              |       |                  |       |
| Cash and due from banks                                                                                                |       | $                 | 9,367      |                  | $          | 9,770 |   |
| Federal funds sold                                                                                                     |       | 14,950            |       | 24,900                |       |
| TOTAL CASH AND  CASH EQUIVALENTS                                                                                       |       | 24,317            |       | 34,670                |       |
|                                                                                                                   | ** ** | ** **        | ** ** | ** **            | ** ** |
| Investment securities  available for sale                                                                              |       | 6,906             |       | 7,872                 |       |
|                                                                                                                   |       |              |       |                  |       |
| Loans:                                                                                                                 |       |              |       |                  |       |
| Commercial                                                                                                             |       | 34,131            |       | 29,491                |       |
| Real estate -  construction                                                                                            |       | 32,250            |       | 25,213                |       |
| Real estate -  other                                                                                                   |       | 72,634            |       | 76,092                |       |
| Consumer                                                                                                               |       | 4,695             |       | 2,866                 |       |
| Other                                                                                                                  |       | 4                 |       | 29                    |       |
| TOTAL LOANS                                                                                                            |       | 143,714           |       | 133,691               |       |
| Net deferred loan fees                                                                                                 |       | (454              | )          | (460                  | )          |
| Allowance for credit  losses                                                                                           |       | (1,244            | )          | (1,183                | )          |
| NET LOANS                                                                                                              |       | 142,016           |       | 132,048               |       |
| Premises and equipment                                                                                                 |       | 8,151             |       | 8,314                 |       |
| Deferred taxes                                                                                                         |       | 124               |       | 329                   |       |
| Federal Reserve Bank  and FHLB stock, at cost                                                                          |       | 938               |       | 923                   |       |
| Accrued interest and  other assets                                                                                     |       | 1,455             |       | 1,568                 |       |
| TOTAL ASSETS                                                                                                           |       | $                 | 183,907    |                  | $          | 185,724 |   |
|                                                                                                                   |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| Deposits:                                                                                                              |       |              |       |                  |       |
| Noninterest-bearing  demand                                                                                            |       | $                 | 44,215     |                  | $          | 40,583 |   |
| Money market and  NOW                                                                                                  |       | 46,905            |       | 45,092                |       |
| Savings                                                                                                                |       | 7,278             |       | 8,856                 |       |
| Time deposits of  $100,000 or more                                                                                     |       | 53,518            |       | 58,984                |       |
| Other time  deposits                                                                                                   |       | 14,570            |       | 15,434                |       |
| TOTAL DEPOSITS                                                                                                         |       | 166,486           |       | 168,949               |       |
| Notes payable                                                                                                          |       | —            |       | 45                    |       |
| Junior  subordinated debt securities                                                                                   |       | 5,155             |       | 5,155                 |       |
| Other  liabilities                                                                                                     |       | 274               |       | 332                   |       |
| TOTAL  LIABILITIES                                                                                                     |       | 171,915           |       | 174,481               |       |
| Commitments and  contingencies                                                                                         |       | —            |       | —                |       |
| Stockholders’ equity:                                                                                             |       |              |       |                  |       |
| Preferred stock  - 10,000,000 authorized, none outstanding                                                             |       | —            |       | —                |       |
| Common stock no  par value; 10,000,000 shares authorized; issued and outstanding: 676,100 in  2006 and 674,100 in 2005 |       | 7,024             |       | 6,950                 |       |
| Retained  earnings                                                                                                     |       | 5,026             |       | 4,373                 |       |
| Accumulated  other comprehensive income - net unrealized losses on available-for-sale  securities                      |       | (58               | )          | (80                   | )          |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                       |       | 11,992            |       | 11,243                |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                       |       | $                 | 183,907    |                  | $          | 185,724 |   |

 

*The accompanying notes are anintegral part of these consolidated financial statements*

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**COASTBANCORP & SUBSIDIARY**

**STATEMENT OF OPERATIONS (unaudited)**

**For theYears Ended June 30, 2006 and 2005**

** **
| ** **                                             | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                             | ** ** | **June 30,**                                  | ** ** | **June 30,**                                | ** ** |
| ** **                                             | ** ** | **2006**                                           | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| **(In thousands, except for per share numbers)**       |       |                                               |       |                                             |       |   |   |   |   |
| Interest income:                                       |       |                                               |       |                                             |       |   |   |   |   |
| Interest and fees on loans                             |       | $                                                  | 3,199      |                                             | $          | 2,498 |   | $ | 6,116 |   | $ | 4,618 |   |
| Interest on investment securities                      |       | 52                                                 |       | 81                                               |       | 108 |   | 161 |   |
| Interest on federal funds sold                         |       | 204                                                |       | 67                                               |       | 446 |   | 151 |   |
| Other interest income                                  |       | 22                                                 |       | 21                                               |       | 30 |   | 27 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| TOTAL INTEREST INCOME                                  |       | 3,477                                              |       | 2,667                                            |       | 6,700 |   | 4,957 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| Interest  expense:                                     |       |                                               |       |                                             |       |   |   |   |   |
| Interest on money market and NOW accounts              |       | 343                                                |       | 140                                              |       | 610 |   | 246 |   |
| Interest on savings deposits                           |       | 31                                                 |       | 21                                               |       | 58 |   | 33 |   |
| Interest on time deposits                              |       | 693                                                |       | 437                                              |       | 1,369 |   | 757 |   |
| Interest on junior subordinated debt securities        |       | 117                                                |       | 92                                               |       | 226 |   | 178 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| TOTAL INTEREST EXPENSE                                 |       | 1,184                                              |       | 690                                              |       | 2,263 |   | 1,214 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| Net interest income                                    |       | 2,293                                              |       | 1,977                                            |       | 4,437 |   | 3,743 |   |
| Provision for loan losses                              |       | 20                                                 |       | —                                           |       | 60 |   | — |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| NET INTEREST INCOME AFTER PROVISION FOR CREDIT  LOSSES |       | 2,273                                              |       | 1,977                                            |       | 4,377 |   | 3,743 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| Noninterest  income:                                   |       |                                               |       |                                             |       |   |   |   |   |
| Service charges on deposit accounts and other          |       | 90                                                 |       | 50                                               |       | 166 |   | 125 |   |
| Gain on sale of loans and servicing fees               |       | 17                                                 |       | 68                                               |       | 146 |   | 107 |   |
| Gain on sale of real estate                            |       | —                                             |       | —                                           |       | — |   | 47 |   |
| Gain on sale of securities                             |       | —                                             |       | —                                           |       | — |   | — |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| TOTAL NONINTEREST INCOME                               |       | 107                                                |       | 118                                              |       | 312 |   | 279 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| Noninterest  expense:                                  |       |                                               |       |                                             |       |   |   |   |   |
| Salaries and benefits                                  |       | 962                                                |       | 808                                              |       | 1,875 |   | 1,667 |   |
| Net occupancy expense (net of rental income)           |       | 125                                                |       | 116                                              |       | 263 |   | 237 |   |
| Equipment expense                                      |       | 83                                                 |       | 82                                               |       | 169 |   | 162 |   |
| Other expense                                          |       | 660                                                |       | 539                                              |       | 1,293 |   | 970 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| TOTAL NONINTEREST EXPENSE                              |       | 1,830                                              |       | 1,545                                            |       | 3,600 |   | 3,036 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| INCOME BEFORE TAXES                                    |       | 550                                                |       | 550                                              |       | 1,089 |   | 986 |   |
| Income taxes                                           |       | 217                                                |       | 282                                              |       | 436 |   | 458 |   |
| NET INCOME                                             |       | $                                                  | 333        |                                             | $          | 268 |   | $ | 653 |   | $ | 528 |   |
|                                                   |       |                                               |       |                                             |       |   |   |   |   |
| Per share data                                         |       |                                               |       |                                             |       |   |   |   |   |
| Earnings per share - Basic                             |       | $                                                  | 0.49       |                                             | $          | 0.40 |   | $ | 0.97 |   | $ | 0.79 |   |
| Earnings per  share - Diluted                          |       | $                                                  | 0.47       |                                             | $          | 0.37 |   | $ | 0.93 |   | $ | 0.73 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

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**COASTBANCORP & SUBSIDIARY**

**STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY(unaudited)**

 
| ** **                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** | ** **        | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|-------------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                                       | ** ** | **Common Stock** | ** ** | ** ** | ** ** | ** **        | ** ** | **Other**    | ** ** | ** **        | ** ** |
| ** **                                                                       | ** ** | **Number of**    | ** ** | ** ** | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| **(In Thousands, Except Number of Shares)**                                      | ** ** | **Shares**            | ** ** | **Amount** | ** ** | **Income**        | ** ** | **Earnings** | ** ** | **Income**        | ** ** | **Total**  | ** ** |
| **Balance  at January 1, 2005**                                                  |       | 652,700               |       | $          | 6,641      |              |       |         | $          | 3,393             |       | (61        | )          | $ | 9,973 |   |
| Exercise of  stock options, including the realization of tax benefits of $22,417 |       | 21,400                |       | 309        |       |              |       |         |       |              |       | 309        |       |
| Cash dividends                                                                   |       |                  |       |       |       |              |       | (118         | )          |              |       | (118       | )          |
| **Comprehensive Income**                                                         | ** ** | ** **            | ** ** | ** ** | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
| Net income                                                                       |       |                  |       |       |       | $                 | 1,098      |         | 1,098      |              |       |       | 1,098      |   |
| Unrealized loss  on available-for-sale securities, net of taxes of $13,024       |       |                  |       |       |       | (19               | )          |         |       | (19               | )          | (19        | )          |
| **Total comprehensive income**                                                   |       |                  |       |       |       | $                 | 1,079      |         |       |              |       |       |       |   |
| ** **                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
| **Balance  at December 31, 2005**                                                |       | 674,100               |       | $          | 6,950      |              |       |         | $          | 4,373             |       | $          | (80        | ) | $ | 11,243 |   |
| Exercise of  stock options including the realization of $7,716 in tax benefits   |       | 2,000                 |       | 36         |       |              |       |         |       |              |       | 36         |       |
| Stock-based  compensation expense                                                |       |                  |       | 38         |       |              |       |         |       |              |       | 38         |       |
| **Comprehensive Income**                                                         | ** ** | ** **            | ** ** | ** ** | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
| Net income                                                                       |       |                  |       |       |       | $                 | 653        |         | 653        |              |       |       | 653        |   |
| Unrealized loss  on available-for-sale securities, net of taxes of $14,783       |       |                  |       |       |       | 22                |       |         |       | 22                |       | 22         |       |
| **Total comprehensive income**                                                   |       |                  |       |       |       | $                 | 675        |         |       |              |       |       |       |   |
| ** **                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** | ** **        | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
| **Balance at June 30, 2006**                                                     |       | 676,100               |       | $          | 7,024      |              |       |         | $          | 5,026             |       | $          | (58        | ) | $ | 11,992 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

6

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# **COASTBANCORP & SUBSIDIARY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)**

**For theSix Months Ended June 30, 2006 and 2005**

** **
| ** **                                                                         | ** ** | **For the Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **(In thousands)**                                                                 | ** ** | **2006**                                                        | ** ** | **2005** | ** ** |
| Operating  activities:                                                             |       |                                                            |       |   |   |
| Net income                                                                         |       | $                                                               | 653        |   | $ | 528 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                            |       |   |   |
| Depreciation and amortization                                                      |       | 249                                                             |       | 235 |   |
| Provision for credit losses                                                        |       | 60                                                              |       | — |   |
| Stock-based compensation                                                           |       | 38                                                              |       | — |   |
| Gain on sale of loans                                                              |       | (176                                                            | )          | — |   |
| Other items - net                                                                  |       | 239                                                             |       | 239 |   |
| Net cash provided by operating activities                                          |       | 1,063                                                           |       | 1,002 |   |
|                                                                               |       |                                                            |       |   |   |
| Investing  activities:                                                             |       |                                                            |       |   |   |
| Net increase in loans                                                              |       | (12,024                                                         | )          | (13,979 | ) |
| Proceeds from loans sold                                                           |       | 2,179                                                           |       | 592 |   |
| Proceeds of Federal Reserve Bank and Federal Home  Loan Bank stock                 |       | (15                                                             | )          | (27 | ) |
| Proceeds from maturities of available-for-sale  securities                         |       | 1,000                                                           |       | — |   |
| Net proceeds/purchase of premises and equipment                                    |       | (84                                                             | )          | 124 |   |
| Net cash used by investing activities                                              |       | (8,944                                                          | )          | (13,290 | ) |
|                                                                               |       |                                                            |       |   |   |
| Financing  activities:                                                             |       |                                                            |       |   |   |
| Increase (decrease) in deposits                                                    |       | (2,463                                                          | )          | 10,487 |   |
| Principle payments on notes payable                                                |       | (45                                                             | )          | (51 | ) |
| Proceeds from exercise of options, including tax  benefits                         |       | 36                                                              |       | 239 |   |
| Net cash provided (used) by financing actvities                                    |       | (2,472                                                          | )          | 10,675 |   |
| ** **                                                                         | ** ** | ** **                                                      | ** ** | ** ** | ** ** |
| Decrease in cash and cash equivalents                                              |       | (10,353                                                         | )          | (1,613 | ) |
|                                                                               |       |                                                            |       |   |   |
| Cash and cash  equivalents at beginning of period                                  |       | 34,670                                                          |       | 20,690 |   |
|                                                                               |       |                                                            |       |   |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                               | 24,317     |   | $ | 19,077 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

7

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**Note 1**                    **Basis ofPresentation**

The accompanyingfinancial information has been prepared in accordance with the Securities andExchange Commission rules and regulations for quarterly reporting and thereforedoes not necessarily include all information and footnote disclosures normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles.  This informationshould be read in conjunction with the Company’s Annual Report for the yearended December 31, 2005 filed on Form 10-KSB.

Operating results forinterim periods are not necessarily indicative of operating results for anentire fiscal year.  In the opinion ofmanagement, the unaudited financial information for the three month and sixmonth period ended June 30, 2006 and 2005 reflect all adjustments, consistingonly of normal recurring accruals and provisions, necessary for a fairpresentation thereof.

Some matters discussed inthis Form 10-QSB may be “forward-looking statements” within the meaning of thePrivate Litigation Reform Act of 1995 and therefore may involve risks,uncertainties and other factors which may cause our actual results to bematerially different from the results expressed or implied by ourforward-looking statements.  Thesestatements generally appear with words such as “anticipate”, “believe”, “estimate”,“may”, “intend”, and “expect”.

# **Note 2                    Earnings Per Share**

Effective December 31,1997, the Company adopted SFAS No. 128, *“Earnings per Share”.*  Accordingly, basic earnings per share arecomputed by dividing income available to common shareholders by the weightedaverage number of common shares outstanding during each period.  The computation of diluted earnings per sharealso considers the number of shares issuable upon the assumed exercise ofoutstanding common stock options.  Allearnings per common share amounts presented have been restated in accordancewith the provisions of this statement.
| ** **                                    | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                    | ** ** | **June 30,**                                  | ** ** | **June 30,**                                | ** ** |
| ** **                                    | ** ** | **2006**                                           | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **Shares**                                         | ** ** | **Shares**                                       | ** ** | **Shares** | ** ** | **Shares** | ** ** |
| Used in Basic EPS                             |       | 676,100                                            |       | 669,973                                          |       | 675,341 |   | 667,202 |   |
| Dilutive Effect of  Outstanding Stock Options |       | 26,362                                             |       | 53,802                                           |       | 25,235 |   | 53,802 |   |
| Used in Earnings Per Share - Diluted          |       | 702,462                                            |       | 723,775                                          |       | 700,576 |   | 721,004 |   |

 

**Note 3**                    **Stock-BasedCompensation**

In December 2004,Financial Accounting Standards Board (“FASB”) revised SFAS 123 and issued underits new name,*“Share-Based Payment”. *This statement eliminates thepreviously allowable alternative to use Opinion 25’s intrinsic value method ofaccounting.  Instead, this Statementgenerally requires entities to recognize the cost of employee services receivedin exchange for awards of stock options, or other equity instruments, based on thegrant-date fair value of those awards. This cost is recognized over the period during which an employee isrequired to provide service in exchange for the award, generally the vestingperiod.

The Company hasadopted this Statement in 2006 for all new stock option awards as well as anyexisting awards that are modified, repurchased or cancelled.  In addition, the unvested portion ofpreviously awarded options have also been recognized as expense during thefirst six months of 2006.  During thehalf of 2006, $37,349 was expensed by the Company for stock option relatedcompensation.

Prior to January1, 2006, the Company accounted for stock-based compensation under the FASB’sSFAS No. 123, “Accounting for Stock-Based Compensation,” which allowedcompanies to use an intrinsic value method prescribed in Accounting PrinciplesBoard (“APB”) Opinion No. 25, *“Accounting for StockIssued to Employees,”* and related interpretations.

SFAS No. 123 (R)requires that cash flows resulting from the realization of tax deductions inexcess of the compensation cost recognized (excess tax benefits) are to beclassified as financing cash flows. Before the adoption of SFAS No. 123 (R), the Company presented all taxbenefits realized from the exercise of stock options as operating cash flows inthe Statement of Cash Flows.  The $7,716excess tax benefit classified as a financing cash inflow would have beenclassified as an operating cash inflow if we had not adopted SFAS 123 (R).

8

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Had previouslyrecognized compensation cost (prior to 2006) for the Company’s stock optionplan been determined based on the fair value at the grant dates for awardsunder those plans consistent with the method of SFAS 123R, the Company’s netincome and earnings per share would have been reduced to the pro forma amountsindicated below:
| ** **                                                                                      | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **June 30,**                                  | ** ** | **June 30,**                                | ** ** |
| ** **                                                                                      | ** ** | **2006**                                           | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                            |       |                                               |       |                                             |       |   |   |   |   |
| Net Income:                                                                                     |       |                                               |       |                                             |       |   |   |   |   |
| As Reported                                                                                     |       | $                                                  | 333        |                                             | $          | 268 |   | $ | 653 |   | $ | 528 |   |
| Stock-Based Compensation using the Intrinsic Value  Method                                      | * *   | *—*                                           | * *   | *—*                                         | * *   | *—* | * * | *—* | * * |
| Stock-Based Compensation that would have been  reported using the Fair Value Method of SFAS 123 |       | *—*                                           |       | (14                                              | )          | *—* |   | (28 | ) |
| Pro Forma Net Income                                                                            |       | $                                                  | 333        |                                             | $          | 254 |   | $ | 653 |   | $ | 500 |   |
|                                                                                            |       |                                               |       |                                             |       |   |   |   |   |
| Basic Earnings  Per Share:                                                                      |       |                                               |       |                                             |       |   |   |   |   |
| As Reported                                                                                     |       | $                                                  | 0.49       |                                             | $          | 0.40 |   | $ | 0.97 |   | $ | 0.79 |   |
| Proforma                                                                                        |       | $                                                  | 0.49       |                                             | $          | 0.38 |   | $ | 0.97 |   | $ | 0.75 |   |
|                                                                                            |       |                                               |       |                                             |       |   |   |   |   |
| Diluted Earnings  Per Share:                                                                    |       |                                               |       |                                             |       |   |   |   |   |
| As Reported                                                                                     |       | $                                                  | 0.47       |                                             | $          | 0.37 |   | $ | 0.93 |   | $ | 0.73 |   |
| Pro Forma                                                                                       |       | $                                                  | 0.47       |                                             | $          | 0.36 |   | $ | 0.93 |   | $ | 0.72 |   |

 

**Note 4                    Current AccountingPronouncements**

As discussed inthe preceding note, SFAS No.123 (R) became effective January 1, 2006 and hasbeen fully implemented by the Company.

In March 2006, theFASB issued SFAS No. 156, *“Accounting for Servicingof Financial Assets, an amendment of FASB Statement No. 140.”* The statement amends SFAS no. 140 by  (1) requiring the separate accounting forservicing assets and servicing liablilties, which arise from the sale offinancial assets; (2) requiring all separately recognized serving assets andservicing liabilities to be initially measured at fair value, if practicable;and (3) permitting an entity to choose between an amortization method or a fairvalue method for subsequent measurement for each class of separately recognizedservicing assets and servicing liabilities. The Company must adopt the statement no later than January 1, 2007.  Management does not expect that the adoptionof this new standard will have a material impact on the Company’s financialposition, results of operations or cash flows.

In June 2006, theFASB issued FASB Interpretation No. 48 (“FIN 48”), *“Accountingfor Uncertainty in Income Taxes*.” This interpretation applies to all tax positions accounted for inaccordance with SFAS No. 109, *“Accounting for IncomeTaxes.”* FIN 48 clarifies theapplication of SFAS No. 109 by defining the criteria that an individual taxposition must meet in order for the position to be recognized within thefinancial statements and provides guidance on measurement, derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition for tax positions. The Company must adopt the interpretation by January 1, 2007.  Management does not expect that the adoptionof this new interpretation will have a material impact on the Company’sfinancial position, results of operations or cash flows.

9

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

The unauditedfinancial statements have been prepared in accordance with the instructions toForm 10-QSB and contain statements relating to future results of the Companythat are considered to be “forward looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995.  These statements relate to, among otherthings, credit loss reserve adequacy and simulation’s of changes in interestrates.  Actual results may differmaterially from those expressed or implied as a result of certain risks anduncertainties, including, but not limited to, changes in political and economicconditions, interest rate fluctuations, competitive product and pricingpressures within the Company’s markets, equity and fixed income marketfluctuations, personal and corporate customers’ bankruptcies, inflation,acquisitions and integrations of acquired businesses, technological change,changes in law, changes in fiscal, monetary, regulatory and tax policies,monetary fluctuations, political and global changes arising from the terroristattacks of September 11, 2001 as well as the war in Iraq and its aftermath,success in gaining regulatory approvals when required as well as other risksand uncertainties detailed elsewhere in this quarterly report or from time totime in the filings of the Company with the Securities ExchangeCommission.  Such forward-lookingstatements speak only as of the date on which such statements are made, and theCompany undertakes no obligation to update any forward-looking statement toreflect events or circumstances after the date on which such statement is madeor to reflect the occurrence of unanticipated events.

The accompanyingfinancial information should be read in conjunction with Coast Bancorp’s AnnualReport on Form 10-KSB for the year ended December 31, 2005.

**Descriptionof Business**

*Coast Bancorp*

Coast Bancorp, (the “Bancorp” or “Coast Bancorp”)headquartered in San Luis Obispo, California, is a California corporationincorporated in 2001.  Coast Bancorpbecame the bank holding company of Coast National Bank on May 31, 2001 througha corporate reorganization.  In thereorganization, Coast National Bank became the wholly-owned subsidiary of CoastBancorp and the shareholders of the Bank became shareholders of CoastBancorp.  Coast Bancorp is operatedthrough a two-tiered corporate structure. At the holding company level the affairs of Coast Bancorp are overseenby a Board of Directors elected by the shareholders of Coast Bancorp at theannual meeting of shareholders.  Thebusiness of the Bank is overseen by a Board of Directors elected by CoastBancorp, the sole owner of the Bank.  Asof the date of this Form 10-QSB the respective members of the Board ofDirectors of the Bank and the Board of Directors of Coast Bancorp areidentical.  Coast Bancorp is subject tothe regulations of, and examination by, the Board of Governors of the FederalReserve System.  At present, CoastBancorp does not engage in any material business activities other than theownership of the Bank.  Financialinformation presented herein for June 30, 2006 and comparative information forDecember 31, 2005 and June 30, 2005 is inclusive of the consolidated Company.

*Coast National Bank*

CoastNational Bank (the “Bank”) was chartered June 16, 1997 (charter #23222) by TheOffice of the Comptroller of the Currency as a national bank.  The Bank commenced operations on that datewith two offices, 16 employees and $6,250,000 in capital.  The original branch offices were located at486 Marsh Street, San Luis Obispo and 1199 Grand Avenue, Arroyo Grande,California.  Since that time, anadditional branch office was opened in June 1998 at 948 Morro Bay Boulevard inMorro Bay, California and another branch office was opened in July 1999 at 1193Los Osos Valley Road in Los Osos, California. In July 2002, a loan production office was opened at 930 South BroadwayStreet in Santa Maria, California and in July 2004 moved to 301 S. MillerStreet, Ste. 110 in Santa Maria, California. In December 2005, the office wasrelocated to 411 Betteravia Rd., Ste 201, Santa Maria, California.  In October 2004 a loan production office wasopened in Santa Barbara, California at 15 West Carrillo Street, Ste. 252.  The original lease on this facility expiredand the office was closed in September 2005. The Bank applied for and received approval from the Comptroller of theCurrency for another branch office at 2138 Spring Street, Paso Robles,California which opened in March 2005. The Bank also purchased a lot at 2045 Spring Street, Paso Robles,California with the intention of relocating the Paso Robles branch sometime inthe future.  In June 2005, the Bankopened a new loan production office at 7429 N. First St., Ste. 104, Fresno,California.

Whenthe Bank opened for business in June 1997, it purchased the real estate andbuilding that housed the Arroyo Grande branch office.  On October 14, 1999, the Bank purchased anadjacent lot next to the San Luis Obispo main office on Marsh Street.  A few months later on February 1, 2000, theBank also purchased the contiguous property and building that was home to theSan Luis Obispo main office at 486 Marsh Street.  Construction of a new head office building onthe adjacent lot began on October 11, 2001 and was completed on November 25,2002.  The new main office, located at500 Marsh Street is approximately 10,700 square feet with the San Luis Obispobranch operation occupying the ground floor and the administrative officesoccupying the second floor.  Half of theoriginal main office at 486 Marsh Street now houses the Bank’s Small BusinessLending Center and the Bank’s Note Department while the other half is leased tovarious businesses.

10

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OnMarch 29, 2002, the Bank purchased a vacant site on Morro Bay Boulevard inMorro Bay that is approximately one block from the existing branch.  The purpose for this acquisition was theeventual construction and relocation of the Morro Bay branch to a largerfacility with a drive-through lane.  InOctober 2003 construction began on the new Morro Bay facility which wascompleted and occupied in August 2004. The branch consists of approximately2700 square feet with two drive through lanes.

Asof June 30, 2006, the Bank had a total of 73 employees.  A number of these employees are part-timehowever. Part-time employees are converted to full-time equivalent employees onthe percentage of their weekly hours worked compared to 40 hours.  On a full-time equivalent basis, employeesrepresent 69 positions.  The Bank valuesits employees.  They are actively engagedindividually and as a team in contributing to the Bank’s realization of itsvision and mission.

**CriticalAccounting Policies**

Ouraccounting policies are integral to understanding the results reported.  In preparing its consolidated financialstatements, the Company is required to make judgments and estimates that mayhave a significant impact upon its financial results.  Certain accounting policies require theCompany to make significant estimates and assumptions, which have a materialimpact on the carrying value of certain assets and liabilities, and areconsidered critical accounting policies. The estimates and assumptions used are based on the historicalexperiences and other factors, which are believed to be reasonable under thecircumstances.  Actual results coulddiffer significantly from these estimates and assumptions, which could have amaterial impact on the carrying value of assets and liabilities at the balancesheet dates and results of operations for the reporting periods.  For example, the Company’s determination ofthe adequacy of its allowance for credit losses is particularly susceptible tomanagement’s judgment and estimates.  Thefollowing is a brief description of our current accounting policies involvingsignificant management valuation judgments.

*Allowance for Credit Losses*

Theallowance for credit losses represents management’s best estimate of lossesinherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loanlosses charged to expense and reduced by loans charged off, net ofrecoveries.  The allowance for loanlosses is determined based on management’s assessment of several factors:reviews and evaluation of individual loans, changes in the nature and volume ofthe loan portfolio, current economic conditions and the related impact onspecific borrowers and industry groups, historical loan loss experiences andthe levels of classified and nonperforming loans.

Loansare considered impaired if, based on current information and events, it isprobable that we will be unable to collect the scheduled payments of principalor interest when due according to the contractual terms of the loan agreement.  The measurement of impaired loans isgenerally based on the present value of expected future cash flows discountedat the historical effective interest rate stipulated in the loan agreement,except that all collateral-dependent loans are measured for impairment based onthe fair value of the collateral.  Inmeasuring the fair value of the collateral, management uses assumptions andmethodologies consistent with those that would be utilized by unrelated thirdparties.

Changesin the financial condition of individual borrowers, in economic conditions, inhistorical loss experience and in the condition of the various markets in whichcollateral may be sold may all affect the required level of the allowance forloan losses and the associated provision for loan losses.

*Available for Sale Securities*

Thefair value of most securities classified as available for sale are based onquoted market prices.  If quoted marketprices are not available, fair values are extrapolated from the quoted pricesof similar instruments.

### *Income Taxes*

Deferredincome taxes are computed using the asset and liability method, whichrecognizes a liability or asset representing the tax effects, based on currenttax law, of future deductible or taxable amounts attributable to events thathave been recognized in the consolidated financial statements.  A valuation allowance is established toreduce the deferred tax asset to the level at which it is “more likely than not”that the tax asset or benefits will be realized.  Realization of tax benefits of deductibletemporary differences and operating loss carry forwards depends on havingsufficient taxable income of an appropriate character within the carry forwardperiods.

11

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##### **Overview**

*Earnings Summary*

For the three months ended June 30, 2006 the Bancorpreported consolidated net income of $333,000 or $0.47 diluted earnings pershare compared to net income of $268,000 and $0.37 diluted earnings per sharefor the same period during 2005, a 24.25% increase.  For the six months ended June 30, 2006 theBancorp reported consolidated net income of $653,000 or $0.93 diluted earningsper share compared to consolidated net income of $528,000 or $0.73 dilutedearnings per share for the same period in 2005, a 23.67% increase.  The increase in net income was due in part toan increase in loans and loan income.

*BalanceSheet Summary*

Asof June 30, 2006, total consolidated assets of Coast Bancorp were $183.9million in comparison to total assets of $185.7 million as of December 31,2005. This represents a decrease of $1.8 million, or 0.98%.  The increase in noninterest-bearing demand,money market and Now accounts was offset by a decrease in time deposits. TheCompany has been strategically reducing the amount of time deposits over$100,000 as a percentage of total deposits while remaining competitive withcustomers that have existing relationships with the Company. Compared to totalconsolidated assets of $171.2 million at June 30, 2005, the Company hasincreased assets by $12.7 million, or 7.40%, over the last twelve months.  These increases are the result of expansionof our customer base.

TheBank has continued to grow its loan portfolio. Total loans as of June 30, 2006 were $143.7 million in comparison tototal loans of $133.7 million as of December 31, 2005.  This represents an increase of $10.0 million,or 7.5%.  Compared to total loans of $129.7million at June 30, 2005, the Company has increased loans by $14.0 million, or10.82%, over the last twelve months. The loan portfolio has grown as a resultof continued strong loan demand in the Bank’s market area and the Bank hasdrawn on Fed funds to fund this growth.

Totaldeposits as of June 30, 2006 were $166.5 million in comparison to totaldeposits of $169.0 million as of December 31, 2005.  This represents a decrease of $2.5 million,or 1.46%. The decrease is due to the Company’s realignment of time depositsover $100,000 as a percentage of total deposits. Compared to total deposits of$155.0 million at June 30, 2005, the Company has increased deposits by $11.5million, or 7.4%, over the last twelve months. This increase is due to the overall growth in our noninterest-bearingdemand deposits, money market and NOW accounts.

**Earnings Analysis**

##### *Net Interest Income*

A significantcomponent of the Bank’s earnings is from net interest income.  Net interest income is the amount by whichthe interest and amortization of fees generated from loans and other earningassets exceed the cost of funding those assets, usually deposit accountinterest expense.  Net interest incomedepends on the difference between gross interest and fees earned on the loansand investment portfolios and the interest rates paid on deposits andborrowings (“the interest rate spread”).  Net interest income after provision for credit losses was $2,273,000 forthe quarter ended June 30, 2006, compared to $1,977,000 for the quarter endedJune 30, 2005, representing an increase of 14.97%.  Net interest income after provision forcredit losses was $4,377,000 for the six months ended June 30, 2006, comparedto $3,743,000 for the six months ended June 30, 2005, representing an increaseof 16.94%.  This increase was primarilythe result of growth in interest earning assets generated by the Banks’branches and the increase in interest rates.

Thefollowing tables present, for the three months and six months ended June 30,2006 and 2005, the distribution of average assets, liabilities and shareholders’equity.  In addition, the total amountsof interest income from average interest-earning assets and the resultantyields, and the dollar amounts of interest expense and average interest-bearingliabilities, expressed both in dollars and in rates are also presented.  Non-accrual loans are included in thecalculation of the average balances of loans, and interest not accrued is excluded(dollar amounts in thousands).

12

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| ** **                                       | ** ** | **Distribution of Assets, Liabilities and Shareholders’ Equity** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **For the Three Months Ended**                                                  | ** ** |
| ** **                                       | ** ** | **June 30, 2006**                                                                         | ** ** | **June 30, 2005** | ** ** |
| ** **                                       | ** ** | ** **                                                                                          | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                       | ** ** | **Average**                                                                                         | ** ** | **Earned** | ** ** | **Yield or** | ** ** | **Average** | ** ** | **Earned** | ** ** | **Yield or** | ** ** |
| ** **                                       | ** ** | **Balance**                                                                                         | ** ** | **or Paid** | ** ** | **Rate Paid** | ** ** | **Balance** | ** ** | **or Paid** | ** ** | **Rate Paid** | ** ** |
| **Assets**                                       | ** ** | ** **                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-Earning  Assets:                        |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Investment Securities                            |       | $                                                                                                   | 7,679      |   | $ | 52 |   | 2.72% |   | $ | 12,776 |   | $ | 81 |   | 2.54% |   |
| Federal Funds Sold                               |       | 16,539                                                                                              |       | 204 |   | 4.95% |   | 9,246 |   | 67 |   | 2.91% |   |
| Other Earning Assets                             |       | 932                                                                                                 |       | 22 |   | 9.47% |   | 903 |   | 21 |   | 9.33% |   |
| Loans                                            |       | 139,404                                                                                             |       | 3,199 |   | 9.20% |   | 126,774 |   | 2,498 |   | 7.90% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  Interest-Earning Assets                   |       | 164,554                                                                                             |       | 3,477 |   | 8.48% |   | 149,699 |   | 2,667 |   | 7.15% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Cash and Due  from Bank                          |       | 8,018                                                                                               |       |   |   |   |   | 9,630 |   |   |   |   |   |
| Premises and Equipment                           |       | 8,190                                                                                               |       |   |   |   |   | 8,385 |   |   |   |   |   |
| Other Real  Estate Owned                         |       | —                                                                                              |       |   |   |   |   | — |   |   |   |   |   |
| Accrued Interest  and Other Assets               |       | 1,572                                                                                               |       |   |   |   |   | 1,769 |   |   |   |   |   |
| Allowance For  Loan Losses                       |       | (1,224                                                                                              | )          |   |   |   |   | (1,168 | ) |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total Assets                                     |       | $                                                                                                   | 181,110    |   |   |   |   |   | $ | 168,315 |   |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**   | ** ** | ** **                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-Bearing  Liabilities:                   |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Money Market and NOW:                            |       | $                                                                                                   | 45,864     |   | $ | 343 |   | 3.00% |   | $ | 37,827 |   | $ | 140 |   | 1.48% |   |
| Savings                                          |       | 7,649                                                                                               |       | 31 |   | 1.63% |   | 8,876 |   | 21 |   | 0.95% |   |
| Time Deposits under $100,000                     |       | 15,252                                                                                              |       | 142 |   | 3.73% |   | 13,847 |   | 76 |   | 2.20% |   |
| Time Deposits of $100,000 or More                |       | 54,137                                                                                              |       | 551 |   | 4.08% |   | 51,041 |   | 361 |   | 2.84% |   |
| Trust Preferred Securities                       |       | 5,155                                                                                               |       | 117 |   | 9.10% |   | 5,155 |   | 92 |   | 7.16% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  Interest-Bearing Liabilities              |       | 128,057                                                                                             |       | 1,184 |   | 3.71% |   | 116,746 |   | 690 |   | 2.37% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Non-Interest  Bearing Liabilities                |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Demand Deposits                                  |       | 40,831                                                                                              |       |   |   |   |   | 40,703 |   |   |   |   |   |
| Other Liabilities                                |       | 413                                                                                                 |       |   |   |   |   | 356 |   |   |   |   |   |
| Shareholders’ Equity                        |       | 11,809                                                                                              |       |   |   |   |   | 10,510 |   |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  Liabilities and Shareholders’ Equity |       | $                                                                                                   | 181,110    |   |   |   |   |   | $ | 168,315 |   |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net Interest  Income                             |       |                                                                                                |       | $ | 2,293 |   |   |   |   |   | $ | 1,977 |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net Yield on  Interest-Earning Assets            |       |                                                                                                |       |   |   | 5.59% |   |   |   |   |   | 5.30% |   |

 

13

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| ** **                                       | ** ** | **Distribution of Assets, Liabilities and Shareholders’ Equity** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **For the Six Months Ended**                                                    | ** ** |
| ** **                                       | ** ** | **June 30, 2006**                                                                         | ** ** | **June 30, 2005** | ** ** |
| ** **                                       | ** ** | ** **                                                                                          | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                       | ** ** | **Average**                                                                                         | ** ** | **Earned** | ** ** | **Yield or** | ** ** | **Average** | ** ** | **Earned** | ** ** | **Yield or** | ** ** |
| ** **                                       | ** ** | **Balance**                                                                                         | ** ** | **or Paid** | ** ** | **Rate Paid** | ** ** | **Balance** | ** ** | **or Paid** | ** ** | **Rate Paid** | ** ** |
| **Assets**                                       | ** ** | ** **                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-Earning  Assets:                        |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Investment Securities                            |       | $                                                                                                   | 7,775      |   | $ | 108 |   | 2.80% |   | $ | 12,824 |   | $ | 161 |   | 2.53% |   |
| Federal Funds Sold                               |       | 19,249                                                                                              |       | 446 |   | 4.67% |   | 11,644 |   | 151 |   | 2.62% |   |
| Other Earning Assets                             |       | 927                                                                                                 |       | 30 |   | 6.53% |   | 893 |   | 27 |   | 6.10% |   |
| Loans                                            |       | 136,596                                                                                             |       | 6,116 |   | 9.03% |   | 122,174 |   | 4,618 |   | 7.62% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  Interest-Earning Assets                   |       | 164,547                                                                                             |       | 6,700 |   | 8.21% |   | 147,535 |   | 4,957 |   | 6.78% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Cash and Due  from Bank                          |       | 8,047                                                                                               |       |   |   |   |   | 9,462 |   |   |   |   |   |
| Premises and  Equipment                          |       | 8,231                                                                                               |       |   |   |   |   | 8,515 |   |   |   |   |   |
| Other Real  Estate Owned                         |       | —                                                                                              |       |   |   |   |   | — |   |   |   |   |   |
| Accrued Interest  and Other Assets               |       | 1,625                                                                                               |       |   |   |   |   | 1,820 |   |   |   |   |   |
| Allowance For  Loan Losses                       |       | (1,209                                                                                              | )          |   |   |   |   | (1,168 | ) |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total Assets                                     |       | $                                                                                                   | 181,241    |   |   |   |   |   | $ | 166,164 |   |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**   | ** ** | ** **                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-Bearing  Liabilities:                   |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Money Market and NOW:                            |       | $                                                                                                   | 44,952     |   | $ | 610 |   | 2.74% |   | $ | 37,142 |   | $ | 246 |   | 1.34% |   |
| Savings                                          |       | 8,005                                                                                               |       | 58 |   | 1.46% |   | 8,633 |   | 33 |   | 0.77% |   |
| Time Deposits under $100,000                     |       | 15,370                                                                                              |       | 271 |   | 3.56% |   | 14,122 |   | 137 |   | 1.96% |   |
| Time Deposits of $100,000 or More                |       | 55,607                                                                                              |       | 1,098 |   | 3.98% |   | 49,598 |   | 620 |   | 2.52% |   |
| Trust Preferred Securities                       |       | 5,155                                                                                               |       | 226 |   | 8.84% |   | 5,155 |   | 178 |   | 6.96% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  Interest-Bearing Liabilities              |       | 129,089                                                                                             |       | 2,263 |   | 3.54% |   | 114,650 |   | 1,214 |   | 2.14% |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Non-Interest  Bearing Liabilities                |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Demand Deposits                                  |       | 40,084                                                                                              |       |   |   |   |   | 40,769 |   |   |   |   |   |
| Other Liabilities                                |       | 451                                                                                                 |       |   |   |   |   | 394 |   |   |   |   |   |
| Shareholders’ Equity                        |       | 11,617                                                                                              |       |   |   |   |   | 10,351 |   |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  Liabilities and Shareholders’ Equity |       | $                                                                                                   | 181,241    |   |   |   |   |   | $ | 166,164 |   |   |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net Interest  Income                             |       |                                                                                                |       | $ | 4,437 |   |   |   |   |   | $ | 3,743 |   |   |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net Yield on  Interest-Earning Assets            |       |                                                                                                |       |   |   | 5.44% |   |   |   |   |   | 5.12% |   |

 

Netinterest income is affected by changes in the amount and mix of ourinterest-earning assets and interest-bearing liabilities, referred to as a “volumechange”.  It is also affected by changesin the yields we earn on interest-earning assets and rates we pay oninterest-bearing deposits and other borrowed funds, referred to as a “ratechange”.

14

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Thefollowing table sets forth changes in interest income and interest expense foreach major category of interest-earning asset and interest-bearing depositaccounts, and the amount of change attributable to volume and rate changes forthe six months ended June 30, 2006 and 2005. Changes not solely attributable to rate or volume have been allocated tovolume and rate changes in proportion to the relationship of the absolutedollar amounts of the changes in each (dollar amounts in thousands).
| ** **                        | ** ** | **Six Months Ended June 30, 2006**             | ** ** | **Three Months Ended June 30, 2006**           | ** ** |
|-----------------------------------|------------|-------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **compared to the**                                           | ** ** | **compared to the**                                           | ** ** |
| ** **                        | ** ** | **Six Months Ended June 30, 2005**             | ** ** | **Three Months Ended June, 30, 2005**          | ** ** |
| ** **                        | ** ** | **Increase (Decrease) in interest income and** | ** ** | **Increase (Decrease) in interest income and** | ** ** |
| ** **                        | ** ** | **expense due to change in:**                       | ** ** | **expense due to change in:**                       | ** ** |
| ** **                        | ** ** | **Volume**                                                              | ** ** | **Rate**                                                                | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest-Earning  Assets:**     |       |                                                                    |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Investment Securities             |       | $                                                                       | (97        | )                                                                       | $          | 44 |   | $ | (53 | ) | $ | (62 | ) | $ | 33 |   | $ | (29 | ) |
| Federal Funds Sold                |       | 134                                                                     |       | 161                                                                     |       | 295 |   | 72 |   | 65 |   | 137 |   |
| Other Earning Assets              |       | 1                                                                       |       | 2                                                                       |       | 3 |   | 1 |   | 0 |   | 1 |   |
| Loans                             |       | 584                                                                     |       | 914                                                                     |       | 1,498 |   | 264 |   | 437 |   | 701 |   |
| **Total Interest Income**         |       | 622                                                                     |       | 1,121                                                                   |       | 1,743 |   | 275 |   | 535 |   | 810 |   |
|                              |       |                                                                    |       |                                                                    |       |   |   |   |   |   |   |   |   |
| **Interest-Bearing  Liabilities** |       |                                                                    |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Transaction Accounts              |       | 62                                                                      |       | 302                                                                     |       | 364 |   | 36 |   | 167 |   | 203 |   |
| Savings                           |       | (7                                                                      | )          | 32                                                                      |       | 25 |   | (18 | ) | 28 |   | 10 |   |
| Time Deposits                     |       | 13                                                                      |       | 121                                                                     |       | 134 |   | 8 |   | 58 |   | 66 |   |
| Time Deposits $100,000 or more    |       | 82                                                                      |       | 396                                                                     |       | 478 |   | 23 |   | 167 |   | 190 |   |
| Trust Preferred                   |       | —                                                                  |       | 48                                                                      |       | 48 |   | — |   | 25 |   | 25 |   |
| **Total Interest Expense**        |       | 150                                                                     |       | 899                                                                     |       | 1,049 |   | 49 |   | 445 |   | 494 |   |
| ** **                        | ** ** | ** **                                                              | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  Interest Income**          |       | $                                                                       | 473        |                                                                    | $          | 221 |   | $ | 694 |   | $ | 226 |   | $ | 90 |   | $ | 316 |   |

 

The following table setsforth the components of net interest income, average earning assets and netinterest margin (in thousands):

|                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** | **Year Ended**   | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** | **December 31,** | ** ** |
| ** **              | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006**              | ** ** | **2005** | ** ** | **2005** | ** ** |
|                    |       |                             |       |                           |       |                  |       |   |   |   |   |
| Interest Income         |       | $                                | 3,477      |                           | $          | 2,667                 |       | $ | 6,700 |   | $ | 4,957 |   | $ | 10,903 |   |
| Interest Expense        |       | 1,184                            |       | 690                            |       | 2,263                 |       | 1,214 |   | 3,171 |   |
|                    |       |                             |       |                           |       |                  |       |   |   |   |   |
| Net Interest Income     |       | $                                | 2,293      |                           | $          | 1,977                 |       | $ | 4,437 |   | $ | 3,743 |   | $ | 7,732 |   |
|                    |       |                             |       |                           |       |                  |       |   |   |   |   |
| Average Earning  Assets |       | $                                | 164,554    |                           | $          | 149,699               |       | $ | 164,547 |   | $ | 147,535 |   | $ | 154,573 |   |
| Net Interest Margin     |       | 5.59                             | %          | 5.30                           | %          | 5.44                  | %          | 5.12 | % | 5.00 | % |

 

15

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Interest expensewas $1,184,000 for the quarter ended June 30, 2006 compared to $690,000 for thequarter ended June 30, 2005, representing an increase of 71.59%.  Interest expense was $2,263,000 for the sixmonths ended June 30, 2006, compared to $1,214,000 for the six months endedJune 30, 2005, an increase of 86.41%. These increases reflect higher interest rates paid to all interestbearing accounts.

The net interestmargin is the ratio of net interest income to average earning assets. Thisratio is useful in allowing the Company to monitor the spread between interestincome and interest expense between reporting periods irrespective of thegrowth of the Company’s assets.  The netinterest margin increased 0.29% to 5.59% for the quarter ended June 30, 2006 ascompared to 5.30% for the quarter ended June 30, 2005.  The net interest margin, 5.44% for the sixmonths ending June 30, 2006 was 0.32% higher than the comparable figure, 5.12%,for the six month period ending June 30, 2005. These increases are primarily due to the continued growth of qualityloans and the Bank’s ability to respond to the changes in interest rates.

*Non-Interest Income*

Non-interest income represents deposit account service charges andother types of fee income.  Non-interestincome for the three months ended June 30, 2006 totaled $107,000 compared to$118,000 for the same period in 2005, a 9.32% decrease. Non-interest income forthe six months ended June 30, 2006 totaled $312,000 compared to $279,000 forthe same period in 2005, an 11.83% increase. For the six months ended June 30, 2006, the increase in non-interestincome was due to both an increase in service charges on deposits accounts,servicing fees and realized gains on the sale of the guaranteed portion ofgovernment guaranteed loans.  It has beenthe Company’s policy to sell securities due in one year if the gain will resultin higher income after reinvesting the proceeds.

##### *Non-Interest Expense*

Non-interestexpense represents salaries, occupancy expenses, professional expenses, outsideservices and other miscellaneous expenses necessary to conduct business.  Non-interest expense for the three monthsended June 30, 2006 totaled $1,830,000 compared to $1,545,000 for the sameperiod in 2005 for an increase of 18.45%. Non-interest expense for the six months ended June 30, 2006 totaled $3,600,000compared to $3,036,000 for the same period in 2005 for an increase of18.58%.  The increase is primarily due toan overall rise in salary and benefit expenses and an increase in promotionalexpenses.  The number of fulltimeequivalent employees necessary to provide superior customer service was 69.2 inJune 2006 as compared to 60.8 in June 2005. The continuing growth of the Bank’s government guaranteed lendingdepartment specializing in Small Business Administration lending programs, andthe overall expansion of the Bank’s customer base also contribute to theincrease.

##### *Income Taxes*

The Company recorded a $217,000 tax provision during the three monthsended June 30, 2006 compared to $282,000 during the same period in 2005.  The Company recorded a $436,000 tax provisionfor the six months ended June 30, 2006 compared to $458,000 during the sameperiod in 2005. The decrease in the tax provisions, despite the steady toincreasing income for the three months and six months ended June 30, 2006, is aresult of a timing issue regarding the Bancorp’s tax adjustment for the taxbenefit it provides the Bank.  In 2006, this adjustment has been performedon a quarterly basis where as in 2005 the provision was made at the end of theyear.

16

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**BalanceSheet Analysis**

*Investment Portfolio*

Thefollowing table summarizes the amounts and distribution of our investmentsecurities held as of the dates indicated, and the weighted average yields asof June 30, 2006 and December 31, 2005 (dollar amounts in thousands):
|                                                       | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | ** **                  | ** ** | ** **                      | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                            | ** ** | **Book**                    | ** ** | **Market**                      | ** ** | **Average** | ** ** | **Book** | ** ** | **Market** | ** ** |
| ** **                                            | ** ** | **Value**                   | ** ** | **Value**                       | ** ** | **Yield** | ** ** | **Value** | ** ** | **Value** | ** ** |
| **Available-for-Sale  Securities**                    | ** ** | ** **                  |       |                            |       |   |   |   |   |   |   |
| **U.S. Treasuries:**                                  |       |                        |       |                            |       |   |   |   |   |   |   |
| Within One Year                                       |       | $                           | —     |                            | $          | — |   | 0.00 | % | $ | — |   | $ | — |   |
| One to Five  Years                                    |       | —                      |       | —                          |       | 0.00 | % | — |   | — |   |
| Five to Ten  Years                                    |       | —                      |       | —                          |       | 0.00 | % | — |   | — |   |
| After Ten Years                                       |       | —                      |       | —                          |       | 0.00 | % | — |   | — |   |
| Total U.S. Treasury  Securities                       |       | —                      |       | —                          |       | 0.00 | % | — |   | — |   |
|                                                  |       |                        |       |                            |       |   |   |   |   |   |   |
| **U.S. Government and Agency  Securities**            |       |                        |       |                            |       |   |   |   |   |   |   |
| Within One Year                                       |       | 6,003                       |       | 5,924                           |       | 2.92 | % | 4,992 |   | 4,920 |   |
| One to Five  Years                                    |       | 1,002                       |       | 982                             |       | 3.00 | % | 3,015 |   | 2,952 |   |
| Five to Ten  Years                                    |       | —                      |       | —                          |       | 0.00 | % | — |   | — |   |
| After Ten Years                                       |       | —                      |       | —                          |       | 0.00 | % | — |   | — |   |
| Total U.S. Treasury and  Government Agency Securities |       | 7,005                       |       | 6,906                           |       | 2.96 | % | 8,007 |   | 7,872 |   |
| **Mutual Funds**                                      |       | —                      |       | —                          |       |   |   | — |   | — |   |
| **Mortgage Backed Securities**                        |       | —                      |       | —                          |       |   |   | — |   | — |   |
| **Total Available-for-Sale  Securities**              |       | $                           | 7,005      |                            | $          | 6,906 |   | 2.96 | % | $ | 8,007 |   | $ | 7,872 |   |

 

Securitiesmay be pledged to meet security requirements imposed as a condition to receiptof deposit of public funds and for other purposes.  At June 30, 2006, the carrying values ofsecurities pledged to secure public deposits and other purposes were $982,000or 14.22% of available for sale securities.

17

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*LoanPortfolio*

Thefollowing table sets forth the components of total net loans outstanding ineach category at the date indicated (dollar amounts in thousands):
|                                                   | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **Loans**                                         | ** ** | ** **                  | ** ** | ** **                      | ** ** |
| Commercial                                        |       | $                           | 34,131     |                            | $          | 29,491 |   |
| Real Estate - Construction                        |       | 32,250                      |       | 25,213                          |       |
| Real Estate -  Other                              |       | 72,634                      |       | 76,092                          |       |
| Consumer                                          |       | 4,695                       |       | 2,866                           |       |
| Other                                             |       | 4                           |       | 29                              |       |
| **Total  Loans**                                  | ** ** | 143,714                     |       | 133,691                         |       |
| Net Deferred  Loan Costs (Fees)                   |       | (454                        | )          | (460                            | )          |
| Allowance for  Loan Losses                        |       | (1,244                      | )          | (1,183                          | )          |
| **Net  Loans**                                    | ** ** | $                           | 142,016    |                            | $          | 132,048 |   |
|                                              |       |                        |       |                            |       |
| **Commitments**                                   | ** ** | ** **                  | ** ** | ** **                      | ** ** |
| Standby Letters  of Credit                        |       | $                           | 3,156      |                            | $          | 2,589 |   |
| Undisbursed  Loans and Commitments to Grant Loans |       | 47,728                      |       | 57,356                          |       |
| **Total Commitments**                             | ** ** | $                           | 50,884     |                            | $          | 59,945 |   |

 

*Asset Quality*

Asof June 30, 2006 the Company had no loans on non-accrual and no loans 90 daypast due and still accruing. As of June 30, 2005, the Company had one loan onnon-accrual and no loans 90 days or more past due and still accruing.  As of December 31, 2005 the company had oneloan on non-accrual of $15,185.63 and no loans 90 days past due and stillaccruing.

Asof June 30, 2006 and 2005 the Company had no OREO or restructured loans.

##### *Provision for Loan Losses*

Managementof the Bank and the Bancorp believes that the allowance for loan losses isadequate.  The Bank has established amonitoring system for loans in order to identify impaired loans and potentialproblem loans and to permit periodic evaluation of impairment and adequacy ofthe allowance for loan losses in a timely manner.  The monitoring system and allowance for loanlosses methodology have evolved over a period of years, and loanclassifications have been incorporated into the determination of the allowancefor loan losses.  This monitoring systemand allowance methodology includes a loan-by-loan analysis for all classifiedloans as well as loss factors for the balance of the unclassifiedportfolio.  Classified loans are reviewedindividually to estimate the amount of probable losses that needs to beincluded in the allowance.  These reviewsinclude analysis of financial information as well as evaluation of collateralsecuring the credit.  Loss factors on theunclassified portion of the portfolio are based on such factors as historicalloss experience, current portfolio delinquency and trends, and other inherentrisk factors such as economic conditions, concentrations in the portfolio, risklevels of particular loan categories, internal loan review and managementoversight.

TheCompany made a $60,000 contribution to the allowance for loan losses for the sixmonths ended June 30, 2006 compared to no contribution having been made in thesame period in 2005.  Management believesthat the allowance, which equals 0.89% of gross loans at June 30, 2006, isadequate to cover future losses.  Theallowance for loan losses at December 31, 2005 was 0.88% of gross loans.

18

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Thefollowing table summarizes, for the periods indicated, changes in the allowancefor loan losses arising from loans charged-off, recoveries on loans previouslycharged-off, and additions to the allowance which have been charged tooperating expenses and certain ratios relating to the allowance for loan losses(dollar amounts in thousands):
|                                                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Outstanding Net Loans**                                                 | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average for the  Year                                                     |       | $                                | 140,216    |                           | $          | 127,746 |   | $ | 137,419 |   | $ | 123,145 |   |
|                                                                      |       |                             |       |                           |       |   |   |   |   |
| **Allowance for Loan Losses:**                                            | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance, beginning of  period                                             |       | $                                | 1,224      |                           | $          | 1,168 |   | $ | 1,183 |   | $ | 1,168 |   |
| Actual Charge-Offs:                                                       |       |                             |       |                           |       |   |   |   |   |
| Commercial                                                                |       | 1                                |       | —                         |       | 1 |   | — |   |
| Consumer                                                                  |       | —                           |       | —                         |       | — |   | — |   |
| Real Estate                                                               |       | —                           |       | —                         |       | — |   | — |   |
| Total Charge-Offs                                                         |       | 1                                |       | —                         |       | 1 |   | — |   |
|                                                                      |       |                             |       |                           |       |   |   |   |   |
| Less Recoveries:                                                          |       |                             |       |                           |       |   |   |   |   |
| Commercial                                                                |       | —                           |       | —                         |       | — |   | — |   |
| Consumer                                                                  |       | 1                                |       | —                         |       | 2 |   | — |   |
| Real Estate                                                               |       | —                           |       | —                         |       | — |   | — |   |
| Total Recoveries                                                          |       | 1                                |       | —                         |       | 2 |   | — |   |
|                                                                      |       |                             |       |                           |       |   |   |   |   |
| Net Loans Recovered  (Charged-Off)                                        |       | —                           |       | —                         |       | 1 |   | — |   |
| Provision for Loan  Losses                                                |       | 20                               |       | —                         |       | 60 |   | — |   |
| Balance, end of period                                                    |       | $                                | 1,244      |                           | $          | 1,168 |   | $ | 1,244 |   | $ | 1,189 |   |
|                                                                      |       |                             |       |                           |       |   |   |   |   |
| **Ratios:**                                                               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Loans  Charged-Off to Average Loans                                   |       | 0.00                             | %          | 0.00                           | %          | 0.00 | % | 0.00 | % |
| Allowance for  Loan Losses to Total Loans                                 |       | 0.87                             | %          | 0.91                           | %          | 0.91 | % | 0.97 | % |
| Net Loans  Recovered (Charged-Off) to Beginning Allowance for Loan Losses |       | 0.00                             | %          | 0.00                           | %          | 0.08 | % | 0.00 | % |
| Net Loans  Recovered (Charged-Off) to Provision for Loan Losses           |       | 0.00                             | %          | 0.00                           | %          | 1.67 | % | 0.00 | % |
| Allowance for Loan  Losses to Non-performing Loans                        |       | n/a                              |       | n/a                            |       | n/a |   | n/a |   |

 

*Funding*

Depositsare our primary source of funds.  At June30, 2006, we had a deposit mix of 45.27% in time and savings deposits, 28.17%in money market and NOW deposits, and 26.56% in non-interest-bearing demanddeposits.  Our net interest income isenhanced by our percentage of non-interest-bearing deposits.

*Return on Equity and Assets*

Thefollowing table sets forth several key operating ratios for the six months endedJune 30, 2006 and 2005:
|                                                           | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **June 30,**              | ** ** |
| ** **                                                | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Return on Average  Assets                                 |       | 0.73                           | %          | 0.64 | % |
| Return on Average  Equity                                 |       | 10.65                          | %          | 9.59 | % |
| Dividend Payout Ratio                                     |       | 0.00                           | %          | 0.00 | % |
| Average Stockholder’s Equity to Average Total Assets |       | 6.82                           | %          | 6.69 | % |

 

19

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##### *Capital Resources*

Stockholders’ equity at June 30, 2006 was $11.992million, compared to $11.243 million at December 31, 2005.  Stockholders’ equity increased primarily fromnet income of $653,000.

The Company is required to meet certain minimumrisk-based capital guidelines and leverage ratios set by the bank regulatoryauthorities. The risk-based capital standards establish capital requirementsthat are more sensitive to risk differences between various assets, consideroff balance sheet activities in assessing capital adequacy, and minimize thedisincentives to holding liquid, low risk assets.  The leverage ratio consists of tangible Tier1 capital divided by average total assets.

BothCoast Bancorp and the Bank maintain capital ratios above the Federal regulatoryguidelines for “well-capitalized” bank holding companies.  The ratios for the Bank are as follows:
|                                  | ** ** | ** **                   | ** ** | ** **             | ** ** | **Coast**                   | ** ** | **Coast**                       | ** ** |
|----------------------------------|------------|------------------------------|------------|------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **Regulatory Standard** | ** ** | **National Bank** | ** ** | **National Bank**      | ** ** |
| ** **                       | ** ** | **Adequately**               | ** ** | **Well**               | ** ** | **As of**              | ** ** | **As of**                  | ** ** |
| ** **                       | ** ** | **Capitalized**              | ** ** | **Capitalized**        | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
| Total Risk-Based  Capital Ratio  |       | 8.00%                        |       | 10.00%                 |       | 11.65%                      |       | 11.52%                          |       |
| Tier 1 Risk-Based  Capital Ratio |       | 4.00%                        |       | 6.00%                  |       | 10.82%                      |       | 10.70%                          |       |
| Tier 1 Leverage Capital Ratio    |       | 4.00%                        |       | 5.00%                  |       | 9.31%                       |       | 8.75%                           |       |

 
|                                  | ** ** | ** **                   | ** ** | ** **      | ** ** | **Coast**                   | ** ** | **Coast**                       | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **Regulatory Standard** | ** ** | **Bancorp**     | ** ** | **Bancorp**                 | ** ** |
| ** **                       | ** ** | **Adequately**               | ** ** | **Well**        | ** ** | **As of**              | ** ** | **As of**                  | ** ** |
| ** **                       | ** ** | **Capitalized**              | ** ** | **Capitalized** | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
| Total Risk-Based  Capital Ratio  |       | 8.00%                        |       | 10.00%          |       | 12.33%                      |       | 11.73%                          |       |
| Tier 1 Risk-Based  Capital Ratio |       | 4.00%                        |       | 6.00%           |       | 10.80%                      |       | 10.04%                          |       |
| Tier 1 Leverage Capital Ratio    |       | 4.00%                        |       | 5.00%           |       | 8.91%                       |       | 8.61%                           |       |

 

*Liquidity*

Theobjective of the Company’s asset/liability strategy is to manage liquidity andinterest rate risk.  Ultimately,management seeks to monitor the safety and soundness of the Bank and itscapital base, while maintaining adequate net interest margins and spreads toprovide an appropriate return to the stockholders.

Management is not aware of any future capital expenditures or othersignificant demands on commitments which would severely impair liquidity.

**Item 3. Controls and****Procedures**

Based on their evaluation as of June 30, 2006 of the filing of thisForm-10QSB, the Company’s Chief Executive Officer and Chief Financial Officerhave concluded that the Company’s disclosure controls and procedures areeffective to ensure that information required to be disclosed in the reportsthat the Company files or submits under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.  There have been no significant changes in theCompany’s internal controls or in other factors that could significantly affectthose controls subsequent to the date of their evaluation.

20

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**PART II – OTHER INFORMATION**

**ITEM 1 –LEGAL PROCEEDINGS**

Not applicable.

**ITEM 2 –****UNREGISTERED SALES OF SECURITIES AND USE OFPROCEEDS**

Not applicable.

**ITEM 3 – DEFAULTSUPON SENIOR SECURITIES**

Not applicable.

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

(a)                                  CoastBancorp’s 2006 Annual Meeting of Shareholders was held on June 20, 2006 (the “Meeting”).  The Meeting involved the following proposals:

1.               To elect nine (9)persons to the Board of Directors to serve until the next Annual Meeting ofShareholders and until their successors are elected and have qualified.

2.               To approve theappointment of Vavrinek, Trine, Day & Co. LLP as independent public accountantsfor the Company’s 2006 fiscal year, and

(b)                                 Proxiesfor the meeting were solicited pursuant to Regulation 14A under the Securitiesand Exchange Act of 1934, as amended. There were no solicitations in opposition to management’s nominees aslisted in the proxy statement, and all such nominees were elected.

On Proposal No. 2 to approve the appointment ofVavrinek, Trine, Day & Co. LLP as independent public accountants for theCompany’s 2006 fiscal year, 474,404 shares voted in favor of approval, nonevoted against approval, and 833 abstained, and there were zero (0) brokernon-votes.  Accordingly, Proposal No. 2was passed by the shareholders.

(c)                                  Therewas no settlement between the Company and any other person terminating anysolicitation subject to Rule 14a-11.

**ITEM 5 –OTHER INFORMATION**

Not applicable

**ITEM 6 –EXHIBITS**

(a)                                  EXHIBITS

Exhibit 11 -  EARNINGSPER SHARE (see note 2 under Item 1-Basis of Presentation on page16 of thisreport)

Exhibit 31 - RULE 13a-14(a) CERTIFICATIONS

31.1                           Certificationof Chief Executive Officer

31.2                           Certificationof Chief Financial Officer

Exhibit 32 -  SECTION1350 CERTIFICATIONS

32.1                           Certificationof Chief Executive Officer

32.2                           Certificationof Chief Financial Officer

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**Signatures**

In accordance withthe requirements of the Exchange Act of 1934, the registrant has caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|        |            | COAST BANCORP                     |
|--------|-----------------|-----------------------------------|
|   |            |                              |
|   |            |                              |
| Date:  | August 14, 2006 | /s/ Jack C. Wauchope              |   |
|   |            | Jack C. Wauchope                  |
|   |            | Chairman of the Board             |
|   |            | President/Chief Executive Officer |
|   |            | (Principal Executive Officer)     |
|   |            |                              |
|   |            |                              |
| Date:  | August 14, 2006 | /s/ Karan C. Pohl                 |   |
|   |            | Karan C. Pohl, CPA                |
|   |            | Senior Vice President             |
|   |            | Chief Financial Officer           |
|   |            | (Principal Financial Officer)     |

 

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