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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2010

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from                  to

Commission file number
0-30777





PACIFIC MERCANTILE BANCORP

(Exact name of Registrant as specified in its charter)







|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|California                                                     |  | 33-0898238                             
|(State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|949 South Coast Drive, Suite 300,
Costa Mesa, California       |  | 92626                                  
|(Address of principal executive offices)                       |  | (Zip Code)                             

(714)
438-2500

(Registrants telephone number, including area code)

Not Applicable

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





Indicate by
check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports); and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ̈

Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).    Yes   ̈    No   ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller
reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.) (Check one):



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  |  ̈
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  | x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes   ̈    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.

10,434,665 shares of Common Stock as of November 9, 2010









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QUARTERLY REPORT ON
FORM 10Q

FOR

THE QUARTER ENDED SEPTEMBER 30, 2010

TABLE OF
CONTENTS



|                                                                                                          |  |                                                                                                                        |     |  |    | 
|--------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------- | --- |  | -- | 
|                                                                                                          |  | Page                                                                                                                   |    
|Part I. Financial Information                                                                             |  |                                                                                                                        |     | 
|                                                                                                          |  |                                                                                                                       
|Item 1.                                                                                                   |  | Financial Statements (unaudited)                                                                                       |     |  |    | 
|                                                                                                          |  |                                                                                                                       
|                                                                                                          |  | Consolidated Statements of Financial Condition at September 30, 2010 and December 31,
2009                             |     |  | 1  | 
|                                                                                                          |  |                                                                                                                       
|                                                                                                          |  | Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2010 and
2009                  |     |  | 2  | 
|                                                                                                          |  |                                                                                                                       
|                                                                                                          |  | Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months ended September 30, 2010
and 2009 |     |  | 3  | 
|                                                                                                          |  |                                                                                                                       
|                                                                                                          |  | Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2010 and
2009                            |     |  | 4  | 
|                                                                                                          |  |                                                                                                                       
|                                                                                                          |  | Consolidated Statement of Shareholders Equity for the Nine Months ended September 30,
2010                            |     |  | 6  | 
|                                                                                                          |  |                                                                                                                       
|                                                                                                          |  | Notes to Consolidated Financial Statements                                                                             |     |  | 7  | 
|                                                                                                          |  |                                                                                                                       
|Item 2.                                                                                                   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                  |     |  | 25 | 
|                                                                                                          |  |                                                                                                                       
|Item 3.                                                                                                   |  | Market Risk                                                                                                            |     |  | 51 | 
|                                                                                                          |  |                                                                                                                       
|Item 4T.                                                                                                  |  | Controls and Procedures                                                                                                |     |  | 52 | 
|                                                                                                          | 
|Part II. Other Information                                                                                |  |                                                                                                                        |     | 
|                                                                                                          |  |                                                                                                                       
|Item 1.                                                                                                   |  | Legal Proceedings                                                                                                      |     |  | 53 | 
|                                                                                                          |  |                                                                                                                       
|Item 1A.                                                                                                  |  | Risk Factors                                                                                                           |     |  | 53 | 
|                                                                                                          |  |                                                                                                                       
|Item 6.                                                                                                   |  | Exhibits                                                                                                               |     |  | 55 | 
|                                                                                                          | 
|Signatures                                                                                                |  |                                                                                                                        | S-1 | 
|                                                                                                          | 
|Exhibit Index                                                                                             |  |                                                                                                                        | E-1 | 
|                                                                                                          | 
|Exhibit 31.1 Certification of Chief Executive Officer under Section 302 of the SarbanesOxley Act of
2002 |  |                                                                                                                        |     | 
|                                                                                                          | 
|Exhibit 31.2 Certification of Chief Financial Officer under Section 302 of the SarbanesOxley Act of
2002 |  |                                                                                                                        |     | 
|                                                                                                          | 
|Exhibit 32.1 Certification of Chief Executive Officer under Section 906 of the SarbanesOxley Act of
2002 |  |                                                                                                                        |     | 
|                                                                                                          | 
|Exhibit 32.2 Certification of Chief Financial Officer under Section 906 of the SarbanesOxley Act of
2002 |  |                                                                                                                        |     | 



i



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PART I. 
FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands)

(Unaudited)



|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------- | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                                                                                                                                                                     |  | September 30,2010 |           |   | December 31,2009 |  
|ASSETS                                                                                                                                                                                                                                                                               |  |                   |           |   |                  |   |           |  
|Cash and due from banks                                                                                                                                                                                                                                                              |  | $                 | 11,106    |   |                  | $ | 13,866    |  
|Interest bearing deposits with financial institutions                                                                                                                                                                                                                                |  |                   | 194,738   |   |                  |   | 127,785   |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|Cash and cash equivalents                                                                                                                                                                                                                                                            |  |                   | 205,844   |   |                  |   | 141,651   |  
|Interest-bearing time deposits with financial institutions                                                                                                                                                                                                                           |  |                   | 9,043     |   |                  |   | 9,800     |  
|Federal Reserve Bank and Federal Home Loan Bank Stock, at cost                                                                                                                                                                                                                       |  |                   | 13,459    |   |                  |   | 14,091    |  
|Securities available for sale, at fair value                                                                                                                                                                                                                                         |  |                   | 113,367   |   |                  |   | 170,214   |  
|Loans held for sale, at lower of cost or market                                                                                                                                                                                                                                      |  |                   | 19,151    |   |                  |   | 7,572     |  
|Loans (net of allowances of $23,301 and $20,345, respectively)                                                                                                                                                                                                                       |  |                   | 738,750   |   |                  |   | 813,194   |  
|Investment in unconsolidated subsidiaries                                                                                                                                                                                                                                            |  |                   | 682       |   |                  |   | 682       |  
|Other real estate owned                                                                                                                                                                                                                                                              |  |                   | 21,459    |   |                  |   | 10,712    |  
|Accrued interest receivable                                                                                                                                                                                                                                                          |  |                   | 3,140     |   |                  |   | 3,730     |  
|Premises and equipment, net                                                                                                                                                                                                                                                          |  |                   | 1,034     |   |                  |   | 1,329     |  
|Other assets                                                                                                                                                                                                                                                                         |  |                   | 21,748    |   |                  |   | 27,661    |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|Total assets                                                                                                                                                                                                                                                                         |  | $                 | 1,147,677 |   |                  | $ | 1,200,636 |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                                                                                                 |  |                   |           |   |                  |   |           |  
|Deposits:                                                                                                                                                                                                                                                                            |  |                   |           |   |                  |   |           |  
|Noninterest-bearing                                                                                                                                                                                                                                                                  |  | $                 | 186,550   |   |                  | $ | 183,789   |  
|Interest-bearing                                                                                                                                                                                                                                                                     |  |                   | 768,108   |   |                  |   | 776,649   |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|Total deposits                                                                                                                                                                                                                                                                       |  |                   | 954,658   |   |                  |   | 960,438   |  
|Borrowings                                                                                                                                                                                                                                                                           |  |                   | 101,027   |   |                  |   | 141,003   |  
|Accrued interest payable                                                                                                                                                                                                                                                             |  |                   | 1,133     |   |                  |   | 1,901     |  
|Other liabilities                                                                                                                                                                                                                                                                    |  |                   | 5,085     |   |                  |   | 5,295     |  
|Junior subordinated debentures                                                                                                                                                                                                                                                       |  |                   | 17,527    |   |                  |   | 17,527    |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|Total liabilities                                                                                                                                                                                                                                                                    |  |                   | 1,079,430 |   |                  |   | 1,126,164 |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|Commitments and contingencies (Note 2)                                                                                                                                                                                                                                               |  |                   |          |   |                  |   |          |  
|Shareholders equity:                                                                                                                                                                                                                                                                |  |                   |           |   |                  |   |           |  
|Preferred stock, no par value, 2,000,000 shares authorized, 126,550 and 80,050 shares issued and outstanding at
September 30, 2010 and December 31, 2009, respectively; liquidation preference $100 per share plus accumulated dividends at September 30, 2010 and December 31, 2009 |  |                   | 12,655    |   |                  |   | 8,050     |  
|Common stock, no par value, 20,000,000 shares authorized, 10,434,665 shares issued and outstanding at September 30, 2010 and
December 31, 2009                                                                                                                                       |  |                   | 73,006    |   |                  |   | 72,891    |  
|Accumulated deficit                                                                                                                                                                                                                                                                  |  |                   | (15,581   | ) |                  |   | (3,599    | )
|Accumulated other comprehensive loss                                                                                                                                                                                                                                                 |  |                   | (1,833    | ) |                  |   | (2,870    | )
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|Total shareholders equity                                                                                                                                                                                                                                                           |  |                   | 68,247    |   |                  |   | 74,472    |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  
|Total liabilities and shareholders equity                                                                                                                                                                                                                                           |  | $                 | 1,147,677 |   |                  | $ | 1,200,636 |  
|                                                                                                                                                                                                                                                                                     |  |                   |           |   |                  |   |           |  

The accompanying notes are an integral part of these consolidated financial statements.



1



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Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except for per share data)

(Unaudited)



|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|---------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------ | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                       |  | Three Months EndedSeptember 30, |            |   | Nine Months EndedSeptember 30, |  
|                                                                       |  | 2010                            |            |   | 2009                           |   |            | 2010 |  |   | 2009       |  
|Interest Income                                                        |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Loans, including fees                                                  |  | $                               | 11,368     |   |                                | $ | 11,936     |      |  | $ | 35,058     |   |  | $ | 35,529     |  
|Securities available for sale and stock                                |  |                                 | 790        |   |                                |   | 814        |      |  |   | 3,448      |   |  |   | 2,912      |  
|Interest bearing deposits with financial institutions                  |  |                                 | 147        |   |                                |   | 129        |      |  |   | 389        |   |  |   | 373        |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Total interest income                                                  |  |                                 | 12,305     |   |                                |   | 12,879     |      |  |   | 38,895     |   |  |   | 38,814     |  
|Interest expense                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Deposits                                                               |  |                                 | 3,822      |   |                                |   | 5,701      |      |  |   | 12,229     |   |  |   | 17,699     |  
|Borrowings                                                             |  |                                 | 564        |   |                                |   | 1,794      |      |  |   | 2,082      |   |  |   | 5,922      |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Total interest expense                                                 |  |                                 | 4,386      |   |                                |   | 7,495      |      |  |   | 14,311     |   |  |   | 23,621     |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Net interest income                                                    |  |                                 | 7,919      |   |                                |   | 5,384      |      |  |   | 24,584     |   |  |   | 15,193     |  
|Provision for loan losses                                              |  |                                 | 1,688      |   |                                |   | 3,790      |      |  |   | 7,488      |   |  |   | 13,833     |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Net interest income after provision for loan losses                    |  |                                 | 6,231      |   |                                |   | 1,594      |      |  |   | 17,096     |   |  |   | 1,360      |  
|Non-interest income                                                    |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Total other than temporary impairment of securities                    |  |                                 | (139       | ) |                                |   | (787       | )    |  |   | (2,051     | ) |  |   | (787       | )
|Portion of losses recognized in other comprehensive loss               |  |                                 | (87        | ) |                                |   | 704        |      |  |   | (1,765     | ) |  |   | 704        |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Net impairment loss recognized in earnings                             |  |                                 | (52        | ) |                                |   | (83        | )    |  |   | (286       | ) |  |   | (83        | )
|Service fees on deposits and other banking services                    |  |                                 | 278        |   |                                |   | 352        |      |  |   | 930        |   |  |   | 1,101      |  
|Mortgage banking (including net gains on sales of loans held for sale) |  |                                 | 1,113      |   |                                |   | 540        |      |  |   | 2,743      |   |  |   | 607        |  
|Gain on sale of securities available for sale                          |  |                                 | 780        |   |                                |   | 446        |      |  |   | 1,417      |   |  |   | 2,334      |  
|Net gain (loss) on sale of other real estate owned                     |  |                                 | (5         | ) |                                |   | (147       | )    |  |   | (64        | ) |  |   | (145       | )
|Other                                                                  |  |                                 | 178        |   |                                |   | 367        |      |  |   | 602        |   |  |   | 776        |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Total non-interest income                                              |  |                                 | 2,292      |   |                                |   | 1,475      |      |  |   | 5,342      |   |  |   | 4,590      |  
|Non-interest expense                                                   |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Salaries & employee benefits                                           |  |                                 | 3,703      |   |                                |   | 4,194      |      |  |   | 11,747     |   |  |   | 11,580     |  
|Occupancy                                                              |  |                                 | 673        |   |                                |   | 682        |      |  |   | 2,020      |   |  |   | 2,038      |  
|Equipment and furniture                                                |  |                                 | 295        |   |                                |   | 313        |      |  |   | 952        |   |  |   | 868        |  
|Data processing                                                        |  |                                 | 156        |   |                                |   | 276        |      |  |   | 514        |   |  |   | 662        |  
|Professional Fees                                                      |  |                                 | 1,227      |   |                                |   | 1,338      |      |  |   | 3,207      |   |  |   | 2,740      |  
|Customer expense                                                       |  |                                 | 52         |   |                                |   | 92         |      |  |   | 232        |   |  |   | 281        |  
|FDIC expense                                                           |  |                                 | 1,256      |   |                                |   | 683        |      |  |   | 2,522      |   |  |   | 1,933      |  
|Other real estate owned expense                                        |  |                                 | 439        |   |                                |   | 1,170      |      |  |   | 1,330      |   |  |   | 1,689      |  
|Other operating expense                                                |  |                                 | 847        |   |                                |   | 764        |      |  |   | 2,837      |   |  |   | 2,252      |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Total non-interest expense                                             |  |                                 | 8,648      |   |                                |   | 9,512      |      |  |   | 25,361     |   |  |   | 24,043     |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Loss before income taxes                                               |  |                                 | (125       | ) |                                |   | (6,443     | )    |  |   | (2,923     | ) |  |   | (18,093    | )
|Income tax provision (benefit)                                         |  |                                 |           |   |                                |   | (2,577     | )    |  |   | 9,059      |   |  |   | (7,546     | )
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Net loss                                                               |  | $                               | (125       | ) |                                | $ | (3,866     | )    |  | $ | (11,982    | ) |  | $ | (10,547    | )
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Cumulative undeclared dividends on preferred stock                     |  | $                               | (327       | ) |                                | $ |           |      |  | $ | (756       | ) |  | $ |           |  
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Net loss allocable to common stockholders                              |  | $                               | (452       | ) |                                | $ | (3,866     | )    |  | $ | (12,738    | ) |  | $ | (10,547    | )
|                                                                       |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Net loss per common share                                              |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Basic                                                                  |  | $                               | (0.04      | ) |                                | $ | (0.37      | )    |  | $ | (1.22      | ) |  | $ | (1.01      | )
|Diluted                                                                |  | $                               | (0.04      | ) |                                | $ | (0.37      | )    |  | $ | (1.22      | ) |  | $ | (1.01      | )
|Weighted average number of shares outstanding                          |  |                                 |            |   |                                |   |            |      |  |   |            |   |  |   |            |  
|Basic                                                                  |  |                                 | 10,434,665 |   |                                |   | 10,434,665 |      |  |   | 10,434,665 |   |  |   | 10,434,665 |  
|Diluted                                                                |  |                                 | 10,434,665 |   |                                |   | 10,434,665 |      |  |   | 10,434,665 |   |  |   | 10,434,665 |  

The accompanying notes
are an integral part of these consolidated financial statements.



2



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##### Table of Contents



Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)



|                                                                                                                                 |  |                                 |      |   |                                |   |        |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ---- | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                                 |  | Three Months EndedSeptember 30, |      |   | Nine Months EndedSeptember 30, |  
|                                                                                                                                 |  | 2010                            |      |   | 2009                           |   |        | 2010 |  |   | 2009    |  
|Net loss                                                                                                                         |  | $                               | (125 | ) |                                | $ | (3,866 | )    |  | $ | (11,982 | ) |  | $ | (10,547 | )
|Other comprehensive loss, net of tax:                                                                                            |  |                                 |      |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Change in unrealized gain (loss) on securities available for sale, 2009 net of tax effect                                        |  |                                 | 88   |   |                                |   | 140    |      |  |   | 1,057   |   |  |   | (506    | )
|Change in net unrealized gain (loss) and prior service benefit on supplemental executive retirement plan, 2009 net of tax
effect |  |                                 | 10   |   |                                |   | 7      |      |  |   | (20     | ) |  |   | 115     |  
|                                                                                                                                 |  |                                 |      |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total comprehensive loss                                                                                                         |  | $                               | (27  | ) |                                | $ | (3,719 | )    |  | $ | (10,945 | ) |  | $ | (10,938 | )
|                                                                                                                                 |  |                                 |      |   |                                |   |        |      |  |   |         |   |  |   |         |  

The accompanying notes are an integral part of these consolidated financial statements.



3



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##### Table of Contents



Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                                |  |                                 |          |   |      |   |          |  
|----------------------------------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                                |  | Nine Months 
EndedSeptember 30, |         
|                                                                                                |  | 2010                            |          |   | 2009 |  
|Cash Flows From Operating Activities:                                                           |  |                                 |          |   |      |   |          |  
|Net loss                                                                                        |  | $                               | (11,982  | ) |      | $ | (10,547  | )
|Adjustments to reconcile net loss to net cash used in operating activities:                     |  |                                 |          |   |      |   |          |  
|Depreciation and amortization                                                                   |  |                                 | 383      |   |      |   | 359      |  
|Provision for loan losses                                                                       |  |                                 | 7,488    |   |      |   | 13,833   |  
|Net amortization of premium on securities                                                       |  |                                 | 456      |   |      |   | 1,104    |  
|Net gains on sales of securities available for sale                                             |  |                                 | (1,417   | ) |      |   | (2,334   | )
|Net gains on sales of mortgage loans held for sale                                              |  |                                 | (2,344   | ) |      |   | (311     | )
|Proceeds from sales of mortgage loans held for sale                                             |  |                                 | 144,276  |   |      |   | 28,874   |  
|Originations and purchases of mortgage loans held for sale                                      |  |                                 | (154,183 | ) |      |   | (39,058  | )
|Market to market adjustment of loans held for sale                                              |  |                                 | (55      | ) |      |   | (166     | )
|Decrease (increase) in current taxes receivable                                                 |  |                                 | 980      |   |      |   | (2,662   | )
|Net amortization of deferred fees and unearned income on loans                                  |  |                                 | (413     | ) |      |   | (141     | )
|Net loss on sales of other real estate owned                                                    |  |                                 | 64       |   |      |   | 145      |  
|Write down of other real estate owned                                                           |  |                                 | 367      |   |      |   | 1,309    |  
|Capitalized costs of other real estate owned                                                    |  |                                 | (1,661   | ) |      |   |         |  
|Stock-based compensation expense                                                                |  |                                 | 115      |   |      |   | 252      |  
|Other than temporary impairment of securities                                                   |  |                                 | 286      |   |      |   | 83       |  
|Changes in operating assets and liabilities:                                                    |  |                                 |          |   |      |   |          |  
|Net (increase) decrease in accrued interest receivable                                          |  |                                 | 590      |   |      |   | (216     | )
|Net increase in other assets                                                                    |  |                                 | (7,159   | ) |      |   | (1,460   | )
|Net (increase) decrease in deferred taxes                                                       |  |                                 | 10,086   |   |      |   | (6,129   | )
|Net decrease in accrued interest payable                                                        |  |                                 | (768     | ) |      |   | (1,221   | )
|Net increase (decrease) in other liabilities                                                    |  |                                 | (182     | ) |      |   | 1,650    |  
|                                                                                                |  |                                 |          |   |      |   |          |  
|Net cash used in operating activities                                                           |  |                                 | (15,073  | ) |      |   | (16,636  | )
|Cash Flows From Investing Activities:                                                           |  |                                 |          |   |      |   |          |  
|Net increase (decrease) in interest-bearing deposits with financial institutions                |  |                                 | 757      |   |      |   | (16,602  | )
|Maturities of and principal payments received for securities available for sale and other stock |  |                                 | 29,103   |   |      |   | 12,037   |  
|Purchase of securities available for sale and other stock                                       |  |                                 | (195,400 | ) |      |   | (136,596 | )
|Proceeds from sale of securities available for sale and other stock                             |  |                                 | 227,466  |   |      |   | 187,681  |  
|Proceeds from sales of other real estate owned                                                  |  |                                 | 4,857    |   |      |   | 3,160    |  
|Net (increase) decrease in loans                                                                |  |                                 | 68,096   |   |      |   | (2,676   | )
|Net increase in other real estate owned                                                         |  |                                 | (14,374  | ) |      |   |         |  
|Purchases of premises and equipment                                                             |  |                                 | (88      | ) |      |   | (549     | )
|                                                                                                |  |                                 |          |   |      |   |          |  
|Net cash provided by investing activities                                                       |  |                                 | 120,417  |   |      |   | 46,455   |  
|Cash Flows From Financing Activities:                                                           |  |                                 |          |   |      |   |          |  
|Net (decrease) increase in deposits                                                             |  |                                 | (5,780   | ) |      |   | 35,852   |  
|Proceeds from issuances of preferred stock                                                      |  |                                 | 4,605    |   |      |   |         |  
|Net decrease in borrowings                                                                      |  |                                 | (39,976  | ) |      |   | (81,758  | )
|                                                                                                |  |                                 |          |   |      |   |          |  
|Net cash used in financing activities                                                           |  |                                 | (41,151  | ) |      |   | (45,906  | )
|                                                                                                |  |                                 |          |   |      |   |          |  
|Net increase (decrease) in cash and cash equivalents                                            |  |                                 | 64,193   |   |      |   | (16,087  | )
|Cash and Cash Equivalents, beginning of period                                                  |  |                                 | 141,651  |   |      |   | 107,133  |  
|                                                                                                |  |                                 |          |   |      |   |          |  
|Cash and Cash Equivalents, end of period                                                        |  | $                               | 205,844  |   |      | $ | 91,046   |  
|                                                                                                |  |                                 |          |   |      |   |          |  

The accompanying notes are an integral part of these consolidated financial statements.



4



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##### Table of Contents



Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                                                                            |  |                               |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                                            |  | Nine Month EndedSeptember 30, |       
|                                                                                                                                            |  | 2010                          |        |   | 2009 |  
|Supplementary Cash Flow Information:                                                                                                        |  |                               |        |   |      |   |        |  
|Cash paid for interest on deposits and other borrowings                                                                                     |  | $                             | 15,079 |   |      | $ | 24,698 |  
|                                                                                                                                            |  |                               |        |   |      |   |        |  
|Cash paid for income taxes                                                                                                                  |  | $                             |       |   |      | $ |       |  
|                                                                                                                                            |  |                               |        |   |      |   |        |  
|Non-Cash Investing Activities:                                                                                                              |  |                               |        |   |      |   |        |  
|Net decrease (increase) in net unrealized losses and prior year service cost on supplemental employee retirement plan, net of
taxes in 2009 |  | $                             | (20    | ) |      | $ | 115    |  
|Net decrease (increase) in net unrealized losses on securities held for sale, 2009 net of tax                                               |  | $                             | 1,057  |   |      | $ | (506   | )
|Transfer into other real estate owned                                                                                                       |  | $                             | 18,382 |   |      | $ | 2,756  |  
|Transfer of loans held for sale to loans held for investment                                                                                |  | $                             | 2,176  |   |      | $ |       |  
|Mark to market (gain) loss adjustment of equity securities                                                                                  |  | $                             | (86    | ) |      | $ | 42     |  

The accompanying notes
are an integral part of these consolidated financial statements.



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##### Table of Contents



Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY

(Shares and dollars in thousands)

(Unaudited)

For The Nine Months Ended September 30, 2010



|                                                                    |  |                 |     |  |              |   |        |                 |  |  |                  |  |  |                    |        |  |                            |   |         |       |  |   |        |   |  |   |         |  
|------------------------------------------------------------------- |  | --------------- | --- |  | ------------ | - | ------ | --------------- |  |  | ---------------- |  |  | ------------------ | ------ |  | -------------------------- | - | ------- | ----- |  | - | ------ | - |  | - | ------- | -
|                                                                    |  | Preferred Stock |     |  | Common Stock |   |        |                 |  |  | AccumulatedOther |  |  |                    |       
|                                                                    |  | Numberof Shares |     |  | Amount       |   |        | Numberof Shares |  |  | Amount           |  |  | AccumulatedDeficit |        |  | ComprehensiveIncome (Loss) |   |         | Total | 
|Balance at December 31, 2009                                        |  |                 | 81  |  |              | $ | 8,050  |                 |  |  | 10,435           |  |  | $                  | 72,891 |  |                            | $ | (3,599  | )     |  | $ | (2,870 | ) |  | $ | 74,472  |  
|Issuances of cumulative preferred stock                             |  |                 | 46  |  |              |   | 4,605  |                 |  |  |                 |  |  |                    |       |  |                            |   |        |       |  |   |       |   |  |   | 4,605   |  
|Stock based compensation expense                                    |  |                 |    |  |              |   |       |                 |  |  |                 |  |  |                    | 115    |  |                            |   |        |       |  |   |       |   |  |   | 115     |  
|Comprehensive income:                                               |  |                 |     |  |              |   |        |                 |  |  |                  |  |  |                    |        |  |                            |   |         |       |  |   |        |   |  |   |         |  
|Net loss                                                            |  |                 |    |  |              |   |       |                 |  |  |                 |  |  |                    |       |  |                            |   | (11,982 | )     |  |   |       |   |  |   | (11,982 | )
|Change in unrealized gain on securities held for sale, net of taxes |  |                 |    |  |              |   |       |                 |  |  |                 |  |  |                    |       |  |                            |   |        |       |  |   | 1,057  |   |  |   | 1,057   |  
|Change in unrealized loss on supplemental executive retirement plan |  |                 |    |  |              |   |       |                 |  |  |                 |  |  |                    |       |  |                            |   |        |       |  |   | (20    | ) |  |   | (20     | )
|                                                                    |  |                 |     |  |              |   |        |                 |  |  |                  |  |  |                    |        |  |                            |   |         |       |  |   |        |   |  |   |         |  
|Balance at September 30, 2010                                       |  |                 | 127 |  |              | $ | 12,655 |                 |  |  | 10,435           |  |  | $                  | 73,006 |  |                            | $ | (15,581 | )     |  | $ | (1,833 | ) |  | $ | 68,247  |  
|                                                                    |  |                 |     |  |              |   |        |                 |  |  |                  |  |  |                    |        |  |                            |   |         |       |  |   |        |   |  |   |         |  

The accompanying notes are an integral part of this consolidated financial statement.



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Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements

(Unaudited)



|1. | Nature of Business
|-- | ------------------

Pacific Mercantile Bancorp (PMBC) is a bank holding company which, through its wholly owned subsidiary, Pacific Mercantile
Bank (the Bank) is engaged in the commercial banking business in Southern California. PMBC is registered as a one bank holding company under the United States Bank Holding Company Act of 1956, as amended. The Bank is chartered by the
California Department of Financial Institutions (the DFI) and is a member of and subject to regulation by the Federal Reserve Bank of San Francisco (FRB). In addition, the deposit accounts of the Banks customers are
insured by the Federal Deposit Insurance Corporation (FDIC) up to the maximum amount allowed by law. PMBC and the Bank, together, shall sometimes be referred to in this report as the Company or as we,
us or our.

Substantially all of our operations are conducted and substantially all our assets are
owned by the Bank, which accounts for substantially all of our consolidated revenues and expenses, and earnings. The Bank provides a full range of banking services to small and medium-size businesses, professionals and the general public in Orange,
Los Angeles, San Bernardino and San Diego Counties of California and is subject to competition from other financial institutions and from financial services organizations conducting operations in those same markets.

During 2002, we organized three business trusts, under the names Pacific Mercantile Capital Trust I, PMB Capital Trust I, and PMB
Statutory Trust III, respectively, to facilitate our issuance of $5.155 million, $5.155 million and $7.217 million, respectively, principal amount of junior subordinated debentures, all with maturity dates in 2032. In October 2004, we organized PMB
Capital Trust III to facilitate our issuance of an additional $10 million principal amount of junior subordinated debentures, with a maturity date in 2034. The financial statements of these trusts are not included in the Companys consolidated
financial statements. In July 2007, we redeemed the $5.155 million principal amount of junior subordinated debentures issued in conjunction with the organization of Pacific Mercantile Capital Trust I and in August 2007, we redeemed the $5.155
million principal amount of junior subordinated debentures issued in conjunction with the organization of PMB Capital Trust I. Those trusts were dissolved as a result of those redemptions.



|2. | Significant Accounting Policies, Recent Accounting Pronouncements, Commitments and Contingencies
|-- | ------------------------------------------------------------------------------------------------

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and,
therefore, do not include all footnotes that would be required for a full presentation of financial position, results of operations, changes in cash flows and comprehensive income (loss) in accordance with generally accepted accounting principles in
the United States (GAAP). However, these interim financial statements reflect all adjustments (consisting of normal recurring adjustments and accruals) which, in the opinion of our management, are necessary for a fair presentation of our
financial position and our results of operations for the interim periods presented.

These unaudited consolidated financial
statements have been prepared on a basis consistent with prior periods, and should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2009, and the notes thereto, included in our
Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934.

Our consolidated financial position at September 30, 2010, and the consolidated results of operations for the three and nine month
periods ended September 30, 2010, are not necessarily indicative of what our financial position will be as of December 31, 2010, or of the results of our operations that may be expected for the full year ending December 31, 2010.



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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|2. | Significant Accounting Policies, Recent Accounting Pronouncements, Commitments and Contingencies (Cont.-)
|-- | ---------------------------------------------------------------------------------------------------------





Use of
Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles
requires management to make certain estimates and assumptions that could affect the reported amounts of certain of our assets, liabilities, and contingencies at the date of the financial statements and the reported amounts of our revenues and
expenses during the reporting periods. For the fiscal periods covered by this Report, those estimates related primarily to our determinations of the allowance for loan losses, the fair value of securities available for sale, loans held for sale and
the valuation of our deferred tax assets. If circumstances or financial trends on which those estimates were based were to change in the future or there were to occur any currently unanticipated events affecting the amounts of those estimates, our
future financial position or results of operations could differ, possibly materially, from those expected at the current time.

Recent Accounting Pronouncements

In September 2009, the Financial Accounting Standards Board (FASB) issued an update to Accounting Standard Codification 105-10, Generally Accepted Accounting Principles. This
standard establishes the FASB Accounting Standard Codification (Codification or ASC) as the source of authoritative U.S. Generally Accepted Accounting Principles (GAAP) recognized by the FASB to be applied by
nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC companies. The Codification supersedes all
then-existing non-SEC accounting and reporting standards. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. FASB Statement No. 162, The Hierarchy of Generally
Accepted Accounting Principles, which became effective on November 13, 2008, identified the sources of accounting principles and the framework for selecting the principles used in preparing the financial statements in conformity with GAAP.
Statement 162 arranged these sources of GAAP in a hierarchy for users to apply accordingly. The Codification, and all of its content, will carry the same level of authority, effectively superseding Statement 162. In other words, the GAAP hierarchy
is modified to include only two levels of GAAP: authoritative and non-authoritative. As a result, this Statement replaces Statement 162 to indicate this change to the GAAP hierarchy.

In January 2010, the FASB issued Accounting Standards Update 2010-06 (ASU 2010-06), an update of ASC 820-10, Fair Value
Measurements and Disclosures, which now requires new disclosures that expand on activity included in the three fair value levels, as defined in ASC 820-10. ASU 2010-06 also provides amendments to ASC 820-10 in that a reporting entity should
provide fair value measurement disclosures for each class of assets and liabilities, and provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those
disclosures are required for fair value measurements that fall in either Level 2 or Level 3. New disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009,
except for certain Level 3 roll forward disclosures, which are effective for fiscal years beginning after December 15, 2010. We adopted the former disclosures and clarifications (those effective after December 15, 2009) as of
January 1, 2010, and they did not have a material effect on our financial statements.

In February 2010, the FASB issued
Accounting Standards Update No. 2010-09, Subsequent Events (Topic 855), Amendments to Certain Recognition and Disclosure Requirements (Topic 855), which states an entity that is an SEC filer is not required to disclose the date
through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and SEC requirements.



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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|2. | Significant Accounting Policies, Recent Accounting Pronouncements, Commitments and Contingencies (Cont.-)
|-- | ---------------------------------------------------------------------------------------------------------





Commitments
and Contingencies

Commitments

To meet the financing needs of our customers in the normal course of business, we are a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to
extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. At September 30, 2010, loan
commitments and letters of credit totaled $163 million and $11 million, respectively. The contractual amount of a credit-related financial instrument such as a commitment to extend credit, a credit-card arrangement or a letter of credit
represents the amounts of potential accounting loss should the commitment be fully drawn upon, the customer were to default, and the value of any existing collateral securing the customers payment obligation become worthless.

As a result, we use the same credit policies in making commitments to extend credit and conditional obligations as we do for on-balance
sheet instruments. Commitments generally have fixed expiration dates; however, since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We
evaluate each customers creditworthiness on a case-by-case basis, using the same credit underwriting standards that are employed in making commercial loans. The amount of collateral obtained, if any, upon an extension of credit is based on
managements credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, real estate and income-producing commercial properties.

Legal Proceedings

James Laliberte, et al. vs. Pacific Mercantile Bank, filed in May 2003 in the California Superior Court for the County of Orange (Case No. 030007092). Information regarding this law suit is
contained under the caption Commitments and ContingenciesLegal Proceeding in, and is incorporated herein by reference to, Note 17 of Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year ended
December 31, 2009 (the 2009 10-K) filed with the SEC on April 1, 2010.

We also are subject to legal
actions that arise from time to time in the ordinary course of our business. Currently there are no such pending legal proceedings that we believe will become material to our financial condition or results of operations.

Current Regulatory Matters

On August 31, 2010, the members of the respective Boards of Directors of Pacific Mercantile Bancorp (the Company) and its the wholly-owned banking subsidiary, Pacific Mercantile Bank (the
Bank), entered into a Written Agreement (the Agreement) with the Federal Reserve Bank of San Francisco (the FRB). On the same date, the Bank consented to the issuance of a Final Order (the Order) by
the California Department of Financial Institutions (the DFI). The principal purposes of the Agreement and Order, which constitute formal supervisory actions by the FRB and the DFI, are to require us to adopt and implement formal plans
and take certain actions, as well as to continue to implement other measures that we previously adopted, to address the adverse consequences that the economic recession has had on the performance of our loan portfolio and our operating results, to
improve our operating results, and to increase our capital to strengthen our ability to weather any further adverse conditions that might arise if the hoped-for improvement in the economy does not materialize.

The Agreement and Order contain substantially similar provisions. They require the Boards of Directors of the Company and the Bank to
prepare and submit written plans to the FRB and the DFI that address the following matters: (i) strengthening board oversight of the management operations of the Bank; (ii) strengthening credit risk management practices;
(iii) improving credit administration policies and procedures; (iv) improving the Banks position with respect to problem assets; (v) maintaining adequate reserves for loan and lease losses in accordance with applicable
supervisory guidelines; (vi) improving the capital position of the Bank and, in the case of the FRB Agreement, the capital position of the Company; (vii) improving the Banks earnings through the formulation, adoption and
implementation of a strategic plan and a budget for fiscal 2011; and (viii) submitting a satisfactory funding contingency plan for the Bank that identifies available sources of liquidity and includes a plan for dealing with adverse economic and
market conditions. The Bank is also prohibited from paying dividends to the Company without the prior approval of the DFI, and the Company may not declare or pay cash dividends, repurchase any of its shares, make payments on its trust preferred
securities or incur or guarantee any debt, without the prior approval of the FRB.



Under the Agreement, the Company also must submit a capital plan to the FRB that will meet with its approval and then implement that plan. Under the Order, the Bank is required to achieve a ratio of
adjusted tangible shareholders equity to its tangible assets to 9.0% by January 31, 2011, by raising additional capital, generating earnings or reducing the Banks tangible assets (subject to a 15% limitation on such a reduction) or
a combination thereof and, upon achieving that ratio, to thereafter maintain that ratio during the Term of the Order.

The
Company and the Bank already have made progress with respect to several of these requirements, and is exploring alternatives for raising additional capital by January 31, 2011, and both the Board of Directors and management are committed to
achieving all of the requirements on a timely basis.



|3. | Income (Loss) Per Share
|-- | -----------------------

Basic income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted income (loss) per share reflects the potential dilution that would occur if stock options or other contracts to issue common stock were exercised or converted into shares of common stock which would
share in our earnings. For the three and nine month periods ended September 30, 2010, (i) stock options to purchase 1,002,842 shares of our common stock and (ii) 1,425,283 shares of our common stock issuable on conversion of our
Series A Preferred Stock, were not considered in computing diluted income (loss) per common share because they were antidilutive. For the three and nine month periods ended September 30, 2009 stock options to purchase 1,151,744 shares were not
considered in computing diluted earnings per common shares because they were antidilutive.



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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|3. | Income (Loss) Per Share (Cont-)
|-- | -------------------------------





The following
table illustrates our computation of basic and diluted loss for the three and nine month periods ended September 30, 2010 and 2009.



|                                                              |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                              |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|(In thousands, except earnings per share data)                |  | 2010                            |        |   | 2009                           |   |        | 2010 |  |   | 2009    |  
|Net loss allocable to common shareholders (A)                 |  | $                               | (452   | ) |                                | $ | (3,866 | )    |  | $ | (12,738 | ) |  | $ | (10,547 | )
|Weighted average outstanding shares of common stock (B)       |  |                                 | 10,435 |   |                                |   | 10,435 |      |  |   | 10,435  |   |  |   | 10,435  |  
|Dilutive effect of employee stock options and preferred stock |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   |        |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Common stock and common stock equivalents (C)                 |  |                                 | 10,435 |   |                                |   | 10,435 |      |  |   | 10,435  |   |  |   | 10,435  |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Loss per share:                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic (A/B)                                                   |  | $                               | (0.04  | ) |                                | $ | (0.37  | )    |  | $ | (1.22   | ) |  | $ | (1.01   | )
|Diluted (A/C)                                                 |  | $                               | (0.04  | ) |                                | $ | (0.37  | )    |  | $ | (1.22   | ) |  | $ | (1.01   | )



|4. | Stock-Based Employee Compensation Plans
|-- | ---------------------------------------

At the Companys 2010 Annual Meeting, held on May 25, 2010, our shareholders approved a 2010 Equity Incentive Plan (the 2010 Plan), which provides for the grant of equity incentives,
consisting of options, restricted shares and stock appreciation rights (SARs) to officers, other key employees and directors of the Company and the Bank. The 2010 Plan set aside, for the grant or awarding of such equity incentives,
400,000 share of our common stock, plus an additional 158,211 shares of common stock which was equal to the total of the shares that were then available for the grant of new equity incentives under our shareholder-approved 2008 and 2004 Plans (the
Previously Approved Plans). At the same time, those 158,211 shares ceased to be issuable under the Previously Approved Plans. As a result, upon approval of the 2010 Plan by our shareholders, a total of 558,211 shares were available for
the grant or awarding of equity incentives under the 2010 Plan.

Options to purchase a total of 1,143,844 shares of our common
stock granted under the Previously Approved Plans were outstanding on the date the 2010 Plan was adopted. Those Plans had provided that, if any of the outstanding options were to expire or otherwise terminate, rather than being exercised, the shares
that had been subject to those options would become available for the grant of new options under those Plans. However, the 2010 Plan provides that if any of the outstanding options granted under the Previously Approved Plans expire or are terminated
for any reason, then, the number of shares that would become available for grants or awards of equity incentives under the 2010 Plan would be increased by an equivalent number of shares, instead of becoming available for new equity incentive grants
under the Previously Approved Plans. Assuming that all of the options that were outstanding under the Previously Approved Plans on the date the 2010 Plan was adopted were to expire or be cancelled, then the maximum number of shares that could be
issued pursuant to equity incentives under the 2010 Plan would be 1,704,555 shares.

Stock options entitle the recipients to
purchase common stock at a price per share that may not be less than 100% of the fair market value of the Companys shares on the respective grant dates of the stock options. Restricted shares may be granted at such purchase prices and on such
other terms, including restrictions and Company repurchase rights, as are fixed by the Compensation Committee at the time rights to purchase such restricted shares are granted. SARs entitle the recipient to receive a cash payment in an amount equal
to the difference between the fair market value of the Companys shares on the date of vesting and a base price (which, in most cases, will be equal to fair market value of the Companys shares on the date of grant), subject to
the right of the Company to make such payment in shares of its common stock at their then fair market value. Options, restricted shares and SARs may vest immediately or in installments over various periods generally ranging up to five years, subject
to the recipients continued employment or service or the achievement of specified performance goals, as determined by the Compensation Committee at the time it grants or awards the options, the restricted shares or the SARs. Stock options and
SARs may be granted for terms of up to 10 years after the date of grant, but will terminate sooner upon or shortly after a termination of service occurring prior to the expiration of the term of the option or SAR. The Company will become entitled to
repurchase any unvested restricted shares, at the same price that was paid for the shares by the recipient, in the event of a termination of employment or service of the holder of such shares or if any performance goals specified in the award are
not satisfied. To date, the Company has not granted any restricted shares or any SARs.



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PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|4. | Stock-Based Employee Compensation Plans (Cont.-)
|-- | ------------------------------------------------





Under ASC 718-10,
we (and other public companies in the United States) are required to recognize, in our financial statements, the fair value of the options or any restricted shares that we grant as compensation cost over their respective service periods.

The fair values of the options that were outstanding at September 30, 2010 under the 2010 Plan or the Previously Approved Plans were
estimated as of their respective dates of grant using the Black-Scholes option-pricing model. The table below summarizes the weighted average assumptions used to determine the fair values of the options granted during the following periods:



|                                                             |  |                                 |      |   |                                |   |      |      |  |   |      |   |  |   |      |  
|------------------------------------------------------------ |  | ------------------------------- | ---- | - | ------------------------------ | - | ---- | ---- |  | - | ---- | - |  | - | ---- | -
|                                                             |  | Three Months EndedSeptember 30, |      |   | Nine Months EndedSeptember 30, |  
|                                                             |  | 2010                            |      |   | 2009                           |   |      | 2010 |  |   | 2009 |  
|Assumptions with respect to:                                 |  |                                 |      |   |                                |   |      |      |  |   |      |   |  |   |      |  
|Expected volatility                                          |  |                                 | 34   | % |                                |   | 34   | %    |  |   | 34   | % |  |   | 34   | %
|Risk-free interest rate                                      |  |                                 | 2.36 | % |                                |   | 2.41 | %    |  |   | 3.09 | % |  |   | 2.41 | %
|Expected dividends                                           |  |                                 | 0.26 | % |                                |   | 0.26 | %    |  |   | 0.26 | % |  |   | 0.26 | %
|Expected term (years)                                        |  |                                 | 6.9  |   |                                |   | 6.9  |      |  |   | 6.9  |   |  |   | 6.9  |  
|Weighted average fair value of options granted during period |  | $                               | 1.36 |   |                                | $ | 1.41 |      |  | $ | 1.20 |   |  | $ | 1.39 |  



|(1) | There were no options granted during the three months ended September 30, 2010.
|--- | -------------------------------------------------------------------------------

The following tables summarize the stock option activity under the Companys 1999, 2004, 2008 and 2010 Plans during the nine month
periods ended September 30, 2010 and 2009, respectively.



|                                    |  |                                   |           |   |                                        |   |       |                                   |  |  |                                        |   |  |   |       | 
|----------------------------------- |  | --------------------------------- | --------- | - | -------------------------------------- | - | ----- | --------------------------------- |  |  | -------------------------------------- | - |  | - | ----- | 
|                                    |  | Nine Months Ended September 30,   |          
|                                    |  | 2010                              |           |   | 2009                                   |  
|                                    |  | Number ofShares Subjectto Options |           |   | Weighted-AverageExercisePricePer Share |   |       | Number ofShares Subjectto Options |  |  | Weighted-AverageExercisePricePer Share |  
|Outstanding  January 1,            |  |                                   | 1,162,744 |   |                                        | $ | 8.93  |                                   |  |  | 1,137,244                              |   |  | $ | 9.31  | 
|Granted                             |  |                                   | 170,122   |   |                                        |   | 2.97  |                                   |  |  | 58,500                                 |   |  |   | 3.58  | 
|Exercised                           |  |                                   |          |   |                                        |   |      |                                   |  |  |                                       |   |  |   |      | 
|Forfeited/Canceled                  |  |                                   | (351,724  | ) |                                        |   | 7.48  |                                   |  |  | (40,500                                | ) |  |   | 10.70 | 
|                                    |  |                                   |           |   |                                        |   |       |                                   |  |  |                                        |   |  |   |       | 
|Outstanding  September 30,         |  |                                   | 981,142   |   |                                        |   | 8.42  |                                   |  |  | 1,155,244                              |   |  |   | 8.97  | 
|                                    |  |                                   |           |   |                                        |   |       |                                   |  |  |                                        |   |  |   |       | 
|Options Exercisable  September 30, |  |                                   | 681,081   |   |                                        | $ | 10.32 |                                   |  |  | 930,936                                |   |  | $ | 9.58  | 
|                                    |  |                                   |           |   |                                        |   |       |                                   |  |  |                                        |   |  |   |       | 

There were no options exercised during the nine months ended September 30, 2010 or the nine
months ended September 30, 2009. The fair values of vested options at September 30, 2010 and 2009 were $164,378 and $272,645, respectively.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|4. | Stock-Based Employee Compensation Plans (Cont.-)
|-- | ------------------------------------------------





The following
table provides additional information regarding the vested and unvested options that were outstanding at September 30, 2010.



|                |  |                                              |         |  |                                                |  |         |                              |  |   |                                                 |  |  |        |      |  |                              |  |         |  |  |   |       | 
|--------------- |  | -------------------------------------------- | ------- |  | ---------------------------------------------- |  | ------- | ---------------------------- |  | - | ----------------------------------------------- |  |  | ------ | ---- |  | ---------------------------- |  | ------- |  |  | - | ----- | 
|                |  | Options Outstanding as of September 30, 2010 |         |  | Options Exercisable as ofSeptember 30, 2010(1) | 
|                |  | Vested                                       |         |  | Unvested                                       |  |         | WeightedAverageExercisePrice |  |   | WeightedAverageRemainingContractualLife (Years) |  |  | Shares |      |  | WeightedAverageExercisePrice | 
|$ 2.97  $5.99  |  |                                              | 63,121  |  |                                                |  | 277,001 |                              |  | $ | 3.34                                            |  |  |        | 8.88 |  |                              |  | 63,121  |  |  | $ | 3.37  | 
|$ 6.00  $9.99  |  |                                              | 180,877 |  |                                                |  | 7,200   |                              |  |   | 7.60                                            |  |  |        | 1.38 |  |                              |  | 180,877 |  |  |   | 7.63  | 
|$10.00  $12.99 |  |                                              | 311,100 |  |                                                |  |        |                              |  |   | 11.23                                           |  |  |        | 3.38 |  |                              |  | 311,100 |  |  |   | 11.23 | 
|$13.00  $17.99 |  |                                              | 110,383 |  |                                                |  | 11,960  |                              |  |   | 15.11                                           |  |  |        | 4.90 |  |                              |  | 110,383 |  |  |   | 15.05 | 
|$18.00  $18.84 |  |                                              | 15,600  |  |                                                |  | 3,900   |                              |  |   | 18.06                                           |  |  |        | 5.34 |  |                              |  | 15,600  |  |  |   | 18.06 | 
|                |  |                                              |         |  |                                                |  |         |                              |  |   |                                                 |  |  |        |      |  |                              |  |         |  |  |   |       | 
|                |  |                                              | 681,081 |  |                                                |  | 300,061 |                              |  |   | 8.42                                            |  |  |        | 5.13 |  |                              |  | 681,081 |  |  |   | 10.32 | 



|(1) | The weighted average remaining contractual life of the options that were exercisable as of September 30, 2010 was 3.55 years
|--- | ----------------------------------------------------------------------------------------------------------------------------

The aggregate intrinsic values of options that were outstanding and exercisable under the Plans at September 30, 2010, and 2009,
were $1,400 and zero, respectively.

A summary of the status of the unvested options as of December 31, 2009, and changes
in the number of shares subject to and in the weighted average grant date fair values of the unvested options during the nine month period ended September 30, 2010, are set forth in the following table.



|                               |  |                                  |         |   |                                     |   |      | 
|------------------------------ |  | -------------------------------- | ------- | - | ----------------------------------- | - | ---- | 
|                               |  | Numberof SharesSubjectto Options |         |   | WeightedAverageGrant DateFair Value |  
|Unvested at December 31, 2009  |  |                                  | 207,032 |   |                                     | $ | 2.36 | 
|Granted                        |  |                                  | 170,122 |   |                                     |   | 1.20 | 
|Vested                         |  |                                  | (60,793 | ) |                                     |   | 2.70 | 
|Forfeited/Cancelled            |  |                                  | (16,300 | ) |                                     |   | 3.64 | 
|                               |  |                                  |         |   |                                     |   |      | 
|Unvested at September 30, 2010 |  |                                  | 300,061 |   |                                     | $ | 1.57 | 
|                               |  |                                  |         |   |                                     |   |      | 

The aggregate amounts of stock based compensation expense recognized in our Consolidated
Statements of Operations for the nine month periods ended September 30, 2010 and 2009 were $115,000 and $148,000, net of $104,000 in taxes, respectively. At September 30, 2010, the weighted average period over which nonvested awards were
expected to be recognized was 1.44 years.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|4. | Stock-Based Employee Compensation Plans (Cont.-)
|-- | ------------------------------------------------





The following
table sets forth the compensation expense which was expected to be recognized during the periods presented below in respect of non-vested stock options outstanding at September 30, 2010:



|                                  |  |                                         |     | 
|--------------------------------- |  | --------------------------------------- | --- | 
|                                  |  | Estimated StockBasedCompensationExpense |    
|                                  |  | (In thousands)                          |    
|Remainder of 2010                 |  | $                                       | 47  | 
|For the years ending December 31, |  |                                         |     | 
|2011                              |  |                                         | 155 | 
|2012                              |  |                                         | 118 | 
|2013                              |  |                                         | 49  | 
|2014                              |  |                                         | 5   | 
|2015                              |  |                                         | 1   | 
|                                  |  |                                         |     | 
|                                  |  | $                                       | 375 | 
|                                  |  |                                         |     | 



|5. | Employee Benefit Plan
|-- | ---------------------

The Company has established a Supplemental Retirement Plan (SERP) for its Chief Executive Officer. The components of net
periodic benefit cost for the SERP are set forth in the table below:



|                                   |  |                                 |    |  |                                |   |    |      |  |   |      |  |  |   |     | 
|---------------------------------- |  | ------------------------------- | -- |  | ------------------------------ | - | -- | ---- |  | - | ---- |  |  | - | --- | 
|                                   |  | Three Months EndedSeptember 30, |    |  | Nine Months EndedSeptember 30, |  
|                                   |  | 2010                            |    |  | 2009                           |   |    | 2010 |  |   | 2009 | 
|                                   |  | (In thousands)                  |    |  | (In thousands)                 |  
|Service cost                       |  | $                               | 48 |  |                                | $ | 47 |      |  | $ | 144  |  |  | $ | 140 | 
|Interest cost                      |  |                                 | 35 |  |                                |   | 30 |      |  |   | 101  |  |  |   | 91  | 
|Expected return on plan assets     |  |                                 |   |  |                                |   |   |      |  |   |     |  |  |   |    | 
|Amortization of prior service cost |  |                                 | 4  |  |                                |   | 3  |      |  |   | 11   |  |  |   | 11  | 
|Amortization of net actuarial loss |  |                                 | 6  |  |                                |   | 7  |      |  |   | 17   |  |  |   | 30  | 
|                                   |  |                                 |    |  |                                |   |    |      |  |   |      |  |  |   |     | 
|Net periodic SERP cost             |  | $                               | 93 |  |                                | $ | 87 |      |  | $ | 273  |  |  | $ | 272 | 
|                                   |  |                                 |    |  |                                |   |    |      |  |   |      |  |  |   |     | 



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)





|6. | Income Taxes
|-- | ------------

We record
as a deferred tax asset on our balance sheet an amount equal to the tax credit and tax loss carryforwards and tax deductions (tax benefits) that we believe will be available to us to offset or reduce the amounts of our income
taxes in future periods. Under applicable federal and state income tax laws and regulations, such tax benefits will expire if not used within specified periods of time. Accordingly, the ability to fully use our deferred tax asset depends on the
amount of taxable income that we generate during those time periods. At least once each year, or more frequently, if warranted, we make estimates of future taxable income that we believe we are likely to generate during those future periods. If we
conclude, on the basis of those estimates and the amount of the tax benefits available to us, that it is more likely than not that we will be able to fully utilize those tax benefits prior to their expiration, we recognize the deferred tax asset in
full on our balance sheet. On the other hand, if we conclude on the basis of those estimates and the amount of the tax benefits available to us that it has become more likely than not that we will be unable to utilize those tax benefits in full
prior to their expiration, then, we would establish (or increase any existing) valuation allowance to reduce the deferred tax asset on our balance sheet to the amount which we believe we are more likely than not to be able to utilize. Such a
reduction is implemented by recognizing a non-cash charge that would have the effect of increasing the provision, or reducing any credit, for income taxes that we would otherwise have recorded in our statements of operations. The determination of
whether and the extent to which we will be able to utilize our deferred tax asset involves significant management judgments and assumptions that are subject to period to period changes as a result of changes in tax laws, changes in market or
economic conditions that could affect our operating results or variances between our actual operating results and our projected operating results, as wells as other factors.

During the fourth quarter of 2008, we concluded that it had become more likely than not that our taxable income in the foreseeable future would not be sufficient to enable us to realize our deferred tax
asset in its entirety. That conclusion was based on our consideration of the relative weight of the available evidence, including the rapid deterioration in market and economic conditions, and the uncertainties regarding the duration of and how our
future operating results would be affected by those conditions. As a result, we recorded a $3.0 million valuation allowance against our deferred tax asset for the portion of the tax benefits which, based on our assessment, we were more likely, than
not, to be unable to use prior to their expiration.

At June 30, 2010 we conducted an assessment of the realizability of
our remaining deferred tax asset. Based on that assessment and due, in part, to continued weakness in the economy and financial markets, we concluded that it had become more likely, than not, that we would be unable to utilize our remaining tax
benefits comprising our deferred tax asset prior to their expiration. Therefore, we recorded an additional valuation allowance against our net deferred tax asset in the amount of $10.7 million by means of a non-cash charge to income tax expense in
the quarter ended June 30, 2010. That second quarter 2010 non-cash charge accounted for $9.0 million of the provision for income taxes recorded in our consolidated statement of operations for the nine months ended September 30, 2010.

If, in the future, market and economic conditions and our financial performance were to improve and, as a result, it were to
become more likely than not that we will be able to utilize a portion of the tax benefits with respect to which we had established that valuation allowance, then we would be able to reverse that portion of the valuation allowance, which would then
become available to reduce income tax expense that we would otherwise have to record in future periods.

The Company files
income tax returns with the U.S. federal government and the state of California. As of September 30, and January 1, 2010, we were subject to examination by the Internal Revenue Service with respect to our U.S. federal tax returns and the
Franchise Tax Board for California, for the 2005 to 2008 tax years. We do not believe there will be any material adverse changes in our unrecognized tax benefits over the next 12 months.

Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of tax expense. We did not have
any accrued interest or penalties associated with any unrecognized tax benefits, and no interest expense was recognized during the nine months ended September 30, 2010 and 2009. Our effective tax rate differs from the federal statutory rate
primarily due to tax free income on municipal bonds and certain non-deductible expenses recognized for financial reporting purposes and state taxes.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)





|7. | Fair Value Measurements
|-- | -----------------------

Fair Value Hierarchy. Under ASC 820-10, we group assets and liabilities at fair value in three levels, based on the markets in
which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:



|        |  |                                                                                                                                                                                                                                                                                                                                                                                   
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Level 1 |  | Valuation is based upon quoted prices for identical instruments traded in active markets.                                                                                                                                                                                                                                                                                         
|        | 
|Level 2 |  | Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and
model-based valuation techniques for which all significant assumptions are observable in the market.                                                                                                      
|        | 
|Level 3 |  | Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of
assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Assets Measured at Fair Value on a Recurring Basis

Investment Securities Available for Sale. Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available.
If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment
assumptions and other factors such as credit loss assumptions. Level 1 investments securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active
over-the-counter markets and money market funds. Level 2 investment securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include
asset-backed securities in less liquid markets.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|7. | Fair Value Measurements (Cont-)
|-- | -------------------------------





The following
table shows the recorded amounts of assets (in thousands of dollars) measured at fair value on a recurring basis.



|                                                         |  |                                     |         |  |         |   |       |         |  |   |         |  |  |   |       | 
|-------------------------------------------------------- |  | ----------------------------------- | ------- |  | ------- | - | ----- | ------- |  | - | ------- |  |  | - | ----- | 
|                                                         |  | At September 30, 2010(in thousands) |        
|                                                         |  | Total                               |         |  | Level 1 |   |       | Level 2 |  |   | Level 3 | 
|Assets at Fair Value:                                    |  |                                     |         |  |         |   |       |         |  |   |         |  |  |   |       | 
|Investment securities available for sale                 |  |                                     |         |  |         |   |       |         |  |   |         |  |  |   |       | 
|Mortgage backed securities issued by U.S. agencies       |  | $                                   | 99,268  |  |         | $ |      |         |  | $ | 99,268  |  |  | $ |      | 
|Municipal securities                                     |  |                                     | 6,482   |  |         |   |      |         |  |   | 6,482   |  |  |   |      | 
|Collateralized mortgage obligations issued by non agency |  |                                     | 3,496   |  |         |   |      |         |  |   | 2,587   |  |  |   | 909   | 
|Asset backed securities                                  |  |                                     | 785     |  |         |   |      |         |  |   |        |  |  |   | 785   | 
|Mutual funds                                             |  |                                     | 3,336   |  |         |   | 3,336 |         |  |   |        |  |  |   |      | 
|                                                         |  |                                     |         |  |         |   |       |         |  |   |         |  |  |   |       | 
|Total assets at fair value on a recurring basis          |  | $                                   | 113,367 |  |         | $ | 3,336 |         |  | $ | 108,337 |  |  | $ | 1,694 | 
|                                                         |  |                                     |         |  |         |   |       |         |  |   |         |  |  |   |       | 

The changes in Level 3 assets measured at fair value on a recurring basis are summarized in the following
table:



|                                                            |  |                                        |        |  
|----------------------------------------------------------- |  | -------------------------------------- | ------ | -
|                                                            |  | InvestmentSecurities Availablefor Sale |       
|                                                            |  | (In thousands)                         |       
|Balance of recurring Level 3 instruments at January 1, 2010 |  | $                                      | 4,103  |  
|Total gains or losses (realized/unrealized)                 |  |                                        |        |  
|Included in earnings realized                               |  |                                        |       |  
|Included in earnings unrealized(1)                          |  |                                        | (286   | )
|Included in other comprehensive income                      |  |                                        | 1,765  |  
|Purchases                                                   |  |                                        |       |  
|Sales                                                       |  |                                        |       |  
|Issuances                                                   |  |                                        |       |  
|Settlements                                                 |  |                                        |       |  
|Transfers in/or out of Level 3                              |  |                                        | (3,888 | )
|                                                            |  |                                        |        |  
|Balance of Level 3 assets at September 30, 2010             |  | $                                      | 1,694  |  
|                                                            |  |                                        |        |  



|(1) | Amount reported as an other-than-temporary impairment loss in the consolidated statements of operations.
|--- | --------------------------------------------------------------------------------------------------------

Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S.
generally accepted accounting principles. These include assets that are measured at the lower of cost or market or that were recognized at a fair value below cost at the end of the period.

Loans Held for Sale. Mortgage loans held for sale are reported at fair value if, on an aggregate basis, the fair value of the
loans is less than cost. In determining whether the fair value of loans held for sale is less than cost when quoted market prices are not available, the Company may consider outstanding investor commitments, discounted cash flow analysis with market
assumptions or the fair value of the collateral if the loan is collateral dependent. Such loans are classified within either level 2 or level 3 of the fair value hierarchy. Where assumptions are made using significant unobservable inputs, such loans
held for sale are classified as level 3.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|7. | Fair Value Measurements (Cont-)
|-- | -------------------------------





Impaired
Loans. ASC 820-10 applies to loans measured for impairment in accordance with ASC 310-10, Accounting by Creditors for Impairment of a Loan, including impaired loans measured at an observable market price (if available), and at
the fair value of the loans collateral (if the loan is collateral dependent). The fair value of an impaired loan is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation
value and discounted cash flows. Those impaired loans not requiring an allowance for possible losses represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. When the fair value
of the collateral is based on an observable market price or a current appraised value, we record the impaired loan at Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired
below the appraised value and there is no observable market price, we record the impaired loan at Level 3.

Foreclosed
Assets. Foreclosed assets are adjusted to fair value, less estimated costs to sell, at the time the loans are transferred to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value less
estimated costs to sell. Fair value is determined based upon independent market prices, appraised values of the collateral or managements estimation of the value of the collateral. When the fair value of the collateral is based on an
observable market price or a current appraised value, we record the foreclosed asset at Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and
there is no observable market price, we record the foreclosed asset at Level 3.

Information regarding assets measured at fair
value on a nonrecurring basis is set forth in the table below.



|                      |  |                                     |        |  |         |   |   |         |  |   |         |  |  |   |        | 
|--------------------- |  | ----------------------------------- | ------ |  | ------- | - | - | ------- |  | - | ------- |  |  | - | ------ | 
|                      |  | At September 30, 2010(in thousands) |       
|                      |  | Total                               |        |  | Level 1 |   |   | Level 2 |  |   | Level 3 | 
|Assets at Fair Value: |  |                                     |        |  |         |   |   |         |  |   |         |  |  |   |        | 
|Impaired loans        |  | $                                   | 44,895 |  |         | $ |  |         |  | $ | 30,807  |  |  | $ | 14,088 | 
|Loans held for sale   |  |                                     | 19,151 |  |         |   |  |         |  |   |        |  |  |   | 19,151 | 
|Foreclosed assets     |  |                                     | 21,459 |  |         |   |  |         |  |   | 21,459  |  |  |   |       | 
|                      |  |                                     |        |  |         |   |   |         |  |   |         |  |  |   |        | 
|Total                 |  | $                                   | 85,505 |  |         | $ |  |         |  | $ | 52,266  |  |  | $ | 33,239 | 
|                      |  |                                     |        |  |         |   |   |         |  |   |         |  |  |   |        | 

There were no significant transfers in or out of level 3 measurements for nonrecurring items during the nine
months ended September 30, 2010.

We have elected to use fair value measurements to record fair value adjustments to
certain assets and liabilities and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a
nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair value estimates are made at a discrete point in time based on relevant market information and other information about the financial
instruments. Because no active market exists for a significant portion of our financial instruments, fair value estimates are based in large part on judgments we make primarily regarding current economic conditions, risk characteristics of various
financial instruments, prepayment rates, and future expected loss experience. These estimates are subjective in nature and invariably involve some inherent uncertainties. Additionally unexpected changes in events or circumstances can occur that
could require us to make changes to our assumptions and which, in turn, could significantly affect and require us to make changes to our previous estimates of fair value.

In addition, the fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of existing and anticipated future customer
relationships and the value of assets and liabilities that are not considered financial instruments, such as premises and equipment and other real estate owned.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|7. | Fair Value Measurements (Cont-)
|-- | -------------------------------





The following
methods and assumptions were used to estimate the fair value of financial instruments.

Cash and Cash Equivalents. The
fair value of cash and cash equivalents approximates its carrying value.

Interest-Bearing Deposits with Financial
Institutions. The fair values of interest-bearing deposits maturing within ninety days approximate their carrying values.

Investment Securities Available for Sale. Investment securities available-for-sale are recorded at fair value on a recurring
basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash
flows, adjusted for the securitys credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury
securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt
securities. Securities classified as level 3 include asset-backed securities in less liquid markets.

Federal Home Loan
Bank and Federal Reserve Bank Stock. The Bank is a member of the Federal Home Loan Bank (the FHLB) and the Federal Reserve Bank of San Francisco (the FRB). As members, we are required to own stock of the FHLB and the FRB,
the amount of which is based primarily on the level of our borrowings from those institutions. We also have the right to acquire additional shares of stock in either or both of the FHLB and the FRB; however, to date, we have not done so. The fair
values of that stock are equal to their respective carrying amounts, are classified as restricted securities and are periodically evaluated for impairment based on our assessment of the ultimate recoverability of our investments in that stock. Any
cash or stock dividends paid to us on such stock are reported as income.

Loans Held for Sale.Loans held for sale are
carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to
nonrecurring fair value adjustments as Level 3. There were no fair value adjustments related to the loans held for sale at September 30, 2010.

Loans. The fair value for loans with variable interest rates is the carrying amount. The fair value of fixed rate loans is derived by calculating the discounted value of future cash flows expected
to be received by the various homogeneous categories of loans. All loans have been adjusted to reflect changes in credit risk.

Impaired Loans. ASC 820-10 applies to loans measured for impairment in accordance with ASC 310-10, Accounting by Creditors
for Impairment of a Loan, including impaired loans measured at an observable market price (if available), and at the fair value of the loans collateral (if the loan is collateral dependent) less selling cost. The fair value of an
impaired loan is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance for possible losses
represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the
impaired loan at nonrecurring Level 2. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price or a discounted cash
flow has been used to determine the fair value, we record the impaired loan at nonrecurring Level 3.

Foreclosed
Assets. Foreclosed assets are adjusted to the lower of cost or fair value, less estimated costs to sell, at the time the loans are transferred to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or
fair value, less estimated costs to sell. Fair value is determined on the basis of independent market prices, appraised values of the collateral or managements estimation of the value of the collateral. When the fair value of the collateral is
based on an observable market price or a current appraised value, we record the foreclosed asset at nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired
below the appraised value and there is no observable market price, we record the foreclosed asset at nonrecurring Level 3.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|7. | Fair Value Measurements (Cont-)
|-- | -------------------------------





Deposits.
The fair value of demand deposits, savings deposits, and money market deposits is defined as the amounts payable on demand at quarter-end. The fair value of fixed maturity certificates of deposit is estimated based on the discounted value of the
future cash flows expected to be paid on the deposits.

Borrowings. The fair value of borrowings is the carrying amount
for those borrowings that mature on a daily basis. The fair value of term borrowings is derived by calculating the discounted value of future cash flows expected to be paid out by the Company.

Junior subordinated debentures. The fair value of the junior subordinated debentures is determined based on an analysis prepared
by management, which considers the companys own credit risk. These securities are variable rate in nature and reprice quarterly.

Commitments to Extend Credit and Standby Letters of Credit. The fair value of commitments to extend credit and standby letters of credit, are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the counterparties credit standing. These fees were not material in amount either at September 30, 2010 or December 31, 2009.

The following table sets forth the estimated fair values and related carrying amounts of our financial instruments as September 30,
2010 and December 31, 2009, respectively.



|                                                      |  |                        |         |  |                     |   |         |                |  |   |                     |  |  |   |         | 
|----------------------------------------------------- |  | ---------------------- | ------- |  | ------------------- | - | ------- | -------------- |  | - | ------------------- |  |  | - | ------- | 
|                                                      |  | September 30, 2010     |         |  | December 31, 2009   |  
|                                                      |  | CarryingAmount         |         |  | EstimatedFair Value |   |         | CarryingAmount |  |   | EstimatedFair Value | 
|                                                      |  | (Dollars in thousands) |        
|Financial Assets:                                     |  |                        |         |  |                     |   |         |                |  |   |                     |  |  |   |         | 
|Cash and cash equivalents                             |  | $                      | 205,844 |  |                     | $ | 205,844 |                |  | $ | 141,651             |  |  | $ | 141,651 | 
|Interest-bearing deposits with financial institutions |  |                        | 9,043   |  |                     |   | 9,043   |                |  |   | 9,800               |  |  |   | 9,800   | 
|Federal Reserve Bank and Federal Home Loan Bank stock |  |                        | 13,459  |  |                     |   | 13,459  |                |  |   | 14,091              |  |  |   | 14,091  | 
|Securities available for sale                         |  |                        | 113,367 |  |                     |   | 113,367 |                |  |   | 170,214             |  |  |   | 170,214 | 
|Loans held for sale                                   |  |                        | 19,151  |  |                     |   | 19,151  |                |  |   | 7,572               |  |  |   | 7,572   | 
|Loans, net                                            |  |                        | 738,750 |  |                     |   | 732,335 |                |  |   | 813,194             |  |  |   | 807,707 | 
|Financial Liabilities:                                |  |                        |         |  |                     |   |         |                |  |   |                     |  |  |   |         | 
|Noninterest bearing deposits                          |  |                        | 186,550 |  |                     |   | 186,550 |                |  |   | 183,789             |  |  |   | 183,789 | 
|Interest-bearing deposits                             |  |                        | 768,108 |  |                     |   | 772,022 |                |  |   | 776,649             |  |  |   | 779,924 | 
|Borrowings                                            |  |                        | 101,027 |  |                     |   | 101,229 |                |  |   | 141,003             |  |  |   | 141,443 | 
|Junior subordinated debentures                        |  |                        | 17,527  |  |                     |   | 17,527  |                |  |   | 17,527              |  |  |   | 17,527  | 



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)





|8. | Investment Securities Available For Sale
|-- | ----------------------------------------

The following table summarizes the major components of securities available for sale and compares the amortized cost, estimated fair market values of, and gross unrealized gains and losses on, such
securities at September 30, 2010 and December 31, 2009:



|                                                            |  |                        |         |  |                   |   |     |      |  |   |           |   |  |                  |         |  |      |   |         |      |  |   |       |  |  |   |        |   |  |   |         | 
|----------------------------------------------------------- |  | ---------------------- | ------- |  | ----------------- | - | --- | ---- |  | - | --------- | - |  | ---------------- | ------- |  | ---- | - | ------- | ---- |  | - | ----- |  |  | - | ------ | - |  | - | ------- | 
|                                                            |  | September 30, 2010     |         |  | December 31, 2009 |  
|                                                            |  | Amortized              |         |  | Gross Unrealized  |   |     | Fair |  |   | Amortized |   |  | Gross Unrealized |         |  | Fair |  
|                                                            |  | Cost                   |         |  | Gain              |   |     | Loss |  |   | Value     |   |  | Cost             |         |  | Gain |   |         | Loss |  |   | Value | 
|                                                            |  | (Dollars in thousands) |        
|Securities Available for Sale                               |  |                        |         |  |                   |   |     |      |  |   |           |   |  |                  |         |  |      |   |         |      |  |   |       |  |  |   |        |   |  |   |         | 
|U.S. Treasury Securities                                    |  | $                      | 5,020   |  |                   | $ | 29  |      |  | $ |          |   |  | $                | 5,049   |  |      | $ | 18,040  |      |  | $ | 11    |  |  | $ |       |   |  | $ | 18,051  | 
|Mortgage backed securities issued by U.S. Agencies(1)       |  |                        | 94,210  |  |                   |   | 173 |      |  |   | (164      | ) |  |                  | 94,219  |  |      |   | 134,331 |      |  |   | 89    |  |  |   | (1,651 | ) |  |   | 132,769 | 
|                                                            |  |                        |         |  |                   |   |     |      |  |   |           |   |  |                  |         |  |      |   |         |      |  |   |       |  |  |   |        |   |  |   |         | 
|Total government and agencies securities                    |  |                        | 99,230  |  |                   |   | 202 |      |  |   | (164      | ) |  |                  | 99,268  |  |      |   | 152,371 |      |  |   | 100   |  |  |   | (1,651 | ) |  |   | 150,820 | 
|Municipal securities                                        |  |                        | 6,389   |  |                   |   | 103 |      |  |   | (10       | ) |  |                  | 6,482   |  |      |   | 10,545  |      |  |   | 13    |  |  |   | (431   | ) |  |   | 10,127  | 
|Collateralized mortgage obligations issued by non agency(1) |  |                        | 3,665   |  |                   |   | 29  |      |  |   | (198      | ) |  |                  | 3,496   |  |      |   | 7,094   |      |  |   | 10    |  |  |   | (1,069 | ) |  |   | 6,035   | 
|Asset backed securities(2)                                  |  |                        | 2,493   |  |                   |   |    |      |  |   | (1,708    | ) |  |                  | 785     |  |      |   | 2,704   |      |  |   |      |  |  |   | (1,732 | ) |  |   | 972     | 
|Mutual funds(3)                                             |  |                        | 3,336   |  |                   |   |    |      |  |   |          |   |  |                  | 3,336   |  |      |   | 2,260   |      |  |   |      |  |  |   |       |   |  |   | 2,260   | 
|                                                            |  |                        |         |  |                   |   |     |      |  |   |           |   |  |                  |         |  |      |   |         |      |  |   |       |  |  |   |        |   |  |   |         | 
|Total securities available for sale                         |  | $                      | 115,113 |  |                   | $ | 334 |      |  | $ | (2,080    | ) |  | $                | 113,367 |  |      | $ | 174,974 |      |  | $ | 123   |  |  | $ | (4,883 | ) |  | $ | 170,214 | 
|                                                            |  |                        |         |  |                   |   |     |      |  |   |           |   |  |                  |         |  |      |   |         |      |  |   |       |  |  |   |        |   |  |   |         | 



|(1) | Secured by closed-end first lien 1-4 family residential mortgages.
|--- | ------------------------------------------------------------------

|(2) | Comprised of a security that represents an interest in a pool of trust preferred securities issued by U.S.-based banks and insurance companies.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Consists primarily of mutual fund investments in closed-end first lien 1-4 family residential mortgages.
|--- | --------------------------------------------------------------------------------------------------------

The amortized cost and estimated fair values of securities available for sale at September 30, 2010 and December 31, 2009, are
shown in the table below by contractual maturities and historical prepayments based on the prior twelve months of principal payments. Expected maturities will differ from contractual maturities and historical prepayments, particularly with respect
to collateralized mortgage obligations, primarily because prepayment rates are affected by changes in conditions in the interest rate market and, therefore, future prepayment rates may differ from historical prepayment rates.



|                                                    |  |                                   |        |   |                                |   |        |                                 |  |   |               |   |  |       |        |   |  |   |         |  
|--------------------------------------------------- |  | --------------------------------- | ------ | - | ------------------------------ | - | ------ | ------------------------------- |  | - | ------------- | - |  | ----- | ------ | - |  | - | ------- | -
|                                                    |  | At September 30, 2010 Maturing in |       
|(Dollars in thousands)                              |  | One yearor less                   |        |   | Over oneyear throughfive years |   |        | Over fiveyears throughten years |  |   | Over tenYears |   |  | Total |       
|Securities available for sale, amortized cost       |  | $                                 | 9,492  |   |                                | $ | 20,481 |                                 |  | $ | 18,605        |   |  | $     | 66,535 |   |  | $ | 115,113 |  
|Securities available for sale, estimated fair value |  |                                   | 9,534  |   |                                |   | 20,539 |                                 |  |   | 18,485        |   |  |       | 64,809 |   |  |   | 113,367 |  
|Weighted average yield                              |  |                                   | 2.90   | % |                                |   | 2.28   | %                               |  |   | 3.05          | % |  |       | 2.94   | % |  |   | 2.84    | %
|                                                    | 
|                                                    |  | At December 31, 2009 Maturing in  |       
|(Dollars in thousands)                              |  | One yearor less                   |        |   | Over oneyear throughfive years |   |        | Over fiveyears throughten years |  |   | Over tenYears |   |  | Total |       
|Securities available for sale, amortized cost       |  | $                                 | 29,819 |   |                                | $ | 40,075 |                                 |  | $ | 36,000        |   |  | $     | 69,080 |   |  | $ | 174,974 |  
|Securities available for sale, estimated fair value |  |                                   | 29,497 |   |                                |   | 38,696 |                                 |  |   | 35,505        |   |  |       | 66,516 |   |  |   | 170,214 |  
|Weighted average yield                              |  |                                   | 1.63   | % |                                |   | 3.58   | %                               |  |   | 3.58          | % |  |       | 3.49   | % |  |   | 3.21    | %

The Company recognized net
gains on sales of securities available for sale of $1.4 million on sale proceeds of $228 million during the nine months ended September 30, 2010 and $1.4 million, net of $980,000 of taxes on sale proceeds of $188 million, during the nine months
ended September 30, 2009.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|8. | Investment Securities Available For Sale (Cont-)
|-- | ------------------------------------------------





The table below
shows, as of September 30, 2010, the gross unrealized losses and fair values of our investments, in thousands of dollars, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized
loss position.



|                                               |  |                                                       |        |  |                   |   |      |            |  |   |                |  |  |            |        |   |                |   |        |  |  |   |        |  
|---------------------------------------------- |  | ----------------------------------------------------- | ------ |  | ----------------- | - | ---- | ---------- |  | - | -------------- |  |  | ---------- | ------ | - | -------------- | - | ------ |  |  | - | ------ | -
|                                               |  | Securities with Unrealized Loss at September 30, 2010 |       
|                                               |  | Less than 12 months                                   |        |  | 12 months or more |   |      | Total      | 
|                                               |  | Fair Value                                            |        |  | UnrealizedLoss    |   |      | Fair Value |  |   | UnrealizedLoss |  |  | Fair Value |        |   | UnrealizedLoss |  
|US agencies and mortgage backed securities     |  | $                                                     | 37,509 |  |                   | $ | (160 | )          |  | $ | 484            |  |  | $          | (4     | ) |                | $ | 37,993 |  |  | $ | (164   | )
|Municipal securities                           |  |                                                       |       |  |                   |   |     |            |  |   | 460            |  |  |            | (10    | ) |                |   | 460    |  |  |   | (10    | )
|Non-agency collateralized mortgage obligations |  |                                                       |       |  |                   |   |     |            |  |   | 2,444          |  |  |            | (198   | ) |                |   | 2,444  |  |  |   | (198   | )
|Asset backed securities                        |  |                                                       |       |  |                   |   |     |            |  |   | 785            |  |  |            | (1,708 | ) |                |   | 785    |  |  |   | (1,708 | )
|                                               |  |                                                       |        |  |                   |   |      |            |  |   |                |  |  |            |        |   |                |   |        |  |  |   |        |  
|Total temporarily impaired securities          |  | $                                                     | 37,509 |  |                   | $ | (160 | )          |  | $ | 4,173          |  |  | $          | (1,920 | ) |                | $ | 41,682 |  |  | $ | (2,080 | )
|                                               |  |                                                       |        |  |                   |   |      |            |  |   |                |  |  |            |        |   |                |   |        |  |  |   |        |  

Impairment exists when the fair value of the security is less than its cost. The company performs a
quarterly assessment of its securities that have an unrealized loss to determine whether the decline in fair value of these securities below their cost is other-than-temporary.

Effective April 1, 2009 we adopted ASC 321-10 and, as a result, we recognize other-than-temporary impairments (OTTI) for
our available-for-sale debt securities in accordance with ASC 321-10. Therefore, when there are credit losses associated with an impaired debt security, but we have no intention to sell, and it is more likely than not that we will not have to sell,
the security before recovery of its cost basis, we will separate the amount of impairment into the amount that is credit related and the amount that is related to non-credit factors. The credit-related impairment is recognized in net gain on the
sale of securities in our consolidated statements of operations. Any non-credit-related impairment is recognized and reflected in other comprehensive income (loss).

Through the impairment assessment process, we determined that the investments discussed below were other-than-temporarily impaired at September 30, 2010. We recorded in our consolidated statements of
operations for the three and nine months ended September 30, 2010 impairment credit losses on available for sale securities of $52,000 and $286,000, respectively.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|8. | Investment Securities Available For Sale (Cont-)
|-- | ------------------------------------------------





Certain OTTI
amounts were related to credit losses and recognized in our consolidated statement of operations, with the remainder recognized as part of other comprehensive loss. The table below presents information regarding other-than-temporary impairments (in
thousands of dollars) for the three months ended September 30, 2010:



|                                                                                                         |  |                                     |        |   |                                                         |   |        |                                                       |  |   |      |  
|-------------------------------------------------------------------------------------------------------- |  | ----------------------------------- | ------ | - | ------------------------------------------------------- | - | ------ | ----------------------------------------------------- |  | - | ---- | -
|                                                                                                         |  | Gross OtherthanTemporaryImpairments |        |   | TemporaryImpairments Includedin OtherComprehensive Loss |   |        | Net Other-ThanTemporaryImpairmentsIncludedin Earnings | 
|Balance at July 1, 2010                                                                                  |  | $                                   | (1,912 | ) |                                                         | $ | (1,678 | )                                                     |  | $ | (234 | )
|Additions for credit and non credit losses on securities for which an OTTI was not previously recognized |  |                                     | (139   | ) |                                                         |   | (87    | )                                                     |  |   | (52  | )
|                                                                                                         |  |                                     |        |   |                                                         |   |        |                                                       |  |   |      |  
|Balance at September 30, 2010                                                                            |  | $                                   | (2,051 | ) |                                                         | $ | (1,765 | )                                                     |  | $ | (286 | )
|                                                                                                         |  |                                     |        |   |                                                         |   |        |                                                       |  |   |      |  

Non-Agency CMO

We have identified one non-agency collateralized mortgage obligation security (CUSIP 94982HAK3) that required an assessment for OTTI at September 30, 2010. This CMO is a Super Senior
Support bond, which was originated in 2005 and issued by Wells Fargo & Company, was rated AAA by Standard & Poors and Aa1 by Moodys, and had a credit support of 2.5% of the total balance at issuance. As of
September 30, 2010, the security was rated BBB and Caa3 by Standard and Poors and Moodys, respectively, has an approximate amortized cost of $967,000 and an approximate fair value of $909,000, for a loss of $57,000. The principal
collateral for this security is a pool of one-to-four family, fully amortizing residential first mortgage loans that have a fixed payment for approximately five years, after which they bear interest at variable rates with annual resets. Credit
support at September 30, 2010 was approximately 5.5% and delinquencies 60 days and over totaled approximately 5.6%. Factors considered in the impairment include the rating change of the security, the current level of subordination from other
CMO classes, anticipated prepayment rates, cumulative default rates and the loss severity given a default. For the three months ended September 30, 2010, there was no impairment for this security, We recognized $87,000 impairment loss with
respect to this CMO, constituting a credit loss, in earnings for the nine months ended September 30, 2010. This non credit portion of OTTI is attributed to external market conditions, primarily the lack of liquidity in these securities and
risks of potential additional declines in the housing market.

Asset Backed Securities

The Company has one asset backed security in its investment securities available for sale portfolio. The security is a multi-class, cash
flow collateralized bond obligation backed by a pool of trust preferred securities issued by a diversified pool of 56 issuers consisting of 45 U.S. depository institutions and eleven insurance companies at the time of issuance in November 2007. The
total size of this security at issuance was $363 million. The security that the Company owns (CUSIP 74042CAE8) is the mezzanine class B piece that floats with 3 month libor +60 basis points and had a rating of Aa2/AA by Moodys and Fitch at the
time of issuance. The Company purchased $3.0 million face value at a price of 95.21 for $2,856,420 in November 2007.

As of
September 30, 2010 the book value of this security was $2.5 million with a fair value of $785,000 for an approximate unrealized loss of $1.7 million. Currently, the security has a Ca1 rating from Moodys and CC rating from Fitch and
has experienced $42.5 million in defaults (12% of total current collateral) and $39 million in payment deferrals (11% of total current collateral) from issuance to September 30, 2010. The security did not pay its scheduled third
quarter interest payment. The Company is not currently accruing interest on this security. The Company estimates that the security could experience another $70 million in defaults before it would not receive all of its contractual cash flows.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|8. | Investment Securities Available For Sale (Cont-)
|-- | ------------------------------------------------





This analysis is
based on the following assumptions: future default rates of 2.2%, prepayment rates of 1% until maturity, and 15% recovery of future defaults. We recognized $52,000 impairment loss with respect to this security, constituting a credit loss, in
earnings, for the three months ended September 30, 2010. The remaining loss of $1.7 million in this security was recognized through other comprehensive loss.

Impairment Losses on OTTI Securities



|                                             |  |                                 |    |  |                                |   |    |      |  |   |      |  |  |   |    | 
|-------------------------------------------- |  | ------------------------------- | -- |  | ------------------------------ | - | -- | ---- |  | - | ---- |  |  | - | -- | 
|                                             |  | Three Months EndedSeptember 30, |    |  | Nine Months EndedSeptember 30, |  
|                                             |  | 2010                            |    |  | 2009                           |   |    | 2010 |  |   | 2009 | 
|                                             |  | (In thousands)                  |    |  | (In thousands)                 |  
|Asset Backed Security                        |  | $                               | 52 |  |                                | $ |   |      |  | $ | 199  |  |  | $ |   | 
|Non Agency CMO                               |  |                                 |   |  |                                |   | 83 |      |  |   | 87   |  |  |   | 83 | 
|                                             |  |                                 |    |  |                                |   |    |      |  |   |      |  |  |   |    | 
|Total impairment loss recognized in earnings |  | $                               | 52 |  |                                | $ | 83 |      |  | $ | 286  |  |  | $ | 83 | 
|                                             |  |                                 |    |  |                                |   |    |      |  |   |      |  |  |   |    | 

As a part of our OTTI assessment, we consider information available about the performance of the underlying
collateral, including credit enhancements, default rates, loss severities, delinquency rates, vintage, as well as rating agency reports and historical prepayment speeds. As a result, significant judgments are required in connection with our analysis
to determine the expected cash flows for impaired securities. In determining the component of the OTTI related to credit losses, we compare the amortized cost basis of each other-than-temporarily impaired security to the present value of its
expected cash flows, discounted using its effective interest rate implicit in the security at the date of acquisition.

Our
assessment of our ability to continue to hold impaired investment securities, along with the evaluation of their future performance, as indicated by the criteria discussed above, provided the basis for our conclusion that, at September 30,
2010, the remainder of our impaired securities were not other-than-temporarily impaired. In assessing whether it is more likely than not that the Company will be required to sell any impaired security before its anticipated recovery, which may be at
its maturity, we consider the amount of impairment, as well as the significance of each investment to our liquidity position and its impact on our capital position. As a result of our analyses, we determined that, at September 30, 2010, the
unrealized losses on our securities portfolio on which impairments have not been recognized are temporary.



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Notes to Interim Consolidated Financial Statements (Cont-)

(Unaudited)



|9. | Loans
|-- | -----





The composition of
the Companys loan portfolio as of September 30, 2010 and December 31, 2009 was as follows:



|                                              |  |                    |         |   |                   |  |       |                |  |   |         |   |  |  |       |  
|--------------------------------------------- |  | ------------------ | ------- | - | ----------------- |  | ----- | -------------- |  | - | ------- | - |  |  | ----- | -
|                                              |  | September 30, 2010 |         |   | December 31, 2009 | 
|                                              |  | Amount             |         |   | Percent           |  |       | Amount         |  |   | Percent |  
|                                              |  | (In thousands)     |         |   |                   |  |       | (In thousands) |  |   |         |  
|Commercial loans                              |  | $                  | 224,421 |   |                   |  | 29.4  | %              |  | $ | 290,406 |   |  |  | 34.8  | %
|Commercial real estate loans  owner occupied |  |                    | 175,712 |   |                   |  | 23.0  | %              |  |   | 179,682 |   |  |  | 21.5  | %
|Commercial real estate loans  all other      |  |                    | 140,400 |   |                   |  | 18.4  | %              |  |   | 135,152 |   |  |  | 16.2  | %
|Residential mortgage loans  multi-family     |  |                    | 90,658  |   |                   |  | 11.9  | %              |  |   | 101,961 |   |  |  | 12.2  | %
|Residential mortgage loans  single family    |  |                    | 74,290  |   |                   |  | 9.7   | %              |  |   | 67,023  |   |  |  | 8.0   | %
|Construction loans                            |  |                    | 5,024   |   |                   |  | 0.7   | %              |  |   | 20,443  |   |  |  | 2.6   | %
|Land development loans                        |  |                    | 34,049  |   |                   |  | 4.5   | %              |  |   | 30,042  |   |  |  | 3.6   | %
|Consumer loans                                |  |                    | 18,147  |   |                   |  | 2.4   | %              |  |   | 9,370   |   |  |  | 1.1   | %
|                                              |  |                    |         |   |                   |  |       |                |  |   |         |   |  |  |       |  
|Gross loans                                   |  |                    | 762,701 |   |                   |  | 100.0 | %              |  |   | 834,079 |   |  |  | 100.0 | %
|                                              |  |                    |         |   |                   |  |       |                |  |   |         |   |  |  |       |  
|Deferred fee (income) costs, net              |  |                    | (650    | ) |                   |  |       |                |  |   | (540    | ) |  |  |       |  
|Allowance for loan losses                     |  |                    | (23,301 | ) |                   |  |       |                |  |   | (20,345 | ) |  |  |       |  
|                                              |  |                    |         |   |                   |  |       |                |  |   |         |   |  |  |       |  
|Loans, net                                    |  | $                  | 738,750 |   |                   |  |       |                |  | $ | 813,194 |   |  |  |       |  
|                                              |  |                    |         |   |                   |  |       |                |  |   |         |   |  |  |       |  

Changes in the allowance for loan losses (in thousands of dollars) for the nine months ended
September 30, 2010 and the year ended December 31, 2009 are as follows:



|                                           |  |                                   |        |   |                             |   |         |  
|------------------------------------------ |  | --------------------------------- | ------ | - | --------------------------- | - | ------- | -
|                                           |  | Nine MonthsEndedSeptember 30,2010 |        |   | Year EndedDecember 31, 2009 |  
|Balance, beginning of period               |  | $                                 | 20,345 |   |                             | $ | 15,453  |  
|Provision for loan losses                  |  |                                   | 7,488  |   |                             |   | 23,673  |  
|Recoveries on loans previously charged off |  |                                   | 2,086  |   |                             |   | 357     |  
|Net, amounts charged off                   |  |                                   | (6,618 | ) |                             |   | (19,138 | )
|                                           |  |                                   |        |   |                             |   |         |  
|Balance, end of period                     |  | $                                 | 23,301 |   |                             | $ | 20,345  |  
|                                           |  |                                   |        |   |                             |   |         |  

The following table sets forth information regarding nonaccrual loans and restructured loans at
September 30, 2010:



|                                                                                 |  |                   |        |  |                  |   |        | 
|-------------------------------------------------------------------------------- |  | ----------------- | ------ |  | ---------------- | - | ------ | 
|                                                                                 |  | September 30,2010 |        |  | December 31,2009 |  
|Impaired loans:                                                                  |  |                   |        |  |                  |   |        | 
|Nonaccruing loans                                                                |  | $                 | 28,262 |  |                  | $ | 28,092 | 
|Nonaccruing restructured loans                                                   |  |                   | 15,433 |  |                  |   | 21,357 | 
|Accruing restructured loans                                                      |  |                   | 1,200  |  |                  |   | 1,243  | 
|Accruing loans 90 days or more delinquent                                        |  |                   |       |  |                  |   | 6,697  | 
|                                                                                 |  |                   |        |  |                  |   |        | 
|Total impaired loans                                                             |  | $                 | 44,895 |  |                  | $ | 57,389 | 
|                                                                                 |  |                   |        |  |                  |   |        | 
|Impaired loans less than 90 days delinquent and included in total impaired loans |  | $                 | 19,098 |  |                  | $ | 27,408 | 
|                                                                                 |  |                   |        |  |                  |   |        | 

Our allowance for loan losses included $9.7 million of reserves for $44.9 million of impaired loans at
September 30, 2010 and $4.8 million of reserves for $57.4 million of impaired loans at December 31, 2009. The impaired loan balances for which no reserves had been allocated totaled $19.6 million and $29.2 million at
September 30, 2010 and December 30, 2009, respectively, based on our conclusion that those loans were sufficiently collateralized to offset any charge-offs or write-downs of those loans.



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|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

Introduction

Pacific Mercantile Bancorp is a bank holding company that
owns all of the stock of Pacific Mercantile Bank (the Bank), which is a commercial bank that provides a full range of banking services to small and medium-size businesses and to professionals and the general public in Orange, Los
Angeles, San Bernardino and San Diego counties, in Southern California. Substantially all of our operations are conducted and substantially all of our assets are owned by the Bank, which accounts for substantially all of our consolidated revenues,
expenses and operating income. For ease of reference we will sometimes refer to Pacific Mercantile Bancorp as the Company or we, us or our.

The following discussion presents information about (i) our consolidated results of operations for the three and nine months ended
September 30, 2010 and comparisons of those results with the results of operations for the corresponding three and nine month periods of 2009, and (ii) our consolidated financial condition, liquidity and capital resources at
September 30, 2010. The information in the following discussion should be read in conjunction with our interim consolidated financial statements and the notes thereto included elsewhere in this Report.

Forward-Looking Information

Statements contained in this Report that are not historical facts or that discuss our expectations, beliefs or views regarding our future operations or future financial performance, or financial or other
trends in our business or in the markets in which we operate, constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include words such as believe, expect, anticipate,
intend, plan, estimate, project, forecast or words of similar meaning, or future or conditional verbs such as will, would, should, could, or
may. The information contained in such forward-looking statements is based on current information and on assumptions that we make about future events over which we do not have control. In addition, our business and the markets in which
we operate are subject to a number of risks and uncertainties. Unexpected future events and such risks and uncertainties could cause our financial condition or actual operating results in the future to differ significantly from our expected
financial condition or operating results that are set forth in the forward looking statements contained in this Report and could, therefore, also affect the price performance of our shares. Certain of those risks and uncertainties are discussed
below in this Item 2 of this Report, in Item 1A, entitled Risk Factors contained in our Annual Report on Form 10-K for our fiscal year ended December 31, 2009 (our 2009 10-K), and in Item 1A,
entitled Risk Factors in Part II of this Report below. Therefore, you are urged to read not only the information contained in this section of this Report, but also the risk factors that are discussed in our 2009 10-K and in this
report in conjunction with your review of the following discussion regarding our results of operations for the three and nine months ended, and our financial condition at, September 30, 2010.

Due to those risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements contained in
this Report, which speak only as of the date of this Report, or to make predictions about future performance based solely on historical financial performance. We also disclaim any obligation to update forward-looking statements contained in this
Report or in our 2009 10-K, except as may otherwise be required by law or Nasdaq rules.



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Overview of Operating Results in
the Three and Nine Months Ended September 30, 2010

The following table sets forth information regarding the interest
income that we generated, the interest expense that we incurred, our net interest income, noninterest income, noninterest expense, and our net income (loss) and net income (loss) per share for the three and nine months ended September 30, 2010
and 2009, respectively.



|                                                    |  |                                 |            |   |                                |   |            |                |  |  |        |    |  |        |            |   |                |   |            |   |  |  |       |   
|--------------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------ | - | ---------- | -------------- |  |  | ------ | -- |  | ------ | ---------- | - | -------------- | - | ---------- | - |  |  | ----- | --
|                                                    |  | Three Months Ended September 30 |            |   | Nine Months Ended September 30 |  
|                                                    |  | Amount                          |            |   | Amount                         |   |            | Percent Change |  |  | Amount |    |  | Amount |            |   | Percent Change |  
|                                                    |  | 2010                            |            |   | 2009                           |   |            | 2010 vs. 2009  |  |  | 2010   |    |  | 2009   |            |   | 2010 vs. 2009  |  
|Interest income                                     |  | $                               | 12,305     |   |                                | $ | 12,879     |                |  |  | (4.5   | )% |  | $      | 38,895     |   |                | $ | 38,814     |   |  |  | 0.2   | % 
|Interest expense                                    |  |                                 | 4,386      |   |                                |   | 7,495      |                |  |  | (41.5  | )% |  |        | 14,311     |   |                |   | 23,621     |   |  |  | (39.4 | )%
|                                                    |  |                                 |            |   |                                |   |            |                |  |  |        |    |  |        |            |   |                |   |            |   |  |  |       |   
|Net interest income                                 |  |                                 | 7,919      |   |                                |   | 5,384      |                |  |  | 47.1   | %  |  |        | 24,584     |   |                |   | 15,193     |   |  |  | 61.8  | % 
|Provision for loan losses                           |  |                                 | 1,688      |   |                                |   | 3,790      |                |  |  | (55.5  | )% |  |        | 7,488      |   |                |   | 13,833     |   |  |  | (45.9 | )%
|                                                    |  |                                 |            |   |                                |   |            |                |  |  |        |    |  |        |            |   |                |   |            |   |  |  |       |   
|Net interest income after provision for loan losses |  |                                 | 6,231      |   |                                |   | 1,594      |                |  |  | 290.9  | %  |  |        | 17,096     |   |                |   | 1,360      |   |  |  | N/M   |   
|Noninterest income                                  |  |                                 | 2,292      |   |                                |   | 1,475      |                |  |  | 55.4   | %  |  |        | 5,342      |   |                |   | 4,590      |   |  |  | 16.4  | % 
|Noninterest expense                                 |  |                                 | 8,648      |   |                                |   | 9,512      |                |  |  | (9.1   | )% |  |        | 25,361     |   |                |   | 24,043     |   |  |  | 5.5   | % 
|                                                    |  |                                 |            |   |                                |   |            |                |  |  |        |    |  |        |            |   |                |   |            |   |  |  |       |   
|Loss before income tax                              |  |                                 | (125       | ) |                                |   | (6,443     | )              |  |  | 98.1   | %  |  |        | (2,923     | ) |                |   | (18,093    | ) |  |  | 83.8  | % 
|Income tax (benefit) provision                      |  |                                 |           |   |                                |   | (2,577     | )              |  |  | N/A    |    |  |        | 9,059      |   |                |   | (7,546     | ) |  |  | 220.1 | % 
|                                                    |  |                                 |            |   |                                |   |            |                |  |  |        |    |  |        |            |   |                |   |            |   |  |  |       |   
|Net loss                                            |  | $                               | (125       | ) |                                | $ | (3,866     | )              |  |  | 96.8   | %  |  | $      | (11,982    | ) |                | $ | (10,547    | ) |  |  | (13.6 | )%
|                                                    |  |                                 |            |   |                                |   |            |                |  |  |        |    |  |        |            |   |                |   |            |   |  |  |       |   
|Cumulative undeclared dividends on preferred stock  |  |                                 | (327       | ) |                                |   |           |                |  |  | N/A    |    |  |        | (756       | ) |                |   |           |   |  |  | N/M   |   
|                                                    |  |                                 |            |   |                                |   |            |                |  |  |        |    |  |        |            |   |                |   |            |   |  |  |       |   
|Net loss allocable to common stockholders           |  |                                 | (452       | ) |                                |   | (3,866     | )              |  |  | 88.3   | %  |  |        | (12,738    | ) |                |   | (10,547    | ) |  |  | (20.8 | )%
|Net loss per diluted share                          |  | $                               | (0.04      | ) |                                | $ | (0.37      | )              |  |  | 89.2   | %  |  | $      | (1.22      | ) |                | $ | (1.01      | ) |  |  | (20.8 | )%
|Weighted average number of diluted shares           |  |                                 | 10,434,665 |   |                                |   | 10,434,665 |                |  |  |       |    |  |        | 10,434,665 |   |                |   | 10,434,665 |   |  |  |      |   

As the above table
indicates, during the three months ended September 30, 2010:



| |  |  | Net interest income increased by $2.5 million, or 47%, to $7.9 million from $5.4 million in the three months ended September 30, 2009.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We were able to reduce the provision we made for loan losses by $2.1 million, or 56%, to $1.7 million from nearly $3.8 million for the
same three months of 2009, due primarily to a decline in net loan charge-offs.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accordingly, our net interest income, after the provision for loan losses, increased by $4.6 million, or 291%, to $6.2 million from
$1.6 million in the same three months of 2009.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our non-interest income increased by $817,000, or 55%, to $2.3 million from $1.5 million in the three months ended September 30, 2009,
due primarily to an increase in our mortgage banking revenues and, to a lesser extent, an increase in gains on sales of securities.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We reduced our non-interest expense by $864,000, or 9.1%, to $8.6 million from $9.5 million in the same three months of 2009, due primarily
to decreases in compensation expense and in other real estate owned (OREO) expense, which more than offset a $573,000 increase in FDIC deposit insurance premiums.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our efficiency ratio improved to 84.7%, from 139% in the same three months of 2009, due to the combination of the increases in our revenues and the
reduction in our non-interest expense.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Due to the above described improvements, we reduced our net loss by $3.8 million, or 97%, to $125,000, or $0.04 per diluted common share, from
$3.9 million, or $0.37 per diluted common share, in the same three months of 2009.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Additionally, Pacific Mercantile Bank, our wholly owned banking subsidiary, generated a net profit of $123,000 in the third quarter ended
September 30, 2010, as the net loss for the quarter was attributable to the operations of the Company on a stand-alone basis.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Similarly, our
operating results for the nine months ended September 30, 2010 showed improvement, due primarily to (i) a $9.4 million, or 62%, increase in net interest income, (ii) a $6.3 million, or 46%, reduction in the provision we made
for loan losses, and (iii) a $752,000, or 16%, increase in non-interest income. Those improvements more than offset a $1.3 million, or 5.5%, increase in non-interest expense that was primarily attributable to an increase in FDIC deposit
insurance premiums and an increase in professional fees incurred primarily in connection with the collection and foreclosures of non-performing loans. As a result, we were able to reduce our pre-tax loss by $15.2 million, or 84%, to
$2.9 million in the nine months ended September 30, 2010 as compared to a pre-tax loss of $18.1 million in the same nine months of 2009.

However, notwithstanding that reduction in our pre-tax loss in the nine months ended September 30, 2010, the provision for income taxes for that nine month period was $9.1 million, of which $9.0
million was attributable to the establishment of a non-cash valuation allowance against our deferred tax asset in the quarter ended June 30, 2010. See Critical Accounting Policies and Results of
OperationsIncome Tax Provision (Benefit) below in this Section of this Report. By contrast, we recorded an income tax benefit of $7.5 million for the nine months ended September 30, 2009. As a result, we recorded a net
loss of nearly $12.0 million, or approximately $1.22 per diluted common share, for the nine months ended September 30, 2010, as compared to a net loss of $10.5 million, or $1.01 per diluted common share, for the same nine months of 2009.
Since that valuation allowance was created by means of a non-cash charge, it did not affect the Companys cash or liquidity in any way.

Due to accumulated but unpaid dividends on our Series A Convertible 10% Cumulative Preferred Stock (the Series A Preferred Shares) of $327,000 and $756,000, respectively, for the three and
nine months ended September 30, 2010, the net losses allocable to common shareholders were $452,000, or $0.04 per diluted common share, in the three months ended September 30, 2010 and $12.7 million, or $1.22 per diluted common share,
in the nine months ended September 30, 2010.

The following table indicates the improvements in our net interest margin,
return on average assets and return on average equity that were attributable to the increases in our net interest income and the improvement in our operating results in the three and nine months ended September 30, 2010:



|                                          |  |                                 |       |    |                                |  |        |      |  |  |        |    |  |  |        |   
|----------------------------------------- |  | ------------------------------- | ----- | -- | ------------------------------ |  | ------ | ---- |  |  | ------ | -- |  |  | ------ | --
|                                          |  | Three Months EndedSeptember 30, |       |    | Nine Months EndedSeptember 30, | 
|                                          |  | 2010                            |       |    | 2009                           |  |        | 2010 |  |  | 2009   |   
|Net interest margin(1)(2)                 |  |                                 | 2.78  | %  |                                |  | 1.88   | %    |  |  | 2.87   | %  |  |  | 1.76   | % 
|Return on average assets(1)               |  |                                 | (0.04 | )% |                                |  | (1.30  | )%   |  |  | (1.36  | )% |  |  | (1.18  | )%
|Return on average shareholders equity(1) |  |                                 | (0.72 | )% |                                |  | (19.86 | )%   |  |  | (31.17 | )% |  |  | (16.67 | )%



|(1) | Annualized.
|--- | -----------

|(2) | Net interest income expressed as a percentage of total average interest earning assets.
|--- | ---------------------------------------------------------------------------------------

Critical Accounting Policies

Introduction. Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (GAAP) and general accounting practices
in the banking industry in the United States. Certain of those accounting policies are considered critical accounting policies, because they require us to make assumptions and judgments regarding circumstances or trends that could affect the value
of those assets, such as, for example, assumptions regarding economic conditions or trends that could impact our ability to fully collect our loans or ultimately realize the carrying value of certain of our other assets, such as securities available
for sale and our deferred tax assets. Those assumptions and judgments are made based on current information available to us regarding those economic conditions or trends or other circumstances impacting our financial results. If adverse changes were
to occur in the events, trends or other circumstances on which our assumptions or judgments had been based, or other unanticipated events were to happen that might affect our operating results, under GAAP it could become necessary for us to reduce
the carrying values of the affected assets on our balance sheet. In addition, because reductions in the carrying value of assets are sometime effectuated by or require charges to income, such reductions also may have the effect of reducing our
income or causing us to incur losses.



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Deferred Tax
Asset. Under our accounting policies, we record as a deferred tax asset on our balance sheet an amount equal to the tax credit and tax loss carryforwards and tax deductions (collectively, tax benefits) that we believe
will be available to us to offset or reduce the amounts of our income taxes in future periods. Under applicable federal and state income tax laws and regulations, such tax benefits will expire if not used within specified periods of time.
Accordingly, the ability to fully use our deferred tax asset depends on the amount of taxable income that we generate during those time periods.

At least once each year, or more frequently, if warranted, we make estimates of future taxable income that we believe we are likely to generate during those future periods. If we conclude, on the basis of
those estimates and the amount of the tax benefits available to us, that it is more likely than not that we will be able to fully utilize those tax benefits prior to their expiration, we recognize the deferred tax asset in full on our balance sheet.
On the other hand, if we conclude that it has become more likely than not that we will be unable to fully utilize those tax benefits prior to their expiration, then, we would establish (or increase any existing) valuation allowance to reduce the
deferred tax asset on our balance sheet to the amount which we believe we are more likely, than not, to be able to utilize to offset future taxes. Such a reduction is implemented by recognizing a non-cash charge that would have the effect of
increasing the provision, or reducing any credit, for income taxes which we would otherwise have recorded in our statement of operations. The determination of whether and the extent to which we will be able to utilize our deferred tax asset involves
significant management judgments and assumptions that are subject to period to period changes as a result of changes in tax laws, changes in market or economic conditions that could affect our operating results or variances between our actual
operating results and our projected operating results, as wells as other factors.

Due primarily to the continued sluggishness
of the economy and market and economic conditions which indicated that the hoped-for economic recovery would be weaker than previously anticipated, and the adverse effects such conditions were likely to have on our future operating results, we
conducted an assessment of the realizability of our deferred tax asset at June 30, 2010. Based on that assessment, we concluded that it had become more likely than not that we would be unable to utilize the remaining tax benefits comprising our
deferred tax asset prior to their expiration and, therefore, we increased our existing valuation allowance against our deferred tax asset by means of a non-cash charge to income tax expense of $9.0 million in the quarter ended June 30, 2010. As
a result, the provision for income taxes for the nine months ended September 30, 2010 was $9.1 million, of which $9.0 million was attributable to the non-cash change we recorded in the quarter ended June 30, 2010. By comparison, we
recorded an income tax benefit of $7.5 million for the nine months ended September 30, 2009. See note 6 to our unaudited interim consolidated financial statements included elsewhere in this Report and Results of Operations 
Income Tax Provision (Benefit) below.

Other Critical Accounting Policies. Our other critical accounting
policies, which require us to make assumptions and estimates regarding circumstances or trends that could affect the value of our assets, relate to the determination of the allowance we establish for loan losses and the determination of the fair
values of the investment securities that are available for sale. Additional information regarding those critical accounting policies is contained in Item 6, entitled MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS  Critical Accounting Policies and Allowance for Loan Losses and in Note 2Significant Accounting Policies in the Notes to our Consolidated Financial Statements contained in Item 8, of
our Annual Report on Form 10-K for the year ended December 31, 2009 and readers of this Report are urged to read those sections of that Annual Report.



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Results of Operations

Net Interest Income

One of the principal determinants of a banks income is its net interest income, which is the difference between (i) the interest that a bank earns on loans, investment securities and other
interest-earning assets, on the one hand, and (ii) its interest expense, which consists primarily of the interest it must pay to attract and retain deposits and the interest that it pays on borrowings and other interest-bearing liabilities, on
the other hand. As a general rule, all other things being equal, the greater the difference or spread between the amount of our interest income and the amount of our interest expense, the greater will be our net income; whereas, a
decline in that difference or spread will generally result in a decline in our net income.

A banks interest
income and interest expense are, in turn, affected by a number of factors, some of which are outside of its control, including national and local economic conditions and the monetary policies of the Federal Reserve Board which affect interest rates;
competition in the market place for loans and deposits, the demand for loans and the ability of borrowers to meet their loan payment obligations. Net interest income, when expressed as a percentage of total average interest earning assets, is a
banking organizations net interest margin.

The following table sets forth our interest income, interest
expense and net interest income (in thousands of dollars) and our net interest margin for the three and nine months ended September 30, 2010 and 2009, respectively:



|                    |  |                                  |        |   |                                 |   |        |                   |  |  |        |    |  |        |        |   |                   |   |        |   |  |  |       |   
|------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ----------------- |  |  | ------ | -- |  | ------ | ------ | - | ----------------- | - | ------ | - |  |  | ----- | --
|                    |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                    |  | Amount                           |        |   | Amount                          |   |        | Percentage Change |  |  | Amount |    |  | Amount |        |   | Percentage Change |  
|                    |  | 2010                             |        |   | 2009                            |   |        | 2010 vs. 2009     |  |  | 2010   |    |  | 2009   |        |   | 2010 vs. 2009     |  
|Interest income     |  | $                                | 12,305 |   |                                 | $ | 12,879 |                   |  |  | 4.5    | %  |  | $      | 38,895 |   |                   | $ | 38,814 |   |  |  | 0.2   | % 
|Interest expense    |  |                                  | 4,386  |   |                                 |   | 7,495  |                   |  |  | (41.5  | )% |  |        | 14,311 |   |                   |   | 23,621 |   |  |  | (39.4 | )%
|                    |  |                                  |        |   |                                 |   |        |                   |  |  |        |    |  |        |        |   |                   |   |        |   |  |  |       |   
|Net interest income |  | $                                | 7,919  |   |                                 | $ | 5,384  |                   |  |  | 47.1   | %  |  | $      | 24,584 |   |                   | $ | 15,193 |   |  |  | 61.8  | % 
|                    |  |                                  |        |   |                                 |   |        |                   |  |  |        |    |  |        |        |   |                   |   |        |   |  |  |       |   
|Net interest margin |  |                                  | 2.78   | % |                                 |   | 1.88   | %                 |  |  |        |    |  |        | 2.87   | % |                   |   | 1.76   | % |  |  |       |   

As the above table indicates, our net interest income increased by $2.5 million, or 47.1%, in
the third quarter of 2010, and by $9.4 million, or 61.8%, in the nine months ended September 30, 2010, due primarily to decreases in interest expense of $3.1 million, or 41.5%, and $9.3 million, or 39.4%, respectively, in the
three and nine months period ended September 30, 2010. The declines in interest expense were primarily attributable to decreases in market rates of interest, which enabled us to reduce the interest we paid on time deposits and resulted in a
lowering of the rates at which we pay interest on our borrowings. Also contributing to the decrease in interest expense was a change in the mix of deposits to a higher proportion of lower-cost core deposits and a lower proportion of higher-cost time
deposits.

Due primarily to the increase in net interest income, our net interest margin increased by 90 basis points to
2.78%, and 111 basis points to 2.87%, respectively, in the three and nine months ended September 30, 2010, from 1.88% and 1.76%, respectively, in the same three and nine month periods of 2009. In the three and nine months ended
September 30, 2010, the average interest rate paid on interest bearing liabilities decreased to 1.90% and 1.53%, respectively, from 3.24% and 3.35% in the same respective periods of 2009.



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Average Balances

Information Regarding Average Assets and Average Liabilities

The following table sets forth information regarding our average balance sheet, yields on interest earning assets, interest expense on
interest-bearing liabilities, the interest rate spread and the interest rate margin for the three months ended September 30, 2010 and 2009.



|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|------------------------------------------ |  | -------------------------------- | --------- |  | ------------------- | - | ------ | ----------------- |  |  | -------------- | - |  | ------------------- | --------- |  | ----------------- | - | ------ |  |  |  | ---- | -
|                                           |  | Three Months Ended September 30, |          
|                                           |  | 2010                             |           |  | 2009                |  
|                                           |  | AverageBalance                   |           |  | InterestEarned/Paid |   |        | AverageYield/Rate |  |  | AverageBalance |   |  | InterestEarned/Paid |           |  | AverageYield/Rate |  
|                                           |  | (Dollars in thousands)           |          
|Interest earning assets:                   |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Short-term investments(1)                  |  | $                                | 228,795   |  |                     | $ | 147    |                   |  |  | 0.25           | % |  | $                   | 148,568   |  |                   | $ | 129    |  |  |  | 0.34 | %
|Securities available for sale and stock(2) |  |                                  | 118,272   |  |                     |   | 790    |                   |  |  | 2.65           | % |  |                     | 147,764   |  |                   |   | 814    |  |  |  | 2.19 | %
|Loans                                      |  |                                  | 784,149   |  |                     |   | 11,368 |                   |  |  | 5.75           | % |  |                     | 842,031   |  |                   |   | 11,936 |  |  |  | 5.62 | %
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total earning assets                       |  |                                  | 1,131,216 |  |                     |   | 12,305 |                   |  |  | 4.32           | % |  |                     | 1,138,363 |  |                   |   | 12,879 |  |  |  | 4.49 | %
|Noninterest earning assets                 |  |                                  | 34,616    |  |                     |   |        |                   |  |  |                |   |  |                     | 48,957    |  |                   |   |        |  |  |  |      |  
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total Assets                               |  | $                                | 1,165,832 |  |                     |   |        |                   |  |  |                |   |  | $                   | 1,187,320 |  |                   |   |        |  |  |  |      |  
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Interest-bearing liabilities:              |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Interest-bearing checking accounts         |  | $                                | 34,556    |  |                     |   | 47     |                   |  |  | 0.54           | % |  | $                   | 26,952    |  |                   |   | 58     |  |  |  | 0.85 | %
|Money market and savings accounts          |  |                                  | 139,675   |  |                     |   | 351    |                   |  |  | 1.00           | % |  |                     | 113,350   |  |                   |   | 348    |  |  |  | 1.22 | %
|Certificates of deposit                    |  |                                  | 623,525   |  |                     |   | 3,420  |                   |  |  | 2.18           | % |  |                     | 604,184   |  |                   |   | 5,295  |  |  |  | 3.48 | %
|Other borrowings                           |  |                                  | 106,799   |  |                     |   | 428    |                   |  |  | 1.59           | % |  |                     | 163,164   |  |                   |   | 1,648  |  |  |  | 4.01 | %
|Junior subordinated debentures             |  |                                  | 17,682    |  |                     |   | 140    |                   |  |  | 3.14           | % |  |                     | 17,682    |  |                   |   | 146    |  |  |  | 3.28 | %
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total interest-bearing liabilities         |  |                                  | 922,237   |  |                     |   | 4,386  |                   |  |  | 1.89           | % |  |                     | 925,332   |  |                   |   | 7,495  |  |  |  | 3.24 | %
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Noninterest-bearing liabilities            |  |                                  | 175,232   |  |                     |   |        |                   |  |  |                |   |  |                     | 184,753   |  |                   |   |        |  |  |  |      |  
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total Liabilities                          |  |                                  | 1,097,469 |  |                     |   |        |                   |  |  |                |   |  |                     | 1,110,085 |  |                   |   |        |  |  |  |      |  
|Shareholders equity                       |  |                                  | 68,363    |  |                     |   |        |                   |  |  |                |   |  |                     | 77,233    |  |                   |   |        |  |  |  |      |  
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total Liabilities and Shareholders Equity |  | $                                | 1,165,832 |  |                     |   |        |                   |  |  |                |   |  | $                   | 1,187,320 |  |                   |   |        |  |  |  |      |  
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Net interest income                        |  |                                  |           |  |                     | $ | 7,919  |                   |  |  |                |   |  |                     |           |  |                   | $ | 5,384  |  |  |  |      |  
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Interest rate spread                       |  |                                  |           |  |                     |   |        |                   |  |  | 2.43           | % |  |                     |           |  |                   |   |        |  |  |  | 1.25 | %
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Net interest margin                        |  |                                  |           |  |                     |   |        |                   |  |  | 2.78           | % |  |                     |           |  |                   |   |        |  |  |  | 1.88 | %
|                                           |  |                                  |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  



|(1) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------

|(2) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------



30



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##### Table of Contents



The following table
sets forth information regarding our average balance sheet, yields on interest earning assets, interest expense on interest-bearing liabilities, the interest rate spread and the interest rate margin for the nine months ended September 30, 2010
and 2009.



|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|------------------------------------------ |  | ------------------------------- | --------- |  | ------------------- | - | ------ | ----------------- |  |  | -------------- | - |  | ------------------- | --------- |  | ----------------- | - | ------ |  |  |  | ---- | -
|                                           |  | Nine Months Ended September 30, |          
|                                           |  | 2010                            |           |  | 2009                |  
|                                           |  | AverageBalance                  |           |  | InterestEarned/Paid |   |        | AverageYield/Rate |  |  | AverageBalance |   |  | InterestEarned/Paid |           |  | AverageYield/Rate |  
|                                           |  | (Dollars in thousands)          |          
|Interest earning assets:                   |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Short-term investments(1)                  |  | $                               | 184,310   |  |                     | $ | 389    |                   |  |  | 0.28           | % |  | $                   | 163,971   |  |                   | $ | 373    |  |  |  | 0.30 | %
|Securities available for sale and stock(2) |  |                                 | 150,896   |  |                     |   | 3,448  |                   |  |  | 3.06           | % |  |                     | 147,791   |  |                   |   | 2,912  |  |  |  | 2.63 | %
|Loans                                      |  |                                 | 810,136   |  |                     |   | 35,058 |                   |  |  | 5.79           | % |  |                     | 845,363   |  |                   |   | 35,529 |  |  |  | 5.62 | %
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total earning assets                       |  |                                 | 1,145,342 |  |                     |   | 38,895 |                   |  |  | 4.54           | % |  |                     | 1,157,125 |  |                   |   | 38,814 |  |  |  | 4.48 | %
|Noninterest earning assets                 |  |                                 | 37,501    |  |                     |   |        |                   |  |  |                |   |  |                     | 38,594    |  |                   |   |        |  |  |  |      |  
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total Assets                               |  | $                               | 1,182,843 |  |                     |   |        |                   |  |  |                |   |  | $                   | 1,195,719 |  |                   |   |        |  |  |  |      |  
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Interest-bearing liabilities:              |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Interest-bearing checking accounts         |  | $                               | 40,770    |  |                     |   | 210    |                   |  |  | 0.69           | % |  | $                   | 26,036    |  |                   |   | 118    |  |  |  | 0.61 | %
|Money market and savings accounts          |  |                                 | 132,150   |  |                     |   | 1,159  |                   |  |  | 1.17           | % |  |                     | 105,473   |  |                   |   | 934    |  |  |  | 1.18 | %
|Certificates of deposit                    |  |                                 | 634,733   |  |                     |   | 10,860 |                   |  |  | 2.29           | % |  |                     | 604,152   |  |                   |   | 16,647 |  |  |  | 3.68 | %
|Other borrowings                           |  |                                 | 110,273   |  |                     |   | 1,695  |                   |  |  | 2.06           | % |  |                     | 187,296   |  |                   |   | 5,425  |  |  |  | 3.87 | %
|Junior subordinated debentures             |  |                                 | 17,682    |  |                     |   | 387    |                   |  |  | 2.93           | % |  |                     | 17,682    |  |                   |   | 497    |  |  |  | 3.75 | %
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total interest-bearing liabilities         |  |                                 | 935,608   |  |                     |   | 14,311 |                   |  |  | 2.05           | % |  |                     | 940,639   |  |                   |   | 23,621 |  |  |  | 3.35 | %
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Noninterest-bearing liabilities            |  |                                 | 173,390   |  |                     |   |        |                   |  |  |                |   |  |                     | 170,509   |  |                   |   |        |  |  |  |      |  
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total Liabilities                          |  |                                 | 1,108,998 |  |                     |   |        |                   |  |  |                |   |  |                     | 1,111,148 |  |                   |   |        |  |  |  |      |  
|Shareholders equity                       |  |                                 | 73,845    |  |                     |   |        |                   |  |  |                |   |  |                     | 84,571    |  |                   |   |        |  |  |  |      |  
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Total Liabilities and Shareholders Equity |  | $                               | 1,182,843 |  |                     |   |        |                   |  |  |                |   |  | $                   | 1,195,719 |  |                   |   |        |  |  |  |      |  
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Net interest income                        |  |                                 |           |  |                     | $ | 24,584 |                   |  |  |                |   |  |                     |           |  |                   | $ | 15,193 |  |  |  |      |  
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Interest rate spread                       |  |                                 |           |  |                     |   |        |                   |  |  | 2.49           | % |  |                     |           |  |                   |   |        |  |  |  | 1.13 | %
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  
|Net interest margin                        |  |                                 |           |  |                     |   |        |                   |  |  | 2.87           | % |  |                     |           |  |                   |   |        |  |  |  | 1.76 | %
|                                           |  |                                 |           |  |                     |   |        |                   |  |  |                |   |  |                     |           |  |                   |   |        |  |  |  |      |  



|(1) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------

|(2) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------



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The following table
sets forth, in thousands of dollars, the changes in interest income, including loan fees, and interest paid in the three and nine months ended September 30, 2010, as compared to the same respective periods of 2009, and the extent to which those
changes were attributable to changes in (i) the volumes of or in the rates of interest earned on interest-earning assets and (ii) the volumes of or the rates of interest paid on our interest-bearing liabilities.



|                                           |  |                                                |      |   |                                               |   |        |                             |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|------------------------------------------ |  | ---------------------------------------------- | ---- | - | --------------------------------------------- | - | ------ | --------------------------- |  | - | ------ | - |  | ---- | ------ | - | ----- | - | ------ | - |  | - | ------ | -
|                                           |  | Three Months Ended September 30, 2010 vs. 2009 |      |   | Nine Months Ended September 30, 2010 vs. 2009 |  
|                                           |  | Increase (Decrease) due to:                    |      |   |                                               |   |        | Increase (Decrease) due to: |  |   |        |  
|                                           |  | Volume                                         |      |   | Rate                                          |   |        | Total                       |  |   | Volume |   |  | Rate |        |   | Total |  
|Interest income:                           |  |                                                |      |   |                                               |   |        |                             |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Short term investments(1)                  |  | $                                              | 57   |   |                                               | $ | (39    | )                           |  | $ | 18     |   |  | $    | 44     |   |       | $ | (28    | ) |  | $ | 16     |  
|Securities available for sale and stock(2) |  |                                                | (179 | ) |                                               |   | 155    |                             |  |   | (24    | ) |  |      | 61     |   |       |   | 475    |   |  |   | 536    |  
|Loans                                      |  |                                                | (835 | ) |                                               |   | 267    |                             |  |   | (568   | ) |  |      | (1,506 | ) |       |   | 1,035  |   |  |   | (471   | )
|                                           |  |                                                |      |   |                                               |   |        |                             |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Total earning assets                       |  |                                                | (957 | ) |                                               |   | 383    |                             |  |   | (574   | ) |  |      | (1,401 | ) |       |   | 1,482  |   |  |   | 81     |  
|Interest expense                           |  |                                                |      |   |                                               |   |        |                             |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Interest bearing checking accounts         |  |                                                | 14   |   |                                               |   | (25    | )                           |  |   | (11    | ) |  |      | 74     |   |       |   | 18     |   |  |   | 92     |  
|Money market and savings accounts          |  |                                                | 73   |   |                                               |   | (70    | )                           |  |   | 3      |   |  |      | 234    |   |       |   | (9     | ) |  |   | 225    |  
|Certificates of deposit                    |  |                                                | 164  |   |                                               |   | (2,035 | )                           |  |   | (1,871 | ) |  |      | 805    |   |       |   | (6,592 | ) |  |   | (5,787 | )
|Borrowings                                 |  |                                                | (444 | ) |                                               |   | (780   | )                           |  |   | (1,224 | ) |  |      | (1,742 | ) |       |   | (1,988 | ) |  |   | (3,730 | )
|Junior subordinated debentures             |  |                                                |     |   |                                               |   | (6     | )                           |  |   | (6     | ) |  |      |       |   |       |   | (110   | ) |  |   | (110   | )
|                                           |  |                                                |      |   |                                               |   |        |                             |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Total interest bearing liabilities         |  |                                                | (193 | ) |                                               |   | (2,916 | )                           |  |   | (3,109 | ) |  |      | (629   | ) |       |   | (8,681 | ) |  |   | (9,310 | )
|                                           |  |                                                |      |   |                                               |   |        |                             |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Net interest income                        |  | $                                              | (764 | ) |                                               | $ | 3,299  |                             |  | $ | 2,535  |   |  | $    | (772   | ) |       | $ | 10,163 |   |  | $ | 9,391  |  
|                                           |  |                                                |      |   |                                               |   |        |                             |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  



|(1) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------

|(2) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------

The above table indicates that the increases in our net interest income of $2.5 million and $9.4 million in the three and nine months ended September 30, 2010, respectively, were primarily
attributable to increases in rate variances of $3.3 million and $10.2 million in the three and nine months ended September 30, 2010, respectively. Those increases in rate variance were primarily the result of (i) decreases in
interest rates paid on interest bearing liabilities of 135 basis points and 86 basis points, respectively, and (ii) increases of 13 and 17 basis points, respectively, in the average yield on our loan portfolio in the three and nine months ended
September 30, 2010, in each case as compared to the same respective periods of 2009.

Provision for Loan Losses

The failure of borrowers to repay their loans is an inherent risk of the banking business. Therefore, like other banks
and lending institutions, we follow the practice of maintaining an allowance to provide for loan losses that occur from time to time as an incidental part of the banking business. When it is determined that payment in full of a loan has become
unlikely, the carrying value of the loan is reduced to what management believes is its realizable value. This reduction, which is referred to as a loan charge-off, or write-down is charged against the allowance for loan
losses.

The amount of the allowance for loan losses is modified periodically (i) to replenish the allowance after it has
been reduced due to loan charge-offs or write-downs, (ii) to reflect changes in the volume of outstanding loans, (iii) to account for increases in the risk of loan losses due to a deterioration in the condition of borrowers or in the value
of property securing non-performing loans or adverse changes in economic conditions, and (iv) to take account of recoveries of previous loan write-offs. Increases in the allowance are made through a charge, recorded as an expense in our
statement of operations, referred to as the provision for loan losses. Recoveries of loans previously charged-off or written down are added back to the allowance and, therefore, have the effect of increasing the allowance and reducing
the amount of the provision that might otherwise have had to be made to replenish or increase the allowance. See Financial ConditionNonperforming Loans, Other Non-Performing Assets and the Allowance for Loan Losses below in
this Section of this Report.

We employ economic models that are based on bank regulatory guidelines, industry standards and
our own historical loan loss experience, as well as a number of more subjective qualitative factors, to determine both the sufficiency of the allowance for loan losses and the amount of the provisions that we need to make for potential loan losses.
However, those determinations involve judgments about trends in current economic conditions and other events



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or circumstances that can affect the ability of borrowers to meet their loan obligations to us and a weighting among the quantitative and qualitative factors we consider in determining the amount
of the allowance. Moreover, the duration and anticipated effects of prevailing economic conditions or trends can be uncertain and can be affected by number of risks and circumstances that are outside of our ability to control. See the discussion
below in this Section under the caption Financial ConditionNonperforming Loans, Other Nonperforming Assets and the Allowance for Loan Losses. If changes in economic or market conditions or unexpected subsequent events were to
occur, or if changes were made to bank regulatory guidelines or industry standards that are used to assess the sufficiency of the allowance for loan losses, it could become necessary for us to incur additional, and possibly significant, charges to
increase the allowance for loan losses, which would have the effect of reducing our income or causing us to incur losses.

In
addition, the Federal Reserve Bank of San Francisco (the FRB or Reserve Bank) and the California Department of Financial Institutions (the DFI), as an integral part of their examination processes, periodically
review the adequacy of our allowance for loan losses. These agencies may require us to make additional provisions for possible loan losses, over and above the provisions that we have already made, the effect of which would be to reduce our income or
increase any losses we might incur.

During the three and nine months ended September 30, 2010, we made provisions for
loan losses of $1.7 million and $7.5 million, respectively, as compared to $3.8 million and $13.8 million in the respective corresponding periods of 2009. The decreases in the provisions for loan losses in the three and nine
months ended September 30, 2010, as compared to the same respective periods of 2009, were the result of reductions in net loan charge offs, during the third quarter and first nine months of this year, as compared to the same respective periods
of last year.

Notwithstanding the reduction in the provision made for loan losses in the nine months ended at
September 30, 2010 the allowance for loan losses totaled $23.3 million, or 3.06% of the loans then outstanding, as compared to $20.3 million, or 2.44% of loans outstanding, at December 31, 2009 and $20.5 million, or 2.46%, of the
loans outstanding at September 30, 2009. That increase in the allowance was primarily attributable to (i) the additions made to the allowance for loan losses in the nine months ended September 30, 2010, (ii) a reduction in loan
charge-offs in the nine months ended September 30, 2010, as compared to the nine months ended 2009, and (iii) a reduction in total amount of loans outstanding at September 30, 2010 as compared to the total loans outstanding at
December 31, 2009 and September 30, 2009, respectively.

Noninterest Income

The following table identifies the amounts (in thousands of dollars) of, and sets forth the percentage changes in, the components of
noninterest income in the three and nine months ended September 30, 2010, as compared to the same period of 2009.



|                                                                       |  |                                 |       |   |                                |   |       |               |  |  |               |    |  |      |       |   |               |   |       |   |  |  |       |   
|---------------------------------------------------------------------- |  | ------------------------------- | ----- | - | ------------------------------ | - | ----- | ------------- |  |  | ------------- | -- |  | ---- | ----- | - | ------------- | - | ----- | - |  |  | ----- | --
|                                                                       |  | Three Months Ended September 30 |       |   | Nine Months Ended September 30 |  
|                                                                       |  | Amounts                         |       |   | PercentChange                  |   |       | Amounts       |  |  | PercentChange |   
|                                                                       |  | 2010                            |       |   | 2009                           |   |       | 2010 vs. 2009 |  |  | 2010          |    |  | 2009 |       |   | 2010 vs. 2009 |  
|Service fees on deposits and other banking services                    |  | $                               | 278   |   |                                | $ | 352   |               |  |  | (21.0         | )% |  | $    | 930   |   |               | $ | 1,101 |   |  |  | (15.5 | )%
|Mortgage banking (including net gains on sales of loans held for sale) |  |                                 | 1,113 |   |                                |   | 540   |               |  |  | 106.1         | %  |  |      | 2,743 |   |               |   | 607   |   |  |  | N/M   |   
|Net gains on sales of securities available for sale                    |  |                                 | 780   |   |                                |   | 446   |               |  |  | 74.9          | %  |  |      | 1,417 |   |               |   | 2,334 |   |  |  | (39.3 | )%
|Net loss on sale of other real estate owned                            |  |                                 | (5    | ) |                                |   | (147  | )             |  |  | (96.6         | )% |  |      | (64   | ) |               |   | (145  | ) |  |  | (55.9 | )%
|Net impairment loss recognized in earnings from securities             |  |                                 | (52   | ) |                                |   | (83   | )             |  |  | (37.3         | )% |  |      | (286  | ) |               |   | (83   | ) |  |  | N/M   |   
|Other                                                                  |  |                                 | 178   |   |                                |   | 367   |               |  |  | (51.5         | )% |  |      | 602   |   |               |   | 776   |   |  |  | (22.4 | )%
|                                                                       |  |                                 |       |   |                                |   |       |               |  |  |               |    |  |      |       |   |               |   |       |   |  |  |       |   
|Total noninterest income                                               |  | $                               | 2,292 |   |                                | $ | 1,475 |               |  |  | 55.4          | %  |  | $    | 5,342 |   |               | $ | 4,590 |   |  |  | 16.4  | % 
|                                                                       |  |                                 |       |   |                                |   |       |               |  |  |               |    |  |      |       |   |               |   |       |   |  |  |       |   

As the table above indicates, the increase in noninterest income in the three months ended
September 30, 2010, as compared to the same period in 2009, was primarily attributable to (i) a $573,000 or 106.1% increase in income generated by our mortgage banking division, which commenced its operations during the second quarter
2009, and (ii) a $334,000, or 74.9% increase in net gains on sales of securities.



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The increase in
noninterest income in the nine months ended September 30, 2010, as compared to the same period in 2009, was primarily the result of a $2.1 million increase in income generated by our mortgage banking division, partially offset by a
$917,000, or 39.3%, decrease in net gains on sales of securities.

Noninterest Expense

The following table compares the amounts (in thousands of dollars) of the principal components of noninterest expense in the three and
nine months ended September 30, 2010 and 2009.



|                               |  |                                  |       |  |                                 |   |       |                |  |  |        |    |  |        |        |  |                |   |        |  |  |  |       |   
|------------------------------ |  | -------------------------------- | ----- |  | ------------------------------- | - | ----- | -------------- |  |  | ------ | -- |  | ------ | ------ |  | -------------- | - | ------ |  |  |  | ----- | --
|                               |  | Three Months Ended September 30, |       |  | Nine Months Ended September 30, |  
|                               |  | Amount                           |       |  | Amount                          |   |       | Percent Change |  |  | Amount |    |  | Amount |        |  | Percent Change |  
|                               |  | 2010                             |       |  | 2009                            |   |       | 2010 vs. 2009  |  |  | 2010   |    |  | 2009   |        |  | 2010 vs. 2009  |  
|Salaries and employee benefits |  | $                                | 3,703 |  |                                 | $ | 4,194 |                |  |  | (11.7  | )% |  | $      | 11,747 |  |                | $ | 11,580 |  |  |  | 1.4   | % 
|Occupancy expense              |  |                                  | 673   |  |                                 |   | 682   |                |  |  | (1.3   | )% |  |        | 2,020  |  |                |   | 2,038  |  |  |  | (0.9  | )%
|Equipment and depreciation     |  |                                  | 295   |  |                                 |   | 313   |                |  |  | (5.8   | )% |  |        | 952    |  |                |   | 868    |  |  |  | 9.7   | % 
|Data processing                |  |                                  | 156   |  |                                 |   | 276   |                |  |  | (43.5  | )% |  |        | 514    |  |                |   | 662    |  |  |  | (22.4 | )%
|Professional fees              |  |                                  | 1,227 |  |                                 |   | 1,338 |                |  |  | (8.3   | )% |  |        | 3,207  |  |                |   | 2,740  |  |  |  | 17.0  | % 
|Customer expense               |  |                                  | 52    |  |                                 |   | 92    |                |  |  | (43.5  | )% |  |        | 232    |  |                |   | 281    |  |  |  | (17.4 | )%
|FDIC insurance                 |  |                                  | 1,256 |  |                                 |   | 683   |                |  |  | 83.9   | %  |  |        | 2,522  |  |                |   | 1,933  |  |  |  | 30.5  | % 
|Other real estate owned        |  |                                  | 439   |  |                                 |   | 1,170 |                |  |  | (62.5  | )% |  |        | 1,330  |  |                |   | 1,689  |  |  |  | (21.3 | )%
|Other operating expenses(1)    |  |                                  | 847   |  |                                 |   | 764   |                |  |  | 10.9   | %  |  |        | 2,837  |  |                |   | 2,252  |  |  |  | 26.0  | % 
|                               |  |                                  |       |  |                                 |   |       |                |  |  |        |    |  |        |        |  |                |   |        |  |  |  |       |   
|Total                          |  | $                                | 8,648 |  |                                 | $ | 9,512 |                |  |  | (9.1   | )% |  | $      | 25,361 |  |                | $ | 24,043 |  |  |  | 5.5   | % 
|                               |  |                                  |       |  |                                 |   |       |                |  |  |        |    |  |        |        |  |                |   |        |  |  |  |       |   



|(1) | Other operating expenses consist primarily of telephone, stationery and office supplies, regulatory expenses, customer expense, investor relations expenses, insurance
premiums, postage and correspondent banking fees.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In the three months ended September 30, 2010,
noninterest expense decreased by $864,000, or 9.1%, compared to the same three months of 2009. That decrease was primarily attributable to (i) a $731,000, or 62.5%, decrease in other real estate owned expenses, and (ii) a $491,000, or
11.7%, decrease in salaries and employee benefits, partially offset by a $573,000, or 83.9%, increase in FDIC insurance premiums.

In the nine months ended September 30, 2010, noninterest expense increased by $1.3 million, or 5.5%, as compared to the same nine months of 2009, primarily as a result of (i) an increase in
FDIC insurance expense of $589,000, or 30.5%, and (ii) an increase of $467,000, or 17.0%, in professional fees incurred in connection with the collection and foreclosures of non-performing loans, partially offset by a $359,000, or 21.3%,
decrease in other real estate owned expenses.

A measure of our ability to control noninterest expense is our efficiency
ratio, which is the ratio of noninterest expense to net revenue (net interest income plus noninterest income). As a general rule, a lower efficiency ratio indicates an ability to generate increased revenue without a commensurate increase in the
staffing and equipment and third party services and, therefore, would be indicative of greater operational efficiencies. For the three and nine months ended September 30, 2010, our efficiency ratios improved to 85% in both those periods, from
139% and 122%, respectively, in the corresponding three and nine month periods of 2009, due primarily to the increases in our net interest income of $2.5 million and $9.4 million in the three and nine months ended September 30, 2010,
respectively.

Expense Reduction Initiatives. In February 2010, we initiated a number of cost-cutting measures that are
designed to improve the efficiency of our operations and reduce our noninterest expense by at least 8%. Those measures included a work force reduction, a freeze on salaries, elimination of a management bonus program for 2010, and suspension of
Company 401-K plan matching contributions. However, there is no assurance that we will achieve our expense reduction objective in fiscal 2010, because the amount of our noninterest expense can be affected by events or conditions that are outside of
our control, such as the costs of managing non-performing loans and foreclosing and reselling other real estate owned and the amount of the FDIC insurance premiums that we are required to pay.



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Income Tax
Provision (Benefit)

We recorded provisions for income tax expense of $0 and $9.1 million, respectively, in the
three and nine months ended September 30, 2010, as compared to income tax benefits of $1.2 million and $6.2 million, respectively, in the three and nine months ended September 30, 2009. Those swings in the provision (benefit) for
income taxes were primarily attributable to our recognition of a $9.0 million non-cash charge recorded in the quarter ended June 30, 2010 to increase the valuation allowance established for the deferred tax asset on our balance sheet as a
result of a determination that it had become more likely, than not, that we would be unable to utilize that deferred tax asset to offset income tax expense in future periods. See Note 6 to our unaudited interim consolidated financial statements
included in Item 1 above in this Report and Critical Accounting Policies above in this Item 2 of this Report for additional information regarding our deferred tax asset and the non-cash charge recognized to increase
the related valuation allowance in the second quarter of 2010.

Asset/Liability Management

The primary objective of asset/liability management is to reduce our exposure to interest rate fluctuations, which can affect our net
interest margins and, therefore, our net interest income and net earnings. We seek to achieve this objective by matching interest rate sensitive assets and liabilities, and maintaining the maturities of and repricing these assets and liabilities in
response to the changes in the interest rate environment. Generally, if rate sensitive assets exceed rate sensitive liabilities, net interest income will be positively impacted during a rising interest rate environment and negatively impacted during
a declining interest rate environment. When rate sensitive liabilities exceed rate sensitive assets, net interest income generally will be positively impacted during a declining interest rate environment and negatively impacted during a rising
interest rate environment. However, interest rates for different asset and liability products offered by depository institutions respond differently to changes in the interest rate environment. As a result, the relationship or gap
between interest sensitive assets and interest sensitive liabilities is only a general indicator of interest rate sensitivity and how our net interest income might be affected by changing rates of interest.

For example, rates on certain assets or liabilities typically lag behind changes in market rates of interest. Additionally, prepayments
of loans and securities available for sale, and early withdrawals of certificates of deposit, can cause the interest sensitivities to vary.



35



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The table below sets
forth information concerning our rate sensitive assets and liabilities at September 30, 2010. The assets and liabilities are classified by the earlier of maturity or repricing dates in accordance with their contractual terms. As described
above, certain shortcomings are inherent in the method of analysis presented in this table.



|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|---------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ----------------------------- | - | -------- | ----------------------------- |  | - | ------------- | - |  | -------------------- | ------- | - | ----- | - | -------- | - |  | - | --------- | 
|                                                                             |  | ThreeMonthsorLess      |         |   | Over ThreeThroughTwelveMonths |   |          | Over OneYearThroughFive Years |  |   | OverFiveYears |   |  | Non-Interest-Bearing |         |   | Total |  
|                                                                             |  | (Dollars in thousands) |        
|Assets                                                                       |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Interest-bearing time deposits in other financial institutions               |  | $                      | 8,599   |   |                               | $ | 444      |                               |  | $ |              |   |  | $                    |        |   |       | $ |         |   |  | $ | 9,043     | 
|Investment in unconsolidated trust subsidiaries                              |  |                        |        |   |                               |   |         |                               |  |   |              |   |  |                      | 682     |   |       |   |         |   |  |   | 682       | 
|Securities available for sale                                                |  |                        | 10,853  |   |                               |   | 12,623   |                               |  |   | 53,220        |   |  |                      | 36,671  |   |       |   |         |   |  |   | 113,367   | 
|Federal Reserve Bank and Federal Home Loan Bank stock                        |  |                        | 13,459  |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 13,459    | 
|Interest bearing deposits with financial institutions                        |  |                        | 205,844 |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 205,844   | 
|Loans held for sale, at Fair value                                           |  |                        | 19,151  |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 19,151    | 
|Loans, gross                                                                 |  |                        | 319,445 |   |                               |   | 47,991   |                               |  |   | 325,190       |   |  |                      | 69,425  |   |       |   |         |   |  |   | 762,051   | 
|Non-interest earning assets, net                                             |  |                        |        |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 24,080   |   |  |   | 24,080    | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Total assets                                                                 |  | $                      | 577,351 |   |                               | $ | 61,058   |                               |  | $ | 378,410       |   |  | $                    | 106,778 |   |       | $ | 24,080   |   |  | $ | 1,147,677 | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Liabilities and Shareholders Equity                                         |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Noninterest-bearing deposits                                                 |  | $                      |        |   |                               | $ |         |                               |  | $ |              |   |  | $                    |        |   |       | $ | 186,550  |   |  | $ | 186,550   | 
|Interest-bearing deposits(1)(2)                                              |  |                        | 276,433 |   |                               |   | 273,814  |                               |  |   | 89,230        |   |  |                      | 128,631 |   |       |   |         |   |  |   | 768,108   | 
|Borrowings                                                                   |  |                        | 23,027  |   |                               |   | 25,000   |                               |  |   | 53,000        |   |  |                      |        |   |       |   |         |   |  |   | 101,027   | 
|Junior subordinated debentures                                               |  |                        | 17,527  |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 17,527    | 
|Other liabilities                                                            |  |                        |        |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 6,218    |   |  |   | 6,218     | 
|Shareholders equity                                                         |  |                        |        |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 68,247   |   |  |   | 68,247    | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Total liabilities and shareholders equity                                   |  | $                      | 316,987 |   |                               | $ | 298,814  |                               |  | $ | 142,230       |   |  | $                    | 128,631 |   |       | $ | 261,015  |   |  | $ | 1,147,677 | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Interest rate sensitivity gap                                                |  | $                      | 260,364 |   |                               | $ | (237,756 | )                             |  | $ | 236,180       |   |  | $                    | (21,853 | ) |       | $ | (236,935 | ) |  | $ |          | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Cumulative interest rate sensitivity gap                                     |  | $                      | 260,364 |   |                               | $ | 22,608   |                               |  | $ | 258,788       |   |  | $                    | 236,935 |   |       | $ |         |   |  | $ |          | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Cumulative % of rate sensitive assets in maturity period                     |  |                        | 50      | % |                               |   | 56       | %                             |  |   | 89            | % |  |                      | 98      | % |       |   | 100      | % |  |   |           | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Rate sensitive assets to rate sensitive liabilities and shareholders equity |  |                        | 182     | % |                               |   | 20       | %                             |  |   | 266           | % |  |                      | 83      | % |       |   | 9        | % |  |   |           | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 
|Cumulative ratio                                                             |  |                        | 182     | % |                               |   | 104      | %                             |  |   | 134           | % |  |                      | 127     | % |       |   | 100      | % |  |   |           | 
|                                                                             |  |                        |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |           | 



|(1) | Excludes savings accounts we maintain at the Bank totaling $5.2 million and maturing within three months of September 30, 2010.
|--- | -------------------------------------------------------------------------------------------------------------------------------

|(2) | Excludes a $250,000 certificate of deposit issued to us by the Bank, which matures January 2011.
|--- | ------------------------------------------------------------------------------------------------

At September 30, 2010, our rate sensitive balance sheet was shown to be in a positive twelve-month gap position. This would imply
that our net interest margin would increase in the short-term if interest rates were to rise and would decrease in the short-term if interest rates were to fall. However, as noted above, the extent to which our net interest margin will be impacted
by changes in prevailing interests rates will depend on a number of factors, including how quickly rate sensitive assets and liabilities react to interest rate changes, the mix of our interest earning assets (loans versus other lower yielding
interest earning assets, such as securities or federal funds sold) and the mix of our interest bearing deposits (between, for example, lower interest core deposits and higher cost time certificates of deposit) and our other interest-bearing
liabilities.



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Financial Condition

Assets

Our consolidated assets totaled $1.148 billion at September 30, 2010, which represents a $52 million decrease from our total consolidated assets of $1.201 billion at December 31, 2009.
That decrease was primarily attributable to a $75 million reduction in the total loans outstanding (net of allowances), and a $57 million decrease in securities, between December 31, 2009 and September 30, 2010, partially offset
by an increase in cash and cash equivalents during the nine months ended September 30, 2010.

The following table sets
forth the composition of our interest-earning assets (in thousands of dollars) at:



|                                                               |  |                   |         |  |                  |   |         | 
|-------------------------------------------------------------- |  | ----------------- | ------- |  | ---------------- | - | ------- | 
|                                                               |  | September 30,2010 |         |  | December 31,2009 |  
|Interest-bearing deposits with financial institutions(1)       |  | $                 | 194,738 |  |                  | $ | 127,785 | 
|Interest-bearing time deposits with financial institutions     |  |                   | 9,043   |  |                  |   | 9,800   | 
|Federal Reserve Bank and Federal Home Loan Bank Stock, at cost |  |                   | 13,459  |  |                  |   | 14,091  | 
|Securities available for sale, at fair value                   |  |                   | 113,367 |  |                  |   | 170,214 | 
|Loans held for sale, at lower of cost or market                |  |                   | 19,193  |  |                  |   | 7,572   | 
|Loans (net of allowances of $23,301 and $20,345, respectively) |  |                   | 738,708 |  |                  |   | 813,194 | 



|(1) | Includes interest-earning balances maintained at the Federal Reserve Bank of San Francisco.
|--- | -------------------------------------------------------------------------------------------

Loans Held for Sale

We commenced a new mortgage banking business during the second quarter of 2009 to originate, primarily in Southern California, residential real estate mortgage loans that qualify for resale into the
secondary mortgage markets. Our mortgage originations have been primarily for the financing of purchases of residential property and, to a lesser extent, refinancing of existing residential mortgage loans. In addition to conventional mortgage loans,
we offer loan programs for low to moderate income families that qualify for mortgage assistance, such as the FHLB Wish Program, Homepath-financing on FNMA repossessed homes, and Southern California home Financing Authority and various mortgage
assistance programs in counties and cities within our branch network. The following table reflects the quarterly activity, in thousands of dollars, of our mortgage loan operations.



|                                    |  |                                |        |  |                               |   |         |                               |  |   |        | 
|----------------------------------- |  | ------------------------------ | ------ |  | ----------------------------- | - | ------- | ----------------------------- |  | - | ------ | 
|                                    |  | Three MonthsEndedSeptember 30, |        |  | Nine MonthsEndedSeptember 30, |   |         | Nine MonthsEndedSeptember 30, | 
|                                    |  | 2010                           |        |  | 2010                          |   |         | 2009(1)                       | 
|Single family mortgage loans funded |  | $                              | 58,443 |  |                               | $ | 154,183 |                               |  | $ | 72,867 | 
|Single family mortgage loan sales   |  |                                | 60,863 |  |                               |   | 142,192 |                               |  |   | 65,523 | 
|Balance End of Period               |  |                                | 19,151 |  |                               |   | N/A     |                               |  |   | N/A    | 



|(1) | Since we commenced our mortgage loan operations in the second quarter of 2009, the results shown for the nine months ended September 30, 2009 are for a period of
approximately five months, rather than nine months.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Loans held for sale are carried at the lower of cost or
estimated fair value in the aggregate. Net unrealized losses on loans held for sale, if any, would be recognized through a valuation allowance established by a charge to income. As of September 30, 2010, the loans held for sale included
$15.4 million of loans with interest rate lock commitments providing a hedge to interest rates and $3.4 million of loans pending investor commitments.



37



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##### Table of Contents



Loans

The following table sets forth, in thousands of dollars, the composition, by loan category, of our loan portfolio at
September 30, 2010 and December 31, 2009, respectively:



|                                              |  |                    |         |   |                   |  |       |        |  |   |         |   |  |  |       |  
|--------------------------------------------- |  | ------------------ | ------- | - | ----------------- |  | ----- | ------ |  | - | ------- | - |  |  | ----- | -
|                                              |  | September 30, 2010 |         |   | December 31, 2009 | 
|                                              |  | Amount             |         |   | Percent           |  |       | Amount |  |   | Percent |  
|Commercial loans                              |  | $                  | 224,421 |   |                   |  | 29.4  | %      |  | $ | 290,406 |   |  |  | 34.8  | %
|Commercial real estate loans  owner occupied |  |                    | 175,712 |   |                   |  | 23.0  | %      |  |   | 179,682 |   |  |  | 21.5  | %
|Commercial real estate loans  all other      |  |                    | 140,400 |   |                   |  | 18.4  | %      |  |   | 135,152 |   |  |  | 16.2  | %
|Residential mortgage loans  multi- family    |  |                    | 90,658  |   |                   |  | 11.9  | %      |  |   | 101,961 |   |  |  | 12.2  | %
|Residential mortgage loans  single-family    |  |                    | 74,290  |   |                   |  | 9.7   | %      |  |   | 67,023  |   |  |  | 8.0   | %
|Construction loans                            |  |                    | 5,024   |   |                   |  | 0.7   | %      |  |   | 20,443  |   |  |  | 2.6   | %
|Land development loans                        |  |                    | 34,049  |   |                   |  | 4.5   | %      |  |   | 30,042  |   |  |  | 3.6   | %
|Consumer loans                                |  |                    | 18,147  |   |                   |  | 2.4   | %      |  |   | 9,370   |   |  |  | 1.1   | %
|                                              |  |                    |         |   |                   |  |       |        |  |   |         |   |  |  |       |  
|Gross loans                                   |  |                    | 762,701 |   |                   |  | 100.0 | %      |  |   | 834,079 |   |  |  | 100.0 | %
|                                              |  |                    |         |   |                   |  |       |        |  |   |         |   |  |  |       |  
|Deferred fee (income) costs, net              |  |                    | (650    | ) |                   |  |       |        |  |   | (540    | ) |  |  |       |  
|Allowance for loan losses                     |  |                    | (23,301 | ) |                   |  |       |        |  |   | (20,345 | ) |  |  |       |  
|                                              |  |                    |         |   |                   |  |       |        |  |   |         |   |  |  |       |  
|Loans, net                                    |  | $                  | 738,750 |   |                   |  |       |        |  | $ | 813,194 |   |  |  |       |  
|                                              |  |                    |         |   |                   |  |       |        |  |   |         |   |  |  |       |  

Commercial loans are loans to businesses to finance capital purchases or improvements, or to
provide cash flow for operations. Commercial real estate and residential mortgage loans are loans secured by trust deeds on real property, including commercial property and single family and multi-family residences. Construction and land development
loans are interim loans to finance specific construction projects. Consumer loans consist primarily of installment loans to consumers.

The following table sets forth, in thousands of dollars, the maturity distribution of our loan portfolio (excluding consumer and residential mortgage loans) at September 30, 2010:



|                                      |  |                    |         |  |                                |   |         |                |  |   |        |  |  |   |         | 
|------------------------------------- |  | ------------------ | ------- |  | ------------------------------ | - | ------- | -------------- |  | - | ------ |  |  | - | ------- | 
|                                      |  | September 30, 2010 |        
|                                      |  | One Yearor Less    |         |  | Over OneYear throughFive Years |   |         | Over FiveYears |  |   | Total  | 
|Real estate and construction loans(1) |  |                    |         |  |                                |   |         |                |  |   |        |  |  |   |         | 
|Floating rate                         |  | $                  | 58,823  |  |                                | $ | 111,799 |                |  | $ | 2,636  |  |  | $ | 173,258 | 
|Fixed rate                            |  |                    | 39,753  |  |                                |   | 92,827  |                |  |   | 49,347 |  |  |   | 181,927 | 
|Commercial loans                      |  |                    |         |  |                                |   |         |                |  |   |        |  |  |   |         | 
|Floating rate                         |  |                    | 22,126  |  |                                |   | 225     |                |  |   |       |  |  |   | 22,351  | 
|Fixed rate                            |  |                    | 109,231 |  |                                |   | 75,642  |                |  |   | 17,197 |  |  |   | 202,070 | 
|                                      |  |                    |         |  |                                |   |         |                |  |   |        |  |  |   |         | 
|Total                                 |  | $                  | 229,933 |  |                                | $ | 280,493 |                |  | $ | 69,180 |  |  | $ | 579,606 | 
|                                      |  |                    |         |  |                                |   |         |                |  |   |        |  |  |   |         | 



|(1) | Does not include mortgage loans on single and multi-family residences and consumer loans, which totaled $164.9 million and $18.1 million, respectively, at
September 30, 2010.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Non-Performing
Loans, Other Non-Performing Assets and Allowance for Loan Losses

Non-Performing Loans. Non-performing loans
consist of loans which, as described below, are on non-accrual status. Generally, the accrual of interest is discontinued on a loan when principal or interest becomes more than 90 days past due, at which time they are placed on non-accrual status,
unless management believes the loan is adequately collateralized and the loan is in the process of collection. Loans on non-accrual status also include loans that have been restructured, but for which there has not been a history of past performance
on debt service in accordance with the contractual terms of such loans. In certain instances, however, we may place a particular loan on non-accrual status earlier, depending on the individual circumstances involved in loans delinquency. When
a loan is placed on non-accrual status, previously accrued but unpaid interest is reversed against current income. Subsequent collections of cash on such loans are applied as principal reductions when received, except when the ultimate
collectability of principal is probable, in which case interest payments are credited to income. Non-accrual loans may be restored to accrual status when principal and interest are brought current and full repayment is expected. Any loan that has
been restructured will remain in non-accrual status unless and until there has been six months of satisfactory performance by the borrower in accordance with the restructured terms of the loan, at which time the loan usually is returned to accrual
status. Interest income is recognized on the accrual basis for impaired loans not meeting the criteria for classification as non-accrual loans.

Other Non-Performing Assets. Other non-performing assets consist of real properties that have been acquired on or in lieu of foreclosure of non-performing loans (which are commonly referred to as
other real estate owned or OREO).

The following table sets forth information regarding nonaccrual
loans and other real estate owned (which, together, comprise our nonperforming assets), and restructured loans, at September 30, 2010 and December 31, 2009:



|                                                       |  |                      |        |  |                     |   |        | 
|------------------------------------------------------ |  | -------------------- | ------ |  | ------------------- | - | ------ | 
|                                                       |  | AtSeptember 30, 2010 |        |  | AtDecember 31, 2009 |  
|Nonaccrual loans:                                      |  |                      |        |  |                     |   |        | 
|Commercial loans                                       |  | $                    | 9,414  |  |                     | $ | 17,150 | 
|Commercial real estate                                 |  |                      | 16,591 |  |                     |   | 20,779 | 
|Residential real estate                                |  |                      | 8,408  |  |                     |   | 1,358  | 
|Construction and land development                      |  |                      | 9,398  |  |                     |   | 10,162 | 
|Consumer loans                                         |  |                      | 128    |  |                     |   |       | 
|                                                       |  |                      |        |  |                     |   |        | 
|Total nonaccrual loans                                 |  |                      | 43,939 |  |                     |   | 49,449 | 
|                                                       |  |                      |        |  |                     |   |        | 
|Other real estate owned (OREO):                        |  |                      |        |  |                     |   |        | 
|Commercial loans                                       |  |                      | 4,146  |  |                     |   |       | 
|Commercial real estate                                 |  |                      | 5,018  |  |                     |   |       | 
|Construction and land development                      |  |                      | 12,295 |  |                     |   | 10,712 | 
|                                                       |  |                      |        |  |                     |   |        | 
|Total other real estate owned                          |  |                      | 21,459 |  |                     |   | 10,712 | 
|                                                       |  |                      |        |  |                     |   |        | 
|Total nonperforming assets                             |  | $                    | 65,398 |  |                     | $ | 60,161 | 
|                                                       |  |                      |        |  |                     |   |        | 
|Restructured loans:                                    |  |                      |        |  |                     |   |        | 
|Accruing loans                                         |  | $                    | 1,200  |  |                     | $ | 1,243  | 
|Nonaccruing loans (included in nonaccrual loans above) |  |                      | 15,433 |  |                     |   | 20,114 | 
|                                                       |  |                      |        |  |                     |   |        | 
|Total Restructured Loans                               |  | $                    | 16,633 |  |                     | $ | 21,357 | 
|                                                       |  |                      |        |  |                     |   |        | 

As the above table indicates, other real estate owned increased by $10.8 million, from $10.7 million to
$21.5 million, and nonaccrual loans decreased by $5.5 million, or 11.1%, from $49.4 million to $43.9 million, during the nine months ended September 30, 2010. The increase in other real estate owned was attributable to our
acquisition, by or in lieu of foreclosure, of four real properties that had collateralized loans which had previously been classified as nonaccrual loans. The acquisition of these properties also accounts for the $5.5 million decrease in nonaccrual
loans. We have established specific reserves to provide for any losses that we may incur on the real properties that were classified as other real estate owned and on the loans that were classified as nonaccrual loans during the nine months ended
September 30, 2010.



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Information
Regarding Impaired Loans. A loan is deemed impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. At September 30,
2010, there were $44.9 million of loans deemed impaired, as compared to $57.4 million at December 31, 2009. We had an average investment in impaired loans for the nine months ended September 30, 2010 of $48.6 million as
compared to $52.3 million for the year ended December 31, 2009. The interest that would have been earned during the three months ended September 30, 2010 had the impaired loans remained current in accordance with their original terms
was $683,000.

The following table sets forth (i) the amounts of impaired loans for which there were related reserves for
loan losses determined in accordance with ASC 310-10, (ii) the amounts of those reserves, and (iii) the amounts of impaired loans for which there were no reserves for loan losses, in each case as of September 30, 2010 and
December 31, 2009:



|                                |  |                    |        |  |                       |   |       |                            |  |  |               |   |  |                       |        |  |                            |   |       |  |  |  |      |  
|------------------------------- |  | ------------------ | ------ |  | --------------------- | - | ----- | -------------------------- |  |  | ------------- | - |  | --------------------- | ------ |  | -------------------------- | - | ----- |  |  |  | ---- | -
|                                |  | September 30, 2010 |        |  | December 31, 2009     |  
|                                |  | ImpairedLoans      |        |  | Reservefor LoanLosses |   |       | Percent ofReserves toLoans |  |  | ImpairedLoans |   |  | Reservefor LoanLosses |        |  | Percent ofReserves toLoans |  
|Impaired loans with reserves    |  | $                  | 25,247 |  |                       | $ | 9,726 |                            |  |  | 38.5          | % |  | $                     | 28,237 |  |                            | $ | 4,779 |  |  |  | 16.9 | %
|Impaired loans without reserves |  |                    | 19,648 |  |                       |   |      |                            |  |  |              |   |  |                       | 29,152 |  |                            |   |      |  |  |  |     |  
|                                |  |                    |        |  |                       |   |       |                            |  |  |               |   |  |                       |        |  |                            |   |       |  |  |  |      |  
|Total impaired loans            |  | $                  | 44,895 |  |                       | $ | 9,726 |                            |  |  | 21.7          | % |  | $                     | 57,389 |  |                            | $ | 4,779 |  |  |  | 8.3  | %
|                                |  |                    |        |  |                       |   |       |                            |  |  |               |   |  |                       |        |  |                            |   |       |  |  |  |      |  

Allowance for Loan Losses. The allowance for loan losses (the Allowance) at
September 30, 2010 was $23.3 million, which represented approximately 3.06% of the loans outstanding at September 30, 2010, as compared to $20.3 million, or 2.44%, of the loans outstanding at December 31, 2009.

The adequacy of the Allowance is determined through periodic evaluations of the loans in our loan portfolio and other factors that can
reasonably be expected to affect the ability of borrowers to meet their loan obligations. However, those factors are inherently subjective as the evaluation process calls for various significant estimates and assumptions, including, among others,
estimates of the amounts and timing of expected future cash flows of borrowers of, and the fair value of collateral on, the loans, estimates of loan losses determined on the basis of historical loss experience and industry loss factors, and
assessments of various qualitative factors. Moreover, those estimates and assessments are subject to risks and uncertainties and future events that are outside of our control, which could cause the performance of our loan portfolio to differ,
possibly significantly, from the performance expected on the basis of those estimates and assessments and, therefore, could require us to increase the Allowance in future periods.

The Allowance is first determined by assigning reserve ratios for all loans. All non-accrual loans and other loans classified as
special mention, substandard or doubtful (classified loans or classification categories) are then assigned certain allocations according to type of loans, with greater reserve ratios or
percentages applied to loans deemed to be of a higher risk. These ratios are determined based on prior loss history and industry guidelines and loss factors, by loan category, adjusted for current economic factors and trends.

On a quarterly basis, we utilize a classification migration model and individual loan review and analytical tools as starting points for
determining the adequacy of the Allowance. Our loss migration analysis tracks a number of quarters of loan loss history and industry loss factors to determine historical losses by classification category for each loan type, except certain loans
(automobile, mortgage and credit cards), which are analyzed as homogeneous loan pools. These calculated loss factors are then applied to outstanding loan balances. We also conduct individual loan review analysis, as part of the Allowance allocation
process, applying specific monitoring policies and procedures in analyzing the existing loan portfolio.



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In determining whether
and the extent to which we will make adjustments to our loan loss migration model for purposes of determining the Allowance, we also consider a number of qualitative factors that can affect the performance and the collectability of the loans in our
loan portfolio. Such qualitative factors include:



| |  |  | The effects of changes that we may make in our loan policies or underwriting standards on the quality of the loans and the risks in our loan
portfolios;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Trends and changes in local, regional and national economic conditions, as well as changes in industry specific conditions, and any other reasonably
foreseeable events that could affect the performance or the collectability of the loans in our loan portfolios;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Material changes that may occur in the mix or in the volume of the loans in our loan portfolios that could alter, whether positively or negatively, the
risk profile of those portfolios;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in management or loan personnel or other circumstances that could, either positively or negatively, impact the application of our loan
underwriting standards, the monitoring of nonperforming loans or our loan collection efforts;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in the concentration of risk in the loan portfolio; and
| | - |  | ---------------------------------------------------------------



| |  |  | External factors that, in addition to economic conditions, can affect the ability of borrowers to meet their loan obligations, such as fires,
earthquakes and terrorist attacks.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Determining the effects that these qualitative factors may have on the
performance of our loan portfolio requires numerous judgments, assumptions and estimates about conditions, trends and events which may subsequently prove to have been incorrect due to circumstances outside of our control. Moreover, the effects of
qualitative factors such as these on the performance of our loan portfolios are often difficult to quantify. As a result, we may sustain loan losses in any particular period that are sizable in relation to the Allowance or that may even exceed the
Allowance.

In response to the economic recession, which has resulted in increased and relatively persistent high rates of
unemployment, and the credit crisis that has led to a severe tightening in the availability of credit, preventing borrowers from refinancing their loans, we have (i) implemented more stringent loan underwriting standards, (ii) strengthened
loan underwriting and approval processes and (iii) added personnel with experience in addressing problem assets and collecting non-performing loans.



41



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The following table
compares the total amount of loans outstanding, and the allowance for loan losses, by loan category, in each case, in thousands of dollars, and certain related ratios, as of September 30, 2010 and December 31, 2009.



|                                              |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|--------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | ------------------------------------- |  | - | ------- | --
|                                              |  |                    |         |   |                   |   |         | Increase (Decrease)                   | 
|                                              |  | September 30, 2010 |         |   | December 31, 2009 |   |         | December 31, 2009to September 30,2010 | 
|Commercial loans                              |  | $                  | 224,421 |   |                   | $ | 290,406 |                                       |  | $ | (65,985 | ) 
|Loans impaired(1)                             |  |                    | 9,663   |   |                   |   | 20,910  |                                       |  |   | (11,247 | ) 
|Loans 90 days past due                        |  |                    | 7,861   |   |                   |   | 13,158  |                                       |  |   | (5,297  | ) 
|Loans 30 days past due                        |  |                    | 1,296   |   |                   |   | 1,127   |                                       |  |   | 169     |   
|Allowance for loan losses                     |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|General component                             |  | $                  | 9,171   |   |                   | $ | 9,050   |                                       |  | $ | 121     |   
|Specific component(1)                         |  |                    | 4,451   |   |                   |   | 2,069   |                                       |  |   | 2,382   |   
|                                              |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|Total allowance                               |  | $                  | 13,622  |   |                   | $ | 11,119  |                                       |  | $ | 2,503   |   
|Ratio of allowance to loan category           |  |                    | 6.07    | % |                   |   | 3.83    | %                                     |  |   | 2.24    | % 
|Real estate loans:                            |  | $                  | 406,770 |   |                   | $ | 416,795 |                                       |  | $ | (10,025 | ) 
|Loans impaired(1)                             |  |                    | 16,591  |   |                   |   | 20,779  |                                       |  |   | (4,188  | ) 
|Loans 90 days past due                        |  |                    | 7,215   |   |                   |   | 11,230  |                                       |  |   | (4,015  | ) 
|Loans 30 days past due                        |  |                    | 4,648   |   |                   |   | 727     |                                       |  |   | 4,643   |   
|Allowance for loan losses                     |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|General component                             |  | $                  | 3,612   |   |                   | $ | 4,003   |                                       |  | $ | (391    | ) 
|Specific component(1)                         |  |                    | 4,596   |   |                   |   | 1,965   |                                       |  |   | 2,631   |   
|                                              |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|Total allowance                               |  | $                  | 8,208   |   |                   | $ | 5,968   |                                       |  | $ | 2,240   |   
|Ratio of allowance to loan category           |  |                    | 2.02    | % |                   |   | 1.43    | %                                     |  |   | 0.59    | % 
|Construction loans and land development       |  | $                  | 39,073  |   |                   | $ | 50,485  |                                       |  | $ | (11,412 | ) 
|Loans impaired(1)                             |  |                    | 9,837   |   |                   |   | 13,830  |                                       |  |   | (3,993  | ) 
|Loans 90 days past due                        |  |                    | 9,398   |   |                   |   | 5,373   |                                       |  |   | 4,025   |   
|Loans 30 days past due                        |  |                    |        |   |                   |   |        |                                       |  |   |        |   
|Allowance for loan losses                     |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|General component                             |  | $                  | 208     |   |                   | $ | 1,702   |                                       |  | $ | (1,494  | ) 
|Specific component(1)                         |  |                    | 436     |   |                   |   | 477     |                                       |  |   | (41     | ) 
|                                              |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|Total allowance                               |  | $                  | 644     |   |                   | $ | 2,179   |                                       |  | $ | (1,535  | ) 
|Ratio of allowance to loan category           |  |                    | 1.65    | % |                   |   | 4.32    | %                                     |  |   | (2.67   | )%
|Consumer loans and family mortgages           |  | $                  | 92,437  |   |                   | $ | 76,393  |                                       |  | $ | 16,044  |   
|Loans impaired(1)                             |  |                    | 8,804   |   |                   |   | 1,870   |                                       |  |   | 6,934   |   
|Loans 90 days past due                        |  |                    | 1,568   |   |                   |   | 87      |                                       |  |   | 1,481   |   
|Loans 30 days past due                        |  |                    | 286     |   |                   |   | 91      |                                       |  |   | 195     |   
|Allowance for loan losses                     |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|General component                             |  | $                  | 584     |   |                   | $ | 811     |                                       |  | $ | (227    | ) 
|Specific component(1)                         |  |                    | 243     |   |                   |   | 268     |                                       |  |   | (25     | ) 
|                                              |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|Total allowance                               |  | $                  | 827     |   |                   | $ | 1,079   |                                       |  | $ | (252    | ) 
|Ratio of allowance to loan category           |  |                    | 0.89    | % |                   |   | 1.41    | %                                     |  |   | (0.52   | )%
|Total loans outstanding                       |  | $                  | 762,701 |   |                   | $ | 834,079 |                                       |  | $ | (71,378 | ) 
|Loans impaired(1)                             |  |                    | 44,895  |   |                   |   | 57,389  |                                       |  |   | (12,494 | ) 
|Loans 90 days past due                        |  |                    | 26,042  |   |                   |   | 29,848  |                                       |  |   | (3,806  | ) 
|Loans 30 days past due                        |  |                    | 6,230   |   |                   |   | 1,945   |                                       |  |   | 5,007   |   
|Allowance for loan losses                     |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|General component                             |  | $                  | 13,575  |   |                   | $ | 15,566  |                                       |  | $ | (1,991  | ) 
|Specific component(1)                         |  |                    | 9,726   |   |                   |   | 4,779   |                                       |  |   | 4,947   |   
|                                              |  |                    |         |   |                   |   |         |                                       |  |   |         |   
|Total allowance                               |  | $                  | 23,301  |   |                   | $ | 20,345  |                                       |  | $ | 2,956   |   
|Ratio of allowance to total loans outstanding |  |                    | 3.06    | % |                   |   | 2.44    | %                                     |  |   | 0.62    | % 



|(1) | Amounts in impaired loans and in specific components include nonperforming delinquent loans.
|--- | --------------------------------------------------------------------------------------------



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Set forth below is a
summary, in thousands of dollars, of the transactions in the allowance for loan losses in the three and nine months ended September 30, 2010 and the year ended December 31, 2009:



|                                           |  |                                     |        |   |                                    |   |        |                             |  |   |         |  
|------------------------------------------ |  | ----------------------------------- | ------ | - | ---------------------------------- | - | ------ | --------------------------- |  | - | ------- | -
|                                           |  | Three MonthsEndedSeptember 30, 2010 |        |   | Nine MonthsEndedSeptember 30, 2010 |   |        | Year EndedDecember 31, 2009 | 
|Balance, beginning of period               |  | $                                   | 23,307 |   |                                    | $ | 20,345 |                             |  | $ | 15,453  |  
|Provision for loan losses                  |  |                                     | 1,688  |   |                                    |   | 7,488  |                             |  |   | 23,673  |  
|Recoveries on loans previously charged off |  |                                     | 845    |   |                                    |   | 2,086  |                             |  |   | 357     |  
|Amounts charged off                        |  |                                     | (2,539 | ) |                                    |   | (6,618 | )                           |  |   | (19,138 | )
|                                           |  |                                     |        |   |                                    |   |        |                             |  |   |         |  
|Balance, end of period                     |  | $                                   | 23,301 |   |                                    | $ | 23,301 |                             |  | $ | 20,345  |  
|                                           |  |                                     |        |   |                                    |   |        |                             |  |   |         |  

The table below sets forth loan delinquencies, by quarter, from September 30, 2010 to
September 30, 2009.



|                                        |  |                |        |  |           |   |        |            |  |   |               |  |  |                |        |  |  |   |        | 
|--------------------------------------- |  | -------------- | ------ |  | --------- | - | ------ | ---------- |  | - | ------------- |  |  | -------------- | ------ |  |  | - | ------ | 
|                                        |  | 2010           |        |  | 2009      |  
|                                        |  | AtSeptember 30 |        |  | AtJune 30 |   |        | AtMarch 31 |  |   | AtDecember 31 |  |  | AtSeptember 30 |       
|Loans Delinquent:                       |  |                |        |  |           |   |        |            |  |   |               |  |  |                |        |  |  |   |        | 
|90 days or more:                        |  |                |        |  |           |   |        |            |  |   |               |  |  |                |        |  |  |   |        | 
|Commercial loans                        |  | $              | 7,861  |  |           | $ | 5,588  |            |  | $ | 5,830         |  |  | $              | 13,158 |  |  | $ | 15,220 | 
|Commercial real estate                  |  |                | 1,123  |  |           |   | 3,834  |            |  |   | 9,481         |  |  |                | 10,550 |  |  |   | 10,049 | 
|Residential mortgages                   |  |                | 7,660  |  |           |   | 853    |            |  |   |              |  |  |                | 767    |  |  |   | 269    | 
|Construction and land development loans |  |                | 9,398  |  |           |   | 5,429  |            |  |   | 5,382         |  |  |                | 5,373  |  |  |   | 6,030  | 
|Consumer loans                          |  |                |       |  |           |   |       |            |  |   |              |  |  |                |       |  |  |   |       | 
|                                        |  |                |        |  |           |   |        |            |  |   |               |  |  |                |        |  |  |   |        | 
|                                        |  |                | 26,042 |  |           |   | 15,704 |            |  |   | 20,693        |  |  |                | 29,848 |  |  |   | 31,568 | 
|30-89 days:                             |  |                |        |  |           |   |        |            |  |   |               |  |  |                |        |  |  |   |        | 
|Commercial loans                        |  |                | 1,296  |  |           |   | 5,742  |            |  |   | 4,038         |  |  |                | 1,127  |  |  |   | 3,652  | 
|Commercial real estate                  |  |                | 4,648  |  |           |   | 3,380  |            |  |   | 10,963        |  |  |                | 726    |  |  |   | 364    | 
|Residential mortgages                   |  |                | 144    |  |           |   | 8,129  |            |  |   | 695           |  |  |                | 92     |  |  |   | 1,152  | 
|Construction and land development loans |  |                |       |  |           |   | 3,999  |            |  |   | 3,228         |  |  |                |       |  |  |   | 2,215  | 
|Consumer loans                          |  |                | 142    |  |           |   |       |            |  |   |              |  |  |                |       |  |  |   | 248    | 
|                                        |  |                | 6,230  |  |           |   | 21,250 |            |  |   | 18,924        |  |  |                | 1,945  |  |  |   | 7,631  | 
|                                        |  |                |        |  |           |   |        |            |  |   |               |  |  |                |        |  |  |   |        | 
|Total Past Due(1):                      |  | $              | 32,272 |  |           | $ | 36,954 |            |  | $ | 39,617        |  |  | $              | 31,793 |  |  | $ | 39,199 | 
|                                        |  |                |        |  |           |   |        |            |  |   |               |  |  |                |        |  |  |   |        | 



|(1) | Past due balances include nonaccrual loans.
|--- | -------------------------------------------

As indicated above, loans 90 days or more delinquent increased by $10.3 million, or 65.6%, to $26.0 million at September 30, 2010, from $15.7 million at June 30, 2010. That
increase was primarily attributable to the filing of bankruptcy by a group of related borrowers, which stayed the payment of principal and interest on their loans. We are currently seeking bankruptcy court approval to permit us to foreclose and take
possession of real properties collateralizing those loans so that we can dispose of those properties and, thereby, reduce our non-performing assets and recover some of the charge-offs that we have taken on those loans.

On the other hand, loans 30 to 89 days delinquent declined by $15.0 million, or 70.7%, to $6.2 million at September 30, 2010, down
from $21.3 million at June 30, 2010. As a result, total past due loans decreased $4.7 million, or 12.7%, to $32.3 million at September 30, 2010, from $37.0 million at June 30, 2010.



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Deposits

Average Balances of and Average Interest Rates Paid on Deposits.

Set forth below are the average amounts (in thousands of dollars) of, and the average rates paid on, deposits in the nine months ended
September 30, 2010:



|                                    |  |                                     |         |  |             |  |      |  
|----------------------------------- |  | ----------------------------------- | ------- |  | ----------- |  | ---- | -
|                                    |  | Nine Months EndedSeptember 30, 2010 |        
|                                    |  | AverageBalance                      |         |  | AverageRate | 
|Noninterest-bearing demand deposits |  | $                                   | 166,272 |  |             |  |     |  
|Interest-bearing checking accounts  |  |                                     | 40,770  |  |             |  | 0.69 | %
|Money market and savings deposits   |  |                                     | 132,150 |  |             |  | 1.17 | %
|Time deposits                       |  |                                     | 634,733 |  |             |  | 2.29 | %
|                                    |  |                                     |         |  |             |  |      |  
|Average total deposits              |  | $                                   | 973,925 |  |             |  | 1.68 | %
|                                    |  |                                     |         |  |             |  |      |  

Deposit Totals. Deposits totaled $955 million at September 30, 2010 as compared to
$960 million at December 31, 2009 and $858 million at September 30, 2009. The following table compares the mix of our deposits, as between lower cost core deposits and higher cost time deposits, at September 30, 2010,
December 31, 2009 and September 30, 2009, respectively:



|                                                        |  |                        |         |  |                         |  |       |                       |  |   |                         |  |  |         |       |   |                         |   |         |  |  |  |       |  
|------------------------------------------------------- |  | ---------------------- | ------- |  | ----------------------- |  | ----- | --------------------- |  | - | ----------------------- |  |  | ------- | ----- | - | ----------------------- | - | ------- |  |  |  | ----- | -
|                                                        |  | At September 30, 2010  |         |  | At December 31, 2009    |  |       | At September 30, 2009 | 
|                                                        |  | Amounts                |         |  | Percent ofTotalDeposits |  |       | Amounts               |  |   | Percent ofTotalDeposits |  |  | Amounts |       |   | Percent ofTotalDeposits |  
|                                                        |  | (Dollars in thousands) |        
|Core deposits                                           |  |                        |         |  |                         |  |       |                       |  |   |                         |  |  |         |       |   |                         |   |         |  |  |  |       |  
|Non-interest bearing demand deposits                    |  | $                      | 186,550 |  |                         |  | 19.5  | %                     |  | $ | 183,789                 |  |  |         | 19.1  | % |                         | $ | 179,270 |  |  |  | 20.9  | %
|Savings and other interest-bearing transaction deposits |  |                        | 168,189 |  |                         |  | 17.6  | %                     |  |   | 154,968                 |  |  |         | 16.2  | % |                         |   | 129,483 |  |  |  | 15.1  | %
|Time deposits                                           |  |                        | 599,919 |  |                         |  | 62.9  | %                     |  |   | 621,681                 |  |  |         | 64.7  | % |                         |   | 548,785 |  |  |  | 64.0  | %
|                                                        |  |                        |         |  |                         |  |       |                       |  |   |                         |  |  |         |       |   |                         |   |         |  |  |  |       |  
|Total deposits                                          |  | $                      | 954,658 |  |                         |  | 100.0 | %                     |  | $ | 960,438                 |  |  |         | 100.0 | % |                         | $ | 857,538 |  |  |  | 100.0 | %
|                                                        |  |                        |         |  |                         |  |       |                       |  |   |                         |  |  |         |       |   |                         |   |         |  |  |  |       |  

As indicated in the above table, savings and other interest-bearing deposits increased to 17.6% of total
deposits at September 30, 2010, from 16.2% of total deposits at December 31, 2009, while time deposits, which bear higher rates of interest than our core deposits, decreased to 62.9% of total deposits at September 30, 2010 from 64.7%
of total deposits at December 31, 2009. That change in the mix of deposits contributed to an improvement in our net interest income and net interest margin in this years third quarter and nine months year-to-date, as compared to the same
period of 2009. See Results of OperationsNet Interest Incomeabove in this Section of this Report.

Set forth below, in thousands of dollars, is a maturity schedule of domestic time certificates of deposit outstanding at September 30, 2010:



|                                     |  |                                      |         |  |                                            |   |         | 
|------------------------------------ |  | ------------------------------------ | ------- |  | ------------------------------------------ | - | ------- | 
|                                     |  | At September 30, 2010                |        
|                                     |  | Certificates ofDeposit under$100,000 |         |  | Certificates ofDeposit of $100,000 or More |  
|Maturities                           |  |                                      |         |  |                                            |   |         | 
|Three months or less                 |  | $                                    | 29,685  |  |                                            | $ | 191,607 | 
|Over three and through twelve months |  |                                      | 69,957  |  |                                            |   | 214,093 | 
|Over twelve months                   |  |                                      | 26,010  |  |                                            |   | 68,567  | 
|                                     |  |                                      |         |  |                                            |   |         | 
|Total certificates of deposit        |  | $                                    | 125,652 |  |                                            | $ | 474,267 | 
|                                     |  |                                      |         |  |                                            |   |         | 



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Liquidity

We actively manage our liquidity needs to ensure that sufficient funds are available to meet our needs for cash, including to fund new
loans to and deposit withdrawals by our customers. We project the future sources and uses of funds and maintain liquid funds for unanticipated events. Our primary sources of cash include cash we have on deposit at other financial institutions,
payments on loans, proceeds from the sale or maturity of securities, and from sales of residential mortgage loans, increases in deposits and increases in borrowings principally from the Federal Home Loan Bank. The primary uses of cash include
funding new loans and making advances on existing lines of credit, purchasing investments, including securities available for sale, funding new residential mortgage loans, funding deposit withdrawals and paying operating expenses. We maintain funds
in overnight federal funds and other short-term investments to provide for short-term liquidity needs. We also have obtained credit lines from the Federal Home Loan Bank and other financial institutions to meet any additional liquidity requirements.

Our liquid assets, which included cash and due from banks, federal funds sold, interest earning deposits with financial
institutions and unpledged securities available for sale (excluding Federal Reserve Bank and Federal Home Loan Bank stock) totaled $237 million, which represented 21% of total assets, at September 30, 2010.

Cash Flow Used in Operating Activities. Although we incurred a net loss of nearly $12.0 million in the nine months ended
September 30, 2010, $10.1 million of that loss represented non-cash charges to the provision for income taxes to increase the valuation allowance for our deferred tax assets. See Critical Accounting Policies  Deferred Tax
Assets above in this Section of this Report. Consequently, during the nine months ended 30, 2010 we used net cash of $15 million from operating activities primarily to fund the origination of $154 million of mortgage loans,
substantially offset by $144 million from the cash proceeds provided by sales of mortgage loans.

Cash Flow Provided by
Investing Activities. In the nine months ended September 30, 2010, investing activities provided net cash of $120 million, primarily attributable to $227 million of proceeds from sales of securities available for sale and
$68 million of loan repayments, partially offset by $195 million of purchases of securities available for sale.

Cash Flow Used by Financing Activities. In the nine months ended September 30, 2010, we used net cash of $41 million in
financing activities, primarily to fund a net decrease of $40 million in borrowings and a $5.8 million decrease in deposits, partially offset by $4.6 million of proceeds from our private placement of Series A Shares, which was
completed in August 2010.

Ratio of Loans to Deposits. The relationship between gross loans and total deposits can
provide a useful measure of a banks liquidity. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan-to-deposit ratio the less liquid are our assets. On the other
hand, since we realize greater yields on loans than we do on investments, a lower loan-to-deposit ratio can adversely affect interest income and earnings. As a result, our goal is to achieve a loan-to-deposit ratio that appropriately balances the
requirements of liquidity and the need to generate a fair return on our assets. At September 30, 2010 and December 31, 2009, the loan-to-deposit ratios were 80% and 86%, respectively. The reduction in that ratio at September 30, 2010,
as compared to December 31, 2009, was primarily attributable to a decline in loan demand from qualified borrowers due, we believe, to the sluggishness of the economic recovery, and the uncertainties about the future prospects for the economy,
which has led many prospective borrowers to curtail expansion and their spending and, hence, their need for loans.

Off Balance Sheet
Arrangements

Loan Commitments and Standby Letters of Credit. In order to meet the financing needs of our customers,
in the normal course of business we make commitments to extend credit and issue standby commercial letters of credit to or for our customers. At September 30, 2010 and December 31, 2009, we were committed to fund certain loans, including
letters of credit, amounting to approximately $174 million and $184 million, respectively.

Commitments to extend
credit and standby letters of credit generally have fixed expiration dates or other termination clauses and the customer may be required to pay a fee and meet other conditions in order to draw on those commitments or standby letters of credit. We
expect, based on historical experience, that many of the commitments will expire without being drawn upon and, therefore, the total commitment amounts do not necessarily represent future cash requirements.



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To varying degrees,
commitments to extend credit involve elements of credit and interest rate risk for us that are in excess of the amounts recognized in our balance sheets. Our maximum exposure to credit loss in the event of nonperformance by the customers to whom
such commitments are made could potentially be equal to the amount of those commitments. As a result, before making such a commitment to a customer, we evaluate the customers creditworthiness using the same underwriting standards that we would
apply if we were approving loans to the customer. In addition, we often require the customer to secure its payment obligations for amounts drawn on such commitments with collateral such as accounts receivable, inventory, property, plant and
equipment, income-producing commercial properties, residential properties and properties under construction. As a consequence, our exposure to credit and interest rate risk on such commitments is not different in character or amount than risks
inherent in the outstanding loans in our loan portfolio.

Standby letters of credit are conditional commitments issued by the
Bank to guarantee a payment obligation of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

We believe that our cash and cash equivalent resources, together with available borrowings under our credit facilities, will be
sufficient to enable us to meet any increases in demand for loans or in the utilization of outstanding loan commitments or standby letters of credit and any increase in deposit withdrawals that might occur in the foreseeable future.

Contractual Obligations

Borrowings. As a source of additional funds that we have used primarily to fund loans and to purchase other interest earning
assets, and to provide us with a supplemental source of liquidity, we have obtained long and short term borrowings from the Federal Home Loan Bank (the FHLB). As of September 30, 2010, our outstanding FHLB borrowings totaled
$101 million, comprised of (i) $53 million of long-term borrowings, with maturities ranging from November 2011 to August 2013, and (ii) $48 million of short-term borrowings, with maturities ranging from
November 2010 to August 2011. These borrowings, together with securities sold under agreements to repurchase, have a weighted-average annualized interest rate of 1.43%. By comparison, as of December 31, 2009, our outstanding FHLB
borrowings totaled $141 million, comprised of (i) $14 million of long-term borrowings and (ii) $127 million of short-term borrowings which, together with the securities sold under agreements to repurchase, had a
weighted-average annualized interest rate of 3.65%.

At September 30, 2010, U.S. agency and mortgage backed securities,
U.S. Government agency securities and collateralized mortgage obligations with an aggregate fair market value of $26.6 million and $138 million of residential mortgage and other real estate secured loans were pledged to secure these
Federal Home Loan Bank borrowings, repurchase agreements, local agency deposits, and treasury, tax and loan accounts.

The
highest amount of borrowings that were outstanding at any month-end during the nine months ended September 30, 2010 consisted of $132 million of FHLB borrowings and $11.8 million of overnight borrowings in the form of securities sold under
repurchase agreements. During 2009, the highest amount of borrowings outstanding at any month-end consisted of $208 million of FHLB borrowings and $13 million of overnight borrowings in the form of securities sold under repurchase
agreements.

Junior Subordinated Debentures. Pursuant to rulings of the Federal Reserve Board, bank holding companies
were permitted to issue long term subordinated debt instruments that, subject to certain conditions, would qualify as and, therefore, augment capital for regulatory purposes. At September 30, 2010, we had outstanding approximately
$17.5 million principal amount of 30-year junior subordinated floating rate debentures (the Debentures), of which $16.8 million qualified as Tier 1 capital for regulatory purposes as of September 30, 2010. See discussion
below under the subcaption Capital Resources-Regulatory Capital Requirements.



46



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Set forth below is
certain information regarding the Debentures:



|                      |  |                  |        |  |                |                  |                   |  |                | 
|--------------------- |  | ---------------- | ------ |  | -------------- | ---------------- | ----------------- |  | -------------- | 
|Original Issue Dates: |  | Principal Amount |        |  | Interest Rates |                  | Maturity Dates(1) | 
|September 2002        |  | $                | 7,217  |  |                | Libor plus 3.40% |                   |  | September 2030 | 
|October 2004          |  |                  | 10,310 |  |                | Libor plus 2.00% |                   |  | October 2034   | 
|                      |  |                  |        |  |                |                  |                   |  |                | 
|Total                 |  | $                | 17,527 |  |                |                  |                   |  |                | 
|                      |  |                  |        |  |                |                  |                   |  |                | 



|(1) | Subject to the receipt of prior regulatory approval, we may redeem the Debentures, in whole or in part, without premium or penalty, at any time prior to maturity.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

Interest on the Debentures is payable quarterly. However, subject to certain conditions, we have the right to
defer those interest payments for up to five years.

As previously reported, in July 2009, we entered into a Memorandum of
Understanding (an MOU) with the FRB and the DFI which, among other things, required us to obtain prior regulatory approval to pay interest on the Debentures. During the quarter ended September 30, 2010, we were advised by the FRB
that it would not approve the payments of interest on the Debentures scheduled to be made on June 24 and July 19, 2010. As a result, we exercised our right, pursuant to the terms of the Debentures, to defer those interest payments. In
August 2010, the Company entered into a Written Agreement with the Federal Reserve Bank (the FRB Agreement) which, among other things, continues the restriction requiring us to obtain the prior approval of the Federal Reserve Bank to pay
interest on the Debentures. Consequently, we expect that it will be necessary for us to exercise our deferral right with respect to subsequent interest payments on the Debentures at least until such time as we are able to return to profitability.
Since we have the right, under the terms of the Debentures to defer interest payments for up to five years, the deferral of the June and July 2010 interest payments did not constitute a default under or with respect to the Debentures. Information
regarding the FRB Agreement and a companion regulatory order issued by the DFI (the DFI Order), and the requirements and restrictions imposed on us by the FRB Agreement and the DFI Order, is set forth below under the subcaption
Capital ResourcesAdditional Capital Requirements Imposed by FRB Agreement and DFI Order and in the Section entitled Risk Factors contained in Item 1A of Part II of this Report.

Investment Policy and Securities Available for Sale

Our investment policy is designed to provide for our liquidity needs and to generate a favorable return on investments without undue interest rate risk, credit risk or asset concentrations.

Our investment policy:



| |  |  | authorizes us to invest in obligations issued or fully guaranteed by the United States Government, certain federal agency obligations, time deposits
issued by federally insured depository institutions, municipal securities and in federal funds sold;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provides that the aggregate weighted average life of U.S. Government obligations and federal agency securities exclusive of variable rate securities
cannot, without approval by the Board of Directors, exceed 10 years and municipal obligations cannot exceed 25 years;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provides that time deposits must be placed with federally insured financial institutions, cannot exceed the current federally insured amount in any one
institution and may not have a maturity exceeding 60 months, unless that time deposit is matched to a liability instrument issued by the Bank; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | prohibits engaging in securities trading activities.
| | - |  | ----------------------------------------------------

Securities available for sale are those that we intend to hold for an indefinite period of time, but which may be sold in response to changes in liquidity needs, changes in interest rates, changes in
prepayment risks or other similar factors. Such securities are recorded at fair value. Any unrealized gains and losses are reported as Other Comprehensive Income (Loss) rather than included in or deducted from earnings.



47



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The following is a
summary of the major components of securities available for sale and a comparison of the amortized cost, estimated fair values and gross unrealized gains and losses, in thousands of dollars, as of September 30, 2010 and December 31, 2009:



|                                                                      |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|--------------------------------------------------------------------- |  | ------------- | ------- |  | ------------------- | - | --- | ------------------- |  | - | ------------------- | - |  | - | ------- | 
|                                                                      |  | AmortizedCost |         |  | GrossUnrealizedGain |   |     | GrossUnrealizedLoss |  |   | EstimatedFair Value |  
|September 30, 2010                                                    |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|Securities Available For Sale:                                        |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|US Treasury securities                                                |  | $             | 5,020   |  |                     | $ | 29  |                     |  | $ |                    |   |  | $ | 5,049   | 
|Mortgage-backed securities issued by US agencies                      |  |               | 94,210  |  |                     |   | 173 |                     |  |   | (164                | ) |  |   | 94,219  | 
|Collateralized mortgage obligations issued by US agencies             |  |               |        |  |                     |   |    |                     |  |   |                    |   |  |   |        | 
|                                                                      |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|Total securities issued or guaranteed by US government or US agencies |  |               | 99,230  |  |                     |   | 202 |                     |  |   | (164                | ) |  |   | 99,268  | 
|Municipal securities                                                  |  |               | 6,389   |  |                     |   | 103 |                     |  |   | (10                 | ) |  |   | 6,482   | 
|Non-agency collateralized mortgage obligations                        |  |               | 3,665   |  |                     |   | 29  |                     |  |   | (198                | ) |  |   | 3,496   | 
|Asset-backed securities                                               |  |               | 2,493   |  |                     |   |    |                     |  |   | (1,708              | ) |  |   | 785     | 
|Mutual fund                                                           |  |               | 3,336   |  |                     |   |    |                     |  |   |                    |   |  |   | 3,336   | 
|                                                                      |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|Total Securities Available For Sale                                   |  | $             | 115,113 |  |                     | $ | 334 |                     |  | $ | (2,080              | ) |  | $ | 113,367 | 
|                                                                      |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|December 31, 2009                                                     |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|Securities Available For Sale:                                        |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|US Treasury securities                                                |  | $             | 18,040  |  |                     | $ | 11  |                     |  | $ |                    |   |  | $ | 18,051  | 
|US agencies and mortgage-backed securities                            |  |               | 134,331 |  |                     |   | 89  |                     |  |   | (1,651              | ) |  |   | 132,769 | 
|Collateralized mortgage obligations                                   |  |               |        |  |                     |   |    |                     |  |   |                    |   |  |   |        | 
|                                                                      |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|Total government and agencies securities                              |  |               | 152,371 |  |                     |   | 100 |                     |  |   | (1,651              | ) |  |   | 150,820 | 
|Municipal securities                                                  |  |               | 10,545  |  |                     |   | 13  |                     |  |   | (431                | ) |  |   | 10,127  | 
|Non-agency collateralized mortgage obligations                        |  |               | 7,094   |  |                     |   | 10  |                     |  |   | (1,069              | ) |  |   | 6,035   | 
|Asset backed securities                                               |  |               | 2,704   |  |                     |   |    |                     |  |   | (1,732              | ) |  |   | 972     | 
|Mutual fund                                                           |  |               | 2,260   |  |                     |   |    |                     |  |   |                    |   |  |   | 2,260   | 
|                                                                      |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 
|Total Securities Available For Sale                                   |  | $             | 174,974 |  |                     | $ | 123 |                     |  | $ | (4,883              | ) |  | $ | 170,214 | 
|                                                                      |  |               |         |  |                     |   |     |                     |  |   |                     |   |  |   |         | 

At September 30, 2010, U.S. agencies and mortgage backed securities, U.S. Government agency securities,
collateralized mortgage obligations and time deposits with an aggregate fair market value of $35 million were pledged to secure Federal Home Loan Bank borrowings, repurchase agreements, local agency deposits, to secure lines of credit at our
correspondent banks and treasury, tax and loan accounts.

The amortized cost, at September 30, 2010, of securities
available for sale are shown, in thousands of dollars, in the following table, by contractual maturities and historical prepayments based on the prior three months of principal payments. Expected maturities will differ from contractual maturities
and historical prepayments, particularly with respect to collateralized mortgage obligations, because borrowers may react to interest rate market conditions differently than the historical prepayment rates.



|                                               |  |                                |       |  |                                |  |      |                                 |  |   |                      |  |  |           |      |   |                      |   |        |           |  |  |                      |   |  |           |        |  |                      |  |      |   |  |   |         |  |  |  |      |  
|---------------------------------------------- |  | ------------------------------ | ----- |  | ------------------------------ |  | ---- | ------------------------------- |  | - | -------------------- |  |  | --------- | ---- | - | -------------------- | - | ------ | --------- |  |  | -------------------- | - |  | --------- | ------ |  | -------------------- |  | ---- | - |  | - | ------- |  |  |  | ---- | -
|                                               |  | September 30, 2010 Maturing in |      
|                                               |  | One yearor less                |       |  | Over oneyear throughfive years |  |      | Over fiveyears throughten years |  |   | Over tenyears        |  |  | Total     |     
|                                               |  | BookValue                      |       |  | WeightedAverageYield           |  |      | BookValue                       |  |   | WeightedAverageYield |  |  | BookValue |      |   | WeightedAverageYield |   |        | BookValue |  |  | WeightedAverageYield |   |  | BookValue |        |  | WeightedAverageYield | 
|                                               |  | (Dollars in thousands)         |      
|Securities available for sale:                 |  |                                |       |  |                                |  |      |                                 |  |   |                      |  |  |           |      |   |                      |   |        |           |  |  |                      |   |  |           |        |  |                      |  |      |   |  |   |         |  |  |  |      |  
|US Treasury securities                         |  | $                              |      |  |                                |  |     |                                 |  | $ | 5,020                |  |  |           | 0.75 | % |                      | $ |       |           |  |  |                     |   |  | $         |       |  |                      |  |     |   |  | $ | 5,020   |  |  |  | 0.75 | %
|US agency/mortgage-backed securities           |  |                                | 5,133 |  |                                |  | 2.66 | %                               |  |   | 15,461               |  |  |           | 2.78 |   |                      |   | 15,582 |           |  |  | 2.91                 | % |  |           | 58,034 |  |                      |  | 2.93 | % |  |   | 94,210  |  |  |  | 2.89 |  
|Non-agency collateralized mortgage obligations |  |                                | 1,023 |  |                                |  | 2.79 |                                 |  |   |                     |  |  |           |     |   |                      |   | 1,675  |           |  |  | 3.46                 |   |  |           | 967    |  |                      |  | 3.90 |   |  |   | 3,665   |  |  |  | 3.39 |  
|Municipal securities                           |  |                                |      |  |                                |  |     |                                 |  |   |                     |  |  |           |     |   |                      |   | 1,348  |           |  |  | 4.10                 |   |  |           | 5,041  |  |                      |  | 4.29 |   |  |   | 6,389   |  |  |  | 4.25 |  
|Asset backed securities                        |  |                                |      |  |                                |  |     |                                 |  |   |                     |  |  |           |     |   |                      |   |       |           |  |  |                     |   |  |           | 2,493  |  |                      |  |     |   |  |   | 2,493   |  |  |  |     |  
|Mutual funds                                   |  |                                | 3,336 |  |                                |  | 3.30 |                                 |  |   |                     |  |  |           |     |   |                      |   |       |           |  |  |                     |   |  |           |       |  |                      |  |     |   |  |   | 3,336   |  |  |  | 3.30 |  
|                                               |  |                                |       |  |                                |  |      |                                 |  |   |                      |  |  |           |      |   |                      |   |        |           |  |  |                      |   |  |           |        |  |                      |  |      |   |  |   |         |  |  |  |      |  
|Total Securities Available for sale            |  | $                              | 9,492 |  |                                |  | 2.90 | %                               |  | $ | 20,481               |  |  |           | 2.28 | % |                      | $ | 18,605 |           |  |  | 3.05                 | % |  | $         | 66,535 |  |                      |  | 2.94 | % |  | $ | 115,113 |  |  |  | 2.84 | %
|                                               |  |                                |       |  |                                |  |      |                                 |  |   |                      |  |  |           |      |   |                      |   |        |           |  |  |                      |   |  |           |        |  |                      |  |      |   |  |   |         |  |  |  |      |  



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The table below shows,
as of September 30, 2010, the gross unrealized losses and fair values (in thousands of dollars) of our investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss
position.



|                                               |  |                                                          |        |  |                   |   |      |            |  |   |                |  |  |            |        |   |                |   |        |  |  |   |        |  
|---------------------------------------------- |  | -------------------------------------------------------- | ------ |  | ----------------- | - | ---- | ---------- |  | - | -------------- |  |  | ---------- | ------ | - | -------------- | - | ------ |  |  | - | ------ | -
|                                               |  | Securities With Unrealized Loss as of September 30, 2010 |       
|                                               |  | Less than 12 months                                      |        |  | 12 months or more |   |      | Total      | 
|(Dollars In thousands)                         |  | Fair Value                                               |        |  | UnrealizedLoss    |   |      | Fair Value |  |   | UnrealizedLoss |  |  | Fair Value |        |   | UnrealizedLoss |  
|US agency mortgage backed securities           |  | $                                                        | 37,509 |  |                   | $ | (160 | )          |  | $ | 484            |  |  | $          | (4     | ) |                | $ | 37,993 |  |  | $ | (164   | )
|Municipal securities                           |  |                                                          |       |  |                   |   |     |            |  |   | 460            |  |  |            | (10    | ) |                |   | 460    |  |  |   | (10    | )
|Non-agency collateralized mortgage obligations |  |                                                          |       |  |                   |   |     |            |  |   | 2,444          |  |  |            | (198   | ) |                |   | 2,444  |  |  |   | (198   | )
|Asset backed securities                        |  |                                                          |       |  |                   |   |     |            |  |   | 785            |  |  |            | (1,708 | ) |                |   | 785    |  |  |   | (1,708 | )
|                                               |  |                                                          |        |  |                   |   |      |            |  |   |                |  |  |            |        |   |                |   |        |  |  |   |        |  
|Total temporarily impaired securities          |  | $                                                        | 37,509 |  |                   | $ | (160 | )          |  | $ | 4,173          |  |  | $          | (1,920 | ) |                | $ | 41,682 |  |  | $ | (2,080 | )
|                                               |  |                                                          |        |  |                   |   |      |            |  |   |                |  |  |            |        |   |                |   |        |  |  |   |        |  

We regularly monitor investments for significant declines in fair value. In our judgment, the declines in
the fair values of these investments below their amortized costs, as set forth in the table above, are temporary, based on the following factors: (i) those declines are due to interest rate changes and not due to a deterioration in the
creditworthiness of the issuers of those investment securities, and (ii) we have the ability to hold those securities until there is a recovery in their values or until their maturity.

Capital Resources

Capital Regulatory Requirements Applicable to Banking
Institutions.

Under federal banking regulations that apply to all United States based bank holding companies and federally
insured banks, the Company (on a consolidated basis) and the Bank (on a stand-alone basis) must meet specific capital adequacy requirements that, for the most part, involve quantitative measures, primarily in terms of the ratios of their capital to
their assets, liabilities, and certain off-balance sheet items, calculated under regulatory accounting practices. Under those regulations, which are based primarily on those quantitative measures, each bank holding company must meet a minimum
capital ratio and each federally insured bank is determined by its primary federal bank regulatory agency to come within one of the following categories.



| |  |  | well capitalized
| | - |  | ----------------



| |  |  | adequately capitalized
| | - |  | ----------------------



| |  |  | undercapitalized
| | - |  | ----------------



| |  |  | significantly undercapitalized; or
| | - |  | ----------------------------------



| |  |  | critically undercapitalized
| | - |  | ---------------------------

Certain qualitative assessments also are made by a banking institutions primary federal regulatory agency that could lead the agency to determine that a banking institution should be assigned to a
lower capital category than the one indicated by the quantitative measures used to assess the institutions capital adequacy. At each successive lower capital category, a banking institution is subject to greater operating restrictions and
increased regulatory supervision by its federal bank regulatory agency.



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The following table
sets forth the capital and capital ratios of the Company (on a consolidated basis) and the Bank (on a stand-alone basis) at September 30, 2010, as compared to the respective regulatory requirements applicable to them.



|                                        |  |        |        |  |                                           |  |      |                                   |  |   |        |  |  |        |              |   |       |   |        |  |  |  |               |  
|--------------------------------------- |  | ------ | ------ |  | ----------------------------------------- |  | ---- | --------------------------------- |  | - | ------ |  |  | ------ | ------------ | - | ----- | - | ------ |  |  |  | ------------- | -
|                                        |  |        |        |  | Applicable Federal Regulatory Requirement | 
|                                        |  | Actual |        |  | Capital Acquacy Purposes                  |  |      | To be Categorized WellCapitalized | 
|                                        |  | Amount |        |  | Ratio                                     |  |      | Amount                            |  |   | Ratio  |  |  | Amount |              |   | Ratio |  
|Total Capital to Risk Weighted Assets:  |  |        |        |  |                                           |  |      |                                   |  |   |        |  |  |        |              |   |       |   |        |  |  |  |               |  
|Company                                 |  | $      | 96,737 |  |                                           |  | 11.5 | %                                 |  | $ | 67,389 |  |  |        | At least 8.0 | % |       |   | N/A    |  |  |  | N/A           |  
|Bank                                    |  |        | 93,132 |  |                                           |  | 11.1 | %                                 |  |   | 67,334 |  |  |        | At least 8.0 | % |       | $ | 84,167 |  |  |  | At least 10.0 | %
|Tier 1 Capital to Risk Weighted Assets: |  |        |        |  |                                           |  |      |                                   |  |   |        |  |  |        |              |   |       |   |        |  |  |  |               |  
|Company                                 |  | $      | 86,047 |  |                                           |  | 10.2 | %                                 |  | $ | 33,694 |  |  |        | At least 4.0 | % |       |   | N/A    |  |  |  | N/A           |  
|Bank                                    |  |        | 82,450 |  |                                           |  | 9.8  | %                                 |  |   | 33,667 |  |  |        | At least 4.0 | % |       | $ | 50,500 |  |  |  | At least 6.0  | %
|Tier 1 Capital to Average Assets:       |  |        |        |  |                                           |  |      |                                   |  |   |        |  |  |        |              |   |       |   |        |  |  |  |               |  
|Company                                 |  | $      | 86,047 |  |                                           |  | 7.4  | %                                 |  | $ | 46,598 |  |  |        | At least 4.0 | % |       |   | N/A    |  |  |  | N/A           |  
|Bank                                    |  |        | 82,450 |  |                                           |  | 7.1  | %                                 |  |   | 46,492 |  |  |        | At least 4.0 | % |       | $ | 58,115 |  |  |  | At least 5.0  | %

At September 30, 2010
the Bank (on a stand-alone basis) continued to qualify as a well-capitalized institution, and the Company continued to exceed the minimum required capital ratios, under the capital adequacy guidelines described above.

The consolidated total capital and Tier 1 capital of the Company, at September 30, 2010, include an aggregate of
$16.8 million principal amount of Junior Subordinated Debentures that we issued in 2002 and 2004. We contributed that amount to the Bank over a six year period ended December 31, 2009, thereby providing it with additional cash to fund the
growth of its banking operations and, at the same time, to increase its total capital and Tier 1 capital.

Additional Capital Requirements under FRB Agreement and DFI Order.

On August 31, 2010, the members of the respective Boards of Directors of the Company and the Bank entered into the FRB Agreement and
the Bank consented to the issuance of the DFI Order. The principal purposes of the FRB Agreement and the DFI Order, which constitute formal supervisory actions by the FRB and the DFI, are to require us to adopt and implement formal plans and take
certain actions, as well as to continue implementing measures that we previously adopted, to address the adverse consequences that the economic recession has had on the performance of our loan portfolio and our operating results and to increase our
capital to strengthen our ability to weather any further adverse conditions that might arise if the improvement in the economy does not materialize or remains sluggish.

The Agreement and Order contain substantially similar provisions. They require the Boards of Directors of the Company and the Bank to prepare and submit written plans to the FRB and the DFI that address a
number of matters, including improving the Banks position with respect to problem assets, maintaining adequate reserves for loan and lease losses in accordance with applicable supervisory guidelines, and improving the capital position of the
Bank and, in the case of the FRB Agreement, the capital position of the Company. The Bank is also prohibited from paying dividends to the Company without the prior approval of the DFI, and without the prior approval of the FRB the Company may not
declare or pay cash dividends, repurchase any of its shares, make interest or principal payments on its Debentures or incur or guarantee any debt.

Under the FRB Agreement, the Company also must submit a capital plan to the FRB that will meet with its approval and then implement that plan. Under the DFI Order, the Bank is required to achieve a ratio
of adjusted tangible shareholders equity to its tangible assets to 9.0% by January 31, 2011, by raising additional capital, generating earnings or reducing the Banks tangible assets (subject to a 15% limitation on such a reduction)
or a combination thereof and, upon achieving that ratio, to thereafter maintain that ratio during the term of the Order. At September 30, 2010, the Banks ratio of adjusted tangible shareholders equity to tangible assets was 7.1%.

We have begun taking steps to meet the requirements of the FRB Agreement and the DFI Order, including the preparation of a
capital augmentation plan for submission to the FRB and we are actively exploring alternatives for raising additional capital to meet the capital requirements of the DFI Order. However, no assurance can be given that we will be able to meet those
requirements. Moreover, even if we succeed in raising such capital, doing so may be dilutive of the share ownership of our existing shareholders. See Risk Factors in Item 1A of Part II of this Report below.



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Sale of Series A
Convertible 10% Cumulative Preferred Stock. As previously reported in a Current Report filed with the SEC on Form 8-K dated October 6, 2009, we commenced a private placement to a limited number of accredited investors (as defined in
Regulation D under the Securities Act of 1933, as amended) of a new issue of Series A Convertible 10% Cumulative Preferred Stock (the Series A Shares), at $100 per Series A Share. We sold a total of 126,550 Series A Shares, raising gross
proceeds of $12.655 million, in the private placement, which we concluded in August 2010. We are using the net proceeds from the sale of the Series A Shares for general corporate purposes, which included a $7 million capital
contribution by us to the Bank in order to increase its equity capital and to provide it with cash to fund additional loans and other interest-earning assets and meet working capital requirements.

Dividends cumulate on the Series A Shares at a rate of 10% per annum and, at September 30, 2010, accumulated but unpaid
dividends on the Series A Shares totaled $815,000. Each outstanding Series A Share is convertible at the option of its holder, at a conversion price of $7.65 per share, into 13.07 shares of our common stock (as the same may be adjusted pursuant
to the anti-dilution provisions applicable to the Series A Shares). On the second anniversary of the original issue date of the Series A Shares (the Automatic Conversion Date), all Series A Shares then outstanding will automatically
convert into common stock at the then conversion price, subject to the payment by the Company, in cash, of the accumulated, but unpaid, dividends on those Series A Shares. If, however, due to regulatory restrictions or for any other reason, the
Company is unable, on the Automatic Conversion Date, to pay the accumulated, but unpaid dividends in cash, then, the Automatic Conversion Date would be extended, and those Shares would remain outstanding and would continue to accumulate dividends,
until such time as the Company is able to pay such dividends, in cash. A more detailed description of the rights, preferences and privileges of and restrictions on the Series A Shares is contained in the above-referenced Current Report on Form
8-K dated October 6, 2009, and the foregoing summary is qualified by reference to that description.

Dividend Policy
and Share Repurchase Programs. Our Board of Directors has followed the policy of retaining earnings to maintain capital and, thereby, support the growth of the Companys banking franchise. On occasion, the Board has considered paying cash
dividends out of cash generated in excess of those capital requirements and, in February 2008, the Board of Directors declared a one-time cash dividend, in the amount of $0.10 per share of common stock, that was paid on March 14, 2008 to our
shareholders.

The Board also authorized share repurchase programs, in June 2005 and in October 2008, when the Board concluded
that, at prevailing market prices, the Companys shares represented an attractive investment opportunity and, therefore, that share repurchases would be a good use of Company funds. No shares were purchased under this program in the nine months
ended September 30, 2010.

In the first quarter of 2009, the Board of Directors decided that the prudent course of
action, in light of the economic recession, was to preserve cash to enhance the Banks capital position and to be in a position to take advantage of improved economic and market conditions in the future. Moreover, the MOU entered into with the
FRB and DFI in July 2009 and the FRB Agreement and DFI Order (which superseded the MOU) prohibit the payment of cash dividends and share repurchases without the approval of those regulatory agencies. Accordingly, we do not expect to pay dividends or
make share purchases at least for the foreseeable future.



|ITEM 3. | MARKET RISK
|------- | -----------

We are
exposed to market risk as a consequence of the normal course of conducting our business activities. The primary market risk to which we are exposed is interest rate risk. Our interest rate risk arises from the instruments, positions and transactions
entered into for purposes other than trading. They include loans, securities, deposit liabilities, and short-term borrowings. Interest rate risk occurs when assets and liabilities reprice at different times as market interest rates change. Interest
rate risk is managed within an overall asset/liability framework for the Company.



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|ITEM 4T. | CONTROLS AND PROCEDURES
|-------- | -----------------------

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the
Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any system of controls and procedures, no matter how
well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.

As required by Rules 13a-15 and 15d-15 under the Exchange Act, in connection with the
filing of this Quarterly Report on Form 10-Q, an evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design
and operation of our disclosure controls and procedures as of September 30, 2010. Based on the evaluation, our CEO and CFO have concluded that, as of, September 30, 2010 the Companys disclosure controls and procedures were effective
to provide reasonable assurance that information required to disclose in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules of the Securities and Exchange
Commission and that such information is accumulated and communicated to management, including our Chief Executive and Chief Financial Officers, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended September 30, 2010 that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting except for the remediation of material weakness disclosed on Form 10-K for the year ended December 31, 2009 and on Form 10-Q for
the quarter ended September 30, 2009, relating to our internal controls over the preparation and review of allowance for loan losses.



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PART II



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

James Laliberte, et al. vs. Pacific Mercantile Bank. This lawsuit was originally filed in May 2003 in the California Superior Court
for the County of Orange (Case No. 030007092). Information regarding this lawsuit is contained in Item 3 of Part I of our Annual Report on Form 10-K for our fiscal year ended December 31, 2009, and there have been no subsequent
developments in that case since we filed that Annual Report with the SEC on April 1, 2010.

We also are subject to legal
actions that arise from time to time in the ordinary course of our business. Currently there are no such pending legal proceedings that we believe will become material to our financial condition or results of operations.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

There have been no material changes from the risk factors that were disclosed under the caption Risk Factors in Item 1A
of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (the 2009 10-K), except as follows:

Risks and Uncertainties Posed by the FRB Agreement and the DFI Order.

As previously reported in our Current Report on Form 8-K dated August 31, 2010, the members of the respective Boards of Directors of
the Company and the Bank entered into a Written Agreement (the Agreement) with the Federal Reserve Bank of San Francisco (the FRB). On the same date, the Bank consented to the issuance of a Final Order (the Order)
by the California Department of Financial Institutions (the DFI). The principal purposes of the FRB Agreement and the DFI Order, which constitute formal supervisory actions by the FRB and the DFI, are to require us to adopt and implement
formal plans and take certain actions, as well as to continue implementing measures that we previously adopted, to address the adverse consequences that the economic recession has had on the performance of our loan portfolio and our operating
results and to increase our capital to strengthen our ability to weather any further adverse conditions that might arise if the hoped-for improvement in the economy does not materialize. Set forth below is a description of material risks and
uncertainties created by the FRB Agreement and DFI Order.

We are required to raise additional equity capital, but that
capital may not be available or may not be on terms acceptable to us. The DFI Order requires us to increase the Banks ratio of tangible shareholders equity-to-total tangible assets to 9.0% which, in turn, will require us to raise
additional equity capital by January 31, 2011. However, our ability to raise additional capital will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, as well
as our financial performance. Accordingly, there is no assurance that we will be able to raise additional capital there is no assurance that, if required, we will be able to raise additional capital in amounts sufficient to meet regulatory
requirements on terms acceptable to us or otherwise. If we are unable to raise such additional capital, the DFI and the FRB could (i) require us to reduce the size of our loan portfolio by limiting the volume of new loans that we can make or by
selling loans or other interest-earning assets as a means of increasing our capital ratios, or (ii) impose other restrictions on our business operations, either or both of which would adversely affect our results of operations and the market
price of our shares.

Our shareholders may be diluted by the sale of additional shares of our common stock in the
future. In order to raise the additional capital required by the DFI Order, it will be necessary for us to sell additional shares of our common stock at a time when the market prices of bank stocks, including our own, are at historic lows. As a
result, the sale of additional shares is likely to be dilutive of the ownership that our existing shareholders have in the Company.

The Company and the Bank are subject to additional regulatory oversight pursuant to the FRB Agreement and the DFI Order which may increase the costs of doing business and restrict our ability to grow
our banking franchise.Under the terms of the FRB Agreement and DFI Order, the Company and the Bank are required to implement certain corrective and remedial measures within strict time frames. Among other things, we are required to maintain
certain levels of liquidity and loan loss reserves, which could reduce our operating income. In addition, we are required to increase management oversight of our operations and we will be subject to more frequent regulatory examinations, which may
increase our operating expenses. However, at the same time, we will be continuing our efforts to reduce our operating expenses in order to improve our results of operations, which could require cutbacks in staffing and the implementation of other
measures, including possibly reducing the scope of our operations or the size of the Bank.



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As a consequence, the FRB Agreement and the DFI Order could have a material adverse effect on our business, financial condition, results of operations, cash flows or future prospects.

The Bank is restricted from paying dividends to us and we are restricted from paying dividends to shareholders and from making
payments on our trust preferred securities.The payment of dividends by the Bank to us is our primary source of funds for paying dividends to our shareholders and paying our financial obligations, which currently consist primarily of interest
payments on our junior subordinated debentures (the Debentures). Pursuant to the FRB Agreement and DFI Order, the Bank may not pay cash dividends to us and we may not pay cash dividends to our shareholders or interest on the Debentures
without the prior approval of the FRB and the DFI. As previously reported, we began to defer interest payments on the Debentures earlier this year, when we were advised by the FRB that it would not approve further interest payments pending an
improvement in our operating results and we cannot predict when the FRB will permit us to resume such payments. Although we are permitted to defer interest payments on the Debentures for up to 20 consecutive quarters, and we have sufficient
cash to make the required interest payments on the Debentures, if we are not permitted by the FRB to pay the deferred interest and resume making interest payments by the end of that five year period, then we would be in default of our obligations
under the Debentures, in which event the entire principal amount of and accrued but unpaid interest on the Debentures would become immediately due and payable.

Failure to satisfy the requirements of the FRB Agreement or the DFI Order could subject us to regulatory enforcement actions and additional restrictions on our business. There is no assurance that
we will be able to meet the requirements of the FRB Agreement or the DFI Order. If we are unable to do so, the FRB and DFI could subject us to additional regulatory enforcement actions, which could include the assessment of civil money penalties on
us and the Bank, as well as our respective directors, officers and other affiliated parties, and the imposition of further restrictions on our business, or even the termination of the Banks FDIC deposit insurance in the event we are unable to
generate profits or we were to suffer a significant decline in our capital position.

The enactment of the Wall Street
Reform and Consumer Protection Act poses uncertainties for our business and is likely to increase our costs of doing business in the future.

On July 21, 2010, the President signed into law the Wall Street Reform and Consumer Protection Act (the Act) which requires a restructuring of the bank regulatory system in the United
States and will require us to make changes in our business that are likely to increase our operating costs. In addition, the Act presents considerable uncertainties for us, as well as other banking institutions, which will not be resolved until
federal regulations are adopted to implement the Act, which will take at least one and possibly two years. As a result, it is not possible to measure or predict, with any degree of certainty, what the full impact of the Act will have on our business
and our operating results in the future.



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|ITEM 6. | EXHIBITS
|------- | --------

The following
documents are filed as Exhibits to this Quarterly Report on Form 10-Q:



|             |  |                                                                                             
|------------ |  | --------------------------------------------------------------------------------------------
|Exhibit No.  |  | Description of Exhibit                                                                      
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.1 |  | Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.2 |  | Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                        |  |  |  |                            |  |                                       
|----------------------- |  |  |  | -------------------------- |  | --------------------------------------
|                        |  |  |  | PACIFIC MERCANTILE BANCORP
|                        |  |  | 
|Date: November 10, 2010 |  |  |  | By:                        |  | /s/  NANCY A. GRAY                    
|                        |  |  |  |                            |  | Nancy A. Gray, Chief Financial Officer



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EXHIBIT INDEX



|             |  |                                                                                             
|------------ |  | --------------------------------------------------------------------------------------------
|Exhibit No.  |  | Description of Exhibit                                                                      
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.1 |  | Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.2 |  | Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002



E-1