**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-K**

(Mark One)

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the fiscal year endedDecember 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the transition period from                         to                           **

**Commission file number 000-52436**

**1**ST PACIFIC BANCORP

(Exact name of registrantas specified in its charter)

| **California**                                                    |   | **33-0905235**                    |
|-------------------------------------------------------------------|--------|-----------------------------------|
| (State or Other  Jurisdiction of   Incorporation or Organization) |   | (IRS Employer  Identification No) |
|                                                              |   |                              |
| **4275  Executive Square #650**                                   |   | **92037**                         |
| **La Jolla,  California**                                    |   | (Zip Code)                        |
| (Address of  Principal Executive Offices)                         |   |                              |

 

**(858)875-2000**(Issuer’s telephone number)

**Securities registered under Section 12(b) ofExchange Act: **None

**Securities registered underSection 12(g) of Exchange Act:**

| ** ** | **Common Stock, No par value** | ** ** |
|------------|--------------------------------|------------|
|       | (Title of Class)               |       |

 

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o No x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes oNo x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes xNo o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. Large accelerated filer o   Accelerated Filer o   Non-accelerated filer x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act).Yes oNo x

The aggregate market value of the common stock held bynon-affiliates of the Registrant as of June 30, 2006 was approximately $49.5million. Number of Registrant’s shares of common stock outstanding at March 12,2007 was 3,893,312.

Documentsincorporated by reference: Certain information required by Part III of thisAnnual Report is incorporated by reference from (i) the Registrant’s definitiveproxy statement to be filed with the Securities and Exchange Commissionpursuant to Regulation 14A if filed not later than 120 days after the end ofthe fiscal year covered by this Annual Report, or (ii) if the Registrant’sdefinitive proxy statement is not filed within the 120 day period, then from anamendment to this Annual Report, which will be filed not later than the end ofthe 120 day period.

 

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**1**st PACIFIC BANK OF CALIFORNIA

**TABLE OF CONTENTS**
| **PART I**                         |   |                                                                                                                   |   |
|------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------|--------|
| ITEM 1.                            |   | BUSINESS                                                                                                               |   |
| ITEM 1A.                           |   | RISK  FACTORS                                                                                                          |   |
| ITEM 1B.                           |   | UNRESOLVED STAFF  COMMENTS                                                                                             |   |
| ITEM 2.                            |   | PROPERTIES                                                                                                             |   |
| ITEM 3.                            |   | LEGAL  PROCEEDINGS                                                                                                     |   |
| ITEM 4.                            |   | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                                                   |   |
|                               |   |                                                                                                                   |   |
| **PART II**                        |   |                                                                                                                   |   |
| ITEM 5.                            |   | MARKET FOR  REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF EQUITY SECURITIES |   |
| ITEM 6.                            |   | SELECTED FINANCIAL  DATA                                                                                               |   |
| ITEM 7.                            |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                            |   |
| ITEM 7A.                           |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                            |   |
| ITEM 8.                            |   | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                           |   |
| ITEM 9.                            |   | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                                  |   |
| ITEM 9A.                           |   | CONTROLS AND  PROCEDURES                                                                                               |   |
| ITEM 9B.                           |   | OTHER INFORMATION                                                                                                      |   |
|                               |   |                                                                                                                   |   |
| **PART III**                       |   |                                                                                                                   |   |
| ITEM 10.                           |   | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                                |   |
| ITEM 11.                           |   | EXECUTIVE  COMPENSATION                                                                                                |   |
| ITEM 12.                           |   | SECURITY OWNERSHIP OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS                        |   |
| ITEM 13.                           |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                                        |   |
| ITEM 14.                           |   | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                                                |   |
|                               |   |                                                                                                                   |   |
| **PART IV**                        |   |                                                                                                                   |   |
| ITEM 15.                           |   | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES                                                                               |   |
|                               |   |                                                                                                                   |   |
| **SIGNATURES**                     |   |                                                                                                                   |
|                               |   |                                                                                                                   |
| **INDEX TO FINANCIAL  STATEMENTS** |   |                                                                                                                   |
|                                    |        |                                                                                                                        |        |  |  |

 

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**PART I**

**ITEM1.**                                                     BUSINESS

**General**

1st Pacific Bancorp (the “Company”, “we”, “our”, or “us”) is aCalifornia corporation incorporated on August 4, 2006 and is registered withthe Board of Governors of the Federal Reserve System as a bank holding companyunder the Bank Holding Company Act of 1956, as amended.  1st Pacific Bank of California (the “Bank”)is a wholly-owned bank subsidiary of the Company and was incorporated inCalifornia on April 17, 2000.  TheBank is a California corporation licensed to operate as a commercial bank underthe California Banking Law by the California Department of FinancialInstitutions (the “DFI”).  In accordancewith the Federal Deposit Insurance Act, the Federal Deposit InsuranceCorporation (the “FDIC”) insures the deposits of the Bank.  The Bank is a member of the Federal ReserveSystem.

A holding company reorganization was completed on January 16, 2007,whereby all outstanding shares of the Bank were converted into an equal numberof shares of the Company. Prior to the reorganization, the Company had minimalactivity, which was primarily related to preparing for the reorganization.  At present, the Company does not engage inany material business activities other than ownership of the Bank. Referencesto the Company are references to 1st Pacific Bancorp (including the Bank),except for periods prior to January 16, 2007, in which case, references to theCompany are references to the Bank.

After completing its initial public offering, the Company commencedoperations on November 17, 2000, from a branch office in the GoldenTriangle area of San Diego and a branch office in the Tri-Cities area ofNorth San Diego County (“North County”). Since then, the Company has opened three branch offices, one in theMission Valley area of San Diego, one in the Inland North County area of SanDiego and the third in El Cajon in April of 2006. In addition, in December2004, the Company moved its executive offices from the Golden Triangle branchto a separate location in the same vicinity. On February 22, 2007, the Company announced it had entered into adefinitive agreement to acquire Landmark National Bank (“Landmark”) in a cashand stock transaction valued at $24.6 million. Subject to regulatory and shareholder approval, Landmark will be merged intothe Bank, which will add Landmark’s two branch offices in Solana Beach and LaJolla to the Company’s branch network.

The Company is organized as a single operating unit with fivefull-service branch offices.  The Company’sprimary source of revenue is interest earned on loans it provides tocustomers.  The Company funds its lendingactivities primarily through providing deposit products and services tocustomers.  The Company’s customers arepredominately small and medium-sized businesses and professionals in San DiegoCounty.  As of December 31, 2006, theCompany has grown to over $318 million in total assets.

**Strategy**

The Company’s mission statement is: “To build relationships that createsignificant results for our customers, employees, shareholders and community.”  The Company believes that to be successful inits competitive environment, it needs to attract and retain great people (e.g.directors and employees) to foster and grow loyal client relationships, whichbuild enduring franchise value.  Thisstrategy is synopsized by the Company’s corporate motto:  *People.Relationships.Results.*  The Company’s vision of being a leadingprovider of commercial banking services in its markets is accentuated by threegoals, to become:

A compelling place to work — the Company will demonstrate a highperformance and high-energy culture where the corporate values are embraced andlived out by “Gung Ho” employees.

A compelling place to bank — clients will experience perceptivelistening, active responses, and significant results that add value to theirbusinesses and will become “Raving Fan” customers.

A compelling place to invest — shareholders will receive outstandingshareholder value and the pride of participating in “The Bank” in the San Diegoregion.

The Company’s strategy during its early *de novo* years was focused on achieving growth and marketshare.  As the Company has matured, thestrategy has progressively shifted to achieve more significantprofitability.  The 

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Company intends to grow within its current equity basefor the immediate future, utilizing retained earnings and debt instruments, asneeded, to bolster capital ratios and minimize shareholder dilution.  The Company intends to communicate regularlywith its shareholders and increase awareness among the brokerage community topromote stock liquidity and market value. To be successful, the Company emphasizes systems which attract, retain,reward and develop employees, including strategies that encourage employees tothink like owners, such as profit sharing plans and employee stock ownershipinitiatives.  To foster long term,profitable customer relationships, the Company utilizes customer surveys topromote exceptional customer service and customer profitability measurementtools to identify and strengthen the most beneficial relationships; the Company’sfranchise value is ultimately rooted in its customer base.

**Services Offered**

*General*. Theprimary operational focus of the Company is to meet the financial servicesneeds of its target market — small and medium-sized businesses andprofessionals — within its service area. Therefore, the Company offers a full line of loan and deposit productsand certain related financial services designed to cater to this targetmarket.  As a community bank, the Company’spersonnel are actively involved in the community and an emphasis is placed onpersonalized “relationship banking,” where the banking relationship ispredicated on the banker’s familiarity with the customer and their business.

*Lending Services*.  As discussed in further detail below, theCompany’s lending activities focus on commercial and residential real estateloans, construction loans, commercial business loans and loans made orguaranteed through the Small Business Administration (the “SBA”) loan programresponsive to the target market’s needs. The Company believes these loan products take advantage of the economicgrowth and the consolidation of banking institutions in San Diego County andcontiguous areas, which have created opportunities for an independent,service-oriented bank.

*Real Estate Loans*.  The Company offers real estate loans forconstruction and term financing. Construction loans include loans for single-family homes (both owneroccupied and speculative), small residential tract developments, commercialprojects (such as multi-family housing, industrial, office and retail centers)and early stage acquisition and development loans for land and lots.  Permanent financing is offered for commercialproperties and single-family residential properties.

*Commercial Loans*.  The Company offers the following types ofcommercial loans:

·                                          Short-termworking capital loans, both secured and unsecured.

·                                          Revolvingcredit accounts, secured and unsecured, such as credit extensions supported byformal business assets (e.g. accounts receivable and inventory).

·                                          Singlepurpose loans, such as term loans for facilities, plant and equipment.

·                                          Stand-byletters of credit.

*SBA Loan Programs*.  The SBA, headquartered in Washington, D.C.,and operating in 10 regions throughout the United States, offers financialassistance to eligible small businesses in the form of partial governmentguarantees on loans made to such businesses by qualified participating lendersunder the SBA’s guaranteed loan program (the “7(a) program”).  In order to be eligible for the7(a) program, a business generally must be operated for profit and,depending on the industry of the potential borrower, must fall within specifiedlimitations on numbers of employees or annual revenues.  The Company is an SBA qualified participatinglender and, in 2002, was awarded SBA’s “Preferred Lender” status.  This Preferred Lender status allows theCompany to make loans under SBA programs without prior SBA approval.

SBA 7(a) program loans are SBA-guaranteed loans made by approvedfinancial institutions.  For term loans,the loan guarantees vary from 75% to 85% of the loan balance, depending on thesize of the loan, and terms vary from five to twenty-five years depending onthe purpose of the loan.  Revolving loansare limited to a maximum term of seven years and the loan guarantee may notexceed 50% of the loan amount.  Theaggregate balance of the SBA guaranteed portions of all outstanding SBA loansto one borrower and its affiliates may not exceed $2.0 million.

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SBA 7(a) program loans are typically written at variable rates ofinterest, which rates are generally limited by SBA guidelines.  These guidelines limit the maximum rate forloans with maturities less than seven years to 225 basis points over the lowestprime-lending rate published in The Wall Street Journal (“WSJ Prime”).  The maximum rate for loans with maturities inexcess of seven years is 275 basis points over the WSJ Prime.  Typically rates are adjusted on the first dayof each calendar quarter.

In addition to participation in the SBA’s 7(a) programs, theCompany also offers loans primarily for real estate-related projects underSection 504 of the Small Business Administration Act of 1953 (“504 loans”),such as for purchasing land and improvements, construction, modernizing orconverting existing facilities and purchasing certain machinery andequipment.  Under the 504 loan program,the borrower must provide at least 10% of the equity for the financing.  Under a typical 504 loan, the Company willmake a loan for 50% of the principal amount, which is secured by, among otherassets, a first priority mortgage on the underlying property.  The Company will provide the remaining amountof the funds as a short-term loan with a maturity from 90 days up to one year (the“Bridge Loan”).  The borrower repays theBridge Loan with the proceeds received from a bond issuance by a certifieddevelopment company — not-for-profit corporations established to create andissue debt securities that are fully guaranteed by the SBA.  The debt securities are sold to institutionalinvestors.   Under the 504 loan program,SBA debentures may be issued up to $4.0 million and, if a public policy is met,up to $8.0 million for manufacturers.

Like many other government programs, the lending programs of the SBAare federal government programs authorized by legislation and uncertaintiessurround the SBA programs due to reliance on the United States Congress and thefederal budgeting process for each fiscal year. There can be no assurance that the SBA lending program will continue inits present manner.

*Consumer Loans*.  The Company offers consumer loans, whichgenerally encompass loans for a personal, family or household purpose.  These loans comprise a proportionatelysmaller portion of the Company’s overall loan portfolio.  However, these loans are important in termsof servicing customer needs in the market area of the Company’s offices andancillary lending needs of the Company’s primary target market.

*Deposit Products and Services*.  The Company’s expertise is developingcustom-tailored financial solutions for individuals, businesses andprofessionals desiring personalized banking services.  The Company offers a wide range of accountsand services, designed around the needs and preferences of our customers.  Account officers consult with the variousspecialists in the Company to satisfy the customer’s immediate and long-rangedeposit and borrowing needs.

*Bank Deposits. *The Company offers personaland business checking, money market, savings and certificates of depositaccounts which can all be tied into a one-statement banking package.  The types and terms of such accounts areoffered on a competitive basis.  The interestrates payable by the Company on the various types of interest-bearing depositaccounts are a function of a number of factors, including rates paid by theCompany’s competitors, the need for liquidity for lending operations and thechanges in monetary policy as announced by the Federal Open Market Committee.

*Cash Management Services*.  The Company specializes in meeting the uniquebanking needs of business owners.  TheCompany accomplishes this by having developed a comprehensive set of cashmanagement tools and services.  Some ofthe cash management products the Company offers are online banking, automatedclearing house (“ACH”) origination, wire transfers, daily sweep products,lockbox processing and account transfers / management.  The Company also has a wire transfer systemwith advanced features for business customers that, among other things,provides immediate confirmation of wire receipts.  In addition to these products, the Companyoffers courier service to collect deposits from San Diego-area customersand has a correspondent relationship with another bank allowing the Company toaccept deposits at thousands of third party locations for non-local depositoryneeds.

During the fourth quarter of 2006, the Company introduced a newservice, Remote Deposit Capture. This service utilizes Check 21 technology andallows the customer to create and submit a deposit from their place ofbusiness. Check 21 is also known by its full name, the Check Clearing for the21st Century Act. See the “Federal Legislation” section of “Supervision andRegulation” below for further information. More recently, in March 2007, theCompany introduced BusinessPro Deposit Link. This additional feature has beenadded to the Company’s online banking program for businesses. Deposit Link willallow customers to make deposits into their checking accounts from theiroffice. Checks can be scanned, transmitted and deposited to their businesschecking account using their 

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office computer. This service will be especiallyvaluable to customers who frequently make deposits by reducing their courierand/or bank visit expenses.

The Company believes that these services, as well as the other customerconvenience services that it offers, allow the Company to offer a competitiveand customized package of services to its customers.

*Internet Banking*.The Company utilizes technology and the Internet as a secondary means forservicing customers.  Through “Internetbanking” customers may conduct their banking business remotely from anylocation with an Internet connection. Business customers are able to access cash management products, whichallow users to, among other things, originate wire transfers and ACHtransactions.  In addition, businesscustomers can have multiple users access accounts via the website, and eachuser can have separately defined user capabilities.  Despite the capabilities to access theseelectronic banking services, customers always have the opportunity to discussspecific banking needs with a knowledgeable service representative available inone of the Company’s offices.

**Marketing Focus**

The Company advertises and markets its services primarily to targetedcustomers in its primary service area. The Company focuses on meeting the needsof its targeted customers, as well as meeting the challenge from itscompetitors.  Among other things, theCompany attempts to capitalize on customers’ frustration with and adversereaction to the loss of locally controlled and managed financial institutionsto large, out-of-state buyers.  TheCompany established an Advisory Board in November 2002, which consists ofup to 15 local community leaders.  Inaddition to their role as advisors to the Company, the Advisory Board membersrepresent the Company at key events and increase the Company’s visibility andparticipation with numerous regional leadership organizations and civic groups.  Furthermore, the members of the Board ofDirectors are highly visible and active in the San Diego community.  Over time, the Company expects to continue tobenefit from involvement in civic activities and the positive association withthe Company.  Public relations effortsemphasize the Company’s local ownership, service and loyalty to its community.

**Service Area**

The Company considers its primary market to be the greater San DiegoCounty region.  The Company has locatedits executive office and full service bank branching system within thisarea.  The Company’s executive office andits largest branch office are both located in the Golden Triangle area ofSan Diego, which is the hub of the “North City” business center.  The Company’s second largest branch office islocated in the Tri-Cities area of North County (Oceanside, Carlsbad andVista).  The Company’s third branchoffice was opened in 2003 in the Mission Valley area of San Diego.  In 2005, the Company opened its fourth branchoffice in the Inland North County Area of San Diego along the Interstate15 corridor. A fifth branch office was opened in April 2006 in the East CountyArea of San Diego, specifically in El Cajon. On February 22, 2007, the Company announced it had entered into adefinitive agreement to acquire Landmark in a cash and stock transaction valuedat $24.6 million.  Subject to regulatoryand shareholder approval, Landmark will be merged into the Bank, which will addLandmark’s two branch offices in Solana Beach and La Jolla to the Company’sbranch network.

The San Diego regional economy is an important and growing centerfor high-technology industries such as telecommunications, biotechnology,electronics, and software.  There is alsoa significant recreational goods manufacturing industry in the region.  The aerospace and defense industries, thetraditional industries of the region, still contribute significantly to theeconomy.  Construction, agriculture, othermanufacturing, wholesale and retail trade, and tourism are also important sectors.  All of these industries have been volatile inthe recent past.  San Diego County’scommercial real estate market remained strong throughout the third quarter2006.  It is believed that the San DiegoCounty economy has held up stronger than other parts of the country due to adiversified work force.  At the end ofthe third quarter 2006, the unemployment rate for San Diego County rose 0.3% to3.9%, as compared to the fourth quarter 2005 figure.  As of December 2006, San Diego County’sunemployment rate is 1.1% lower than California’s rate of 5.0% and is 0.9%lower than the overall United States rate of 4.8%.

While the Southern California region continues to be susceptible to theeffects of the national recession, the regions productivity continues to exceedmost areas of the country.  However,rapidly rising health and liability insurance costs are becoming overwhelmingfor California businesses.  Over the pastyear, the average increase in health insurance premiums for small businesseswas 15% and the average increase for large businesses was 13.5%.  Increased energy costs have also impactedregional businesses as electricity, water, natural gas and gasoline prices 

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continue to be some of the highest in the nation.  The exodus of more mobile companies hasquietly begun as long time manufacturers continue to move to more affordableareas in search of lower operating costs, tax breaks and less expensive realestate.  For those companies that aretied to Southern California, the Southwest Riverside County community ofTemecula has become one of the nation’s fastest growing areas.  Its population growth for the past yearexceeded the growth in San Diego County and its employment base continues toexpand with new employers.  Although theunemployment rates, at December 31, 2006, for Riverside *(4.3%)*and Los Angeles *(5.1%)*Counties remain higher than that ofSan Diego *(3.9%)* and Orange *(3.2%)* Counties, both employment centersare on par with the nation as a whole.

San Diego County’s economy remains vulnerable despite a greaterlevel of diversity and less reliance upon defense related industries.  Although the county has experiencedsignificant growth in recent years and current estimates believed to bereliable continue to project further growth, the Company cannot guarantee thatsuch future growth will occur as estimated and that currently unforeseeneconomic circumstances, such as a slow-down in one or more of the region’smajor industries or employers, or a general change in the general economy ofthe region, the state or the nation, or a change in the Company’s competition,as discussed below, would not reverse or slow-down these growth trends and posenew challenges to the success of the Company. Historically economic trends tend to run in cycles of varying durationand the Company will have no ability to control such cycles.  The ongoing success of the Company depends inlarge part on the ability of the Company to adapt to such changes, utilizingsuch management, capital resources and business acumen as is available to theCompany at such time.

**Risk Management**

As a fundamental part of its business, the Company has developed riskmanagement practices to identify, measure, monitor and control the risksinvolved in its various products and lines of business.  While the Company’s business is dependent ontaking risks, appropriate management of these business risks is critical to itssuccess.  The Company has a riskmanagement program to evaluate a broad spectrum of risks, including, but notlimited to, credit risk, market risk, liquidity risk, operational risk, legalrisk and reputational risk.  In assessingits risk management practices across the Company’s functional areas (e.g.lending, branch operations, informational technology, asset and liabilitymanagement, and administration), management considers the following elements ofa sound risk management system in each critical area:  the level of board and senior managementoversight; the adequacy of policies, procedures and limits; the adequacy ofinternal controls; the results of internal monitoring and / or independentreviews and audits; and the experience of its personnel.

In recent years, the Company has experienced strong growth in loans,deposits and total assets.  Increasedlevels of staffing, new office space, and increased utilization of vendorservices, such as data processing and professional services, have facilitatedthis growth.  While the Company believesit has a sound risk management program that will address its future growthplans, the Company’s ability to manage future growth will depend on, amongother things, its ability to manage associated risks, including: monitoringoperations, controlling funding costs and operating expenses, maintainingpositive customer relations, and hiring and retaining qualified personnel.

**Competition**

The banking business in California, generally, and specifically in thegreater San Diego and adjacent areas, is highly competitive with respectto both loans and deposits.  The businessis dominated by a relatively small number of major banks, most of which havemany offices operating over wide geographic areas.  Many of the major commercial banks and theiraffiliates, including those headquartered outside California, offer certainservices (such as trust and securities brokerage services) that are not offereddirectly by the Company.  By virtue oftheir greater total capitalization, such banks have substantially higherlending limits than the Company and substantially larger advertising andpromotional budgets.  In addition, theCompany faces competition from other community banks headquartered in thegreater San Diego area that are also serving individuals and businesses.

In recent years, a large number of mergers and consolidations of bothbanks and savings entities have occurred in California and throughout thenation.  A substantial number of thelarger banks have been involved in major mergers.  The result is that these institutions generallyhave centralized and standardized their services.  Similarly, most lending functions anddecisions are sent outside the area. Acquisitions by major interstate bank holding companies and other largeacquirers in the greater San Diego vicinity have resulted in numerousbranch consolidations in the area.  Manylong-standing relationships have been disrupted or severed, while many othercustomers are now subjected to less personalized and more “standardized”services.

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As a result of this merger and consolidation activity, since 2000, community banking in San Diego hasundergone a renaissance, with close to 20 new or *de novo* banks opening.  Despite the increased competition from newercommunity banks, larger institutions continue to control the majority of thedeposit market share in the region and the Company believes that this continuesto present the Company with the opportunity to attract customers who aredissatisfied with the level of service provided by larger banks.  Additionally, it is expected that mergeractivity will continue to provide opportunities in its market area.

In order to compete with the major financial institutions in theCompany’s primary service areas, the Company uses to the fullest extentpossible the contacts of its organizers, founders, advisors, directors andofficers with residents and businesses in the Company’s primary serviceareas.  The Company emphasizesspecialized services, local promotional activity and personal contacts by theCompany’s officers, directors and other employees.  Programs have been developed to specificallyaddress the needs of small to medium-sized businesses, professional businesses,as well as business owners and their employees. As necessary, the Company can arrange for loans that are too large, dueto legal lending limits, for the Company to make by itself, to be made on aparticipation basis with other financial institutions and intermediaries.

**Employees**

Currently, the Company employs Messrs. A. Vincent Siciliano, JamesH. Burgess, Larry A. Prosi, and Richard H. Revier, under written employmentagreements.  See “Item 10, Directors,Executive Officers and Corporate Governance,” below.  On December 31, 2006, the Companyemployed 72 persons full-time and 7 persons part-time.  None of the Company’s employees arerepresented by any collective bargaining agreements.  The Company considers its relations withemployees to be excellent.

See “Item 7 — Management’s Discussion and Analysis of FinancialCondition and Results of Operation” below for more regarding the Company’sfinances.

**SUPERVISION ANDREGULATION**

**Thefollowing discussion of statutes and regulations affecting banks and bankholding companies is only a summary and does not purport to be complete.  This discussion is qualified in its entiretyby reference to such statutes and regulations. No assurance can be given that such statutes and regulations will notchange in the future.  Moreover, anychanges may have a material effect on the business of the Bank.**

**General**

***Bank Holding Company Regulation.***  TheCompany is bank holding company within the meaning of the Bank Holding Company Act,and is registered as such with and subject to the supervision of the FederalReserve Board (“FRB”).  Generally, a bankholding company is required to obtain the approval of the FRB before it mayacquire all or substantially all of the assets of any bank, or ownership orcontrol of the voting shares of any bank if, after giving effect to suchacquisition of shares, the bank holding company would own or control more than5% of the voting shares of such bank. The FRB’s approval is also required for the merger or consolidation ofbank holding companies.  The Company isrequired to file reports with the FRB and provide such additional informationas the FRB may require.  The FRB also hasthe authority to examine the Company and each of its subsidiaries, as well asany arrangements between it and any of its subsidiaries, with the cost of anysuch examination to be borne by the Company.

Banking subsidiaries of bank holdingcompanies are also subject to certain restrictions imposed by federal law indealings with their holding companies and other affiliates.  Subject to certain restrictions set forth inthe Federal Reserve Act, a bank can loan or extend credit to an affiliate,purchase or invest in the securities of an affiliate, purchase assets from anaffiliate, or issue a guarantee, acceptance, or letter of credit on behalf ofan affiliate; provided that the aggregate amount of the above transactions of abank and its subsidiaries does not exceed 10% of the capital stock and surplusof the bank on a per affiliate basis or 20% of the capital stock and surplus ofthe bank on an aggregate affiliate basis. In addition, such transactions must be on terms and conditions that areconsistent with safe and sound banking practices and, in particular, a bank andits subsidiaries generally may not purchase from an affiliate a low-qualityasset, as that term is defined in the Federal Reserve Act.  Such restrictions also prevent a bank holdingcompany and its other affiliates from borrowing from a banking subsidiary ofthe bank holding company unless the loans are secured by marketable collateralof designated amounts.  Further, the 

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Company and the Bank areprohibited from engaging in certain tie-in arrangements in connection with anyextension of credit, sale or lease of property or furnishing of services.

Under the FRB’s regulations, a bank holdingcompany is required to serve as a source of financial and managerial strengthto its subsidiary banks and may not conduct its operations in an unsafe andunsound manner.  In addition, it is theFRB’s policy that in serving as a source of strength to its subsidiary banks, abank holding company should stand ready to use available resources to provideadequate capital funds to its subsidiary banks during periods of financialstress or adversity and should maintain the financial flexibility andcapital-raising capacity to obtain additional resources for assisting itssubsidiary banks.  A bank holding company’sfailure to meet it obligations to serve as a source of strength to its subsidiarybanks will generally be considered by the FRB to be an unsafe and unsoundbanking practice or a violation of the FRB’s regulations or both.  Under certain conditions, the FRB mayconclude that certain actions of a bank holding company, such as payment ofcash dividends, would constitute unsafe and unsound banking practices becausethey violate the FRB’s “source of strength” doctrine.

A bank holding company is prohibited from engaging in or acquiringdirect or indirect ownership or control of more than 5% of the voting shares ofany company engaged in nonbanking activities. One of the principal exceptions to this prohibition is for activitiesfound by the FRB to be so closely related to banking or managing or controllingbanks as to be a proper incident thereto. In making these determinations, theFRB considers whether the performance of such activities by a bank holdingcompany would offer advantages to the public which outweigh possible adverseeffects.

As a public company, the Company is subject to the Sarbanes-Oxley Actof 2002.  The Sarbanes-Oxley Act amendscertain parts of the Securities and Exchange Act of 1934, and is intended toprotect investors by, among other things, improving the reliability of financialreporting, increasing management accountability, and increasing theindependence of directors and our external accountants.

The Company is subject to the periodic reporting requirements of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), which includebut are not limited to the filing of annual, quarterly and other currentreports with the Securities and Exchange Commission (“SEC”).

***Banking Regulation.***  Various requirements and restrictions underfederal and state laws affect the operation of the Bank.  As a California state-chartered bank, theBank is regulated, supervised and regularly examined by the DFI. Federalregulations address several areas including loans, investments, mergers andacquisitions, borrowings, dividends, and the number and locations of branch offices.  In addition, the FRB is the Bank’s primaryfederal regulator.  Deposits of the Bankare insured up to the maximum limits (presently $100,000 per account) allowedby the FDIC.  As a result of this depositinsurance function, the FDIC has certain supervisory authority and powers overFDIC-insured institutions.

**Proposed Legislative andRegulatory Changes**

Proposals pending in Congress would, among other things, allow banks topay interest on checking accounts, allow the FRB to pay interest on reserves,and permit interstate branching on a *de novo*basis*.*  Certain of these proposals, if adopted, couldsignificantly change the regulation or operations of banks and the financialservices industry.  It cannot bepredicted whether any of these proposals will be adopted, and, if adopted, howthese proposals will affect us or the Bank.

**Federal Reserve BankRegulation**

Each state-chartered bank that is a member of the FRB is referred to asa “state member bank.”  The Bank, likeall other state member banks, subscribes to capital stock in the FRB of itsdistrict (the Federal Reserve Bank of San Francisco in the case of theBank) in an amount equal to 6% of its combined capital and surplus (butexcluding retained earnings); 3% must be paid-in and the remaining 3% is on call.  The FDIC insures the deposits of the Bank andmonitors the Bank in such capacity.  TheFRB discount window and other services are available to all depositoryinstitutions on an equivalent basis. However, there are certain other unique considerations to being a memberof the FRB, including:

·                                          Thereduction of federal supervisors from two to one in those situations involvinga bank holding company organization.

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·                                          Theability to engage in activities to the same extent as national banks, unlessrestricted by applicable state laws and regulations.

·                                          Theabsence of any fees charged in connection with FRB examinations and applicationfilings.

·                                          Theprivilege of voting for directors of the FRB and eligibility for service as adirector.

**Impact of Monetary Policies**

Banking is a business that depends on rate differentials.  In general, the difference between theinterest rate paid by the Bank on its deposits and other borrowings and theinterest rate earned by the Bank on loans, securities and other interest-earningassets comprises the major source of the Bank’s earnings.  These rates are highly sensitive to manyfactors which are beyond the control of the Bank and, accordingly, the earningsand growth of the Bank are subject to the influence of economic conditionsgenerally, both domestic and foreign, including inflation, recession, andunemployment; and also to the influence of monetary and fiscal policies of theUnited States and its agencies, particularly the FRB.  The FRB implements national monetary policy,such as seeking to curb inflation and combat recession, by its open-marketdealings in United States government securities, by adjusting the requiredlevel of reserves for financial institutions subject to reserve requirements,by placing limitations upon savings and time deposit interest rates, andthrough adjustments to the discount rate applicable to borrowings by bankswhich are members of the Federal Reserve System.  The actions of the FRB in these areas influencethe growth of bank loans, investments, and deposits and also affect interestrates.  The nature and timing of anyfuture changes in such policies and their impact on the Bank cannot bepredicted; however, the impact on the Bank’s net interest margin, whetherpositive or negative, depends on the degree to which the Bank’sinterest-earning assets and interest-bearing liabilities are ratesensitive.  In addition, adverse economicconditions could make a higher provision for loan losses a prudent course andcould cause higher loan charge-offs, thus adversely affecting the Bank’s netincome.

**Recent Regulation**

On December 6, 2006, the federal bank regulatory agencies releasedfinal guidance on “Concentrations in Commercial Real Estate Lending” (the “FinalGuidance”), largely consistent with the proposed guidance they released onJanuary 10, 2006.  This guidance definescommercial real estate (“CRE”) loans as exposures secured by raw land, landdevelopment and construction (including 1-4 family residential construction),multi-family property, and non-farm nonresidential property where the primaryor a significant source of repayment is derived from rental income associatedwith the property or the proceeds of the sale, refinancing, or permanentfinancing of the property.  Loans onowner occupied CRE are generally excluded.

The Final Guidance requires that appropriate processes be in place toidentify, monitor and control risks associated with real estate lendingconcentrations.  This could includeenhanced strategic planning, CRE underwriting policies, risk management,internal controls, portfolio stress testing and risk exposure limits as well asappropriately designed compensation and incentive programs.  Higher allowances for loan losses and highercapital levels may also be required.  TheFinal Guidance is triggered when CRE loan concentrations exceed either:

·              Total reported loans forconstruction, land development, and other land of 100% or more of a bank’stotal capital; or

·              Total reported loans secured bymultifamily and nonfarm nonresidential properties and loans for construction,land development, and other land of 300% or more of a bank’s total capital.

Management of the Bank believes that the Final Guidance applies to theBank’s CRE lending activities due to its concentration in construction and landdevelopment loans. The Bank has always had meaningful exposures to loanssecured by commercial real estate due to the nature of its growing markets andthe loan needs of both its retail and commercial customers.  The Bank believes its long-term experience inCRE lending, underwriting policies, internal controls, and other policiescurrently in place are generally appropriate in managing its concentrations asrequired under the Final Guidance. Furthermore, the Bank has recently adopted additional enhancements toits analysis and review of CRE concentrations consistent with many of therequirements found in the Final Guidance.

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**Banking Legislation**

From time to time legislation is proposed or enacted which has theeffect of increasing the cost of doing business and changing the competitivebalance between banks and other financial and non-financial institutions.  These laws have generally had the effect ofaltering competitive relationships existing among financial institutions,reducing the historical distinctions between the services offered by banks,savings and loan associations and other financial institutions, and increasingthe cost of funds to banks and other depository institutions.  Certain of the potentially significantchanges, which have been enacted in the past several years, are discussedbelow.

***The Sarbanes-Oxley Act. ***OnJuly 30, 2002, in the wake of numerous corporate scandals and in anattempt to protect investors and help restore investor confidence by improvingthe accuracy and reliability of corporate disclosures made pursuant to thesecurities laws, President George W. Bush signed into law the Sarbanes-OxleyAct of 2002 (the “Act”).  The Act appliesto any issuer, such as the Bank, that has securities registered under, or isotherwise required to file reports under, the Exchange Act.  The Act imposes new and unprecedentedcorporate disclosure and governance mandates on public companies, includingstate chartered banks such as the Bank that are required to file periodicreports with the FRB.

While certain provisions of the Act, such as accelerated filingdeadlines for periodic reports, will not apply to the Bank, most of the Act’sprovisions are (or upon implementation will be) applicable.  These provisions include (i) therequirement for certifications of each annual and quarterly report by theissuer’s principal executive and financial officers, with criminal penaltiesimposed for knowing or willful violations, (ii) the forfeiture of bonusesor profits received by such officers if accounting restatements are required asa result of misconduct, (iii) disclosure of all material off-balance sheettransactions and relationships that may have a material effect upon thefinancial status of an issuer and of any “material correcting adjustments” inthe issuer’s financials, (iv) disclosure of management’s assessment ofinternal controls and procedures, (v) disclosure as to whether the issuerhas adopted a “code of ethics” for its senior financial officers and, if not,an explanation as to why not, and (vi) prohibitions or limits on loans toofficers, directors and other insiders except to the extent such loans complywith FRB Regulation O.  The Act alsoimposes certain additional regulations, such as accelerated filing periods forreports on Form 4 of changes in the beneficial ownership of officers, directorsand principal security holders.

The Act also imposes increased requirements on auditors and theauditing procedures of their public clients, including prohibitions on theperforming of specified non-audit services contemporaneously with anaudit.  The Act heightens therequirements for, and the authority of, audit committees.  Among other provisions, the Act vests an issuer’saudit committee with direct responsibility for the appointment, compensationand oversight of any registered public accounting firm engaged to perform auditservices and with the ability to hire independent outside legal counsel andother advisors.

The Act also requires that each audit committee member be entirely “independent”(meaning that no member may be affiliated with the issuer or may accept (orhave recently received) any consulting, advisory or other compensatory feesfrom the issuer) and be a member of the issuer’s board of directors and thatthe committee include a designated “audit committee financial expert.”

Finally, the Act requires that legal counsel for subject companiesreport any evidence of material violations of securities laws or breaches offiduciary duty to or by their client and imposes federal criminal penalties,including fines and imprisonment of up to 25 years, upon those convicted ofdefrauding shareholders of public companies.

The Bank has experienced increased costs associated with the increasedlevel of disclosure and compliance required under the Act.  Such increased costs are likely to continueand this diversion of resources may adversely affect the financial conditionand operations of the Bank.

***Gramm-Leach-Bliley Act. ***TheFinancial Services Act of 1999, known as the Gramm-Leach-Bliley Act (“GLBA”),was signed into law on November 12, 1999 and became effective onMarch 11, 2000.  The GLBA repealsprovisions of the Glass-Steagall Act, which had prohibited commercial banks andsecurities firms from affiliating with each other and engaging in each other’sbusinesses.  Thus, many of the barriersprohibiting affiliations between commercial banks and securities firms havebeen eliminated.

The Bank Holding Company Act (“BHCA”) was amended by GLBA to allow anew “financial holding company” (“FHC”) to offer banking, insurance, securitiesand other financial products to consumers. Specifically, 

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the GLBA amended Section 4 of the BHCA in orderto provide for a framework for the engagement in new financial activities.  A bank holding company (“BHC”) may elect tobecome an FHC if all its subsidiary depository institutions are wellcapitalized and well managed.

Under the GLBA, national banks (as well as FDIC-insured state banks,subject to various requirements) are permitted to engage through “financial subsidiaries”in certain financial activities permissible for affiliates of FHCs.  However, to be able to engage in suchactivities the bank must also be well capitalized and well managed and receiveat least a “satisfactory” rating in its most recent Community Reinvestment Actexamination.  In addition, if the bankranks as one of the top 50 largest insured banks in the United States, it musthave an issue of outstanding long-term debt rated in one of the three highestrating categories by an independent rating agency.  If the bank falls within the next group of50, it must either meet the debt-rating test described above or satisfy acomparable test jointly agreed to by the FRB and the Treasury Department.  No debt rating is required for any bank, suchas the Bank, not within the top 100 largest insured banks in the United States.

The Bank cannot be certain of the effect of the foregoing legislationon its business, although there is likely to be consolidation among financialservices institutions and increased competition for the Bank.

***The Riegle-Neal Act.***  The Riegle-Neal Interstate Banking andBranching Efficiency Act of 1994 (the “Riegle-Neal Act”), enacted onSeptember 29, 1994, repealed the McFadden Act of 1927, which requiredstates to decide whether national or state banks could enter their state, andallowed banks to open branches across state lines beginning on June 1,1997.  The Riegle-Neal Act also repealedthe 1956 Douglas Amendment to the BHCA, which placed the same requirements onBHCs.  The repeal of the DouglasAmendment now makes it possible for banks to buy out of-state banks in anystate and convert them into interstate branches.

The Riegle-Neal Act provides that interstate branching and merging ofexisting banks is permitted, provided that the banks are at least “adequatelycapitalized” and demonstrate good management. The states are also authorized to enact a law to permit interstate banksto branch de novo.

On September 28, 1995, the California Interstate Banking andBranching Act of 1995 (“CIBBA”) was enacted and signed into law allowing earlyinterstate branching in California. CIBBA authorizes out-of-state banks to enter California by theacquisition of or merger with a California bank that has been in existence forat least five years, unless the California bank is in danger of failing or incertain other emergency situations.

***Federal Deposit Insurance Corporation Improvement Act of 1991.***  The Federal Deposit Insurance CorporationImprovement Act of 1991 (“FDICIA”) was signed into law on December 19,1991. FDICIA recapitalized the FDIC’s Bank Insurance Fund, granted broadauthorization to the FDIC to increase deposit insurance premium assessments andto borrow from other sources, and continued the expansion of regulatoryenforcement powers, along with many other significant changes.

FDICIA establishes five categories of capitalization: “wellcapitalized,” “adequately capitalized,” “undercapitalized,” “significantlyundercapitalized,” and “critically undercapitalized.”  If a bank falls in the “undercapitalized,” “significantlyundercapitalized” or “critically undercapitalized” categories, it will besubject to significant enforcement actions by its primary federalregulator).  See “EnforcementPowers-Corrective Measures for Capital Deficiencies,” below.

FDICIA also grants the regulatory agencies authority to prescribestandards relating to internal controls, credit underwriting, asset growth andcompensation, among others, and requires the regulatory agencies to promulgateregulations prohibiting excessive compensation or fees.  Many regulations have been adopted by theregulatory agencies to begin to implement these provisions and subsequentlegislation (the Riegle-Neal Act, discussed above) gives the regulatoryagencies the option of prescribing the safety and soundness standards asguidelines rather than regulations.

As previously noted, FDICIA places restrictions on certain bankactivities authorized under state law. FDICIA generally restricts activities through subsidiaries to those permissiblefor national banks, thereby effectively eliminating real estate investment.Insurance activities are also limited, except to the extent permissible fornational banks.

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***USA Patriot Act***.  The United and Strengthening America ByProviding Appropriate Tools Required to Intercept and Obstruct Terrorism Act of2001 (the “USA Patriot Act”) was signed into law on October 26, 2001.  The USA Patriot Act requires financialinstitutions, such as the Bank, to implement and follow procedures designed tohelp prevent, detect and prosecute international money laundering and thefinancing of terrorism.  Title III of theUSA Patriot Act is the International Money Laundering Abatement and FinancialAnti-Terrorism Act of 2001 (“IMLAFATA”). In general, the IMLAFATA amends current law, primarily the Bank SecrecyAct (see “—Bank Secrecy Act,” below), to authorize the Secretary of theTreasury, in consultation with the heads of other government agencies, to adoptspecial measures applicable to banks, bank holding companies and otherfinancial institutions including enhanced record-keeping and reportingrequirements for certain financial transactions that are of primary moneylaundering concern, due diligence requirements concerning the beneficialownership of certain types of accounts, and restrictions or prohibitions oncertain types of accounts with foreign financial institutions.  Among its other provisions, the IMLAFATArequires financial institutions to: (i) establish an anti-money launderingprogram; (ii) establish due diligence policies, procedures and controlswith respect to private banking accounts and correspondent banking accountsinvolving foreign individuals and certain foreign banks; and (iii) avoidestablishing, maintaining, administering or managing correspondent accounts inthe United States for, or on behalf of, a foreign bank that does not have aphysical presence in any country.  Inaddition, the IMLAFATA contains a provision encouraging cooperation amongfinancial institutions, regulatory authorities and law enforcement authoritieswith respect to individuals, entities and organizations engaged in, orreasonably suspected of engaging in, terrorist acts or money launderingactivities.  The IMLAFATA expands thecircumstances under which deposited funds may be forfeited and requires coveredfinancial institutions to respond under certain circumstances to requests forinformation from federal banking agencies within 120 hours.  The IMLAFATA also amends the BHCA and the BankMerger Act to require the federal banking agencies to consider theeffectiveness of a financial institution’s anti-money laundering activitieswhen reviewing an application under these Acts. Among other programs implemented to comply with the USA Patriot Act, theBank implemented a customer identification program.

***Bank Secrecy Act***.  The Financial Recordkeeping and Reporting ofCurrency and Foreign Transactions Act of 1970 (the “Bank Secrecy Act”) is adisclosure law that forms the basis of the United States federal government’sframework to prevent and detect money laundering and to deter other criminalenterprises.  Following theSeptember 11, 2001 terrorist attacks, an additional purpose was added tothe Bank Secrecy Act:  “To assist in theconduct of intelligence or counter-intelligence activities, including analysis,to protect against international terrorism.” Under the Bank Secrecy Act, financial institutions such as the Bank arerequired to maintain certain records and file certain reports regardingdomestic currency transactions and cross-border transportations ofcurrency.  This, in turn, allows lawenforcement officials to create a paper trail for tracing illicit funds thatresulted from drug trafficking or other criminal activities.  Among other requirements, the Bank SecrecyAct requires financial institutions to report imports and exports of currencyin excess of $10,000 and, in general, all cash transactions in excess of$10,000.  The Bank has established a BankSecrecy Act compliance policy under which, among other precautions, the Bankkeeps currency transaction reports to document cash transactions in excess of$10,000 or in multiples totaling more than $10,000 during one business day,monitors certain potentially suspicious transactions such as the exchange of alarge number of small denomination bills for large denomination bills, andscrutinizes electronic funds transfers for Bank Secrecy Act compliance.

**Administrative Actions**

Following the September 11, 2001 terrorist attacks on the UnitedStates, President George W. Bush signed an executive order onSeptember 24, 2001 that has a number of consequences for the operations ofcommercial banks.  First, it ordered thefreezing of assets of persons on a list included in the order and requires eachfinancial institution to monitor its deposits to determine whether they shouldbe frozen.  Second, it makes it illegalto do business with any of the persons or entities named on the list.  This means that the Bank is obligated tocarefully screen its customers on an ongoing basis to assure that the Bank ispermitted to do business with them. These types of administrative orders and similar regulations of bankregulators may increase the cost of operating the Bank and it is possible thatfurther such orders will be made although the Bank is not aware of any at thistime.

**Restrictions onTransactions With Insiders**

Sections 23A and 23B of the Federal Reserve Act regulatetransactions between insured institutions and their “affiliates” andtransactions by the Bank that benefit affiliates.  For these purposes, an “affiliate” is acompany under common control with the institution.  In general, Section 23A imposes limitson the dollar amount of such transactions, and also requires certain levels ofcollateral for loans to affiliates. Section 23B generally requires that 

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certain transactions between a bank and its respectiveaffiliates be on terms substantially the same, or at least as favorable to suchbank, as those prevailing at the time for comparable transactions with orinvolving other nonaffiliated persons. At this time the Bank does not have any “affiliates.”

The restrictions on loans to directors, executive officers, principalstockholders and their related interests (collectively referred to herein as “insiders”)contained in the Federal Reserve Act and Regulation O promulgated thereunderapply to all federally insured institutions and their subsidiaries and holdingcompanies.  These restrictions includelimits on loans to one borrower and conditions that must be met before such aloan can be made.  There is also anaggregate limitation on all loans to insiders and their related interests.  These loans cannot exceed the institution’stotal unimpaired capital and surplus, and the FDIC may determine that a lesseramount is appropriate.  Insiders aresubject to enforcement actions for knowingly accepting loans in violation ofapplicable restrictions.

**Deposit InsuranceAssessments**

The deposits of the bank are insured up to regulatory limits by theFDIC and the bank is required under the FDIC’s deposit insurance assessments tomaintain the Bank Insurance Fund (“BIF”) and Savings Association Insurance Fund(“SAIF”). The FDIC has adopted regulations establishing a permanentrisk-related deposit insurance assessment system. Each financial institution isassigned to one of three capital groups: well capitalized, adequatelycapitalized or undercapitalized; and further assigned to one of three subgroupswithin a capital group. A bank’s assignment is based on supervisory evaluationsby the institution’s primary federal regulator and, if applicable, otherinformation relevant to the institution’s financial condition and the riskposed to the applicable insurance fund. The assessment rate applicable to thebank in the future will depend in part upon the risk assessment classificationassigned to each bank by the FDIC and in part on the BIF assessment scheduleadopted by the FDIC. Institutions are prohibited from disclosing the riskclassification to which they have been assigned. The Deposit Insurance Funds Actof 1996 provides for assessments to be imposed on insured depositoryinstitutions with respect to deposits insured by the BIF and the SAIF. For2006, the annual insurance premiums on bank deposits insured by the BIF andSAIF varied between $0.01 to $0.27 per $100 of deposits. The Bank’s premiumamount for the year ended December 31, 2006, was $28,370.

The FDIC has adopted a risk-based assessment system for insureddepository institutions that takes into account the risks attributable todifferent categories and concentrations of assets and liabilities. In early2006, Congress passed the Federal Deposit Insurance Reform Act of 2005, whichmade certain changes to the Federal deposit insurance program. These changesincluded merging the BIF and the SAIF, increasing coverage to $250,000 for IRAaccounts and providing for inflationary adjustments to general coveragebeginning in 2010, providing the FDIC with authority to set the fund’s reserveratio within a specified range and requiring dividends to banks if the reserveratio exceeds certain levels. The new statute grants banks an assessment creditbased on their share of the assessment base on December 31, 1996 and the amountof the credit can be used to reduce assessments in any year subject to certainlimitations.

**Risk-BasedCapital Guidelines**

The federal banking agencies have issued risk-based capital guidelinesthat include a definition of capital and a framework for calculating riskweighted assets by assigning assets and off-balance sheet items to broad creditrisk categories. A bank’s risk-based capital ratio is calculated by dividingits qualifying total capital (the numerator of the ratio) by its risk-weightedassets (the denominator of the ratio).

A bank’s qualifying total capital will consist of two types of capitalcomponents: “core capital elements” (comprising Tier 1 capital) and “supplementarycapital elements” (comprising Tier 2 capital). The Tier 1 component of a bank’s qualifying capital must represent atleast 50% of qualifying total capital and may consist of the following itemsthat are defined as core capital elements: (i) common stockholders’equity; (ii) qualifying noncumulative perpetual preferred stock (includingrelated surplus); and (iii) minority interest in the equity accounts ofconsolidated subsidiaries.  The Tier 2component of a bank’s qualifying total capital may consist of the followingitems: (i) allowance for loan and lease losses (subject to limitations);(ii) perpetual preferred stock and related surplus (subject to conditions);(iii) hybrid capital instruments (as defined) and mandatory convertibledebt securities; and (iv) term subordinated debt and intermediate-termpreferred stock, including related surplus (subject to limitations).

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Assets and credit equivalent amounts of off-balance sheet items areassigned to one of several broad risk categories, according to the obligor, or,if relevant, the guarantor or the nature of collateral.  The aggregate dollar value of the amount ineach category is then multiplied by the risk weight associated with thatcategory.  The resulting weighted valuesfrom each of the risk categories are added together, and this sum is the bank’stotal risk weighted assets that comprise the denominator of the risk-basedcapital ratio.

A two-step process determines risk weights for all off-balance sheetitems.  First, the “credit equivalentamount” of off-balance sheet items is determined, in most cases by multiplyingthe off-balance sheet item by a credit conversion factor.  Second, the credit equivalent amount istreated like any balance sheet asset and generally is assigned to theappropriate risk category according to the obligor, or, if relevant, theguarantor or the nature of the collateral.

All banks are required to meet a minimum ratio of qualifying totalcapital to risk weighted assets of 8%, of which at least 4% should be in theform of Tier 1 capital.  The Bank’s totalcapital and Tier 1 capital to risk weighted assets as of December 31,2006, exceeded these requirements.

The regulatory agencies have adopted leverage requirements that applyin addition to the risk-based capital requirements.  Under these requirements, banks are requiredto maintain core capital of at least 3% of their quarterly average assets (the “LeverageRatio”).  However, an institution may berequired to maintain core capital of at least 4% or 5% or possibly higher,depending upon its activities, risks, rate of growth, and other factors deemedmaterial by regulatory authorities.  AtDecember 31, 2006, the Bank’s leverage was in excess of this requirement.

**Enforcement Powers**

Federal regulatory agencies have broad and strong enforcement authorityreaching a wide range of persons and entities. Some of these provisions includethose which: (i) establish a broad category of persons subject toenforcement under the Federal Deposit Insurance Act; (ii) establish broadauthority for the issuance of cease and desist orders and provide for theissuance of temporary cease and desist orders; (iii) provide for the suspension and removal of wrongdoers on anindustry-wide basis; (iv) prohibit the participation of persons suspendedor removed or convicted of a crime involving dishonesty or breach of trust fromserving in another insured institution; (v) require regulatory approval ofnew directors and senior executive officers in certain cases; (vi) provideprotection from retaliation against “whistleblowers” and establish rewards for “whistleblowers”in certain enforcement actions resulting in the recovery of money;(vii) require the regulators to publicize all final enforcementorders;  (viii) require each insuredfinancial institution to provide its independent auditor with its most recentReport of Condition (“Call Report”); (ix) permit the imposition ofsignificant penalties for failure to file accurate and timely Call Reports; and(x) provide for the assessment of significant civil money penalties andthe imposition of civil and criminal forfeiture and other civil and criminalfines and penalties.

***Crime Control Actof 1990.***  The CrimeControl Act of 1990 further strengthened the authority of federal regulators toenforce capital requirements, increased civil and criminal penalties forfinancial fraud, and enacted provisions allowing the FDIC to regulate orprohibit certain forms of golden parachute benefits and indemnificationpayments to officers and directors of financial institutions.

***Corrective Measuresfor Capital Deficiencies.*** The prompt corrective action regulations, which were promulgated toimplement certain provisions of FDICIA, also effectively impose capitalrequirements on national banks, by subjecting banks with less capital toincreasingly stringent supervisory actions. For purposes of the prompt corrective action regulations, a bank is “undercapitalized”if it has a total risk-based capital ratio of less than 8%; a Tier 1 risk-basedcapital ratio of less than 4%; or a leverage ratio of less than 4% (or lessthan 3% if the bank has received a composite rating of 1 in its most recentexamination report and is not experiencing significant growth).  A bank is “adequately capitalized” if it hasa total risk-based capital ratio of 8% or higher; a Tier 1 risk-based capitalratio of 4% or higher; a leverage ratio of 4% or higher (3% or higher if thebank was rated a composite 1 in its most recent examination report and is notexperiencing significant growth); and does not meet the criteria for a “wellcapitalized” bank.  A bank is “wellcapitalized” if it has a total risk-based capital ratio of 10% or higher; aTier 1 risk-based capital ratio of 6% or higher; a leverage ratio of 5% orhigher; and is not subject to any written requirement to meet and maintain anyhigher capital level(s).  There is noassurance as to what capital ratios the Bank will be able to maintain.

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Under the provisions of FDICIA and the prompt corrective actionregulations, for example, an “undercapitalized” bank is subject to a limit onthe interest it may pay on deposits. Also, an undercapitalized bank cannot make any capital distribution,including paying a dividend (with some exceptions), or pay any management fee(other than compensation to an individual in his or her capacity as an officeror employee of the bank).  Such a bankalso must submit a capital restoration plan to its primary federal regulatorfor approval, restrict total asset growth and obtain regulatory approval priorto making any acquisition, opening any new branch office or engaging in any newline of business.  Additional broadregulatory authority is granted with respect to “significantly undercapitalized”banks, including forced mergers, ordering new elections for directors, forcingdivestiture by its holding company, if any, requiring management changes, andprohibiting the payment of bonuses to senior management.  Additional mandatory and discretionaryregulatory actions apply to “significantly undercapitalized” and “criticallyundercapitalized” banks, the latter being a bank with capital at or less than2%.  The primary federal regulator mayappoint a receiver or conservator for a “critically undercapitalized” bankafter 90 days, even if the bank is still solvent.  Failure of a bank to maintain the requiredcapital could result in such bank being declared insolvent and closed.

**Community ReinvestmentAct and Fair Lending Developments**

The Bank is subject to certain fair lending requirements and reportingobligations involving home mortgage lending operations and CommunityReinvestment Act (“CRA”) activities.  TheCRA generally requires the federal banking agencies to evaluate the record offinancial institutions in meeting the credit needs of their local communities,including low and moderate income neighborhoods. In addition to substantialpenalties and corrective measures that may be required for a violation ofcertain fair lending laws, the federal banking agencies may take compliancewith such laws and CRA into account when regulating and supervising otheractivities.

The federal banking agencies have adopted regulations to measure a bank’scompliance with its CRA obligations on a performance-based evaluation system.This system bases CRA ratings on an institution’s actual lending service andinvestment performance rather than the extent to which the institution conductsneeds assessments, documents community outreach or complies with other proceduralrequirements. In March 1994, the Federal Interagency Task Force on FairLending issued a policy statement on discrimination in lending. The policystatement describes the three methods that federal agencies will use to provediscrimination: overt evidence of discrimination, evidence of disparatetreatment and evidence of disparate impact.

**Allowance For Loan andLease Losses**

On December 13, 2006, the FRB and the other federal financialinstitution regulatory agencies issued an interagency policy statement on theallowance for loan and lease losses (the “Policy Statement”). The PolicyStatement replaces a 1993 policy statement, which described theresponsibilities of the boards of directors and management of banks and savingsassociations and of examiners regarding allowance for loan and lease losses. Inaddition to the Policy Statement, the accounting profession groups periodicallyprovide guidance to the banking industry on allowance for loan and lease losses(“ALLL”) methodology.

 The Policy Statement outlinesthe responsibility of the institution’s management and board of directorsregarding their roles in maintaining ALLL at an appropriate level and fordocumenting its analysis. Management should evaluate the ALLL reported on thebalance sheet as of the end of each quarter, or more frequently if warranted,and charge or credit the provision for loan and lease losses (“PLLL”) to bringthe ALLL to an appropriate level as of each evaluation date. The determinationsof the amounts of the ALLL and PLLL should be based on management’s currentjudgments about the credit quality of the loan portfolio, and should considerall known relevant internal and external factors that affect loancollectibility as of the evaluation date.

In carrying out its responsibility for maintaining an appropriate ALLL,management is expected to adopt and adhere to written policies and proceduresthat, at a minimum, ensure that: (1) the institution’s process fordetermining an appropriate level for ALLL is based on a comprehensive, well-documented,and consistently applied analysis of its loan portfolio; (2) theinstitution has an effective loan review system and controls (including aneffective loan classification or credit grading system) that identify, monitor,and address asset quality problems in an accurate and timely manner;(3) the institution has adequate data capture and reporting systems tosupply the information necessary to support and document its estimate of anappropriate ALLL; (4) the institution evaluates any loss estimation modelsbefore they are employed and modifies the models’ assumptions, as needed, toensue that the resulting loss estimates are consistent with GAAP; (5) theinstitution promptly charges off loans, or portions of 

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loans, that available information confirms to beuncollectible, and; (6) the institution periodically validates the ALLLmethodology.

The Policy Statement also provides guidance to examiners in evaluatingthe credit quality of an institution’s loan portfolio, the appropriateness ofits ALLL methodology and documentation, and the appropriateness of the reportedALLL in the institution’s regulatory reports. In their review andclassification or grading of the loan portfolio, examiners should consider allsignificant factors that affect the collectibility of the portfolio, includingthe value of any collateral.

**Other Aspects of Federaland State Law**

The Bank is also subject to federal and state statutory and regulatoryprovisions covering, among other things, security procedures, technology andinformation security and risk assessment, currency and foreign transactionsreporting, insider and affiliated party transactions, management interlocks,truth-in-lending, electronic funds transfers, funds availability,truth-in-savings, home mortgage disclosure, and equal credit opportunity.  There are also a variety of federal statutesthat restrict the acquisition of control of the Bank.

**ProposedLegislation**

From time to time, various types of federal and state legislation havebeen proposed that could result in additional regulation of, and restrictionson, the business of the Bank.  It cannotbe predicted whether any legislation currently being considered will be adoptedor how such legislation or any other legislation that might be enacted in thefuture would affect the business of the Bank.

**ITEM 1A.               RISKFACTORS**

We have set forth below risk factors, as of the date this report isbeing filed, that we believe are applicable to us.  The risks and uncertainties described beloware not the only ones we face. Additional risks and uncertainties not presently known to us or that wecurrently believe are immaterial also may impair our business.  If any of the events described below occur,our business, results of operations and financial condition could be materiallyadversely affected.

**Fluctuations in interestrates could reduce our income, cash flows and asset values.**

Our income and cash flows and the value of our assets depend to a greatextent on the difference between the interest rates we earn on interest-earningassets, such as loans and investment securities, and the interest rates we payon interest-bearing liabilities such as deposits and borrowings. These ratesare highly sensitive to many factors, which are beyond our control, includinggeneral economic conditions and policies of various governmental and regulatoryagencies and, in particular, the Board of Governors of the Federal ReserveSystem.  If the rate of interest we payon our deposits and other borrowings increases more than the rate of interestwe earn on our loans and other investments, our net interest income, andtherefore our earnings, could be adversely affected. Our earnings also could beadversely affected if the rates on our loans and other investments fall morequickly than those on our deposits and other borrowings.

**Economic conditionseither nationally or locally in areas in which our operations are concentratedmay adversely affect our business.**

Deterioration in local, regional, national or global economicconditions could cause us to experience a reduction in deposits and new loans,an increase in the number of borrowers who default on their loans and areduction in the value of the collateral securing their loans, all of whichcould adversely affect our performance and financial condition. Unlike largerbanks that are more geographically diversified, we provide banking andfinancial services locally, specifically, within San Diego County. Therefore,we are particularly vulnerable to adverse local economic conditions.

**Our small businesscustomers may lack the resources to weather a downturn in the economy.**

One of the primary focal points of our business is serving the bankingand financial services needs of small and medium-sized businesses andprofessionals within our service area. Such customers generally have fewer 

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financial resources in terms of capital or borrowingcapacity than do larger businesses.  Ifeconomic conditions are generally unfavorable in San Diego County, ourcustomers may not be able to fully repay their loans and we could suffer loanlosses as a result.

**Our financial conditionand results of operations would be adversely affected if our allowance for loanlosses is not sufficient to absorb actual losses or if we are required toincrease our allowance.**

Despite our underwriting criteria, we may experience loan delinquenciesand losses. In order to absorb losses associated with nonperforming loans, wemaintain an allowance for loan losses based on, among other things, historicalexperience, an evaluation of economic conditions, and regular reviews ofdelinquencies and loan portfolio quality. Determination of the allowanceinherently involves a high degree of subjectivity and requires us to makesignificant estimates of current credit risks and future trends, all of whichmay undergo material changes. At any time there are likely to be loans in ourportfolio that will result in losses but that have not been identified asnonperforming or potential problem credits. We cannot be sure that we will beable to identify deteriorating credits before they become nonperforming assetsor that we will be able to limit losses on those loans that are identified. Wemay be required to increase our allowance for loan losses for any of severalreasons. Regulators, in reviewing our loan portfolio as part of a regulatoryexamination, may request that we increase our allowance for loan losses.Changes in economic conditions affecting borrowers, new information regardingexisting loans, identification of additional problem loans and other factors,both within and outside of our control, may require an increase in ourallowance. In addition, actual charge-offs in future periods, if not adequatelyreserved for, will require additional increases in our allowance for loanlosses. Any increases in our allowance for loan losses will result in adecrease in our net income and, possibly, our capital, and may materiallyaffect our results of operations in the period in which the allowance isincreased.

**Competition with otherbanks and other financial institutions may decrease our growth or profits.**

We face substantial competition in all phases of our operations from avariety of different competitors, including other banks and other financialinstitutions, including savings and loan associations, savings banks, financecompanies and credit unions.  There isvery strong competition among financial services providers in our service area.Our competitors have substantially greater resources and lending limits, largerbranch systems and a wider array of banking services than we offer.  Accordingly, they may be able to offer abroader range of products and services as well as better pricing for thoseproducts and services than we can.  Thiscompetition may reduce or limit our profit margins on banking services, maykeep us from building or maintaining market share and may adversely affect ourresults of operations and financial condition.

In addition, some of the financial services organizations with which wecompete are not subject to the same degree of regulation as is imposed onfederally insured financial institutions. As a result, those nonbankcompetitors may be able to access funding and provide various services moreeasily or at less cost than we can, adversely affecting our ability to competeeffectively.

**We operate in a highlyregulated industry, which adds significant costs to our operations.**

Banking is a heavily regulated industry and the costs of regulatorycompliance are rising.  Bankingregulations are primarily intended to protect the federal deposit insurancefunds and depositors, not shareholders. Changes in the laws, regulations, andregulatory practices affecting the banking industry may increase our costs ofdoing business or otherwise adversely affect us and create competitiveadvantages for others. Regulations affecting banks and financial servicescompanies undergo continuous change, and we cannot predict the ultimate effectof these changes, which could have a material adverse effect on ourprofitability or financial condition.  Wewill be implementing Section 404 of the Sarbanes-Oxley Act of 2002 in 2007 andthe costs to implement may be material and may affect our profitability.

**We rely on our managementand other key personnel, and the loss of any of them may adversely affect ouroperations.**

We are and will continue to be dependent upon the services of ourexecutive management team. In addition, we will continue to depend on ourability to retain and recruit key loan officers. The unexpected loss ofservices of any key management personnel or loan officers could have an adverseeffect on our business and 

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financial condition because of their skills, knowledgeof our market, years of industry experience and the difficulty of promptlyfinding qualified replacement personnel.

In the event that the employment of our executive officers isterminated in the future without cause, under the terms of their respectiveemployment agreements, each of our executive officers would be entitled toreceive continued salary at the rate then in effect for varying periods of timefollowing termination.  Such obligationsto make severance payments could be triggered in the event we are acquired andthe executive officer is terminated in connection with such acquisition.

**Failure to implement newtechnologies in our operations may adversely affect our growth or profits.**

Advances in technology increasingly affect the market for financialservices, including banking services and consumer finance services. Our abilityto compete successfully in our markets may depend on the extent to which we areable to exploit such technological changes. However, we can provide noassurance that we will be able properly or timely to anticipate or implementsuch technologies or properly train our staff to use such technologies. Further,the added cost of technology for a small bank such as us adversely affects ourprofitability.  Any failure to adapt tonew technologies could adversely affect our business, financial condition oroperating results.

**An investment in ourcommon stock is not an insured deposit.**

Our common stock is not a bank deposit and, therefore, is not insuredagainst loss by the Federal Deposit Insurance Corporation, commonly referred toas the FDIC, any other deposit insurance fund or by any other public or privateentity. Investment in our common stock is subject to the same market forcesthat affect the price of common stock in any company.

**We plan to continue togrow and there are risks associated with growth.**

We intend to continue to expand our business and operations to increasedeposits and loans. Continued growth may present operating and other problemsthat could adversely affect our business, financial condition and results ofoperations. Our growth may place a strain on our administrative, operational,personnel and financial resources and increase demands on our systems andcontrols. Our ability to manage growth successfully will depend on our abilityto attract qualified personnel and maintain cost controls and asset qualitywhile attracting additional loans and deposits on favorable terms, as well ason factors beyond our control, such as economic conditions and interest ratetrends. If we grow too quickly and are not able to attract qualified personnel,control costs and maintain asset quality, this continued rapid growth couldmaterially adversely affect our financial performance.

**Our legal lending limitsare relatively low and restrict our ability to compete for larger customers.**

At December 31, 2006, our lending limit per borrower was approximately$8.6 million, which is primarily based on our capital level. Accordingly, thesize of loans that we can offer to potential borrowers (without participationby other lenders) is less than the size of loans that many of our competitorswith larger capitalization are able to offer. Our legal lending limit alsoimpacts the efficiency of our lending operation because it tends to lower ouraverage loan size, which means we have to generate a higher number oftransactions to achieve the same portfolio volume. We may engage in loanparticipations with other banks for loans in excess of our legal lendinglimits. However, there can be no assurance that such participations will beavailable at all or on terms, which are favorable to us and to our customers.

**We may be unable toconsummate our proposed merger with Landmark National Bank.**

Our proposed merger with Landmark, described in more detail above, isanticipated to close in the second or third quarter of 2007 but must beapproved by both our and Landmark’s shareholders before it can be finalized.Consummation of this merger is also subject to the receipt of requiredregulatory approvals and the satisfaction of other customary closingconditions. If the merger is not completed for any reason, our stock price maydecline because certain costs related to the merger, such as legal, accountingand a portion of financial advisory fees, must be paid even if the merger isnot completed. In addition, if the merger is not completed, our stock price maydecline to the extent that the current market price reflects the assumption byinvestors that the merger will be completed.

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**We may not be able toachieve the benefits and efficiencies expected as a result of our anticipatedacquisition of Landmark National Bank.**

We have entered into a merger agreement withLandmark based on the belief, after thorough analysis, that the anticipatedimpact on the merged operations, growth of its customer base, and improvedefficiencies resulting from economies of scale, will positively effect the ourresults of operations and related earnings per share.  Actual results may differ materially from thoseanticipated due to various risks and uncertainties. These risks anduncertainties include, but are not limited to the possible loss of keyemployees; the planned merger and relative cost savings cannot be realized orrealized within the expected time frame; revenues are lower than expected; theintegration of Landmark’s business costs more, takes longer or is lesssuccessful than expected; our ability to obtain the cash required to consummatethe transaction, or to achieve expected synergies and operating efficiencieswithin expected time-frames or at all, or to successfully integrate Landmark’soperations; or regulatory approvals for the proposed merger cannot be obtainedon the terms expected or on the anticipated schedule.  These could negatively affect our ability tomaintain relationships with customers and employees, or achieve the anticipatedbenefits of the merger within the time period expected, if at all. As with anymerger of financial institutions, there may also be disruptions that cause customers,both deposit and loan, to take their business to competitors. Although webelieve that we have strong management, polices and procedures, and experienceto integrate Landmark’s operations, no guarantees exist that Landmark’sintegration within our operations will be successful.

**Uncertainty regarding themerger may result in the loss of the employees and customers of either Landmarkor us prior to the completion of the merger.**

Employees of Landmark and us may experience uncertainty about theirfuture role with the combined bank. This may adversely affect the ability ofthe combined bank to retain and attract key management and other personnel.Similarly, uncertainty regarding the merger may cause customers of Landmark orof ours to withdraw their business prior to the completion of the merger.  Any loss of Landmark’s or our customers couldhave a material adverse effect on our business, regardless of whether or notthe merger is ultimately completed. There can be no assurance that customers ofeither of Landmark or us will continue their business without regard to theproposed merger.

**ITEM 1B.               UNRESOLVED STAFF COMMENTS**

The Company is not aware of any unresolved comments from the staff ofthe SEC.

**ITEM 2.                  PROPERTIES**

The Company’s corporate headquarters is located at 4275 ExecutiveSquare, La Jolla, California. In addition, the Company currently operates fivebranch offices in San Diego County.  InApril 2006, the Company opened its fifth branch office in El Cajon,California.  Each office is leased pursuantto an operating lease, the principal terms of which are outlined in the tablebelow.  For additional informationregarding the Company’s premises and equipment see Note D to the FinancialStatements included in “Item 8, Financial Statements,” below.
| Date  Opened | ** ** | **Address**                                    | ** ** | **Approx.  Usable Sq.  Footage** | ** ** | **Current  Monthly  Obligation** | ** ** | **Lease  Expiration** | ** ** |
|--------------|------------|------------------------------------------------|------------|---------------------------------------|------------|----------------------------------|------------|-----------------------|------------|
| 12/2004      |       | Corporate  Headquarters                        |       | 4,307                                 |       | $                                | 16,079     |                  | 1/2008     |   |
|              |       | 4275 Executive  Square, Ste. 650, La Jolla, CA |       |                                  |       |                             |       |                  |       |
|         |       |                                           |       |                                  |       |                             |       |                  |       |
| 11/2000      |       | Golden Triangle  Branch Office                 |       | 3,920                                 |       | $                                | 13,557     |                  | 12/2007    |   |
|              |       | 7728 Regents  Road, Ste. 503, San Diego, CA    |       |                                  |       |                             |       |                  |       |
|         |       |                                           |       |                                  |       |                             |       |                  |       |
| 11/2000      |       | Tri-Cities  Branch Office                      |       | 2,838                                 |       | $                                | 10,421     |                  | 12/2009    |   |
|              |       | 3500 College Blvd.,  Oceanside, CA             |       |                                  |       |                             |       |                  |       |

 

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| Date  Opened | ** ** | **Address**                                             | ** ** | **Approx.  Usable Sq.  Footage** | ** ** | **Current  Monthly  Obligation** | ** ** | **Lease  Expiration** | ** ** |
|--------------|------------|---------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------|------------|-----------------------|------------|
| 8/2003       |       | Mission Valley  Branch Office                           |       | 3,904                                 |       | $                                | 11,008     |                  | 8/2013     |   |
|              |       | 8889 Rio San  Diego Dr., San Diego, CA                  |       |                                  |       |                             |       |                  |       |
|         |       |                                                    |       |                                  |       |                             |       |                  |       |
| 2/2005       |       | Inland North  County Branch Office                      |       | 4,664                                 |       | $                                | 15,310     |                  | 2/2012     |   |
|              |       | 13500 Evening  Creek Dr. North, Ste. 100, San Diego, CA |       |                                  |       |                             |       |                  |       |
|         |       |                                                    |       |                                  |       |                             |       |                  |       |
| 11/2005      |       | East County  Branch Office                              |       | 1,950                                 |       | $                                | 3,500      |                  | 12/2006    |   |
|              |       | 169 E. Main St., El  Cajon, CA                          |       |                                  |       |                             |       |                  |       |

 

Management believes that the Company’s presentfacilities are in good physical condition and are adequately covered byinsurance. Certain of the leases noted above contain options to extend the termof the lease.  The Company is confidentthat, if necessary, it would be able to secure suitable alternative space onsimilar terms without having a substantial effect on operations.

The following is information regarding new leased facilities, whichfacilities will replace the leases shown above for the Corporate Headquarters,the Golden Triangle Branch Office, and the East County Branch Office, and inwhich the Company anticipates commencing occupancy in 2007:
| Anticipated  Lease  Commencement | ** ** | **Address**                               | ** ** | **Approx.  Usable Sq.  Footage** | ** ** | **Approx. Future  Monthly  Obligation** | ** ** | **Lease  Expiration** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|-----------------------|------------|
| 8/2007                           |       | East County  Branch Office                |       | 4,000                                 |       | $                                            | 9,200      |                  | 7/2017     |   |
|                                  |       | 343 E. Main St.,  El Cajon, CA            |       |                                  |       |                                         |       |                  |       |
|                             |       |                                      |       |                                  |       |                                         |       |                  |       |
| 9/2007                           |       | Corporate  Headquarters and Branch Office |       | 15,778                                |       | $                                            | 57,110     |                  | 8/2017     |   |
|                                  |       | 9333 Genesee Ave., San  Diego, CA         |       |                                  |       |                                         |       |                  |       |

 

**ITEM 3.                  LEGALPROCEEDINGS**

The Company and it subsidiaries are involved only in routine litigationincidental to the business of banking, none of which the Company’s managementexpects to have a material adverse effect on the Company.

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

On November 29, 2006, the Bank mailed a Written Consent SolicitationStatement to its shareholders.  Thepurpose of the Written Consent Solicitation Statement was:

1.                                       Toconsider and vote on a proposal to approve a Plan of Reorganization and MergerAgreement, pursuant to which 1st Pacific Bank of California will become awholly-owned subsidiary of 1st Pacific Bancorp, and the shareholders of 1st Pacific Bank of California will become shareholdersof 1st Pacific Bancorp, receiving, in exchange foreach share of 1st Pacific Bank of California’s common stockowned, one share of common stock of 1st Pacific Bancorp, without any recognition ofgain or loss for tax purposes.

Written Consents were received from approximately 55% of allshareholders. Of the Written Consents received, approximately 98% voted infavor of the proposal, which represented approximately 54% of all outstandingshares. The details of voting results were as follows:
|   | Allowed   |   | 3,869,660 |   |
|--------|-----------|--------|-----------|--------|
|   | Responded |   | 2,124,292 |   |
|   | Yes Votes |   | 2,084,292 |   |
|   | No Votes  |   | 40,000    |   |

 

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**PART II**

**ITEM 5.**                                                  MARKET FORREGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF EQUITY SECURITIES

**Market Information**

As a result of the bank holding companyreorganization, effective January 30, 2007, the Company’s common stock begantrading under the symbol “FPBN” and is quoted on the OTC Bulletin Board. Priorto the reorganization, trading in the Bank’s common stock under the symbol “FPBS”was not extensive and such trades cannot be characterized as constituting anactive trading market.  The common stockis not listed on any exchange or quoted by the NASDAQ® Stock Market (“NASDAQ”),although it is quoted on the OTC Bulletin Board® (“OTCBB”). Trades may alsooccur in unreported private transactions. The OTCBB is a regulated quotationservice that displays real-time quotes, last-sale prices and volume informationin over-the-counter equity securities. Unlike the NASDAQ, however, the OTCBB does not impose listing standardsand does not provide automated trade executions.

The following table sets forth the range of high and low bidinformation and the trading volume of the common stock for the yearsindicated.  Bid information is based onreports received from the OTCBB based on all transactions reported on theOTCBB.  Such information reflectsinter-dealer prices, without retail markups, markdowns or commissions and maynot represent actual transactions.
| ** **     | ** ** | **Bid Information** | ** ** | **Share Volume** | ** ** |
|----------------|------------|--------------------------|------------|-----------------------|------------|
| ** **     | ** ** | **High**                 | ** ** | **Low**               | ** ** | ** ** | ** ** |
| **2005**       | ** ** | ** **               | ** ** | ** **            | ** ** | ** ** | ** ** |
| First Quarter  |       | $                        | 11.63      |                  | $          | 10.25 |   | 107,430 |   |
| Second Quarter |       | $                        | 12.88      |                  | $          | 10.25 |   | 91,526 |   |
| Third Quarter  |       | $                        | 17.50      |                  | $          | 11.00 |   | 61,068 |   |
| Fourth Quarter |       | $                        | 14.00      |                  | $          | 12.40 |   | 68,135 |   |
| ** **     | ** ** | ** **               | ** ** | ** **            | ** ** | ** ** | ** ** |
| 2006           |       |                     |       |                  |       |   |   |
| First Quarter  |       | $                        | 13.75      |                  | $          | 12.50 |   | 87,994 |   |
| Second Quarter |       | $                        | 14.69      |                  | $          | 13.25 |   | 149,555 |   |
| Third Quarter  |       | $                        | 15.00      |                  | $          | 13.50 |   | 149,035 |   |
| Fourth Quarter |       | $                        | 16.75      |                  | $          | 14.25 |   | 49,687 |   |

 

**Stockholders**

There were approximately 367 holders of record for the common stock ofthe Company as of March 12, 2007.

**Dividends**

To date, the Company has not paid any cash dividends.  Payment of stock or cash dividends in thefuture will depend upon the Company’s earnings and financial condition andother factors deemed relevant by the Board of Directors, as well as the Company’slegal ability to pay dividends.  It isthe Company’s current intention to follow its strategic plan of retainingearnings to increase capital and provide additional basis for growth.  Accordingly, no assurance can be given thatany cash dividends will be declared in the foreseeable future.

Further, under California law, the Company would be prohibited frompaying dividends unless: (1) its retained earnings immediately prior to thedividend payment equals or exceeds the amount of the dividend; or (2)immediately after giving effect to the dividend the sum of the Company’s assetswould be at least equal to 125% of its liabilities, or, if the average of itsearnings before taxes on income and before interest expense for the twopreceding fiscal years was less than the average of its interest expense forthe two preceding fiscal years, the current assets of the Company would be atleast equal to 125% of its current liabilities. The primary source of funds with 

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which dividends could be paid to shareholders wouldcome from cash dividends received by the Company from the Bank.

The Bank, as a state-chartered bank, is subject to dividendrestrictions set forth in California state banking law, and administered by theDFI. Under such restrictions, the Bank may not pay cash dividends in an amountwhich exceeds the lesser of the retained earnings of the Bank or the Bank’s netincome for the last three fiscal years (less the amount of distributions toshareholders during that period of time). If the above test is not met, cash dividends may only be paid with theprior approval of the DFI, in an amount not exceeding the Bank’s net income forits last fiscal year or the amount of its net income for the current fiscalyear. Such restrictions do not apply to stock dividends, which generallyrequire neither the satisfaction of any tests nor the approval of the DFI.Notwithstanding the foregoing, if the DFI finds that the shareholders’ equityis not adequate or that the declarations of a dividend would be unsafe orunsound, the DFI may order the state bank not to pay any dividend.  The FRB may also limit dividends paid by theBank.

**Equity Compensation PlanInformation**

See “Item 12, Security Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters — Securities Authorized for IssuanceUnder Equity Compensation Plan,” below.

**Recent Sales ofUnregistered Securities**

None.

 

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**ITEM 6.  SELECTED FINANCIAL DATA**

See “Item 7, Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” for a description of the Company’slimited activities in 2006.  Thefollowing selected financial data of the Bank has been derived from and shouldbe read in conjunction with the Bank’s audited Financial Statements and notesincluded in “Item 8, Financial Statements and Supplementary Data.”

**1stPacific Bank of California**

**Selected Financial Data**
| ** **                                              | ** ** | **As of or For the Periods Ending December 31,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                              | ** ** | **(dollars in thousands, except per share data)**                                        | ** ** |
| **Summary of Operations**                               |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Interest Income                                         |       | $                                                                                        | 23,460     |   | $ | 16,695 |   | $ | 10,363 |   | $ | 7,088 |   | $ | 4,464 |   |
| Interest Expense                                        |       | 8,217                                                                                    |       | 4,125 |   | 1,923 |   | 1,362 |   | 1,292 |   |
| Net Interest  Income                                    |       | 15,243                                                                                   |       | 12,570 |   | 8,440 |   | 5,726 |   | 3,172 |   |
| Provision for  Loan Losses                              |       | 444                                                                                      |       | 553 |   | 850 |   | 630 |   | 500 |   |
| Noninterest  Income                                     |       | 538                                                                                      |       | 491 |   | 466 |   | 361 |   | 146 |   |
| Noninterest  Expense                                    |       | 9,928                                                                                    |       | 8,532 |   | 5,993 |   | 4,528 |   | 3,225 |   |
| Income before  Income Taxes                             |       | 5,409                                                                                    |       | 3,976 |   | 2,063 |   | 929 |   | (407 | ) |
| Income Taxes  (Benefit)                                 |       | 2,207                                                                                    |       | 1,626 |   | 837 |   | (778 | ) | (320 | ) |
| Net Income  (Loss)                                      |       | $                                                                                        | 3,202      |   | $ | 2,350 |   | $ | 1,226 |   | $ | 1,707 |   | $ | (87 | ) |
| ** **                                              |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| **Per Share Data**                                      |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Net Income —  Basic                                |       | $                                                                                        | .83        |   | $ | .61 |   | $ | .34 |   | $ | .55 |   | $ | (.04 | ) |
| Net Income —  Diluted                              |       | .76                                                                                      |       | .56 |   | .32 |   | .50 |   | (.04 | ) |
| Book Value                                              |       | 6.67                                                                                     |       | 5.77 |   | 5.16 |   | 4.56 |   | 3.99 |   |
| Ending Number of  Shares Outstanding                    |       | 3,889,692                                                                                |       | 3,849,540 |   | 3,819,920 |   | 3,147,188 |   | 3,091,916 |   |
| Weighted Average  Number of Shares Outstanding          |       | 3,865,330                                                                                |       | 3,840,596 |   | 3,560,036 |   | 3,107,197 |   | 2,424,742 |   |
| ** **                                              |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Data — At Period  End**            |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Total Assets                                            |       | $                                                                                        | 318,446    |   | $ | 265,582 |   | $ | 209,709 |   | $ | 144,299 |   | $ | 102,608 |   |
| Total Loans                                             |       | 275,266                                                                                  |       | 230,382 |   | 188,552 |   | 121,127 |   | 82,265 |   |
| Allowance for  Loan Losses                              |       | 3,251                                                                                    |       | 2,809 |   | 2,265 |   | 1,454 |   | 823 |   |
| Investment  Securities                                  |       | 8,998                                                                                    |       | 3,146 |   | 5,940 |   | 5,591 |   | 4,695 |   |
| Other Real  Estate Owned                                |       | —                                                                                   |       | — |   | — |   | — |   | — |   |
| Total Deposits                                          |       | 261,838                                                                                  |       | 237,208 |   | 180,291 |   | 129,409 |   | 90,069 |   |
| Total  Shareholders’ Equity                        |       | 25,962                                                                                   |       | 22,230 |   | 19,697 |   | 14,362 |   | 12,327 |   |
| ** **                                              |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| **Operating Ratios and Other  Selected Data**           |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Return on  Average Assets                               |       | 1.14                                                                                     | %          | 1.01 | % | .71 | % | 1.43 | % | (0.12 | %) |
| Return on  Average Equity                               |       | 13.36                                                                                    | %          | 11.28 | % | 7.00 | % | 12.86 | % | (1.01 | %) |
| Operating  Efficiency Ratio                             |       | 62.91                                                                                    | %          | 65.32 | % | 67.29 | % | 74.39 | % | 97.20 | % |
| Net Interest  Margin                                    |       | 5.61                                                                                     | %          | 5.56 | % | 5.06 | % | 4.97 | % | 4.59 | % |
| Dividend Payout  Ratio                                  |       | 0.00                                                                                     | %          | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Equity to Assets                                        |       | 8.15                                                                                     | %          | 8.37 | % | 9.39 | % | 10.00 | % | 12.00 | % |
| ** **                                              |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| **Selected Asset Quality Ratios —  At Period End** |       |                                                                                     |       |   |   |   |   |   |   |   |   |
| Nonperforming  Loans to Total Loans                     |       | 0.00                                                                                     | %          | 0.46 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Nonperforming  Assets to Total Assets                   |       | 0.00                                                                                     | %          | 0.40 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| ALLL as a Percentage of  Total Loans                    |       | 1.18                                                                                     | %          | 1.22 | % | 1.20 | % | 1.20 | % | 1.00 | % |

 

22

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**ITEM 7.**                                                  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**BASISOF PRESENTATION**

As of December 31, 2006, the Company had only limited operatingactivity and no significant assets or liabilities. The Company was formed forpurposes of becoming the bank holding company parent of 1st Pacific Bank ofCalifornia and its activities up until the completion of the reorganization onJanuary 16, 2007 were limited to preparing for this reorganization.

Following is summary unaudited balance sheet information for theCompany as of December 31, 2006:

|                              | ** ** | **1**st Pacific  Bancorp | ** ** |
|------------------------------|------------|-------------------------------|------------|
| **Assets**                   |       |                          |       |
| Deferred Tax Asset           |       | $                             | 18,247     |   |
| Other Assets                 |       | 658                           |       |
| Total Assets                 |       | $                             | 18,905     |   |
|                         |       |                          |       |
| **Liabilities  and Equity**  |       |                          |       |
| Accounts Payable             |       | $                             | 35,013     |   |
| Outstanding Commitment Line  |       | 10,000                        |       |
| Total Liabilities            |       | 45,013                        |       |
| ** **                   |       |                          |       |
| Total Equity                 |       | (26,108                       | )          |
|                         |       |                          |       |
| Total Liabilities and Equity |       | $                             | 18,905     |   |

 

Following is summary statement of expenses for the Company frominception, August 4, 2006, through December 31, 2006:

|                                           | ** ** | **1**st Pacific  Bancorp | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|
| **Expenses**                              |       |                          |       |
| Legal                                     |       | $                             | 23,629     |   |
| Transfer Agent & Shareholder Services |       | 2,315                         |       |
| Printing & Edgar Filings              |       | 9,000                         |       |
| Application Fees and Other Costs          |       | 9,561                         |       |
| Total Organizational Expenses             |       | 44,505                        |       |
|                                      |       |                          |       |
| Deferred Tax Benefit                      |       | (18,247                       | )          |
|                                      |       |                          |       |
| Net Loss                                  |       | $                             | 26,258     |   |

 

Given the limited activity of the Company in 2006, the remainder ofthis Item 7 discusses the financial condition and results of operations of theBank, which became the Company’s wholly-owned subsidiary on January 16, 2007 asa result of the reorganization. This analysis is intended to assist inunderstanding the significant factors that influence the Bank’s financialcondition. This information also provides an assessment of the operating trendsover the past few years and certain expectations for 2007.

23

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**FINANCIALOVERVIEW**

During 2006, the Bank significantly grew its customer base andincreased its construction, real estate and commercial business lending,resulting in significant growth in its total assets (20%), loans (19%) anddeposits (10%) with total assets ending the year at $318.4 million.  As a result of the Bank’s growth, incomebefore taxes significantly increased by over $1.4 million in 2006 compared to2005.  During 2006, the Bank benefitedfrom continued increases in overall interest rates during the first half of theyear due to its asset sensitive interest rate risk profile.  In the latter half of the year, asset yieldsstabilized and competition for deposits continued to drive up interest rates ondeposits, including competition from a number of newly chartered banks thathave opened in the local market over the last few years. The Bank intends tocontinue to grow and increase its profitability in 2007 by continuing to focuson the financial services needs within its target market — small andmedium-sized businesses and professionals in the greater San Diego Countyarea.  The Bank expects its internalgrowth will be enhanced by the completion of its acquisition of LandmarkNational Bank, which will add two branch offices to the Bank’s branchnetwork.  Asset growth will continue tobe focused on real estate secured and commercial business lending.  There are a number of factors that couldprevent the Bank from achieving its plans. See “Risk Factors”.  However, ifthe current economic environment and growth in the Bank’s primary market areascontinue, management is optimistic that the Bank’s performance will continue toimprove in 2007.

In 2006, the Bank’s growth resulted from an increase in deposits fromits local markets of $24.6 million to $261.8 million, as well as short-termborrowings from the Federal Home Loan Bank of San Francisco.  This increased funding was utilized forlending activities of the Bank.  Totalloans outstanding for 2006 increased $44.9 million to $275.3 million.  Net interest income increased $2.7 millioncompared to the prior year, primarily as a result of the increased volume ofloans and deposits; but also as a result of net interest margin increasing from5.56% in 2005 to 5.61% in 2006.  The Bank’sgrowth and the resulting increase in net interest income coupled with increasesin noninterest income from the Bank’s operations, more than offset the increasein operating expenses which was also primarily related to the Bank’s growth.For the year ended December 31, 2006, net income increased $852,000 to $3.2million.

**DISTRIBUTIONOF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY; INTEREST RATES AND INTERESTDIFFERENTIAL**

During 2006, total assets increased $52.8 million from $265.6 millionat December 31, 2005 to $318.4 million at December 31, 2006.  The significant increases in loans anddeposits noted above were the result of the Bank’s continued marketing effortsand an indication of the strength in the local economy and the demand in themarketplace for the Bank’s relationship-oriented approach to its services.

The following table presents, for the periods indicated, thedistribution of average assets, liabilities and shareholders’ equity, as wellas the total dollar amounts of interest income from average interest-earningassets and the resultant yields, and the dollar amounts of interest expense andaverage interest-bearing liabilities, expressed both in dollars and inrates.  Nonaccrual loans are included inthe calculation of the average balances of loans, and interest not accrued isexcluded.

24

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**Average Balances withRates Earned and Paid**
| ** **                                                            | ** ** | **For the Periods Ended December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                            | ** ** | **(dollars in thousands)**                            | ** ** |
| ** **                                                            | ** ** | **Average  Balance**                                            | ** ** | **Interest  Earned  or Paid** | ** ** | **Average  Yield or  Rate  Paid** | ** ** | **Average  Balance** | ** ** | **Interest  Earned  or Paid** | ** ** | **Average  Yield or  Rate  Paid** | ** ** | **Average  Balance** | ** ** | **Interest  Earned  or Paid** | ** ** | **Average  Yield or  Rate  Paid** | ** ** |
| **Assets**                                                            |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Earning  Assets:                                             |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment Securities                                                 |       | $                                                               | 6,448      |   | $ | 285 |   | 4.42 | % | $ | 4,999 |   | $ | 164 |   | 3.29 | % | $ | 7,696 |   | $ | 274 |   | 3.56 | % |
| Federal Funds Sold                                                    |       | 13,208                                                          |       | 650 |   | 4.92 | % | 13,665 |   | 437 |   | 3.19 | % | 6,588 |   | 99 |   | 1.50 | % |
| Federal Reserve, FHLB and Bankers’ Bank Stock                    |       | 1,794                                                           |       | 90 |   | 5.00 | % | 1,431 |   | 72 |   | 5.02 | % | 985 |   | 47 |   | 4.81 | % |
| Loans (1)                                                             |       | 250,369                                                         |       | 22,435 |   | 8.96 | % | 205,818 |   | 16,022 |   | 7.78 | % | 151,688 |   | 9,943 |   | 6.55 | % |
| Total  Interest-Earning Assets                                        |       | 271,819                                                         |       | 23,460 |   | 8.63 | % | 225,913 |   | 16,695 |   | 7.39 | % | 166,957 |   | 10,363 |   | 6.21 | % |
| Noninterest-Earning  Assets, net                                      |       | 8,442                                                           |       |   |   |   |   | 7,774 |   |   |   |   |   | 5,529 |   |   |   |   |   |
| Total Assets                                                          |       | $                                                               | 280,261    |   |   |   |   |   | $ | 233,687 |   |   |   |   |   | $ | 172,486 |   |   |   |   |   |
|                                                                  |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**                        |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing  Liabilities:                                        |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing Checking                                             |       | $                                                               | 14,200     |   | $ | 174 |   | 1.22 | % | $ | 11,346 |   | $ | 99 |   | 0.88 | % | $ | 11,894 |   | $ | 67 |   | 0.57 | % |
| Savings & Money Market                                       |       | 67,989                                                          |       | 2,541 |   | 3.74 | % | 72,725 |   | 1,728 |   | 2.38 | % | 54,328 |   | 790 |   | 1.45 | % |
| Time Deposits under $100k                                             |       | 26,109                                                          |       | 1,092 |   | 4.18 | % | 21,672 |   | 633 |   | 2.92 | % | 20,613 |   | 463 |   | 2.25 | % |
| Time Deposits, $100k or More                                          |       | 82,840                                                          |       | 3,756 |   | 4.53 | % | 43,170 |   | 1,375 |   | 3.19 | % | 24,724 |   | 557 |   | 2.25 | % |
| Other Borrowings                                                      |       | 10,818                                                          |       | 654 |   | 6.04 | % | 6,279 |   | 290 |   | 4.62 | % | 3,505 |   | 46 |   | 1.31 | % |
| Total Interest-Bearing Liabilities                                    |       | 201,956                                                         |       | 8,217 |   | 4.07 | % | 155,192 |   | 4,125 |   | 2.66 | % | 115,064 |   | 1,923 |   | 1.67 | % |
| Demand Deposits                                                       |       | 52,550                                                          |       |   |   |   |   | 56,437 |   |   |   |   |   | 39,501 |   |   |   |   |   |
| Other Liabilities                                                     |       | 1,573                                                           |       |   |   |   |   | 1,040 |   |   |   |   |   | 474 |   |   |   |   |   |
| Shareholders’  Equity                                            |       | 24,182                                                          |       |   |   |   |   | 21,018 |   |   |   |   |   | 17,447 |   |   |   |   |   |
| Total Liabilities and Shareholders’ Equity                       |       | $                                                          | 280,261    |   |   |   |   |   | $  | 233,687 |   |   |   |   |   | $  | 172,486 |   |   |   |   |   |
| Net Interest  Income                                                  |       |                                                            |       | $ | 15,243 |   |   |   |   |   | $ | 12,570 |   |   |   |   |   | $ | 8,440 |   |   |   |
|                                                                  |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Interest Margin (Net  Interest Income to Interest-Earning Assets) |       |                                                            |       |   |   | 5.61 | % |   |   |   |   | 5.56 | % |   |   |   |   | 5.06 | % |

----

(1)             Interest Income includes amortized loanfees and costs of approximately $706,000, $704,000 and $441,000 in 2006, 2005 and2004, respectively.

The principal component of the Bank’s revenues is netinterest income.  Net interest income isthe difference between the interest earned on the Bank’s loans and investmentsand the interest paid on deposits and other interest-bearing liabilities.  For 2006, net interest income was $15.2million compared to $12.6 million for the year ending December 31, 2005, a 21%increase.  This increase in net interestincome for the year ending December 31, 2006 primarily relates to the increase inaverage earning assets, which increased from $226 million in 2005 to $272million in 2006, a 20% increase.  For2005, net interest income was $12.6 million compared to $8.4 million forthe year ending December 31, 2004, a 49% increase.  This significant increase was primarilyrelated to a 35% increase in average earning assets, which increased from $167million in 2004 to $226 million in 2005.

In addition to the increase in average earning assets,during 2006, the Bank’s net interest margin increased from 5.56% to 5.61%.Despite this slight increase in net interest margin year-over-year, the Bank’snet interest margin fell to 5.20% in the fourth quarter of 2006 due to risingdeposit costs and strong local competition for deposits; asset yields began tostabilize in the latter half of 2006 as the Federal Reserve halted itstightening monetary policy in June 2006, yet deposit costs continued to repriceupwards with a lagging effect.  During2005, net interest margin increased from 5.06% to 5.56% as a result of theincreasing interest rate environment and the Bank’s asset sensitive balancesheet, which resulted in asset yields increasing at a faster rate than the costof liabilities.  During 2004, netinterest margin increased from 4.97% to 5.06% as a result of improved asset mix(a higher concentration in loan assets) and an improved deposit mix, includingan increase in the level of non-interest bearing deposits.

25

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The followingtables shows the changes in interest income and expense as a result of changesin volume and rates for each of the last two fiscal years.  Changes due to both rate and volume areallocated to volume.

**Analysis of Volume andInterest Rate Changes**
| ** **                           | ** ** | **(dollars in thousands)**                                                                                    | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Year Ended December 31, 2006  Versus the Year Ended  December 31, 2005** | ** ** |
| ** **                           | ** ** | **Amount of Change Attributed to**                                                                  | ** ** |
| ** **                           | ** ** | **Volume**                                                                                                              | ** ** | **Rate** | ** ** | **Total   Change** | ** ** |
| Investment  securities               |       | $                                                                                                                       | 64         |   | $ | 57 |   | $ | 121 |   |
| Federal funds  sold                  |       | (23                                                                                                                     | )          | 236 |   | 213 |   |
| Other earning  assets                |       | 18                                                                                                                      |       | 0 |   | 18 |   |
| Loans                                |       | 3,993                                                                                                                   |       | 2,420 |   | 6,413 |   |
| Changes in interest income           |       | 4,052                                                                                                                   |       | 2,713 |   | 6,765 |   |
|                                 |       |                                                                                                                    |       |   |   |   |   |
| NOW, savings and  money market       |       | (142                                                                                                                    | )          | 1,030 |   | 888 |   |
| Time deposits  under $100,000        |       | 186                                                                                                                     |       | 273 |   | 459 |   |
| Time deposits of  $100,000 or more   |       | 1,799                                                                                                                   |       | 582 |   | 2,381 |   |
| Other borrowings                     |       | 274                                                                                                                     |       | 90 |   | 364 |   |
| Changes in interest expense          |       | 2,117                                                                                                                   |       | 1,975 |   | 4,092 |   |
| Total change in  net interest income |       | $                                                                                                                       | 1,935      |   | $ | 738 |   | $ | 2,673 |   |

 

|                                      | ** ** | **Year Ended December 31, 2005  Versus the Year Ended  December 31, 2004** | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Amount of Change Attributed to**                                                                  | ** ** |
| ** **                           | ** ** | **Volume**                                                                                                              | ** ** | **Rate** | ** ** | **Total   Change** | ** ** |
| Investment  securities               |       | $                                                                                                                       | (103       | ) | $ | (7 | ) | $ | (110 | ) |
| Federal funds  sold                  |       | 222                                                                                                                     |       | 116 |   | 338 |   |
| Other earning  assets                |       | 23                                                                                                                      |       | 2 |   | 25 |   |
| Loans                                |       | 4,814                                                                                                                   |       | 1,265 |   | 6,079 |   |
| Changes in interest income           |       | 4,956                                                                                                                   |       | 1,376 |   | 6,332 |   |
|                                 |       |                                                                                                                    |       |   |   |   |   |
| NOW, savings and  money market       |       | 617                                                                                                                     |       | 353 |   | 970 |   |
| Time deposits  under $100,000        |       | 97                                                                                                                      |       | 73 |   | 170 |   |
| Time deposits of  $100,000 or more   |       | 617                                                                                                                     |       | 201 |   | 818 |   |
| Other borrowings                     |       | 140                                                                                                                     |       | 104 |   | 244 |   |
| Changes in interest expense          |       | 1,471                                                                                                                   |       | 731 |   | 2,202 |   |
| Total change in net  interest income |       | $                                                                                                                       | 3,485      |   | $ | 645 |   | $ | 4,130 |   |

 

The Bank expects its risk exposure to changes in interest rates during2007 to remain manageable and within acceptable policy ranges. Management willcontinue to strive for an optimal balance between risk and earnings.

**Liquidityand Interest Rate Risk Management**

The objective of the Bank’s asset/liability strategy is to manageliquidity and interest rate risks to ensure the safety and soundness of theBank’s capital base, while maintaining adequate net interest margins andspreads to provide an appropriate return to shareholders.  The Bank’s balance sheet liquidity, which isa measure of its ability to meet fluctuations in deposit levels and provide forcustomers’ credit needs, is managed through various funding strategies thatreflect the maturity structures of the sources of funds being gathered and theassets being funded.  The 

26

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Bank’s liquidity results primarily from funds providedby short-term liabilities such as demand deposits, certificates of deposit, andshort-term borrowings and is augmented by payments of principal and interest onloans.  Access to short-term investments,primarily Federal funds sold, is the primary means for providing immediateliquidity; however, the Bank maintains credit facilities with correspondentbanks and has access to borrowing facilities through its Federal Home Loan Bankmembership to aid in managing its short-term liquidity needs.

In order to manage the Bank’s liquidity, management monitors a numberof liquidity ratios, including the level of liquid assets to funding sources(both on and off the balance sheet), the level of dependence on non-corefunding sources, the level of loans to funding sources, the level of short-terminvestments to total assets, and the level of unfunded loan commitments.  As of December 31, 2006, management considersthe Bank’s liquidity sufficient to meet the Bank’s liquidity needs.

The objectives of interest rate risk management are to control exposureof net interest income to risks associated with interest rate movements in themarket, to achieve consistent growth in net interest income and to profit fromfavorable market opportunities.  Evenwith perfectly matched repricing of assets and liabilities, risks remain in theform of prepayment of assets and timing lags in adjusting certain assets and liabilitiesthat have varying sensitivities to market interest rates and basis risk.

The table below sets forth the interest rate sensitivity of the Bank’sinterest-earning assets and interest-bearing liabilities as of December 31,2006, using the interest rate sensitivity gap ratio.  For purposes of the following table, an assetor liability is considered rate-sensitive within a specified period when it canbe repriced or matures within its contractual terms.  When the rate on a loan with a floating ratehas reached a contractual floor or ceiling level, the loan is treated as afixed rate loan for purposes of determining its rate-sensitivity until the rateis again free to float.

**Interest Rate Sensitivityof Interest-Earning Assets and Liabilities**
| ** **                                                            | ** ** | **Estimated Maturity or Repricing** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                            | ** ** | **Up to  Three  Months**                      | ** ** | **Over Three  Months  To Less  Than One  Year** | ** ** | **Over  One to  Five  Years** | ** ** | **Over  Five  Years** | ** ** | **Total** | ** ** |
| ** **                                                            | ** ** | **(dollars in thousands)**               | ** ** |
| ** **                                                            |       |                                               |       |   |   |   |   |   |   |   |   |
| **Interest-Earning  Assets:**                                         | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investment Securities                                                 |       | $                                                  | —     |   | $ | 1,877 |   | $ | 6,989 |   | $ | 132 |   | $ | 8,998 |   |
| Federal Funds Sold                                                    |       | 20,985                                             |       | — |   | — |   | — |   | 20,985 |   |
| Loans                                                                 |       | 169,071                                            |       | 28,388 |   | 30,167 |   | 47,640 |   | 275,266 |   |
| Totals                                                                |       | $                                                  | 190,056    |   | $ | 30,265 |   | $ | 37,156 |   | $ | 47,772 |   | $ | 305,249 |   |
|                                                                  |       |                                               |       |   |   |   |   |   |   |   |   |
| **Interest-Bearing  Liabilities:**                                    | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest-Bearing Checking                                             |       | $                                                  | 13,323     |   | $ | — |   | $ | — |   | $ | — |   | $ | 13,323 |   |
| Savings & Money Market                                       |       | 87,783                                             |       | — |   | — |   | — |   | 87,783 |   |
| Time Deposits                                                         |       | 24,740                                             |       | 62,102 |   | 27,790 |   | — |   | 114,632 |   |
| Other Borrowings                                                      |       | 29,000                                             |       | — |   | — |   | — |   | 29,000 |   |
| Totals                                                                |       | $                                                  | 154,846    |   | $ | 62,102 |   | $ | 27,790 |   | $ | — |   | $ | 244,738 |   |
|                                                                  |       |                                               |       |   |   |   |   |   |   |   |   |
| Interest Rate  Sensitivity Gap                                        |       | $                                                  | 35,210     |   | $ | (31,837 | ) | $ | 9,366 |   | $ | 47,772 |   | $ | 60,511 |   |
| Cumulative  Interest Rate Sensitivity Gap                             |       | $                                                  | 35,210     |   | $ | 3,373 |   | $ | 12,739 |   | $ | 60,511 |   | $ | 60,511 |   |
| Cumulative Interest  Rate Sensitivity Gap Ratio Based on Total Assets |       | 11.06                                              | %          | 1.06 | % | 4.00 | % | 19.00 | % | 19.00 | % |

 

Gap analysis is a method of analyzing exposure to interest rate risk,by measuring the ability of the Bank to reprice its interest rate-sensitiveassets and liabilities.  The actualimpact of interest rate movements on the Bank’s net interest income may differfrom that implied by any gap measurement, depending on the direction andmagnitude of the interest rate movements and the repricing characteristics ofvarious on and off-balance sheet instruments, as well as competitive pressures.  These factors are not fully reflected in theforegoing gap analysis and, as a result, the gap report may not provide acomplete assessment of the Bank’s interest rate risk.  In addition to gap 

27

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analysis, such as the table above, the Bank estimatesthe effect of changing interest rates on its net interest income using therepricing and maturity characteristics of its assets and liabilities and theestimated effects on yields and costs of those assets and liabilities.

Based on the gap analysis and the Bank’s assessment of its exposure tointerest rate risk, the Bank is “asset sensitive.”  In general, “asset sensitive” means that,over time, the Bank’s assets will reprice faster than its liabilities.  In a rising interest rate environment, netinterest income can be expected to increase and that, in a declining interestrate environment, net interest income can be expected to decrease.  In addition, a rising interest rateenvironment will affect the Bank’s ability to reprice loans that bear variableinterest rates but are currently at their floor rates and will not fluctuateimmediately.  At December 31, 2006,approximately $75 million of loans were priced at their floor interestrate.  As interest rates increase, therates earned on these loans will begin to adjust above their floor rates andthe Bank’s asset sensitivity will increase. Conversely, in a declining interest rate environment, the Bank willbenefit from floor rates built into existing variable rate loans as the indexedrates decline to the floor rates and stop adjusting downwards.  At December 31, 2006, loans totalingapproximately $155 million had floor rates that were below the existing fullyindexed rate; these floors reduce the Bank’s asset sensitivity in a decliningrate environment.  The benefit derived,if any, by the Bank when loan rates drop to their floor rates may be mitigatedby the increased likelihood that those loans may be refinanced by the borrowerswith other financial institutions.

**INVESTMENTPORTFOLIO**

The primary objective of the Bank’s investment portfolio is tocontribute to maximizing shareholder value by providing adequate liquiditysources to meet fluctuations in the Bank’s loan demand and depositstructure.  To meet this objective, theBank invests in high-quality investment securities that generate reasonablerates of return to the Bank given its liquidity objectives.  Secondary objectives of the investmentportfolio which may be considered include: meeting pledging requirements ofpublic or other depositors; minimizing the Bank’s tax liability; accomplishingstrategic goals; and assisting various local public entities with theirfinancing needs (which may assist the Bank in meeting its CRA objectives).

The Board of Directors has established policies regarding theinvestment activities of the Bank, including establishment of risk limits andensuring that management has the requisite skills to manage the risksassociated with the Bank’s investment activities.  The Board of Directors reviews portfolioactivity and risk levels and requires management to demonstrate compliance withapproved risk limits.  Senior managementis responsible for establishing and enforcing policies and procedures forconducting investment activities.  Managementmust have an understanding of the nature and level of various risks involved inthe Bank’s investments and how such risks fit within the overall riskcharacteristics of the Bank’s balance sheet.

The Chief Financial Officer acts as the Bank’s Investment Officer andensures that the day-to-day guidelines of the Bank’s investment policies areproperly implemented and that all investments meet regulatory and accountingguidelines.  The Chief Executive Officeror the Chief Financial Officer must approve each investment transaction.  The Bank monitors its investment portfolioclosely, and accordingly, its composition may change substantially over time.

At December 31, 2006, the Bank held $3,107,446 in FNMA Mortgage-BackedSecurities, which is in excess of 10% of the Bank’s shareholder equity.

28

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**Amounts and Distribution of Investment Portfolio**
| ** **                                | ** ** | **December 31,**                | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|
| ** **                                | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(dollars in thousands)** | ** ** |
| ** **                                | ** ** | **Amortized  Cost**                  | ** ** | **Market  Value** | ** ** | **Wghtd  Avg  Yield** | ** ** | **Amortized  Cost** | ** ** | **Market  Value** | ** ** | **Wghtd  Avg  Yield** | ** ** | **Amortized  Cost** | ** ** | **Market  Value** | ** ** | **Wghtd  Avg  Yield** | ** ** |
| **Available-for-Sale Securities:**        |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate Notes:                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One Year or Less                          |       | $                                    | —     |   | $ | — |   |   |   | $ | — |   | $ | — |   | — |   | $ | 507 |   | $ | 511 |   | 4.69 | % |
| One Year to Five Years                    |       | 3,958                                |       | 3,985 |   | 5.86 | % | — |   | — |   | — |   | 508 |   | 513 |   | 5.16 | % |
| Total Corporate  Notes                    |       | 3,958                                |       | 3,985 |   | 5.86 | % | — |   | — |   | — |   | 1,015 |   | 1,024 |   | 4.93 | % |
|                                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage-Backed  Securities (Unallocated) |       | 5,023                                |       | 5,013 |   | 6.84 | % | 3,212 |   | 3,146 |   | 3.74 | % | 4,959 |   | 4,916 |   | 3.57 | % |
| Total Investment  Securities              |       | $                                    | 8,981      |   | $ | 8,998 |   | 4.98 | % | $ | 3,212 |   | $ | 3,146 |   | 3.74 | % | $ | 5,974 |   | $ | 5,940 |   | 3.93 | % |

 

**LOAN PORTFOLIO**

**Types of Loans**

The Bank originates, purchases, or acquires participating interests inloans for its portfolio and for possible sale in the secondary market.  Total loans were $230.4 million at December31, 2005 and increased to $275.3 million at December 31, 2006. The Bank’s loansinclude construction loans, single-family residential and commercial realestate loans, commercial business loans, SBA loans, and consumer loans.

**Loan Portfolio Composition by Type of Loan**
| ** **                                        | ** ** | **December 31,**                | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                        | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                        | ** ** | **(dollars in thousands)** | ** ** |
| **Loans:**                                        |       |                                 |       |   |   |   |   |   |   |   |   |
| Construction &  Land Development         |       | $                                    | 116,389    |   | $ | 94,912 |   | $ | 59,579 |   | $ | 27,468 |   | $ | 14,796 |   |
| Real Estate —  Residential & Commercial  |       | 81,131                               |       | 65,123 |   | 57,058 |   | 42,006 |   | 32,639 |   |
| SBA Loans —  7a & 504               |       | 19,883                               |       | 21,965 |   | 24,640 |   | 23,137 |   | 16,132 |   |
| Commercial  Business                              |       | 52,797                               |       | 43,970 |   | 41,555 |   | 24,857 |   | 16,729 |   |
| Consumer                                          |       | 5,066                                |       | 4,412 |   | 5,720 |   | 3,659 |   | 1,969 |   |
| Total Loans                                       |       | 275,266                              |       | 230,382 |   | 188,552 |   | 121,127 |   | 82,265 |   |
| Allowance for Loan  Losses                        |       | (3,251                               | )          | (2,809 | ) | (2,265 | ) | (1,454 | ) | (823 | ) |
| Net Loans                                         |       | $                                    | 272,015    |   | $ | 227,573 |   | $ | 186,287 |   | $ | 119,673 |   | $ | 81,442 |   |
|                                              |       |                                 |       |   |   |   |   |   |   |   |   |
| **Commitments:**                                  |       |                                 |       |   |   |   |   |   |   |   |   |
| Standby Letters  of Credit                        |       | $                                    | 3,224      |   | $ | 1,649 |   | $ | 153 |   | $ | 1,616 |   | $ | 64 |   |
| Undisbursed  Loans and Commitments to Grant Loans |       | 87,527                               |       | 85,661 |   | 69,034 |   | 42,162 |   | 21,892 |   |
| Total Commitments                                 |       | $                                    | 90,751     |   | $ | 87,310 |   | $ | 69,187 |   | $ | 43,778 |   | $ | 21,956 |   |

 

During 2006, San Diego County experienced a continued increase in thedevelopment and construction of residential and commercial properties.  As a result, with the Bank’s expertise inreal estate financing, there was a great opportunity for growth in the Bank’sconstruction and real estate loan portfolio during 2006.  The increases in commercial business loansare a direct result of the Bank’s strategic focus and direct marketing effortsto develop relationships with small-to-medium sized businesses.  Additionally, the Bank’s legal lending limitsto any one borrower have increased significantly over the past two years inrelation to the Bank’s growth in capital; this has

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allowed the Bank to compete for larger individual loantransactions, which has been a contributing factor to the Bank’s loangrowth.   San Diego County has begun toexperience signs of a real estate slowdown, similar to that experienced in thenational real estate market.  If the realestate market continues to soften in 2007, it could impact the Bank’s abilityto grow its loan portfolio; however, the Bank will continue to adhere to itsstrict underwriting guidelines.

The Bank makes construction loans primarily as interim loans to financethe construction of commercial and single family residential property.  These loans are typically for a term ofapproximately 12 months.  Other realestate loans consist primarily of commercial and industrial real estateloans.  The Bank makes these loans basedon the income generating capacity of the property or the cash flow of theborrower.  These loans are secured by theproperty.  The Bank’s general policy isto restrict these loans to no more than 75% of the lower of the appraised valueor the purchase price of the property. The Bank offers both fixed and variable rate loans with maturities thatgenerally do not exceed 15 years, unless the loans are SBA loans secured byreal estate or other commercial real estate loans easily sold in the secondarymarket.

A portion of the Bank’s real estate loans and commercial business loansare made under certain SBA loan programs. These loans generally are structured such that they may be sold, eitheras a whole with servicing released, as is the case for SBA 504 loans, or in thecase of SBA 7(a) loans, the guaranteed portion may be sold in the secondarymarket and the servicing is retained.  Todate, the Bank has elected to sell SBA 7(a) loans in only a limited number ofcases; however, certain SBA 504 loans have been packaged for sale when therates and terms of the loans do not meet the Bank’s asset and liabilitymanagement structure.

The Bank makes commercial loans to provide working capital, finance thepurchase of equipment and for other business purposes.  These loans can be “short-term,” withmaturities ranging from 30 days to one year, or “term loans” with maturitiesnormally ranging from one to 25 years. Short-term loans are generally intended to finance current transactionsand typically provide for periodic principal payments, with interest payablemonthly.  Term loans normally provide forfloating interest rates, with monthly payments of both principal and interest.

**Maturities and Sensitivitiesof Loans to Changes in Interest Rates**

Many of the Bank’s loans have floating rates tied to the prime-lendingrate as published in The Wall Street Journal or other rate indices.  The majority of these floating rate loans areadjusted at least quarterly.

**Loan Maturity by Category**

|                                                  | ** ** | **December  31, 2006**        | ** ** |
|--------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                       | ** ** | **(dollars in thousands)**         | ** ** |
| ** **                                       | ** ** | **Due in  One Year  Or Less** | ** ** | **Due After  One Year to  Five Years** | ** ** | **Due After  Five Years** | ** ** | **Total** | ** ** |
| Construction &  Land Development        |       | $                                            | 101,094    |   | $ | 14,717 |   | $ | 578 |   | $ | 116,389 |   |
| Real Estate -  Residential & Commercial |       | 14,121                                       |       | 14,687 |   | 52,323 |   | 81,131 |   |
| SBA Loans -  7a & 504                   |       | 3,425                                        |       | 1,586 |   | 14,872 |   | 19,883 |   |
| Commercial  Business                             |       | 39,964                                       |       | 8,684 |   | 4,149 |   | 52,797 |   |
| Consumer                                         |       | 3,318                                        |       | 1,715 |   | 33 |   | 5,066 |   |
| Total                                            |       | $                                            | 161,922    |   | $ | 41,389 |   | $ | 71,955 |   | $ | 275,266 |   |
|                                             |       |                                         |       |   |   |   |   |   |   |
| Floating Rate                                    |       |                                         |       |   |   |   |   | $ | 165,577 |   |
| Fixed Rate                                       |       |                                         |       |   |   |   |   | 109,689 |   |
| Total                                            |       |                                         |       |   |   |   |   | $ | 275,266 |   |

 

At December 31, 2006, approximately $75 million of the floating rateloans, noted above, were priced at their floor interest rate. The level ofsensitivity of the Bank’s loan portfolio to changes in interest rates ismonitored on a regular basis in conjunction with the Bank’s overall interestrate risk management practices (see “Liquidity and Interest Rate RiskManagement” above).

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**Loan Quality**

The risk of nonpayment of loans is an inherent feature of the bankingbusiness.  That risk varies with the typeand purpose of the loan, the collateral that is utilized to secure payment, andultimately, the credit worthiness of the borrower.  In order to minimize this credit risk, theChief Executive Officer, the Chief Credit Officer, or the Loan Committee of theBoard of Directors approve virtually all loans made by the Bank.  The Loan Committee is comprised of directorsand members of its senior management.

The Bank grades its loans from “pass” to “loss,” depending on creditquality, with “pass” representing loans with an acceptable degree of risk giventhe favorable aspects of the credit and with both primary and secondary sourcesof repayment.  Classified loans orsubstandard loans are ranked below “pass” loans.  As these loans are identified in the reviewprocess, they are added to the internal watch list and loss allowances areestablished.  Additionally, loans areexamined regularly by the Bank’s regulatory agencies.  A loan which has been placed on non-accrualstatus is not returned to accrual basis until it has been brought current withrespect to both principal and interest payments, is performing to current termsand conditions, its interest rate is commensurate with market interest ratesand future principal and interest payments are no longer in doubt.  During 2006, the Bank had an average recordedinvestment in loans in a non-accrual status of $1,229,197.

**Components of Nonperforming Assets**
| ** **                                                        | ** ** | **For the Year Ended  December 31,** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                        | ** ** | **(dollars in thousands)**                     | ** ** |
|                                                              |       |                                                     |       |   |   |   |   |   |   |   |   |
| Non-Accrual  Loans                                                |       | $                                                        | —     |   | $ | 1,052 |   | $ | — |   | $ | — |   | $ | — |   |
| Loans 90 Days  Past Due and Still Accruing                        |       | —                                                   |       | — |   | — |   | — |   | — |   |
| Restructured  Loans                                               |       | —                                                   |       | — |   | — |   | — |   | — |   |
| Total Nonperforming Loans                                         |       | —                                                   |       | 1,052 |   | — |   | — |   | — |   |
| Other Real  Estate Owned                                          |       | —                                                   |       | — |   | — |   | — |   | — |   |
| Total Nonperforming Assets                                        |       | $                                                        | —     |   | $ | 1,052 |   | $ | — |   | $ | — |   | $ | — |   |
| ** **                                                        |       |                                                     |       |   |   |   |   |   |   |   |   |
| Non-Accrual  Loans as a Percentage of Total Loans                 |       | 0.00                                                     | %          | 0.46 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Loans 90 Days  Past Due as a Percentage of Total Loans            |       | 0.00                                                     | %          | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Restructured  Loans as a Percentage of Total Loans                |       | 0.00                                                     | %          | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Nonperforming  Loans as a Percentage of Total Loans               |       | 0.00                                                     | %          | 0.46 | % | 0.00 | % | 0.00 | % | 0.00 | % |
|                                                              |       |                                                     |       |   |   |   |   |   |   |   |   |
| Allowance for  Loan Losses as a Percentage of Nonperforming Loans |       | N/A                                                      |       | 267.00 | % | N/A |   | N/A |   | N/A |   |
| Nonperforming Assets as  a Percentage of Total Assets             |       | 0.00                                                     | %          | 0.40 | % | 0.00 | % | 0.00 | % | 0.00 | % |

 

Restructured loans are those loans where the Bank has made concessionsin interest rates or repayment terms to assist the borrower.  Non-accrual loans are generally loans whichare past due 90 days or are loans upon which management believes the interestmay not be collectible.

During March 2007, the Bank became aware that acompleted project, financed by a construction loan, would likely be taken overby the Bank with the borrower’s full cooperation.  The project consists of twenty six (26)condominium units, of which eight (8) or 30% are sold and paid off throughescrow closings, leaving a balance owing of $4,669,683 and eighteen (18) unitsunsold.  A recent escrow closing in March2007 reflected a sales price of $349,900. The Bank expects to make full recovery of outstanding principal andinterest via future property sales contracted through a real estate salesbroker and, should there be any deficiency, from guarantors. In addition tothis project, as of December 31, 2006, the Bank had $5.8 million of potentialproblem loans which are not disclosed nonperforming loans, but where knowninformation about possible credit problems of borrowers causes management tohave serious doubts as to the ability of such borrowers to comply with theirpresent loan repayment terms and which may result in disclosure of such loansas nonperforming loans in the future.

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Other real estate owned may be acquired in satisfaction of loanreceivables through foreclosure or other means. If acquired, these properties are recorded on an individual asset basisat the estimated fair value less selling expenses.

**Loan Concentrations**

The Bank’s loan portfolio consists primarily of loans to borrowerswithin San Diego County.  Although theBank seeks to avoid concentrations of loans to a single industry or based upona single class of collateral, real estate and real estate associated businessesare among the principal industries in the Bank’s market area and, as a result,the Bank’s loan and collateral portfolios are, to some degree, concentrated inthose industries. As of December 31, 2006, the Bank held approximately $48million of loans to real estate developers, $38 million in land loans in thecounty of San Diego and $34 million in loans to real estate investmentcompanies for non-owner occupied buildings. The Bank’s commercial loanportfolio is to a diverse group of industries including professional attorneysand merchant wholesalers of plumbing and heating equipment and supplies; noindustry group represents more than 3% of total loans.  While the Bank’s strategy includes developingrelationships with business customers, including related commercial lendingopportunities, it is expected that the Bank will continue to have similar loanconcentrations for the foreseeable future.

**Allowance for Loan Losses**

The following table summarizes, for the periods indicated, changes inthe allowance for loan losses arising from loans charged off, recoveries onloans previously charged off, additions to the allowance which have beencharged to operating expenses and certain ratios relating to the allowance forloan losses:

**Changes in Allowance for Loan Losses**
| ** **                                       | ** ** | **For the Year Ended  December 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                       | ** ** | **(dollars in thousands)**                     | ** ** |
| **Allowance  for Loan Losses:**                  |       |                                                     |       |   |   |   |   |   |   |   |   |
| Balance at  Beginning of Period                  |       | $                                                        | 2,809      |   | $ | 2,265 |   | $ | 1,454 |   | $ | 823 |   | $ | 323 |   |
|                                             |       |                                                     |       |   |   |   |   |   |   |   |   |
| **Net  Loans Charged off:**                      |       |                                                     |       |   |   |   |   |   |   |   |   |
| Total Charge-Offs                                |       | (2                                                       | )          | (11 | ) | (41 | ) | — |   | — |   |
| Total Recoveries on Loans Previously Charged Off |       | —                                                   |       | 2 |   | 2 |   | 1 |   | — |   |
| Net Loans  (Charged-Off) Recoveries              |       | (2                                                       | )          | (9 | ) | (39 | ) | 1 |   | — |   |
| ** **                                       |       |                                                     |       |   |   |   |   |   |   |   |   |
| Provision for  Loan Losses                       |       | 444                                                      |       | 553 |   | 850 |   | 630 |   | 500 |   |
| Balance at End  of Period                        |       | $                                                        | 3,251      |   | $ | 2,809 |   | $ | 2,265 |   | $ | 1,454 |   | $ | 823 |   |
|                                             |       |                                                     |       |   |   |   |   |   |   |   |   |
| **Ratios:**                                      |       |                                                     |       |   |   |   |   |   |   |   |   |
| Net Loans  Charged Off to Average Loans          |       | 0.00                                                     | %          | 0.00 | % | 0.03 | % | 0.00 | % | 0.00 | % |
| Allowance for Loan  Losses to Total Loans        |       | 1.18                                                     | %          | 1.22 | % | 1.20 | % | 1.20 | % | 1.00 | % |

 

Provisions for loan losses are based on an analysis of the loanportfolio and include such factors as historical experience, the volume andtype of loans in the portfolio, the amount of nonperforming loans, regulatorypolicies, general economic conditions, and other factors related to the abilityto collect on loans in the portfolio. The amount provided for loan losses is charged to earnings.  The provision for loan losses was $444,000for 2006 compared to $552,500 for the year ending December 31, 2005. The Bankended 2006 with a 1.18% level of allowance for loan losses to total loanscompared to 1.22% for the year ended December 31, 2005.

The Bank, in the last five years, has charged off a total of $54,000.This total includes four charge offs related to the un-guaranteed portion ofSBA 7a loans of approximately $53,000, of which $7,000 has been recovered. TheBank also charged off an overdraft protection loan of approximately $1,000. Intotal, these charge offs represent 0.0003% of the Bank’s December 31, 2006 netloans.

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A quarterly detailed review is performed to identify the risks inherentin the loan portfolio, to assess the overall quality of the loan portfolio andto determine the adequacy of the allowance for loan losses and the relatedprovision for loan losses, which is charged to expense.

A key element of the methodology for assessing the risks inherent inthe loan portfolio is the credit classification process.  Loans identified as less than “pass” arereviewed individually to estimate the amount of probable losses that need to beincluded in the allowance.  These reviewsinclude analysis of financial information as well as evaluation of collateralsecuring the credit.  The Bank uses fourallocation components; General, Specific, Specific Impaired and Qualitative.The General component estimates probable future loan loss based on historicalexperience, the Specific component is designed to calculate a reserve forcriticized and classified loans, the Specific Impaired component allocates aprobable loss amount on one particular loan and a Qualitative designationconsiders factors such as national and local economic changes, changes tomanagement or staff and unemployment rates. Additionally, the inherent riskpresent in the “pass” portion of the loan portfolio is assessed by taking intoconsideration historical losses on pools of similar loans, adjusted for trends,conditions and other relevant factors that may affect repayment of the loans inthese pools.  Upon completion, thewritten analysis is presented to the Board of Directors for discussion, reviewand approval.

The Bank considers its allowance for loan losses to be adequate toprovide for risks inherent in the loan portfolio.  All available information is used to recognizelosses on loans and leases; however, future additions to the allowance may benecessary based on changes in economic conditions.  In addition, the Bank’s regulatory agencies,as an integral part of their examination process, periodically review theallowance for loan losses and may recommend additions based upon theirevaluation of the portfolio at the time of their examination.  Accordingly, there can be no assurance thatthe allowance for loan losses will be adequate to cover future loan losses orthat significant additions to the allowance for loan losses will not berequired in the future.  Materialadditions to the allowance for loan losses would decrease the Bank’s earningsand capital, among other adverse consequences.

**Allocationof the Allowance for Loan Loss by Loan Type**
| ** **                                       | ** ** | **December 31,**                | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                       | ** ** | **(dollars in thousands)** | ** ** |
| ** **                                       | ** ** | **Allowance  Amount**                | ** ** | **Type as a  % of Loans** | ** ** | **Allowance  Amount** | ** ** | **Type as a  % of Loans** | ** ** | **Allowance  Amount** | ** ** | **Type as a  % of Loans** | ** ** | **Allowance  Amount** | ** ** | **Type as a  % of Loans** | ** ** | **Allowance  Amount** | ** ** | **Type as a  % of Loans** | ** ** |
|                                             |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Construction &  Land Development        |       | $                                    | 1,119      |   | 42.3 | % | $ | 863 |   | 41.2 | % | $ | 261 |   | 31.6 | % | $ | 123 |   | 22.7 | % | $ | 118 |   | 18.0 | % |
| Real Estate -  Residential & Commercial |       | 626                                  |       | 29.5 | % | 518 |   | 28.3 | % | 405 |   | 30.3 | % | 356 |   | 34.7 | % | 138 |   | 39.7 | % |
| SBA  Loans-7a & 504                     |       | 500                                  |       | 7.2 | % | 456 |   | 9.5 | % | 636 |   | 13.1 | % | 441 |   | 19.1 | % | 168 |   | 19.6 | % |
| Commercial  Business                             |       | 814                                  |       | 19.2 | % | 817 |   | 19.1 | % | 614 |   | 22.0 | % | 381 |   | 20.5 | % | 240 |   | 20.3 | % |
| Consumer                                         |       | 31                                   |       | 1.8 | % | 25 |   | 1.9 | % | 31 |   | 3.0 | % | 20 |   | 3.0 | % | 11 |   | 2.4 | % |
| Unallocated                                      |       | 161                                  |       | 0.0 | % | 130 |   | 0.0 | % | 318 |   | 0.0 | % | 133 |   | 0.0 | % | 148 |   | 0.0 | % |
| Totals                                           |       | $                                    | 3,251      |   | 100.0 | % | $ | 2,809 |   | 100.0 | % | $ | 2,265 |   | 100.0 | % | $ | 1,454 |   | 100.0 | % | $ | 823 |   | 100.0 | % |

 

**DEPOSITS**

Deposits are the primary source of funding for the lending andinvesting needs of the Bank.  Totaldeposits were $237.2 million at December 31, 2005 and increased to $261.8million at December 31, 2006.

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**Distribution of Average Deposits and Average RatesPaid**
| ** **                            | ** ** | **For the Period Ended December 31,** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** ** | **(dollars in thousands)**                           | ** ** |
| ** **                            | ** ** | **Average  Balance**                                           | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Average  Rate** | ** ** |
| Interest Bearing  Checking            |       | $                                                              | 14,200     |   | 1.22 | % | $ | 11,346 |   | 0.88 | % | $ | 11,894 |   | 0.57 | % |
| Savings &  Money Market      |       | 67,989                                                         |       | 3.74 | % | 72,725 |   | 2.38 | % | 54,328 |   | 1.45 | % |
| TCD Less than  $100,000               |       | 26,109                                                         |       | 4.18 | % | 21,672 |   | 2.92 | % | 20,613 |   | 2.25 | % |
| TCD $100,000 or  More                 |       | 82,840                                                         |       | 4.53 | % | 43,170 |   | 3.19 | % | 24,724 |   | 2.25 | % |
| Total Interest-Bearing Deposits       |       | 191,138                                                        |       | 3.96 | % | 148,913 |   | 2.58 | % | 111,559 |   | 1.67 | % |
|                                  |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Non  Interest-Bearing Demand Deposits |       | 52,550                                                         |       | 0.00 | % | 56,437 |   | 0.00 | % | 39,501 |   | 0.00 | % |
|                                  |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Total Deposits                        |       | $                                                              | 243,688    |   | 3.10 | % | $ | 205,350 |   | 1.87 | % | $ | 151,060 |   | 1.27 | % |

 

The changes in interest rates paid on deposit accounts from 2005 to2006 reflect changes in the interest rate environment.  The Bank made adjustments to interest rateson deposit accounts to remain competitive and to react to increases in Federalmonetary policy that began in June 2004 and continued through June 2006.

Growth in the Bank’s deposits is attributable to the Bank’s sales andmarketing efforts to implement its strategic goals, including developing andbuilding relationships with small-to-medium sized businesses and professionals.The opening of the Bank’s fifth branch office in El Cajon in April 2006 contributedto the Bank’s deposit growth in 2006; total deposits for this branch officewere $7.0 million at December 31, 2006.

While the Bank continues to plan for healthy growth in 2007, the comingyear is likely to be one where we continue to feel pressure on our net interestmargin and strong competition for deposits. As of December 31, 2006, the Bankhad approximately 3,338 deposit accounts comprised of savings and money marketaccounts (34%), certificates of deposit (43%), and transaction accounts (23%).

The Bank experienced a decrease in the average balance ofnoninterest-bearing demand deposits of approximately $4 million from 2005 to2006; the Bank attributes this decrease in balances to the increased level ofinterest rates causing business customers to be more conscientious aboutactively managing operational demand deposit accounts.  To augment the Bank’s marketing efforts andas a means to build new relationships in the community, the Bank periodicallysolicits new deposits through deposit promotions, which may be advertised,typically in print media.  During 2006,two such campaigns were initiated that resulted in approximately $30.0 millionin new money market and CD funds.  Typically,when running a promotional deposit campaign, the Bank will offer interest rateson deposits that are very competitive in the market place.  These rates are typically higher thanpre-promotion interest rates offered by the Bank, but are generally not thehighest interest rates available in the market place.  The Bank expects to continue to periodicallyrun promotional deposit campaigns and market directly to its strategic niche inorder to grow its deposit base and to attract new deposit relationships.

The Bank also acquires deposits from non-traditional sources throughrelationships with correspondent banks and related deposit programs as well asthrough deposit brokers. The Bank participates in a “portfolio deposit program”offered by a correspondent bank in which the Bank receives variable rate moneymarket deposits as pass through funds from the correspondent bank.  The Bank also receives deposits in the formof time certificates through the use of deposit brokers who place the fundswith the Bank on behalf of their clients. The total level of deposits from these non-traditional sources wasapproximately $40 million at December 31, 2006, compared to approximately $31million at December 31, 2005.  The Bankcarefully manages the level of deposits it accepts from these non-traditionalsources as these types of deposits expose the Bank to different characteristicsin managing its liquidity.  The Bank hasadopted procedures to monitor these deposits and has made arrangements forborrowing funds from other sources (see “Short-Term and Other Borrowings”below) should these programs become less available.  However, should deposits from these programssuddenly decline, the Bank’s other sources of funds could become more costly.

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**Scheduled Maturity of Distribution of Time Deposits of$100,000 or More**

As of December 31, 2006,

(dollars in thousands)
| Three Months or Less                   |   | $      | 18,867 |   |
|----------------------------------------|--------|--------|--------|--------|
| Over Three Months  Through Six Months  |   | 19,314 |   |
| Over Six Months Through  Twelve Months |   | 30,569 |   |
| Over Twelve Months                     |   | 25,265 |   |
| Total                                  |   | $      | 94,015 |   |

 

**SHORT-TERM AND OTHERBORROWINGS**

The Bank may borrow up to $13.0 million overnight on an unsecured basisfrom its correspondent banks; each of these facilities may terminate at anytime without notice.  In addition, theBank has arranged a borrowing line with the Federal Home Loan Bank of SanFrancisco, under which the Bank may borrow up to 25% of its assets subject toproviding adequate collateral and fulfilling other conditions of the line.  As of December 31, 2006, the Bank had $24.0million outstanding in FHLB advances under these borrowing lines, which maturein January 2007 and have a weighted average interest rate of 5.34%. The Bankhad no outstanding advances on borrowing lines as of December 31, 2005 and $9.0million as of December 31, 2004, which matured in January 2005 and had aweighted average interest rate of 2.27%.

Below is a table of maximum amounts of short-term borrowingsoutstanding at any month-end during the reporting periods, and the approximateaverage amounts outstanding and weighted average interest rate as of December31 of the reporting periods.

| Year Ended | ** ** | **Maximum Amt  Outstanding at  any Month-End** | ** ** | **Average Balance** | ** ** | **Weighted  Average  Interest Rate** | ** ** |
|-----------------|------------|---------------------------------------------------------------|------------|--------------------------|------------|-------------------------------------------|------------|
| ** **      | ** ** | **(dollars in thousands)**                          | ** ** | ** **               | ** ** |
| 2006            |       | $                                                             | 24,000     |                     | $          | 5,786                                     |       | 5.29 | % |
| 2005            |       | $                                                             | 17,500     |                     | $          | 2,496                                     |       | 3.43 | % |
| 2004            |       | $                                                             | 12,700     |                     | $          | 3.473                                     |       | 1.30 | % |

 

On March 31, 2005, the Bank issued $5.0 million in Floating Rate JuniorSubordinated Debentures in a private placement offering.  This offering was undertaken in order toraise the Bank’s capital ratios.  Undercurrent risk-based capital guidelines, subordinated debentures qualify for Tier2 capital treatment up to 50% of Tier 1 capital and, therefore, increased theBank’s total risk-based capital ratio. The terms of the subordinated debt are: a final maturity of June 15,2020, a right on behalf of the Bank for early redemptions beginning in June,2010, and an interest rate which floats quarterly based on 3 Month LIBOR plus aspread of 178 basis points.  The interestrate on the subordinated debt as of December 31, 2006 is 7.14%.

**CAPITAL RESOURCES**

The Bank opened in November 2000 after completing its initial publicoffering and raising $11.5 million in capital. In 2002, the Bank completed a secondary offering of securities, raising$4.2 million in new capital.  During 2003and 2004, the Bank raised approximately $4.3 million from the conversion of 95%of common stock purchase warrants that were issued in connection with its 2000initial public offering and the 2002 secondary offering.   On May 16, 2005, the Bank’s board ofdirectors declared a two-for-one stock split of the Bank’s common stock payableto shareholders of record on June 15, 2005. The shareholders received one additional share for each share theyowned.  All share and per share data hasbeen restated for prior periods to reflect this stock split.

Shareholders’ equity at December 31, 2006 was $26.0 million, anincrease of $3.8 million compared to the $22.2 million at December 31, 2005,increasing primarily as a result of retained earnings.

In 1990, the banking industry began to phase in new regulatory capitaladequacy requirements based on risk-adjusted assets.  These requirements take into considerationthe risk inherent in investments, loans, and other assets for both on-balancesheet and off-balance sheet items.  Underthese requirements, the regulatory agencies 

35

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have set minimum thresholds for Tier 1 capital, totalcapital and leverage ratios.  The Bank’srisk-adjusted capital ratios, shown below as of December 31, 2006, 2005 and2004 have been computed in accordance with regulatory accounting policies.  See also Note M to the Financial Statementsand “Item 1, Description of Business - Supervision and Regulation - Risk-BasedCapital Guidelines” above for more information on regulatory capitalrequirements.

**Capital Ratios**
| ** **                             | ** ** | **December 31,** | ** ** | ** ** |
|----------------------------------------|------------|------------------|------------|------------|
| ** **                             | ** ** | **2006**         | ** ** | **2005**   | ** ** | **2004** | ** ** | **Minimum Requirements** |
| Tier 1 Capital to Average Assets       |       | 8.7%             |       | 8.8%       |   | 9.8% |   | 4.0% |
| Tier 1 Capital to Risk-Weighted Assets |       | 8.7%             |       | 9.0%       |   | 10.0% |   | 4.0% |
| Total Capital to Risk-Weighted Assets  |       | 11.5%            |       | 12.2%      |   | 11.2% |   | 8.0% |

 

**NONINTEREST INCOME ANDNONINTEREST EXPENSE**

Noninterest income for 2006 was $538,000, compared to $491,000 for2005, an increase of $47,000. The increase in noninterest income wasattributable to increased service charges on deposit accounts, related fees,and other income, which increased 22% from $325,000 in 2005 to $395,000 in2006, and was primarily the result of the increase in deposit accounts and relatedactivity.  However, these increases inservice charges were somewhat offset by a decline in gains and fee income onthe sale or brokering of loans, which decreased from $166,000 in 2005 to$143,000 in 2006.  While the Bank willcontinue to periodically realize gains on sale of loan assets, the timing ofsuch sales is not expected to be regular.

Noninterest expense increased from $8.5 million for the year endingDecember 31, 2005 to $9.9 million for the year ending December 31, 2006.  This increase is primarily attributableexpenses associated with supporting the Bank’s growth.  Salary and benefits expense increased from$5.1 million in 2005 to $6.1 million in 2006; during 2006, the Bank increasedits number of full-time equivalent employees from 69 at December 31, 2005 to 77at December 31, 2006.  Occupancy andequipment expense increased 14%, from $1.4 million in 2005 to $1.5 million in2006.  The relatively small increase isdue to additional 2005 expenses incurred to open a new corporate headquartersin La Jolla, which did not reoccur in 2006. Both asset and revenue growth haveoutpaced growth of noninterest expense in 2006 despite the expenses associatedwith the addition of a new branch in April 2006 in El Cajon, California.  Other operating expenses increased from $2.1million in 2005 to $2.3 million in 2006 including data processing expenses,professional fees and office and administrative expenses.  Noninterest expenses improved from 3.65% ofaverage assets for 2005 to 3.54% for the fiscal year 2006.

In 2007, as the Bank continues to expand and add personnel, noninterestexpenses are expected to increase at a level to sustain the growth of the Bank’scustomer base.   Specifically, asdetailed in “Item 2. Properties,” in 2007 the Bank will be expanding itsfacilities; the East County Branch Office will be relocated to a larger,permanent location from its existing temporary facility and the Golden TriangleBranch Office and the Headquarters Office will be relocated and combined in alarger facility.  As a result of thesemoves, the Bank will incur moving expenses, increased rent and other occupancyexpenses, and will likely have short periods where the Bank will be paying rentexpense on old facilities and new facilities. Furthermore, depending on the timing of these moves, the Bank may needto amortize leasehold improvements faster than currently anticipated.  Additionally, noninterest expenses areexpected to increase significantly as a result of the expected consummation ofthe acquisition of Landmark National Bank; however, the Bank expects that theefficiencies realized from this acquisition will more than offset the increasedcosts and expenses.

**INCOME TAXES**

During 2006, the Bank recognized income tax expense of $2.2 millioncompared to $1.6 million for 2005.  Theincrease in total income tax expense is attributable to the increase in incomebefore income taxes; total income tax expense as a percentage of income beforetaxes was 40.8% in 2006 and 40.9% in 2005. See also Note F, Income Taxes, to the Financial Statements for moreinformation.

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**EFFECTS OF INFLATION**

The impact of inflation on a financial institution can differsignificantly from that exerted on other companies.  Banks, as financial intermediaries, have manyassets and liabilities, which may move in concert with inflation both as tointerest rates and value.  This isespecially true for banks with a high percentage of interest rate-sensitiveassets and liabilities.  The Bank managesits sensitivity to changes in interest rates by performing a gap analysis ofits rate sensitive balance sheet and modeling the effects of changes ininterest rates on its net interest income. The Bank attempts to structure its mix of financial instruments andmanage its interest rate sensitivity gap in order to minimize the potentialadverse effects of inflation or other market forces on its net interest incomeand, therefore, its earnings and capital.

**CONTRACTUAL OBLIGATIONS**

See Note D, Premises and Equipment included in “Item 8 — FinancialStatements and Supplementary Data.”

**OFF-BALANCE SHEETARRANGEMENTS**

The Bank is a party to financial instruments with off-balance sheetrisk in the normal course of business to meet the financing needs of itscustomers.  These financial instrumentsinclude commitments to extend credit and standby letters of credit totaling$90.8 million at December 31, 2006 and $87.3 million as of December 31, 2005.

The Bank leases its facilities under noncancellable operating leasesand routinely enters contracts for services to be provided over extended futureperiods, which may contain penalty clauses for the early termination of thecontracts.

In addition, the Bank is a member of The Federal Home Loan Bank of SanFrancisco and, as such, is offered wholesale credit products and services, whichprovide the Bank access to funds that help the Bank meet the borrowing needs ofits customers.  For additionalinformation regarding the Bank’s off-balance sheet arrangements, see Notes D, Gand H to the Financial Statements included in “Item 8, Financial Statements andSupplementary Data,” below.

**CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES**

This form 10-K is based on the Bank’s financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States of America. The process of preparing these financialstatements requires management to make difficult, subjective or complexjudgments that could have a material effect on the Bank’s financial conditionand results of operations. A critical accounting policy is defined as one thatis material to the presentation of the Bank’s financial statements. A summaryof significant accounting policies is presented in Note A of the FinancialStatements found in “Item 8- Financial Statements and Supplementary Data,” below.Management believes that the following are critical accounting policies.

*Use of Estimates in the Preparationof Financial Statements*. The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires the Bank’smanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, disclosure of contingent assets and liabilities atthe date of the financial statements, and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates.  Note A to the Financial Statements describesthe significant accounting policies used in the preparation of the FinancialStatements.

*Loans*.  Loans receivable that management has theintent and ability to hold for the foreseeable future or until maturity orpayoff are reported at their outstanding unpaid principal balances reduced byany charge-offs or specific valuation accounts and net of any deferred fees or costson originated loans, or unamortized premiums or discounts on purchasedloans.  Loan origination fees and certaindirect origination costs are capitalized and recognized as an adjustment of theyield of the related loan.  The accrualof interest on impaired loans is discontinued when, in management’s opinion,the borrower may be unable to meet payments as they become due.  Interest income is subsequently recognizedonly to the extent cash payments are received.

37

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*Allowance for Loan Losses*.  The allowance for loan losses is adjusted bycharges to income and decreased by charge-offs (net of recoveries).  Management’s periodic evaluation of theadequacy of the allowance is based on the Bank’s past loan loss experience,known and inherent risks in the portfolio, adverse situations that may affectthe borrower’s ability to repay, the estimated value of any underlyingcollateral, and current economic conditions. This evaluation is inherentlysubjective, as it requires estimates that are susceptible to significantrevision as more information becomes available.

*Stock-Based Compensation*.  In December 2004, Financial AccountingStandards Board revised Statement of Financial Accounting Standard 123 andissued it under its new name, “Share-Based Payment” (the “Statement”).  The Statement eliminates the alternative touse APB Opinion 25’s intrinsic value method of accounting.  Instead, the Statement generally requiresentities to recognize the cost of employee services received in exchange forawards of stock options, or other equity instruments, based on the grant-datefair value of those awards.

The Bank adopted SFAS No. 123 (R) on January 1, 2006 using the “modifiedprospective method.”  Under this methodcompensation expense is recognized using the fair-value method for all newstock option awards as well as any existing awards that are modified,repurchased or cancelled after January 1, 2006 and prior periods are notrestated.  In addition, the unvestedportion of previously awarded options outstanding as of January 1, 2006 willalso be recognized as expense over the requisite service period based on thefair value of those options as previously calculated at the grant date underthe pro-forma disclosures of SFAS No. 123 (R). See Note A, Summary ofSignificant Accounting Policies included in “Item 8 - Financial Statements andSupplementary Data.”

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**FORWARD-LOOKINGSTATEMENTS**

This Annual Report on Form 10-K and other documents that we incorporateby reference into this report contain forward-looking statements concerning theCompany’s beliefs, plans, objectives, goals, expectations, anticipations,estimates, intentions, operations, future results and prospects, includingstatements that include the words “may,” “could,” “should,” “would,” “believe,”“expect,” “will,” “shall,” “anticipate,” “estimate,” “intend,” “plan” andsimilar expressions. These forward-looking statements are based upon currentexpectations and are subject to risk, uncertainties and assumptions, includingthose described in this annual report and the other documents that areincorporated by reference herein.  Shouldone or more of these risks or uncertainties materialize, or should underlyingassumptions prove incorrect, actual results may vary materially from thoseanticipated, estimated, expected, projected, intended, committed orbelieved.  In connection with the safeharbors created by Section 21E of the Exchange Act and the provisions ofthe Private Securities Litigation Reform Act of 1995, the Company provides thefollowing cautionary statement identifying important factors (some of which arebeyond the Company’s control) which could cause the actual results or events todiffer materially from those set forth in or implied by the forward-lookingstatements and related assumptions.  Suchfactors include, without limitation, the following:

·                                          Theexpected cost savings to result from the merger with Landmark.

·                                          Theanticipated accretive effect to earnings of the combined enterprise uponeffectiveness of the merger with Landmark.

·                                          Animproved ability to compete with larger competitors upon effectiveness of themerger with Landmark.

·                                          Restructuringcharges expected to be incurred in connection with the merger with Landmark.

·                                          Theeffect of changing regional and national economic conditions, especially as theymay affect the demand for loans and other banking services or lead to increasedloan losses.

·                                          Potentiallosses of businesses and population in the County of San Diego, and risinghousing and insurance costs that may be responsible for such losses.

·                                          Theeffects of trade, monetary and fiscal policies and laws.

·                                          Increasingor decreasing interest rate environments, or changing interest rate policies ofthe Federal Reserve Board, that could lead to decreased net interest margin andvolatility of rate sensitive loans and deposits.

·                                          Stock,bond market and monetary fluctuations.

·                                          Risksof loss of funding of SBA loan programs, or changes in those programs.

·                                          Creditrisks of commercial, SBA, real estate, consumer and other lending activities,including risks related to changes in the values of real estate and othersecurity for loans.

·                                          Risksassociated with concentrations, including commercial real estate loans, in theloan portfolio.

·                                          Lackof take-out financing or problems with sales or lease-up with respect to theCompany’s construction and land development loans.

·                                          Changesin federal and state banking and financial services laws and regulations.

·                                          Competitorsin the Company’s market area with greater financial resources than the Company.

·                                          Competitorsin the Company’s market area of similar size, with similar business plansand/or offering similar services.

·                                          Risksof sudden changes in interest rate, especially with respect to the Company’sincreasing real estate loan portfolios.

·                                          TheCompany’s ability to develop competitive new products and services and theacceptance of those products and services by targeted customers and, whenrequired, regulators.

·                                          TheCompany’s ability to securely and effectively implement new technology(including Internet services) for both the delivery of services and internaloperations.

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·                                          Thewillingness of customers to substitute competitors’ products and services forthose of the Company and vice versa.

·                                          Changesin consumer and business spending and savings habits.

·                                          Unanticipatedregulatory or judicial proceedings.

·                                          Theloss of significant customers.

·                                          Therisk and cost resulting from the opening of one or more new offices and addingemployees.

·                                          Theloss of executives or key employees.

·                                          Creditquality deterioration among the Company’s current or future customers thatcould cause an increase in the provision for loan losses.

·                                          Dividendrestrictions.

·                                          Increasedregulation of the securities markets, including the securities of the Company,whether pursuant to the Sarbanes-Oxley Act of 2002 or otherwise.

·                                          Otherinternal and external developments that could materially impact the Company’soperational and financial performance.

Investors and other readers are cautioned not to place undue relianceon forward-looking statements, which reflect management’s analysis only as ofthe date of the statement.  The Companyundertakes no obligation to revise any forward-looking statement to reflectlater events or circumstances.

**ITEM 7A.               QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

Market risk for the Company is primarilyderived from the exposure to interest rate risk.  Other types of market risk, such as foreigncurrency exchange risk, commodity price risk and equity price risk, are notsignificant in the normal course of the Company’s operations.  Furthermore, the Company has not entered intoany significant market risk sensitive instruments for trading purposes.

One of the objectives of the Company’s asset/liability strategy is tomanage interest rate risks to ensure the safety and soundness of the Company’scapital base, while maintaining adequate net interest margins and spreads toprovide an appropriate return to shareholders. The objectives of interest raterisk management are to control exposure of net interest income to risksassociated with interest rate movements in the market, to achieve consistentgrowth in net interest income and to profit from favorable marketopportunities.

To manage interest rate risk, the Company performs a gap analysis,which is a method of analyzing exposure to interest rate risk, by measuring theability of the Company to reprice its interest rate sensitive assets andliabilities.  In addition to gapanalysis, the Company estimates the effect of changing interest rates on itsnet interest income using the repricing and maturity characteristics of itsassets and liabilities and the estimated effects on yields and costs of thoseassets and liabilities.  Based on the gapanalysis and the Company’s assessment of its exposure to interest rate risk, theCompany is “asset sensitive.”  Ingeneral, “asset sensitive” means that, over time, the Company’s assets willreprice faster than its liabilities.  Ina rising interest rate environment, net interest income can be expected toincrease and, in a declining interest rate environment, net interest income canbe expected to decrease.  During adeclining rate environment, the Company’s interest rate risk exposure issomewhat mitigated by floor rates built into loan contracts.

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Using the Company’s current interest rate risk model,the Company estimates the following changes in its net interest income assumingdifferent interest rate shocks to the Federal Funds rate as of December 31,2006:

| Projected Shock to Federal  Funds Rate | ** ** | **Estimated Change in  Net Interest Income** | ** ** | **Percentage  Change in Net  Interest Income** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| + 200 bp                                              |       | $                                                                | 1,052,000  |                                                          | 6.9        | % |
| + 100 bp                                              |       | $                                                                | 527,000    |                                                          | 3.5        | % |
| - 200 bp                                              |       | $                                                                | (541,000   | )                                                             | (3.6       | %) |
| - 100 bp                                              |       | $                                                                | (766,000   | )                                                             | (5.0       | %) |

 

Information concerning market risk is also containedin “Item 7, Management’s Discussion and Analysis of Financial Condition andResults of Operations” included in this report.

**ITEM 8.                  FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

The financial statements and supplementary data required by this Item 8are set forth at the pages indicated on the Index to Financial Statementsincluded in this Annual Report on Form 10-K.

**ITEM 9.                  CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

None.

**ITEM 9A.               CONTROLSAND PROCEDURES**

Under the supervision and with the participation of management,including the Company’s principal executive officer and principal financialofficer, the Company has evaluated the effectiveness of its disclosure controlsand procedures as defined in Rule 13a-15(e) and 15d-15(e) under the ExchangeAct for the end of the period covered by this Annual Report on Form 10-K.  Based on that evaluation, the Company’sprincipal executive officer and principal financial officer have concluded thatthese controls and procedures are effective in all material respects, includingthose to ensure that information required to be disclosed in reports filed orsubmitted under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the rules and forms of the SEC,and is accumulated and communicated to management, including the principalexecutive officer and the principal financial officer, as appropriate, to allowfor timely decisions regarding required disclosure.

This Annual Report on Form 10-K does not include a report on management’sassessment regarding internal control over financial reporting or anattestation report of the Company’s registered public accounting firm due to atransition period established by rules of the SEC for newly public companies.

There have been no significant changes in the Company’s internalcontrol over financial reporting during the Company’s most recent fiscalquarter that have materially affected, or are reasonably likely to affect, theCompany’s internal control over financial reporting. Inherent limitations existin any system of internal control including the possibility of human error andthe potential of overriding controls. Even effective internal controls canprovide only reasonable assurance with respect to financial statementpreparation. The effectiveness of an internal control system may also beaffected by changes in conditions.

**ITEM 9B.               OTHERINFORMATION**

None.

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**PART III**

**ITEM 10.               DIRECTORS, EXECUTIVE OFFICERS ANDCORPORATE GOVERNANCE**

Incorporated by reference to the sections entitled “Proposal 1 —Election of Directors” and “Board of Directors and Committees —Section 16(a) Beneficial Ownership Reporting Compliance,” in (i) theCompany’s definitive proxy statement for its 2007 annual meeting ofshareholders if filed not later than 120 days after the end of the fiscal yearcovered by this annual report, or (ii) if the Company’s definitive proxystatement is not filed within the 120 day period, in an amendment to thisannual report, which will be filed not later than the end of the 120 dayperiod.

**Code of Ethics**

The Company has adopted a code of ethics that applies to the Company’sChief Executive Officer, Chief Financial Officer, Chief Credit Officer, ChiefBanking Officer and senior managers, a copy of which is available on theCompany’s website at www.1stpacbank.com.

**ITEM 11.               EXECUTIVE COMPENSATION**

Incorporated by reference to the section entitled “ExecutiveCompensation” in (i) the Company’s definitive proxy statement for its 2007annual meeting of shareholders if filed not later than 120 days after the endof the fiscal year covered by this annual report, or (ii) if the Company’sdefinitive proxy statement is not filed within the 120 day period, in anamendment to this annual report, which will be filed not later than the end ofthe 120 day period.

**ITEM 12.               SECURITYOWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

Incorporated by reference to the section entitled “Security Ownershipof Certain Beneficial Owners and Management” in (i) the Company’s definitiveproxy statement for its 2007 annual meeting of shareholders if filed not laterthan 120 days after the end of the fiscal year covered by this annual report,or (ii) if the Company’s definitive proxy statement is not filed within the 120day period, in an amendment to this annual report, which will be filed notlater than the end of the 120 day period.

**Securities Authorized forIssuance Under Equity Compensation Plan**

The Second Amended and Restated 2000 Stock Option Plan of 1st PacificBank of California has been previously approved by the Company’sshareholders.  The Company has no equitycompensation plans not previously approved by shareholders.  The following table sets forth certaininformation concerning aggregate common stock options authorized for issuanceunder the Second Amended and Restated 2000 Stock Option Plan of 1st PacificBank of California.

**EQUITY COMPENSATION PLANINFORMATION**

**AT DECEMBER 31, 2006**

 

| **Number of Securities to be  Issued Upon Exercise of Outstanding Options** | ** ** | **Weighted-Average  Exercise Price of Outstanding Options** | ** ** | **Number  of Securities Remaining Available for Future Issuance Under the Plan  (excluding securities reflected in Column 1)** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|
| 809,642                                                                     |       | $7.32                                                       |       | 227,500                                                                                                                        |

**ITEM 13.               CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

Incorporated by reference to the sections entitled “Transactions WithDirectors, Executive Officers and Principal Shareholders” and “Other MaterialTransactions” in (i) the Company’s definitive proxy statement for its 

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2007 annual meeting of shareholders if filed not laterthan 120 days after the end of the fiscal year covered by this annual report,or (ii) if the Company’s definitive proxy statement is not filed within the 120day period, in an amendment to this annual report, which will be filed notlater than the end of the 120 day period.

**ITEM 14.               PRINCIPALACCOUNTANT FEES AND SERVICES**

Incorporated by reference to the section entitled “Independent PublicAccountants” in (i) the Company’s definitive proxy statement for its 2007annual meeting of shareholders if filed not later than 120 days after the endof the fiscal year covered by this annual report, or (ii) if the Company’sdefinitive proxy statement is not filed within the 120 day period, in anamendment to this annual report, which will be filed not later than the end ofthe 120 day period.

**PART IV**

**ITEM 15.               EXHIBITS,FINANCIAL STATEMENT SCHEDULES**

(a) (1) FinancialStatements. The consolidated financial statements listed on the index to Item 8of this Annual Report on Form 10-K are filed as a part of this Annual Report.

(2) Financial Statement Schedules. All financial statement scheduleshave been omitted since the information is either not applicable or required oris included in the financial statements or notes thereof.

(3) Exhibits. Those exhibits marked with a (*) refer to exhibits filedherewith. The other exhibits are incorporated herein by reference, as indicatedin the following list. Those exhibits marked with a (†) refer to managementcontracts or compensatory plans or arrangements.

**EXHIBIT INDEX**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                  | ** ** | ** ** |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 2.1              |       | Agreement and Plan of Reorganization and Merger by  and between 1st Pacific Bancorp, PBC Merger Company and 1st Pacific Bank of  California dated as of November 7, 2006, incorporated by reference to Exhibit  2 to 1st Pacific Bancorp’s Registration Statement on Form S-4EF filed on  November 9, 2006. |       |       |
|             |       |                                                                                                                                                                                                                                                                                                             |       |       |
| 2.2              |       | Agreement and Plan of Reorganization and Merger  dated February 22, 2007, by and among 1st Pacific Bancorp, 1st Pacific Bank  of California and Landmark National Bank incorporated by reference to Exhibit  10.2 to 1st Pacific Bancorp’s report on Form 8-K filed February 23, 2007.                      |       |       |
|             |       |                                                                                                                                                                                                                                                                                                             |       |       |
| 3.1              |       | Articles of Incorporation of 1st Pacific Bancorp  incorporated by reference to Exhibit 3.1 to 1st Pacific Bancorp’s  Registration Statement on Form S-4EF filed on November 9, 2006.                                                                                                                        |       |       |
|             |       |                                                                                                                                                                                                                                                                                                             |       |       |
| 3.2              |       | Bylaws of 1st Pacific Bancorp incorporated by  reference to Exhibit 3.2 to 1st Pacific Bancorp’s Registration Statement on  Form S-4EF filed on November 9, 2006.                                                                                                                                           |       |       |
|             |       |                                                                                                                                                                                                                                                                                                             |       |       |
| 4.1              |       | Specimen form of Certificate for 1st Pacific Bancorp  Common Stock incorporated by reference to Exhibit 4 to 1st Pacific Bancorp’s  Registration Statement on Form S-4EF filed on November 9, 2006.                                                                                                         |       |       |
|             |       |                                                                                                                                                                                                                                                                                                             |       |       |
| 4.2†        |       | Second Amended and Restated 2000 Stock Option Plan  of 1st Pacific Bank of California, as amended by Amendment No. 1,  incorporated by reference to Exhibit 4.1 to 1st Pacific Bancorp’s  Registration Statement on Form S-8 filed February 21, 2007.                                                       |       |       |
|             |       |                                                                                                                                                                                                                                                                                                             |       |       |
| 10.1*            |       | Sublease, dated December 30, 1999, among  Washington Mutual Bank, FA, 1st Pacific Bank of California and La Jolla  Association (7728 Regents Road, Suite 503, San Diego, California).                                                                                                        |       |       |

 

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| 10.2*        |   | Lease, dated March 26, 2001, among La Jolla  Investors, Larry Tucker, Trustee, and 1st Pacific Bank of California (7728 Regents  Road, Suite 503, San Diego, California).                                                                                                                   |   |   |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.3*        |   | Assumption, Affirmation and Amendment to Lease,  dated March 26, 2001, among La Jolla Investors, Larry Tucker as Trustee  of Larry Tucker Separate Property Trust dated September 17, 1987, and 1st Pacific Bank of California (7728 Regents  Road, Suite 503, San Diego, California). |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.4*        |   | Shopping Center Lease, dated November 1, 1999,  among 95 College Plaza, Ltd., 1st Pacific Bank of California and La Jolla  Association (3500 College Boulevard, Oceanside, California).                                                                                                               |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.5*        |   | First Amendment to Shopping Center Lease, dated  November 17, 2004, among 95 College Plaza, Ltd., 1st Pacific Bank of California and La Jolla  Association (3500 College Boulevard, Oceanside, California).                                                                                                |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.6*        |   | Lease dated April 15, 2003, between Griffin  Properties, LLC and 1st Pacific Bank of California (8889 Rio  San Diego Drive, San Diego, California).                                                                                                                                         |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.7*        |   | First Amendment to Lease Agreement dated  July 25, 2003, between Griffin Properties, LLC and 1st Pacific Bank of California (8889 Rio  San Diego Drive, San Diego, California).                                                                                                             |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.8*        |   | Lease dated September 17, 2004, between FSP  Regents Square, LLC and 1st Pacific Bank of  California (4275 Executive Square, Suite 650, La Jolla, California).                                                                                                                                   |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.9*        |   | Lease dated September 30, 2004, between Legacy Sabre  Springs, LLC and 1st Pacific Bank of California (13500 Evening  Creek Drive North, Suite 100, San Diego, California).                                                                                                                      |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.10*       |   | Amendment No. 1 to Lease dated January 27,  2005, between Kilroy Realty, L.P., a Delaware Limited Partnership, Kilroy  Realty Corporation, a Maryland Corporation, General Partner and 1st Pacific Bank of California (13500 Evening  Creek Drive North, Suite 100, San Diego, California). |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.11*       |   | Indenture Agreement between 1st Pacific Bank of California and Wilmington  Trust Company, as Trustee, dated March 31, 2005, for Floating Rate Junior  Subordinated Debentures Due 2020.                                                                                                                    |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.12*† |   | Employment Agreement, effective as of November 17,  2006, by and between 1st Pacific Bank of California and James H. Burgess.                                                                                                                                                                                   |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.13*† |   | Form of Indemnification Agreement entered into by  and between 1st Pacific Bank of California and each of its  directors and officers.                                                                                                                                                                     |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.14*† |   | 1st Pacific Bank of  California Incentive Compensation Plan - Senior Management.                                                                                                                                                                                                                           |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.15*† |   | Employment Agreement, effective as of December 22,  2005, by and between 1st Pacific Bank of California and A. Vincent  Siciliano.                                                                                                                                                                         |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.16*† |   | Employment Agreement, effective as of  November 17, 2005, by and between 1st Pacific Bank of California and  Richard H. Revier.                                                                                                                                                                            |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.17*† |   | Employment Agreement, effective as of January 1,  2006, by and between 1st Pacific Bank of California and Larry Prosi.                                                                                                                                                                                     |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.18*       |   | Lease dated August 11 2006, among AMJ  Properties, LLC, and 1st Pacific Bank of California (343 East Main  Street, El Cajon, California).                                                                                                                                                             |   |   |
|         |   |                                                                                                                                                                                                                                                                                                            |   |   |
| 10.19        |   | Standard Office Lease by and between Arden Realty  Limited Partnership and 1st Pacific Bank of California dated February 5,  2007, incorporated by reference to Exhibit 10.1 to 1st Pacific Bancorp’s  report on Form 8-K filed February 13, 2007.                                                         |   |   |

 

44

----

 
| 10.20  |   | Form of Landmark Director-Shareholder’s Agreement,  each dated February 22, 2007, incorporated by reference to Exhibit 10.3 to  1st Pacific Bancorp’s report on Form 8-K filed February 23, 2007.                                                                                                      |   |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 10.21  |   | Landmark Director-Shareholder’s Agreement dated  February 22, 2007, between 1st Pacific Bancorp and 1st Pacific Bank of  California on one hand and F.J. “Rick” Mandelbaum, incorporated by reference  to Exhibit 10.4 to 1st Pacific Bancorp’s report on Form 8-K filed February  23, 2007. |   |   |
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 10.22  |   | Form of Affiliates Agreement, each dated February  22, 2007, incorporated by reference to Exhibit 10.6 to 1st Pacific Bancorp’s  report on Form 8-K filed February 23, 2007.                                                                                                                                |   |   |
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 21.1*  |   | List of subsidiaries of 1st Pacific Bancorp                                                                                                                                                                                                                                                                      |   |   |
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 23.1*  |   | Consent of Vavrinek, Trine, Day & Co. LLP                                                                                                                                                                                                                                                                    |   |   |
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 24     |   | Power of Attorney (incorporated by reference to the  signature page to this Form 10-K)                                                                                                                                                                                                                           |   |   |
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 31.1*  |   | Certification of the Chief Executive Officer  pursuant to Rule 13a-14(a)/15d-14(a).                                                                                                                                                                                                                              |   |   |
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 31.2*  |   | Certification of the Chief Financial Officer  pursuant to Rule 13a-14(a)/15d-14(a).                                                                                                                                                                                                                              |   |   |
|   |   |                                                                                                                                                                                                                                                                                                             |   |   |
| 32.1*  |   | Certification of the Chief Executive Officer and  Chief Financial Officer pursuant to 18 USC Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                       |   |   |

----

(b)           See(a)3 above.

(c)           See(a)1 above.

45

----

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) of the Securitiesand Exchange Act of 1934, the registrant has duly caused this report to besigned in its behalf by the undersigned, thereunto duly authorized.
| Date: March 22, 2007 | **1****st PACIFIC BANK OF CALIFORNIA****** |
|----------------------|-------------------------------------------------|
|                 | ** **                                      |
|                 | ** **                                      |
|                 | By:                                             | /s/ A. Vincent Siciliano |
|                 |                                            | A. Vincent Siciliano |
|                 |                                            | President & Chief Executive Officer |
|                 |                                            |
|                 | By:                                             | /s/ James H. Burgess |
|                 |                                            | James H. Burgess |
|                 |                                            | Executive Vice President & Chief Financial  Officer |

 

**POWEROF ATTORNEY**

KNOW ALL MEN BY THESE PRESENTS that each person whose signature appearsbelow constitutes and appoints A. Vincent Siciliano and James H. Burgess, andeach of them, as such person’s true and lawful attorneys-in-fact and agents,with full power of substitution and resubstitution, for such person and in suchperson’s name, place and stead, in any and all capacities, to sign any and allamendments (including post-effective amendments) to this Annual Report on Form10-K, and to file the same with all exhibits thereto, and other documents inconnection therewith, with the Securities and Exchange Commission, grantingunto said attorneys-in-fact and agents full power and authority to do andperform each and every act and thing requisite and necessary to be done in andabout the premises, as fully to all intents and purposes as he or she might doin person, hereby ratifying and confirming all that said attorneys-in-fact andagents, or their substitute or substitutes, may lawfully do or cause to be doneby virtue hereof.

In accordance with the Exchange Act, this report hasbeen signed by the following persons on behalf of the registrant and in thecapacities on the dates indicated:
| Signature                | ** ** | **Title**                                                                                                           | ** ** | **Date**       | ** ** |
|--------------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|----------------|------------|
| /s/ A. Vincent Siciliano |       | President, Chief  Executive Officer, Director (principal executive officer)                                         |       | March 22, 2007 |       |
| A.Vincent Siciliano      |       |                                                                                                                |       |           |       |
| /s/ James H. Burgess     |       | Executive Vice  President,  Chief Financial Officer (principal financial  officer and principal accounting officer) |       | March 22, 2007 |       |
| James H. Burgess         |       |                                                                                                                |       |           |       |
|                     |       |                                                                                                                |       |           |       |
| /s/ Robert P. Cange      |       | Director                                                                                                            |       | March 22, 2007 |       |
| Robert P. Cange          |       |                                                                                                                |       |           |       |
|                     |       |                                                                                                                |       |           |       |
| /s/ Albert Colucci       |       | Director                                                                                                            |       | March 22, 2007 |       |
| Albert Colucci           |       |                                                                                                                |       |           |       |
|                     |       |                                                                                                                |       |           |       |
| /s/ Veronica Z. Froman   |       | Director                                                                                                            |       | March 22, 2007 |       |
| Veronica Z. Froman       |       |                                                                                                                |       |           |       |

 

46

----

 
| Signature           | ** ** | **Title** | ** ** | **Date**       |
|---------------------|------------|-----------|------------|----------------|
|                |       |      |       |           |
| /s/ James G. Knight |       | Director  |       | March 22, 2007 |
| James G. Knight     |       |      |       |           |
|                |       |      |       |           |
| /s/ Susan Lew       |       | Director  |       | March 22, 2007 |
| Susan Lew           |       |      |       |           |
|                |       |      |       |           |
| /s/ Albert Logan    |       | Director  |       | March 22, 2007 |
| Albert Logan        |       |      |       |           |

** **

 

47

----

**1****ST PACIFIC BANK OF CALIFORNIA**

**INDEX TO FINANCIAL STATEMENTS**
|                                                          | ** ** | ** ** |
|----------------------------------------------------------|------------|------------|
|                                                     |       |       |
| REPORT OF  INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM |       |       |
|                                                     |       |       |
| FINANCIAL STATEMENTS                                     |       |       |
|                                                     |       |       |
| Statements of Financial  Condition                       |       |       |
| Statements of Operations                                 |       |       |
| Statement of Changes  in Shareholders’ Equity       |       |       |
| Statements of Cash Flows                                 |       |       |
| Notes to Financial  Statements                           |       |       |

 

48

----

|  | **Vavrinek, Trine, Day & Co., LLP**

Certified Public Accountants & Consultants |  |
|--|-----------------------------------------------------------------------------------------|--|

 

######  

###### **REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

Board of Directors and Shareholders of

1st Pacific Bank ofCalifornia

We have audited the accompanyingstatements of financial condition of 1st Pacific Bank of California as ofDecember 31, 2006 and 2005, and the related statements of operations, changesin shareholders’ equity, and cash flows for the three years ended December 31,2006.  These financial statements are theresponsibility of the Bank’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of 1st Pacific Bank of California as ofDecember 31, 2006 and 2005, and the results of its operations and cash flowsfor the three years ended December 31, 2006 in conformity with accountingprinciples generally accepted in the United States of America.

As discussed in Note A tothe financial statements, the Bank adopted a new accounting pronouncement whichimpacts the accounting for stock options.
|                                        |
|----------------------------------------|
|                                   |
| Laguna Hills, California               |
| March 7, 2007                          |
|                                   |
| Board of Directors and Shareholders of |
| 1st Pacific Bank of California         |

 

 

25231 Paseo De Alicia,Suite 100   Laguna Hills, CA 92653   Tel:949-768-0833   Fax: 949-768-8408   www.vtdcpa.com

**FRESNO  ****·  LAGUNAHILLS  ****·  PALOALTO  ****·  PLEASANTON  ****·  RANCHOCUCAMONGA**

F-1

----

**1STPACIFIC BANK OF CALIFORNIA**

**STATEMENTSOF FINANCIAL CONDITION**

**December31, 2006 and 2005**
| ** **                                                                                                                          | ** ** | **2006**    | ** **  | **2005**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                                                                                                          |       |        |        |        |       |
| Cash and Due from Banks                                                                                                             |       | $           | 9,098,939   |        | $          | 5,228,147 |   |
| Federal Funds Sold                                                                                                                  |       | 20,985,000  |        | 23,710,000  |       |
| **TOTAL  CASH AND CASH EQUIVALENTS**                                                                                                |       | 30,083,939  |        | 28,938,147  |       |
| Investment Securities  Available for Sale                                                                                           |       | 8,998,338   |        | 3,145,621   |       |
| Loans:                                                                                                                              |       |        |        |        |       |
| Construction and  Land Development                                                                                                  |       | 116,389,134 |        | 94,912,271  |       |
| Real Estate -  Commercial and Residential                                                                                           |       | 81,130,349  |        | 65,122,928  |       |
| SBA                                                                                                                                 |       | 19,883,247  |        | 21,964,919  |       |
| Commercial                                                                                                                          |       | 52,796,722  |        | 43,970,126  |       |
| Consumer                                                                                                                            |       | 5,066,085   |        | 4,411,829   |       |
| **TOTAL  LOANS**                                                                                                                    |       | 275,265,537 |        | 230,382,073 |       |
| Allowance for  Loan Losses                                                                                                          |       | (3,251,002  | )           | (2,808,883  | )          |
| **NET  LOANS**                                                                                                                      |       | 272,014,535 |        | 227,573,190 |       |
| Federal Reserve, FHLB  and Bankers’ Bank Stock, at Cost                                                                        |       | 2,086,850   |        | 1,615,500   |       |
| Premises and Equipment                                                                                                              |       | 1,604,318   |        | 1,592,224   |       |
| Accrued Interest and  Other Assets                                                                                                  |       | 3,657,713   |        | 2,716,912   |       |
|                                                                                                                                |       | $           | 318,445,693 |        | $          | 265,581,594 |   |
|                                                                                                                                |       |        |        |        |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                      |       |        |        |        |       |
| Deposits:                                                                                                                           |       |        |        |        |       |
| Noninterest-Bearing  Demand                                                                                                         |       | $           | 46,099,641  |        | $          | 54,772,554 |   |
| NOW  Interest-Bearing Checking                                                                                                      |       | 13,323,197  |        | 14,539,658  |       |
| Savings and Money  Market Accounts                                                                                                  |       | 87,783,374  |        | 76,319,842  |       |
| Time Deposits  Under $100,000                                                                                                       |       | 20,617,162  |        | 26,661,648  |       |
| Time Deposits  $100,000 and Over                                                                                                    |       | 94,015,104  |        | 64,914,710  |       |
| **TOTAL  DEPOSITS**                                                                                                                 |       | 261,838,478 |        | 237,208,412 |       |
| Subordinated Debt and  Other Borrowings                                                                                             |       | 29,000,000  |        | 5,000,000   |       |
| Accrued Interest and  Other Liabilities                                                                                             |       | 1,644,853   |        | 1,142,820   |       |
| **TOTAL  LIABILITIES**                                                                                                              |       | 292,483,331 |        | 243,351,232 |       |
| Commitments and  Contingencies - Notes D and G                                                                                      |       | —      |        | —      |       |
| Shareholders’ Equity:                                                                                                          |       |        |        |        |       |
| Common Stock -  20,000,000 Shares Authorized, No Par Value; Shares Issued and Outstanding:  3,889,692 in 2006 and 3,849,540 in 2005 |       | 20,636,930  |        | 20,261,472  |       |
| Additional  Paid-in Capital                                                                                                         |       | 104,915     |        | —      |       |
| Retained  Earnings                                                                                                                  |       | 5,210,116   |        | 2,008,341   |       |
| Accumulated  Other Comprehensive Income (Loss), Net of Taxes                                                                        |       | 10,401      |        | (39,451     | )          |
| **TOTAL  SHAREHOLDERS’ EQUITY**                                                                                                |       | 25,962,362  |        | 22,230,362  |       |
|                                                                                                                                |       | $           | 318,445,693 |        | $          | 265,581,594 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

F-2

----

##### **1ST PACIFIC BANK OF CALIFORNIA**

**STATEMENTSOF OPERATIONS**

**For theYears Ended December 31, 2006, 2005 and 2004**
| ** **                                               | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **INTEREST INCOME**                                      |       |       |       |       |       |       |       |
| Interest and  Fees on Loans                              |       | $          | 22,435,496 |       | $          | 16,021,950 |       | $ | 9,942,904 |   |
| Interest on  Investment Securities                       |       | 374,560    |       | 236,334    |       | 321,768    |       |
| Interest on  Federal Funds Sold                          |       | 649,660    |       | 436,525    |       | 98,576     |       |
| **TOTAL  INTEREST INCOME**                               |       | 23,459,716 |       | 16,694,809 |       | 10,363,248 |       |
|                                                     |       |       |       |       |       |       |       |
| **INTEREST EXPENSE**                                     |       |       |       |       |       |       |       |
| Interest on NOW,  Savings and Money Market Accounts      |       | 2,714,586  |       | 1,827,233  |       | 856,841    |       |
| Interest on Time  Deposits                               |       | 4,848,524  |       | 2,008,048  |       | 1,020,345  |       |
| Interest on  Borrowings                                  |       | 653,744    |       | 290,039    |       | 45,906     |       |
| **TOTAL  INTEREST EXPENSE**                              |       | 8,216,854  |       | 4,125,320  |       | 1,923,092  |       |
|                                                     |       |       |       |       |       |       |       |
| **NET  INTEREST INCOME**                                 |       | 15,242,862 |       | 12,569,489 |       | 8,440,156  |       |
|                                                     |       |       |       |       |       |       |       |
| Provision for Loan  Losses                               |       | 444,000    |       | 552,500    |       | 850,000    |       |
| ** **                                               |       |       |       |       |       |       |       |
| **NET  INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES** |       | 14,798,862 |       | 12,016,989 |       | 7,590,156  |       |
|                                                     |       |       |       |       |       |       |       |
| **NONINTEREST INCOME**                                   |       |       |       |       |       |       |       |
| Service Charges,  Fees and Other Income                  |       | 395,676    |       | 325,244    |       | 238,625    |       |
| Gain on Early  Redemption of Investment Securities       |       | —     |       | —     |       | 38,979     |       |
| Brokered Loan  Fees and Gain on Loan Sales               |       | 142,762    |       | 165,963    |       | 187,982    |       |
|                                                     |       | 538,438    |       | 491,207    |       | 465,586    |       |
| **NONINTEREST EXPENSE**                                  |       |       |       |       |       |       |       |
| Salaries and  Employee Benefits                          |       | 6,075,991  |       | 5,072,754  |       | 3,480,053  |       |
| Occupancy and  Equipment Expense                         |       | 1,536,809  |       | 1,352,077  |       | 940,993    |       |
| Marketing and  Business Promotion                        |       | 580,119    |       | 587,679    |       | 412,125    |       |
| Data Processing                                          |       | 717,034    |       | 637,624    |       | 526,870    |       |
| Professional and  Regulatory Fees                        |       | 395,204    |       | 381,520    |       | 318,047    |       |
| Office and  Administrative Expenses                      |       | 601,350    |       | 487,458    |       | 313,323    |       |
| Other  Miscellaneous Expenses                            |       | 21,818     |       | 12,650     |       | 1,350      |       |
|                                                     |       | 9,928,325  |       | 8,531,762  |       | 5,992,761  |       |
| **INCOME  BEFORE INCOME TAXES**                          |       | 5,408,975  |       | 3,976,434  |       | 2,062,981  |       |
|                                                     |       |       |       |       |       |       |       |
| Income Tax Expense                                       |       | 2,207,200  |       | 1,626,300  |       | 836,500    |       |
| **NET  INCOME**                                          |       | $          | 3,201,775  |       | $          | 2,350,134  |       | $ | 1,226,481 |   |
|                                                     |       |       |       |       |       |       |       |
| **NET  INCOME PER SHARE - BASIC**                        |       | $          | 0.83       |       | $          | 0.61       |       | $ | 0.34 |   |
| **NET INCOME PER SHARE - DILUTED**                       |       | $          | 0.76       |       | $          | 0.56       |       | $ | 0.32 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

F-3

----

###### **1ST PACIFIC BANK OF CALIFORNIA**

**STATEMENTOF CHANGES IN SHAREHOLDERS’ EQUITY**

## **For the Years Ended December 31, 2006, 2005 and 2004**

| ** **                                                                              | ** ** | ** **            | ** ** | ** **      | ** ** | ** **   | ** ** | ** **    | ** ** | ** **        | ** ** | **Accumulated**   | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|--------------|------------|---------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                              | ** ** | **Common Stock** | ** ** | **Addt’l** | ** ** | **Retained** | ** ** | ** **    | ** ** | **Other**         | ** ** |
| ** **                                                                              | ** ** | **Number of**    | ** ** | ** **      | ** ** | **Paid-in**  | ** ** | **Earnings**  | ** ** | **Comprehensive** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                              | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **Capital**  | ** ** | **(Deficit)** | ** ** | **Income**        | ** ** | **Income**        | ** ** |
|                                                                                    |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| **Balance, January 1, 2004**                                                            |       | 3,147,188             |       | $               | 15,857,202 |         | $          | —        |       | $                 | (1,568,274 | )                 |       |   | $ | 73,198 |   |
| Exercise  of Stock Options and Warrants, Including Tax Benefits of $24,100              |       | 672,732               |       | 4,201,577       |       |         |       |          |       |              |       |              |       |
|                                                                                    |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Comprehensive Income:                                                                   |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Net  Income                                                                             |       |                  |       |            |       |         |       | 1,226,481     |       | $                 | 1,226,481  |              |       |   |
| Unrecognized  Loss in Investment Securities Available for Sale, Net of Taxes of $48,889 |       |                  |       |            |       |         |       |          |       | (70,351           | )          | (70,351           | )          |
| Less  Reclassification of Gains Included in Net Income, Net of Taxes of $15,981         |       |                  |       |            |       |         |       |          |       | (22,998           | )          | (22,998           | )          |
| Total  Comprehensive Income                                                             |       |                  |       |            |       |         |       |          |       | $                 | 1,133,132  |              |       |   |
| **Balance, December 31, 2004**                                                          |       | 3,819,920             |       | 20,058,779      |       | —       |       | (341,793      | )          |              |       | (20,151           | )          |
|                                                                                    |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Exercise  of Stock Options and Warrants, Including Tax Benefits of $45,500              |       | 29,620                |       | 202,693         |       |         |       |          |       |              |       |              |       |
|                                                                                    |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Comprehensive Income:                                                                   |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Net  Income                                                                             |       |                  |       |            |       |         |       | 2,350,134     |       | $                 | 2,350,134  |              |       |   |
| Unrecognized  Loss in Investment Securities Available for Sale, Net of Taxes of $14,255 |       |                  |       |            |       |         |       |          |       | (20,513           | )          | (20,513           | )          |
| Add  Reclassification of Loss Included in Net Income, Net of Taxes of $843              |       |                  |       |            |       |         |       |          |       | 1,213             |       | 1,213             |       |
| Total  Comprehensive Income                                                             |       |                  |       |            |       |         |       |          |       | $                 | 2,330,834  |              |       |   |
| **Balance, December 31, 2005**                                                          |       | 3,849,540             |       | 20,261,472      |       | —       |       | 2,008,341     |       |              |       | (39,451           | )          |
|                                                                                    |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Stock-Based  Compensation                                                               |       |                  |       |            |       | 104,915      |       |          |       |              |       |              |       |
| Exercise  of Stock Options, Including Tax Benefits of $142,600                          |       | 40,152                |       | 375,458         |       |         |       |          |       |              |       |              |       |
|                                                                                    |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Comprehensive  Income:                                                                  |       |                  |       |            |       |         |       |          |       |              |       |              |       |
| Net  Income                                                                             |       |                  |       |            |       |         |       | 3,201,775     |       | $                 | 3,201,775  |              |       |   |
| Unrecognized  Gain in Investment Securities Available for Sale, Net of Taxes of $34,643 |       |                  |       |            |       |         |       |          |       | 49,852            |       | 49,852            |       |
| Total  Comprehensive Income                                                             |       |                  |       |            |       |         |       |          |       | $                 | 3,251,627  |              |       |   |
| **Balance, December 31, 2006**                                                          |       | 3,889,692             |       | $               | 20,636,930 |         | $          | 104,915       |       | $                 | 5,210,116  |              |       |   | $ | 10,401 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

F-4

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**1STPACIFIC BANK OF CALIFORNIA**

**STATEMENTSOF CASH FLOWS**

**For theYears Ended December 31, 2006, 2005 and 2004**
| ** **                                                                         | ** ** | **2006**    | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **OPERATING ACTIVITIES**                                                           |       |        |       |        |       |        |       |
| Net Income                                                                         |       | $           | 3,201,775  |        | $          | 2,350,134   |       | $ | 1,226,481 |   |
| Adjustments to  Reconcile Net Income to Net Cash Provided by Operating Activities: |       |        |       |        |       |        |       |
| Provision for  Loan Losses                                                         |       | 444,000     |       | 552,500     |       | 850,000     |       |
| (Gain) Loss on  Sale, Redemption of Securities                                     |       | —      |       | 2,056       |       | (38,979     | )          |
| Stock-Based  Compensation                                                          |       | 104,915     |       | —      |       | —      |       |
| Depreciation and  Amortization                                                     |       | 487,027     |       | 378,098     |       | 294,640     |       |
| Deferred Income  Tax Expense (Benefit)                                             |       | (245,300    | )          | (246,800    | )          | 354,800     |       |
| Other Items                                                                        |       | (228,111    | )          | 230,803     |       | (118,473    | )          |
| ** **                                                                         |       |        |       |        |       |        |       |
| **NET  CASH PROVIDED BY OPERATING ACTIVITIES**                                     |       | 3,764,306   |       | 3,266,791   |       | 2,568,469   |       |
|                                                                               |       |        |       |        |       |        |       |
| **INVESTING ACTIVITIES**                                                           |       |        |       |        |       |        |       |
| Purchase of  Investment Securities Available for Sale                              |       | (7,261,146  | )          | —      |       | (5,108,594  | )          |
| Maturities,  Sales, Calls and Principal Reduction on Securities Available for Sale |       | 1,492,924   |       | 2,759,730   |       | 4,640,132   |       |
| Change in Equity  Stock                                                            |       | (471,350    | )          | (392,300    | )          | (544,950    | )          |
| Net Increase in  Loans                                                             |       | (44,885,345 | )          | (41,838,644 | )          | (67,463,764 | )          |
| Purchases of  Premises and Equipment                                               |       | (499,121    | )          | (688,616    | )          | (682,108    | )          |
| ** **                                                                         |       |        |       |        |       |        |       |
| **NET  CASH USED BY INVESTING ACTIVITIES**                                         |       | (51,624,038 | )          | (40,159,830 | )          | (69,159,284 | )          |
|                                                                               |       |        |       |        |       |        |       |
| **FINANCING ACTIVITIES**                                                           |       |        |       |        |       |        |       |
| Net Increase in  Demand, NOW and Savings Accounts                                  |       | 1,574,158   |       | 21,053,850  |       | 33,702,343  |       |
| Net Increase in  Time Deposits                                                     |       | 23,055,908  |       | 35,863,589  |       | 17,179,535  |       |
| Proceeds from  Issuance of Subordinated Debt                                       |       | —      |       | 5,000,000   |       | —      |       |
| Increase  (Decrease) in Short-Term Borrowings                                      |       | 24,000,000  |       | (9,000,000  | )          | 9,000,000   |       |
| Proceeds from  Exercise of Options and Warrants                                    |       | 375,458     |       | 157,193     |       | 4,177,477   |       |
| ** **                                                                         |       |        |       |        |       |        |       |
| **NET CASH  PROVIDED BY FINANCING ACTIVITIES**                                     |       | 49,005,524  |       | 53,074,632  |       | 64,059,355  |       |
|                                                                               |       |        |       |        |       |        |       |
| ** **                                                                         |       |        |       |        |       |        |       |
| **INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS**                              |       | 1,145,792   |       | 16,181,593  |       | (2,531,460  | )          |
| Cash and Cash  Equivalents at Beginning of Period                                  |       | 28,938,147  |       | 12,756,554  |       | 15,288,014  |       |
| ** **                                                                         |       |        |       |        |       |        |       |
| **CASH  AND CASH EQUIVALENTS AT END OF YEAR**                                      |       | $           | 30,083,939 |        | $          | 28,938,147  |       | $ | 12,756,554 |   |
|                                                                               |       |        |       |        |       |        |       |
| **Supplemental Disclosures of  Cash Flow Information:**                            |       |        |       |        |       |        |       |
| Interest Paid                                                                      |       | $           | 7,970,434  |        | $          | 3,907,834   |       | $ | 1,886,789 |   |
| Taxes Paid                                                                         |       | $           | 2,680,000  |        | $          | 1,642,983   |       | $ | 410,844 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

F-5

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**1STPACIFIC BANK OF CALIFORNIA**

**NOTES TOFINANCIAL STATEMENTS**

**NOTE A — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

Nature of Operations

The Bank has beenorganized as a single operating segment and operates five full-service branchoffices, three in San Diego, California, one in Oceanside, California and onein El Cajon, California, and a loan production office in Murrieta,California.  The Bank’s primary source ofrevenue is derived from providing loans and deposits to its customers, who arepredominately small and middle-market businesses and individuals.  The Bank operates under a state bank charterand, as such, is subject to regulation by the California Department ofFinancial Institutions.  As a member ofthe Federal Reserve System, the Bank is also subject to regulation by theFederal Reserve Bank and the Federal Deposit Insurance Corporation insures theBank’s deposits.

Use of Estimates in thePreparation of Financial Statements

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

Cash and Cash Equivalents

For purposes of reportingcash flows, cash and cash equivalents include cash, due from banks and federalfunds sold.  Generally, federal funds aresold for one-day periods.

Cash and Due from Banks

Banking regulationsrequire that banks maintain a percentage of their deposits as reserves in cashor on deposit with the Federal Reserve Bank. The Bank was in compliance with all reserve requirements as of December31, 2006.  The Bank maintains amounts duefrom banks, which exceed federally insured limits; the Bank has not experiencedany losses in such accounts.

Investment Securities

Bonds, notes, and debenturesfor which the Bank has the positive intent and ability to hold to maturity arereported at cost, adjusted for premiums and discounts that are recognized ininterest income using the interest method over the period to maturity.

Investments not classifiedas trading securities nor as held to maturity securities are classified asavailable-for-sale securities and recorded at fair value.  Unrealized gains or losses onavailable-for-sale securities are excluded from net income and reported as anamount net of taxes as a separate component of other comprehensive incomeincluded in shareholders’ equity. Premiums or discounts on held-to-maturity and available-for-salesecurities are amortized or accreted into income using the interestmethod.  Realized gains or losses onsales of held-to-maturity or available-for-sale securities are recorded usingthe specific identification method.

F-6

----

Declines in the fairvalue of individual held-to-maturity and available-for-sale securities belowtheir cost that are other than temporary result in write-downs of theindividual securities to their fair value. The related write-downs are included in earnings as realizedlosses.  In estimating other-than-temporaryimpairment losses, management considers: the length of time and the extent towhich the fair value has been less than cost, the financial condition andnear-term prospects of the issuer, and the intent and ability of the Bank toretain its investment in the issuer for a period of time sufficient to allowfor any anticipated recovery in fair value.

Loans

Loans that management hasthe intent and ability to hold for the foreseeable future or until maturity orpayoff are reported at their outstanding unpaid principal balances reduced byany charge-offs or specific valuation accounts and net of any deferred fees orcosts on originated loans, or unamortized premiums or discounts on purchasedloans.  Loan origination fees and certaindirect origination costs are capitalized and recognized as an adjustment of theyield of the related loan.

The accrual of intereston impaired loans is discontinued when, in management’s opinion, the borrowermay be unable to meet payments as they become due, generally when past due 90days based on the contractual terms of the loan. Interest income issubsequently recognized only to the extent cash payments are received.  For impairment recognized in accordance withFinancial Accounting Standards Board (FASB) Statement of Financial AccountingStandards (SFAS) No. 114, “*Accounting by Creditorsfor Impairment of a Loan,”* as amended by SFAS No. 118, the entirechange in the present value of expected cash flows is reported as eitherprovision for credit losses in the same manner in which impairment initiallywas recognized, or as a reduction in the amount of provision for credit lossesthat otherwise would be reported.

Allowance for Loan Losses

The allowance for loanlosses is adjusted by charges to income and decreased by charge-offs (net ofrecoveries).  Management’s periodicevaluation of the adequacy of the allowance is based on the Bank’s past loanloss experience, known and inherent risks in the portfolio, adverse situationsthat may affect the borrower’s ability to repay, the estimated value of anyunderlying collateral, and current economic conditions.  This evaluation is inherently subjective, asit requires estimates that are susceptible to significant revision as moreinformation becomes available.

The allowance consists ofspecific, general and unallocated components. The specific component relates to loans that are classified doubtful,substandard and special mention.  Thegeneral component covers non-classified loans and is based on historical lossexperience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that couldaffect management’s estimate of probable losses.  The unallocated component reflects the marginof imprecision inherent in the underlying assumptions used in the methodologiesfor estimating specific and general losses in the portfolio.

F-7

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Premises and Equipment

Premises and equipmentare carried at cost less accumulated depreciation and amortization.  Depreciation is computed using thestraight-line method over the estimated useful lives, which ranges from threeto ten years for furniture and fixtures. Leasehold improvements are amortized using the straight-line method overthe estimated useful lives of the improvements or the remaining lease term,whichever is shorter.  Expenditures forbetterments or major repairs are capitalized and those for ordinary repairs andmaintenance are charged to operations as incurred.

Advertising Costs

The Bank expenses the costs of advertising in the yearincurred.

Income Taxes

Deferred income taxes arecomputed using the asset and liability method, which recognizes a liability orasset representing the tax effects, based on current tax law, of futuredeductible or taxable amounts attributable to events that have been recognizedin the financial statements.  A valuationallowance is established to reduce the deferred tax asset to the level at whichit is “more likely than not” that the tax asset or benefits will berealized.  Realization of tax benefits ofdeductible temporary differences and operating loss carry-forwards depends onhaving sufficient taxable income of an appropriate character within thecarry-forward periods.

Financial Instruments

In the ordinary course ofbusiness, the Bank has entered into off-balance sheet financial instrumentsconsisting of commitments to extend credit, commercial letters of credit, andstandby letters of credit as described in Note G.  Such financial instruments are recorded inthe financial statements when they are funded or related fees are incurred orreceived.

Earnings Per Share (EPS)

Basic EPS excludes dilution and is computed bydividing income available to common stockholders by the weighted-average numberof common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock or resulted in the issuance of common stock that then sharedin the earnings of the entity.

Weighted average shares outstanding used in thecomputation of basic earnings per share were 3,865,330 in 2006, 3,840,596 in2005 and 3,560,036 in 2004.  Weightedaverage shares outstanding used in the computation of diluted earning per sharewere 4,193,154 in 2006, 4,183,787 in 2005 and 3,886,072 in 2004.

F-8

----

Disclosure about FairValue of Financial Instruments

SFAS No. 107 specifies the disclosure of the estimatedfair value of financial instruments.  TheBank’s estimated fair value amounts have been determined using available marketinformation and appropriate valuation methodologies.

However, considerable judgment is required to developthe estimates of fair value. Accordingly, the estimates are not necessarily indicative of the amountsthe Bank could have realized in a current market exchange.  The use of different market assumptionsand/or estimation methodologies may have a material effect on the estimatedfair value amounts.

Accounting for Uncertainty in Income Taxes

In July 2006, the FASBissued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN48”), which clarifies the accounting for uncertainty in tax positions.  The provisions of FIN 48 are effective as ofthe beginning of fiscal year 2007.  TheBank does not anticipate any significant financial impact from implementing FIN48.

Stock-Based Compensation

The Bank hasadopted SFAS No. 123(R) “*Shared-Based Payment.”*ThisStatement generally requires entities to recognize the cost of employeeservices received in exchange for awards of stock options, or other equityinstruments, based on the grant-date fair value of those awards.  This cost is recognized over the period inwhich an employee is required to provide services in exchange for the award,generally the vesting period.

Change inAccounting Principle

The Bank adoptedSFAS No. 123(R) on January 1, 2006 using the “modified prospective method.”  Under this method compensation expense isrecognized using the fair-value method for all new stock option awards as wellas any existing awards that are modified, repurchased or cancelled afterJanuary 1, 2006 and prior periods are not restated.  In addition, the unvested portion ofpreviously awarded options outstanding as of January 1, 2006 will also berecognized as expense over the requisite service period based on the fair valueof those options as previously calculated at the grant date under the pro-formadisclosures of SFAS No. 123(R).  The fairvalue of each grant is estimated using the Black-Scholes option-pricing model.During 2006 the Bank recognized pre-tax stock-based compensation expense of$104,915, as a result of adopting SFAS No. 123(R), which resulted in areduction in net income of approximately $74,000 and reduced basic and dilutedearnings per share by $0.02.

Prior to the adoption of SFAS No. 123(R), the Bankaccounted for stock-based awards using the intrinsic value method prescribed inAccounting Principles Board (“APB”) Opinion No. 25, “*Accountingfor Stock Issued to Employees,”* and related interpretations.  Accordingly, compensation cost for stockoptions was measured as the excess, if any, of the quoted market price of theBank’s stock at the date of the grant over the amount an employee must pay toacquire the stock.  All of the Bank’sstock option grants included exercise prices equal to the Bank’s current marketprice per share; accordingly, no compensation expense was reported using theintrinsic value method of APB Opinion No. 25.

F-9

----

Had compensation cost forthe Bank’s stock option plans been determined based on the fair value at thegrant dates for awards under those plans consistent with the method of SFAS No.123(R), the Bank’s net income and income per share for 2005 and 2004 would havechanged to the pro forma amounts indicated below:
| ** **                                                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net Income:                                                                                        |       |     |       |     |       |
| As Reported                                                                                        |       | $        | 2,350,134  |     | $          | 1,226,481 |   |
| Stock-Based Compensation using Instrinsic Value  Method                                            |       | —   |       | —   |       |
| Stock-Based Compensation that would have been  reported using the Fair Value Method of SFAS 123(R) |       | (532,719 | )          | (254,518 | )          |
| Pro Forma Net Income                                                                               |       | $        | 1,817,415  |     | $          | 971,963 |   |
| Basic Net Income  Per Share:                                                                       |       |     |       |     |       |
| As Reported                                                                                        |       | $        | 0.61       |     | $          | 0.34 |   |
| Pro Forma                                                                                          |       | $        | 0.47       |     | $          | 0.27 |   |
| Diluted Net  Income Per Share:                                                                     |       |     |       |     |       |
| As Reported                                                                                        |       | $        | 0.56       |     | $          | 0.32 |   |
| Pro Forma                                                                                          |       | $        | 0.43       |     | $          | 0.25 |   |

 

During November2005, the Bank accelerated the vesting of all unexpired outstanding stockoptions that would otherwise have vested at various times during the two yearsending December 31, 2007 (the “accelerated vesting period”).  Of the total options outstanding at thattime, vesting was accelerated on approximately 128,000 options that werescheduled to vest at various times during the accelerated vesting period.  This action did not affect options that wouldhave already vested by December 31, 2005, which totaled approximately585,000.  With the consent of theindividual optionees, any such options exercised during the accelerated vestingperiod will be restricted and subject to a holding period through the date onwhich the options would have been permitted to be exercised under the option’soriginal vesting terms. No expense was recognized in 2005 in connection withthis acceleration as the Bank believes all of the employees and directorsreceiving the acceleration benefit will continue on as employees and directorsthrough the original option vesting terms.

The decision toaccelerate the vesting of these stock options was made primarily to reducenon-cash compensation expense that would have been recorded in future periodsfollowing the Bank’s adoption of SFAS 123(R). As a result of the acceleration of the vesting of these options,approximately $338,000, net of tax benefits, is reflected in pro forma incomedisclosure above in 2005 under SFAS 123(R) and will not result in a futureexpense in the statement of operations.

Comprehensive Income

The Bank adopted SFAS No. 130, *“ReportingComprehensive Income,”* which requires the disclosure ofcomprehensive income and its components. Changes in unrealized gain or loss on available-for-sale securities, netof taxes, are the only components of other comprehensive income for the Bank.

Reclassifications

Certain amountshave been reclassified in the 2005 and 2004 financial statements to conform tothe 2006 financial statement presentation, with no effect on net income orequity.

F-10

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# **NOTE B —INVESTMENT SECURITIES**

Debt and equitysecurities have been classified in the statements of condition according tomanagement’s intent.  The carrying amountof securities and their approximate fair values at December 31 were as follows:
| ** **                          | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                          | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                          | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| **Available-for-Sale  Securities:** |       |          |       |           |       |           |       |       |       |
| **December 31, 2006**               |       |          |       |           |       |           |       |       |       |
| Corporate Debt Securities           |       | $             | 3,958,200  |           | $          | 26,675         |       | $          | —     |   | $ | 3,984,875 |   |
| Mortgaged-Backed Securities         |       | 5,022,509     |       | 30,118         |       | (39,164        | )          | 5,013,463  |       |
|                                |       |          |       |           |       |           |       |       |       |
|                                |       | $             | 8,980,709  |           | $          | 56,793         |       | $          | (39,164    | ) | $ | 8,998,338 |   |
|                                |       |          |       |           |       |           |       |       |       |
| **December 31, 2005**               |       |          |       |           |       |           |       |       |       |
| Mortgaged-Backed Securities         |       | $             | 3,212,487  |           | $          | 2,875          |       | $          | (69,741    | ) | $ | 3,145,621 |   |
|                                |       |          |       |           |       |           |       |       |       |
|                                |       | $             | 3,212,487  |           | $          | 2,875          |       | $          | (69,741    | ) | $ | 3,145,621 |   |

 

As of December 31, 2006and 2005, the Bank had two agency mortgage-backed securities with a fair valueof $2,031,281 and $2,912,648 and an unrealized holding loss of $39,164 and$69,741, respectively, that had been in an unrealized loss position for morethan twelve months.  Such unrealizedholding losses are the result of an increase in market interest rates during2005 and 2006 and are not the result of increased credit or principal risk;each of these securities are guaranteed by the federal government or agovernment-sponsored agency.  Based onthe nature of the investments and as management has the ability to hold thedebt securities for the foreseeable future, these unrealized losses were notconsidered other-than-temporary as of December 31, 2006.

The scheduled maturitiesof securities available for sale at December 31, 2006 were as follows:
| ** **                       | ** ** | **Amortized** | ** ** | **Fair**  | ** ** |
|----------------------------------|------------|---------------|------------|-----------|------------|
| ** **                       | ** ** | **Cost**      | ** ** | **Value** | ** ** |
|                             |       |          |       |      |       |
| Due in One Year  or Less         |       | $             | —     |      | $          | — |   |
| Due from One  Year to Five Years |       | 3,958,200     |       | 3,984,875 |       |
| Mortgaged-Backed  Securities     |       | 5,022,509     |       | 5,013,463 |       |
|                             |       |          |       |      |       |
|                             |       | $             | 8,980,709  |      | $          | 8,998,338 |   |

 

As of December 31, 2006,included in accumulated other comprehensive income is net unrealized gains of$17,629 less deferred tax liability of $7,228. As of December 31, 2005, included in accumulated other comprehensiveincome is net unrealized losses of $66,866 less deferred tax benefit of$27,415.

F-11

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**NOTE C — LOANS**

The Bank’s loanportfolio consists primarily of loans to borrowers within San Diego County,California.  Although the Bank seeks toavoid concentrations of loans to a single industry or based upon a single classof collateral, real estate and real estate associated businesses are among theprincipal industries in the Bank’s market area and, as a result, the Bank’sloan and collateral portfolios are, to some degree, concentrated in thoseindustries.

A summary of the changes in the allowance for loanlosses as of December 31 follows:
| ** **                                     | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                           |       |      |       |      |       |      |       |
| Balance at  Beginning of Year                  |       | $         | 2,808,883  |      | $          | 2,264,726 |       | $ | 1,453,647 |   |
| Additions to the  Allowance Charged to Expense |       | 444,000   |       | 552,500   |       | 850,000   |       |
| Recoveries on  Loans Charged Off               |       | 384       |       | 2,873     |       | 2,447     |       |
|                                           |       | 3,253,267 |       | 2,820,099 |       | 2,306,094 |       |
|                                           |       |      |       |      |       |      |       |
| Less Loans  Charged Off                        |       | (2,265    | )          | (11,216   | )          | (41,368   | )          |
|                                           |       |      |       |      |       |      |       |
|                                           |       | $         | 3,251,002  |      | $          | 2,808,883 |       | $ | 2,264,726 |   |

 

The following is asummary of the investment in impaired loans, the related allowance for loanlosses, and income recognized thereon and information pertaining to loans onnonaccrual and certain past due loans as of December 31:
| ** **                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
|                                                     |       |     |       |     |       |      |       |
| Recorded  Investment in Impaired Loans                   |       | $        | —     |     | $          | 1,052,300 |       | $ | — |   |
| Related  Allowance for Loan Losses                       |       | $        | —     |     | $          | 7,427     |       | $ | — |   |
| Average Recorded  Investment in Impaired Loans           |       | $        | 1,229,197  |     | $          | 625,908   |       | $ | 241,292 |   |
| Interest Income  Recognized for Cash Payments            |       | $        | 95,176     |     | $          | 83,652    |       | $ | 32,128 |   |
| Total Loans on  Nonaccrual                               |       | $        | —     |     | $          | 1,052,300 |       | $ | — |   |
| Total Loans Past  Due 90 Days or More and Still Accruing |       | $        | —     |     | $          | —    |       | $ | — |   |

 

The Bank has pledgedcertain loans as collateral for public deposits. These loans totaled $1,057,000as of December 31, 2006 and $1,257,000 as of December 31, 2005.  In addition, as of December 31, 2006, loanstotaling $122.8 million were pledged to secure credit facilities availablethrough the Federal Home Loan Bank discussed in Note H.

Included in total loansare deferred loan fees, net of deferred loan costs, of $371,605 as of December31, 2006 and $457,909 as of December 31, 2005.

F-12

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**NOTE D - PREMISES AND EQUIPMENT**

A summary of premises andequipment as of December 31 follows:
| ** **                                      | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|
|                                            |       |       |       |       |       |
| Furniture,  Fixtures, and Equipment             |       | $          | 1,626,779  |       | $          | 1,494,236 |   |
| Computer  Equipment                             |       | 635,603    |       | 455,397    |       |
| Leasehold  Improvements                         |       | 988,748    |       | 820,051    |       |
| Construction in  Progress                       |       | 28,728     |       | 11,053     |       |
|                                            |       | 3,279,858  |       | 2,780,737  |       |
| Less Accumulated  Depreciation and Amortization |       | (1,675,540 | )          | (1,188,513 | )          |
|                                            |       |       |       |       |       |
|                                            |       | $          | 1,604,318  |       | $          | 1,592,224 |   |

 

Below is a summary offuture lease rental payables under non-cancelable operating lease commitments,including estimated common area charges. The table below includes commitmentson existing office leases at December 31, 2006, as well as a lease for newcorporate office space, which will commence on September 1, 2007:

| 2007       |   | $         | 1,003,075  |   |
|------------|--------|-----------|------------|--------|
| 2008       |   | 1,143,564 |       |
| 2009       |   | 1,193,033 |       |
| 2010       |   | 1,105,946 |       |
| 2011       |   | 1,197,448 |       |
| Thereafter |   | 5,529,578 |       |
|       |   |      |       |
|       |   | $         | 11,172,644 |   |

 

The minimum rentalpayments shown above are given for the existing lease obligations and are not aforecast of future rental expense.  Theoperating leases generally include either annual fixed increases in the minimumrent or an increase based on the increase in the consumer price index.  Additionally, each lease requires paymenttowards common area charges, either as a pro-rata portion of all operatingcosts or for increases in such costs over a base year.  Management expects that in the normal courseof business, leases that expire will be renewed through existing renewaloptions or be replaced by other leases.

Total rental expense wasapproximately $725,000 for the year ended December 31, 2006, $661,000 for theyear ended December 31, 2005 and $377,000 for the year ended December 31, 2004.

F-13

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**NOTE E — DEPOSITS**

At December 31, 2006, thescheduled maturities of time deposits are as follows:

| Due in One Year or Less      |   | $          | 86,842,397  |   |
|------------------------------|--------|------------|-------------|--------|
| Due from One to  Three Years |   | 27,789,869 |        |
|                         |   |       |        |
|                         |   | $          | 114,632,266 |   |

 

Deposits from executiveofficers, directors and their related interests with which they are associatedheld by the Bank totaled $3,249,246 at December 31, 2006 and $5,941,622 atDecember 31, 2005.

**NOTE F — INCOME TAXES**

The following is asummary of the components of the net deferred tax asset accounts recognized inthe accompanying statements of financial condition at December 31:

|                                                  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|--------------------------------------------------|------------|-----------|------------|-----------|------------|
| Deferred Tax  Assets:                            |       |      |       |      |       |
| Allowance for Loan Losses Due to Tax Limitations |       | $         | 1,194,500  |      | $          | 1,011,800 |   |
| State Franchise Taxes                            |       | 183,500   |       | 118,300   |       |
| Other Items                                      |       | 88,500    |       | 68,100    |       |
|                                             |       | 1,466,500 |       | 1,198,200 |       |
| Deferred Tax  Liabilities:                       |       |      |       |      |       |
| Deferred Loan Costs                              |       | (255,800  | )          | (231,300  | )          |
| Other Items                                      |       | (106,200  | )          | (73,100   | )          |
|                                             |       | (362,000  | )          | (304,400  | )          |
| Valuation  Allowance                             |       | —    |       | —    |       |
|                                             |       |      |       |      |       |
| Net Deferred Tax Assets                          |       | $         | 1,104,500  |      | $          | 893,800 |   |

 

The provision for income taxes consists of thefollowing:

|                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|----------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Taxes Currently  Payable   |       | $        | 2,452,500  |     | $          | 1,873,100 |       | $ | 481,700 |   |
| Deferred Taxes  (Benefits) |       | (245,300 | )          | (246,800 | )          | 354,800   |       |
|                       |       |     |       |     |       |      |       |
|                       |       | $        | 2,207,200  |     | $          | 1,626,300 |       | $ | 836,500 |   |

 

F-14

----

The principal sources of deferred income taxes and thetax effect of each are as follows:
| ** **                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Accelerated  Depreciation         |       | $        | 200        |     | $          | (43,700  | )          | $ | (32,200 | ) |
| Provision for Loan  Losses        |       | (182,700 | )          | (247,700 | )          | (356,400 | )          |
| State Taxes                       |       | (65,200  | )          | (125,400 | )          | (15,900  | )          |
| Net Operating Loss  Carryforwards |       | —   |       | 62,300   |       | 633,000  |       |
| Organizational Costs              |       | —   |       | 105,000  |       | 126,000  |       |
| Other                             |       | 2,400    |       | 2,700    |       | 300      |       |
|                              |       |     |       |     |       |     |       |
| Net deferred taxes  (benefits)    |       | $        | (245,300   | )        | $          | (246,800 | )          | $ | 354,800 |   |

 

As a result of thefollowing items, the total tax expense was different from the amount computedby applying the statutory income tax rate to earnings before income taxes:
| ** **                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal “Expected” Tax |       | $        | 1,839,000  |     | 34.0       | %        | $          | 1,352,000 |   | 34.0 | % | $ | 701,400 |   | 34.0 | % |
| State Franchise Tax,  Net        |       | 341,000  |       | 6.3      | %          | 258,000  |       | 6.5 | % | 147,600 |   | 7.2 | % |
| Other                            |       | 27,200   |       | 0.5      | %          | 16,300   |       | 0.4 | % | (12,500) |   | -0.6 | % |
|                             |       |     |       |     |       |     |       |   |   |   |   |   |   |
|                             |       | $        | 2,207,200  |     | 40.8       | %        | $          | 1,626,300 |   | 40.9 | % | $ | 836,500 |   | 40.6 | % |

 

**NOTE G - COMMITMENTS**

In the ordinary course of business, the Bank entersinto financial commitments to meet the financing needs of its customers.  These financial commitments includecommitments to extend credit and standby letters of credit.  Those instruments involve to varying degrees,elements of credit and interest rate risk not recognized in the Bank’sfinancial statements.

The Bank’s exposure to loan loss in the event ofnonperformance on commitments to extend credit and standby letters of credit isrepresented by the contractual amount of those instruments.  The Bank uses the same credit policies inmaking commitments as it does for loans reflected in the financial statements.

As of December 31, 2006and 2005, the Bank had the following outstanding financial commitments whosecontractual amount represents credit risk:
| ** **                    | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-------------------------------|------------|-----------|------------|-----------|------------|
|                          |       |      |       |      |       |
| Commitments to Extend  Credit |       | $         | 87,527,000 |      | $          | 85,661,000 |   |
| Standby Letters of  Credit    |       | 3,224,000 |       | 1,649,000 |       |
|                          |       |      |       |      |       |
|                          |       | $         | 90,751,000 |      | $          | 87,310,000 |   |

 

F-15

----

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Since many of the commitments areexpected to expire without being drawn upon, the total amounts do notnecessarily represent future cash requirements. The Bank evaluates each client’s credit worthiness on a case-by-casebasis.  The amount of collateral obtainedif deemed necessary by the Bank is based on management’s credit evaluation ofthe customer.  The majority of the Bank’scommitments to extend credit and standby letters of credit are secured by realestate.

**NOTE H - BORROWING ARRANGEMENTS**

The Bank may borrow up to$13,000,000 overnight on an unsecured basis from its correspondent banks.  In addition, the Bank has arranged a creditfacility with the Federal Home Loan Bank of San Francisco.  Under this credit facility, the Bank mayborrow up to 25% of its assets subject to providing adequate collateral andfulfilling other conditions of the credit facility.  As of December 31, 2006, the Bank had$24,000,000 outstanding in FHLB advances, which mature in January 2007, andhave a weighted average interest rate of 5.34%. The Bank had no outstanding advances under these borrowing lines atDecember 31, 2005.

On March 31, 2005, theBank issued $5 million in Floating Rate Junior Subordinated Debentures in aprivate placement offering.  Thisoffering was undertaken in order to raise the Bank’s capital ratios.  Under current risk-based capital guidelines,subordinated debentures qualify for Tier 2 capital treatment up to 50% of Tier1 capital and, therefore, increased the Bank’s total risk-based capitalratio.  The terms of the subordinateddebt are: a final maturity of June 15, 2020, a right on behalf of the Bank forearly redemptions beginning in June, 2010, and an interest rate which floatsquarterly based on 3-Month LIBOR plus a spread of 178 basis points. Theinterest rate on the subordinated debt as of December 31, 2006 was 7.14%.

**NOTE I - EMPLOYEE BENEFIT PLAN**

The Bank has a retirementsavings 401(k) plan in which substantially all employees may participate.  The Bank makes discretionary contributions tothe plan.  Total contribution expense forthe plan was $73,000 in 2006, $53,000 in 2005 and $36,000 in 2004.

**NOTE J - STOCK OPTION PLAN**

The 2000 Stock Option Plan (2000 Plan) was approved bythe stockholders on April 26, 2001, which makes available options on shares ofthe Bank’s common stock for grant to employees, directors and consultants atprices not less than the fair market value of such shares at dates of grant.During 2003 and 2005, the shareholders approved amendments to the 2000 planincreasing the total shares available under the 2000 Plan to 1,145,976.  All options under the 2000 Plan shall expireon such date as the Board of Directors may determine, but not later than tenyears from the date an option is granted, and generally vest over fiveyears.  The 2000 Plan provides foraccelerated vesting if there is a change of control.  The Bank recognized stock-based compensationexpense of approximately $105,000 in 2006 and related tax benefits of $31,000.

F-16

----

The fair value of eachoption grant was estimated on the date of grant using the Black-Scholesoption-pricing model with the assumptions presented below:  
| ** **                              | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                    |       |      |       |      |       |      |       |
| Expected  Volatility                    |       | 16.90     | %          | 33.20     | %          | 19.00     | %          |
| Expected Term                           |       | 6.5 Years |       | 6.5 Years |       | 7.0 Years |       |
| Expected  Dividends                     |       | None      |       | None      |       | None      |       |
| Risk Free Rate                          |       | 4.54      | %          | 4.31      | %          | 3.50      | %          |
| Weighted-Average Grant  Date Fair Value |       | $         | 4.36       |      | $          | 5.09      |       | $ | 2.72 |   |
|                                         |            |           |            |           |            |           |            |  |  |  |

 

Although trading in the Bank’sstock has not been extensive, it is quoted and trades are reported on the OTCBulletin Board.  Given the limitedhistorical trading activity, the expected volatility is based on historicalactivity.  The expected term representsthe estimated average period of time that the options remain outstanding.  Since the Bank does not have sufficienthistorical data on the exercise of stock options, the expected term is based onthe “simplified” method that measures the expected term as the average of thevesting period and the contractual term. The risk free rate of return reflects the grant date interest rateoffered for U.S. Treasury bonds over the expected term of the options.

A summary of the status of the Bank’s stock optionplan as of December 31, 2006 and changes during the year ending thereon is presentedbelow:
| ** **                        | ** ** | ** **      | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **    | ** ** |
|-----------------------------------|------------|-----------------|------------|---------------|------------|-----------------|------------|---------------|------------|
| ** **                        | ** ** | ** **      | ** ** | **Weighted-** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                        | ** ** | ** **      | ** ** | **Average**   | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                        | ** ** | **Shares**      | ** ** | **Exercise**  | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                        | ** ** | **Outstanding** | ** ** | **Price**     | ** ** | **Term**        | ** ** | **Value**     | ** ** |
|                              |       |            |       |          |       |            |       |          |       |
| Outstanding at  Beginning of Year |       | 817,962         |       | $             | 6.95       |            |       |          |       |   |
| Granted                           |       | 41,500          |       | $             | 14.30      |            |       |          |       |   |
| Exercised                         |       | (40,152         | )          | $             | 5.80       |            |       |          |       |   |
| Forfeited and  Expired            |       | (9,668          | )          | $             | 12.09      |            |       |          |       |   |
|                              |       |            |       |          |       |            |       |          |       |
| Outstanding at  End of Year       |       | 809,642         |       | $             | 7.32       |            | 6.62 Years |          | $          | 7,025,000 |   |
|                              |       |            |       |          |       |            |       |          |       |
| Options Exercisable               |       | 673,902         |       | $             | 6.39       |            | 6.63 Years |          | $          | 6,479,000 |   |

 

The total intrinsic valueof options exercised during the years ended December 31, 2006 and 2005 was$347,000 and $158,000, respectively.  Asof December 31, 2006, there was $450,000 of total unrecognized compensationcost related to the outstanding stock options that will be recognized over aweighted average period of approximately 3 years.

F-17

----

**NOTE K - STOCK SPLIT**

During 2005, the Bankissued a two-for-one stock split of the Bank’s common stock.  All per share data in the financialstatements and footnotes have been adjusted to give retroactive effect of thissplit.

**NOTE L - FAIR VALUE OF FINANCIALINSTRUMENTS**

The fair value of afinancial instrument is the amount at which the asset or obligation could beexchanged in a current transaction between willing parties, other than in aforced or liquidation sale.  Fair valueestimates are made at a specific point in time based on relevant marketinformation and information about the financial instrument.  These estimates do not reflect any premium ordiscount that could result from offering for sale at one time the entireholdings of a particular financial instrument. Because no market value exists for a significant portion of thefinancial instruments, fair value estimates are based on judgments regardingfuture expected loss experience, current economic conditions, riskcharacteristics of various financial instruments, and other factors.  These estimates are subjective in nature,involve uncertainties and matters of judgment and, therefore, cannot bedetermined with precision.  Changes inassumptions could significantly affect the estimates.

Fair value estimates arebased on financial instruments both on and off the balance sheet withoutattempting to estimate the value of anticipated future business, and the valueof assets and liabilities that are not considered financial instruments.  Additionally, tax consequences related to therealization of the unrealized gains and losses can have a potential effect onfair value estimates and have not been considered in many of the estimates.

The following methods andassumptions were used to estimate the fair value of significant financialinstruments:

Financial Assets

The carrying amounts ofcash, short-term investments, and due from customers on acceptances, and bank acceptancesoutstanding are considered to approximate fair value. Short-term investmentsinclude federal funds sold, securities purchased under agreements to resell,and interest bearing deposits with banks. The fair values of investment securities, including available for sale,are generally based on quoted market prices. The fair value of loans are estimated using a combination of techniques,including discounting estimated future cash flows and quoted market prices ofsimilar instruments where available.

Financial Liabilities

The carrying amounts ofdeposit liabilities payable on demand, commercial paper, and other borrowedfunds are considered to approximate fair value. For fixed maturity deposits, fair value is estimated by discountingestimated future cash flows using currently offered rates for deposits ofsimilar remaining maturities.  The fairvalue of long-term debt is based on rates currently available to the Bank fordebt with similar terms and remaining maturities.

Off-Balance SheetFinancial Instruments

The fair value ofcommitments to extend credit and standby letters of credit is estimated usingthe fees currently charged to enter into similar agreements.  The fair value of these financial instrumentsis not material.

F-18

----

The estimated fair valueof financial instruments at December 31 is summarized as follows (amounts inthousands):
| ** **                                                   | ** ** | **2006**     | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------|------------|--------------|------------|------------|------------|
| ** **                                                   | ** ** | **Carrying** | ** ** | **Fair**   | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                                   | ** ** | **Value**    | ** ** | **Value**  | ** ** | **Value** | ** ** | **Value** | ** ** |
| **Financial  Assets:**                                       | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and Due from Banks                                      |       | $            | 9,099      |       | $          | 9,099 |   | $ | 5,228 |   | $ | 5,228 |   |
| Federal Funds Sold                                           |       | 20,985       |       | 20,985     |       | 23,710 |   | 23,710 |   |
| Investment Securities                                        |       | 8,998        |       | 8,998      |       | 3,146 |   | 3,146 |   |
| Loans                                                        |       | 272,015      |       | 272,221    |       | 227,573 |   | 227,711 |   |
| Federal Reserve, FHLB and Bankers’ Bank Stock, at  Cost |       | 2,087        |       | 2,087      |       | 1,616 |   | 1,616 |   |
| Accrued Interest Receivable                                  |       | 1,432        |       | 1,432      |       | 1,043 |   | 1,043 |   |
|                                                         |       |         |       |       |       |   |   |   |   |
| **Financial  Liabilities:**                                  | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                                                     |       | 261,838      |       | 262,152    |       | 237,208 |   | 237,120 |   |
| Borrowings                                                   |       | 29,000       |       | 29,025     |       | 5,000 |   | 5,069 |   |
| Accrued Interest  and Other Liabilities                      |       | 1,645        |       | 1,645      |       | 1,143 |   | 1,143 |   |
|                                                              |            |              |            |            |            |  |  |  |  |  |  |  |  |

 

**NOTE M - REGULATORY MATTERS**

The Bank is subject tovarious regulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory - and possibly additionaldiscretionary - actions by regulators that, if undertaken, could have a directmaterial effect on the Bank’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios (set forth in the table below) of total andTier 1 capital (as defined in the regulations) to risk-weighted assets (asdefined), and of Tier 1 capital (as defined) to average assets (asdefined).  Management believes, as ofDecember 31, 2006, that the Bank meets all capital adequacy requirements towhich it is subject.

As of December 31, 2006,the most recent notification from the Federal Reserve Board categorized theBank as well capitalized under the regulatory framework for prompt correctiveaction (there are no conditions or events since that notification that managementbelieves have changed the Bank’s category).

F-19

----

To be categorized as wellcapitalized, the Bank must maintain minimum ratios as set forth in the tablebelow.  The following table also setsforth the Bank’s actual capital amounts and ratios (dollar amounts inthousands):
| ** **                               | ** ** | ** ** | ** ** | ** **      | ** ** | **Amount of Capital Required**         | ** ** |
|------------------------------------------|------------|------------|------------|-----------------|------------|-------------------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **      | ** ** | **Under Prompt Corrective Provisions** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **      | ** ** | **To Be **                                  | ** ** | **To Be** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **      | ** ** | **Adequately**                                        | ** ** | **Well** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Capitalized** | ** ** | **Capitalized**                                       | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**       | ** ** | **Amount**                                            | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of  December 31, 2006:**            | ** ** | ** ** | ** ** | ** **      | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 34,198     |            | 11.5       | %                                                     | $          | 23,836 |   | 8 | % | $ | 29,796 |   | 10 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 25,947     |            | 8.7        | %                                                     | $          | 11,918 |   | 4 | % | $ | 17,877 |   | 6 | % |
| Tier 1 Capital (to Average Assets)       |       | $          | 25,947     |            | 8.7        | %                                                     | $          | 11,981 |   | 4 | % | $ | 14,977 |   | 5 | % |
|                                     |       |       |       |            |       |                                                  |       |   |   |   |   |   |   |
| **As of  December 31, 2005:**            | ** ** | ** ** | ** ** | ** **      | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 30,073     |            | 12.2       | %                                                     | $          | 19,783 |   | 8 | % | $ | 24,728 |   | 10 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 22,264     |            | 9.0        | %                                                     | $          | 9,891 |   | 4 | % | $ | 14,837 |   | 6 | % |
| Tier 1 Capital  (to Average Assets)      |       | $          | 22,264     |            | 8.8        | %                                                     | $          | 10,162 |   | 4 | % | $ | 12,703 |   | 5 | % |

 

The California FinancialCode provides that a bank may not make a cash distribution to its shareholdersin excess of the lesser of the Bank’s undivided profits or the Bank’s netincome for its last three fiscal years less the amount of any distribution madeby the Bank to shareholders during the same period.

##### **NOTE N - FORMATION OF 1****st PACIFIC BANCORP**

On January 16, 2007, theBank was involved in a corporate reorganization whereby the Bank became awholly-owned subsidiary of a newly formed bank holding company, 1st Pacific Bancorp.  Theappropriate state and federal regulators, and the shareholders of 1st PacificBank of California, approved the bank holding company reorganization.  In the reorganization, 100% of theoutstanding shares of common stock of 1st Pacific Bank of California were converted intoan equal number of shares of common stock of 1st Pacific Bancorp.  There was no cash involved in the transactionand the reorganization was accounted for like a pooling of interests.

1st Pacific Bancorp has had no significantbusiness activity other than its investment in 1st Pacific Bank of California; therefore, noseparate financial information on 1st Pacific Bancorp is provided.

**NOTE O - SUBSEQUENT EVENTS**

On February 23, 2007, 1stPacific Bancorp announced that it entered into a definitive agreement toacquire all of the outstanding common stock and options of Landmark NationalBank (“Landmark”) in a cash and stock deal valued at approximately $24.6million. Landmark shareholders will have the option to receive either $12.45 incash or 0.778125 of a share of 1st Pacific Bancorp common stock for each share ofLandmark common stock, provided that about 65% of the consideration is paid instock. The acquisition of Landmark is subject to regulatory approval and theapproval of the shareholders of both companies and is currently expected toclose in the second or third quarter of 2007.

F-20

----

An unaudited summary of 1st Pacific Bancorp’s preliminary purchase priceallocations for the Landmark acquisitions follows, based on balance sheetinformation from Landmark as of December 31, 2006.  These purchase price allocations are based onestimates and are subject to change as more information becomes available andafter final analyses of the fair values of both tangible and intangible assetsacquired and liabilities assumed are completed. Accordingly, the final fair value adjustments may be materiallydifferent from those presented in this report.

|                                                                               | ** ** | **Landmark  National Bank  (in 000’s)** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **Assets  Acquired or to be Acquired:**                                       | ** ** | ** **                                             | ** ** |
| Cash and Investments                                                          |       | $                                                      | 42,200     |   |
| Loans, Net                                                                    |       | 74,900                                                 |       |
| Goodwill and Other Intangibles                                                |       | 9,400                                                  |       |
| Deferred Tax Asset                                                            |       | 3,100                                                  |       |
| Other Assets                                                                  |       | 2,000                                                  |       |
| Total Assets Acquired                                                         |       | 131,600                                                |       |
|                                                                          |       |                                                   |       |
| **Liabilities  Assumed or to be Assumed:**                                    | ** ** | ** **                                             | ** ** |
| Deposits                                                                      |       | 102,200                                                |       |
| Borrowings & Other Liabilities                                            |       | 4,800                                                  |       |
| Total Liabilities Assumed                                                     |       | 107,000                                                |       |
|                                                                          |       |                                                   |       |
| Total Consideration  Paid Including Net Value of Options and Warrants Assumed |       | $                                                      | 24,600     |   |

 

F-21

----