Table ofContents

** **

 

** **

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

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**x****      Quarterlyreport under Section 13 or 15(d) of the Securities Exchange Act of1934**

 

**for the quarterly periodended June 30, 2010**

 

**o****         Transitionreport under Section 13 or 15(d) of the Securities Exchange Act of1934 (No fee required)**

 

**for the period from           to           **

 

**Commission File Number 0-27666**

 

**NORTHERN CALIFORNIA BANCORP, INC.**

(Name of Small BusinessIssuer in its Charter)

 

**Incorporated in the State ofCalifornia**

**IRS Employer IdentificationNumber 77-0421107**

**Address:  601 Munras Avenue, Monterey, CA  93940**

**Telephone: (831) 649-4600**

 

Check whether the issuer: (1) filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act duringthe past 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes  x  No  o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes  o  No  o

 

Indicateby check mark whether the registrant is an accelerated filer, a non-acceleratedfiler, or a smaller reporting company (as defined in Rule 12b-2 of theAct).

 

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

 

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

 

As of August 10, 2010, the Corporation had 1,785,891 shares ofcommon stock outstanding.

 

 

 

----

Table of Contents

 

TABLE OF CONTENTS

 
| **Facing Page**       | 1                                                                                           |
|-----------------------|---------------------------------------------------------------------------------------------|
| **Table of Contents** | 2                                                                                           |
| **PART I**       | Financial Information                                                                       | 3-6 |
| Item 1                | Financial Statements                                                                        |   |
|                  | Consolidated  Balance Sheets                                                                | 3 |
|                  | Consolidated  Statements of Operations                                                      | 4 |
|                  | Consolidated****Statements****of  Changes in Shareholders’ Equity                      | 5 |
|                  | Consolidated Statements of Cash Flows                                                       | 6 |
|                  | Notes to Consolidated Financial Statements                                                  | 7-18 |
| Item 2                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 18-37 |
| Item  3               | (Not  Applicable)                                                                           |   |
| Item 4T               | Controls and  Procedures                                                                    | 37 |
|                  |                                                                                        |   |
| **PART II**      | Other Information                                                                           |   |
| Item 1                | Legal Proceedings                                                                           | 38 |
| Item 2                | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 39 |
| Item 3                | Defaults  Upon Senior Securities                                                            | 39 |
| Item 4                | Submission  of Matters to a Vote of Security Holders                                        | 39 |
| Item 5                | Other Information                                                                           | 39 |
| Item 6                | Exhibits                                                                                    | 39 |
| Signatures            | 40                                                                                          |
| Certifications        | 41-44                                                                                       |

 

2

----

Table of Contents

 

**PART I-FINANCIAL INFORMATION**

 

Item 1.    FINANCIAL STATEMENTS

 

NORTHERN CALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 
| ** **                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(in  thousands except share data)**                                               | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                                                          | ** ** | **(Unaudited)**   | ** ** | **(Audited)**         | ** ** |
| ASSETS:                                                                             |       |              |       |                  |       |
| Cash and Due From Banks                                                             |       | $                 | 38,507     |                  | $          | 12,251 |   |
| Trading Assets                                                                      |       | 90                |       | 153                   |       |
| Time Deposits with other Financial Institutions                                     |       | 3,000             |       | —                |       |
| Investment Securities, available for sale (Note 6)                                  |       | 56,740            |       | 62,413                |       |
| Other Investments                                                                   |       | 3,960             |       | 4,085                 |       |
| Loans Held for Sale, at lower of cost or market                                     |       | 4,287             |       | 2,216                 |       |
| Loans, net of allowance for loan losses of $3,251  in 2010; $3,529 in 2009 (Note 7) |       | 150,832           |       | 160,997               |       |
| Bank Premises and Equipment, Net                                                    |       | 4,982             |       | 4,909                 |       |
| Cash Surrender Value of Life Insurance                                              |       | 4,160             |       | 4,097                 |       |
| Other Real Estate Owned                                                             |       | 20,227            |       | 14,333                |       |
| Interest Receivable and Other Assets                                                |       | 7,293             |       | 7,841                 |       |
| Total Assets                                                                        |       | $                 | 294,078    |                  | $          | 273,295 |   |
|                                                                                |       |              |       |                  |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY:                                          |       |              |       |                  |       |
|                                                                                |       |              |       |                  |       |
| Non interest-bearing demand                                                         |       | $                 | 35,261     |                  | $          | 25,781 |   |
| Interest-bearing demand                                                             |       | 17,118            |       | 16,984                |       |
| Savings                                                                             |       | 7,602             |       | 6,270                 |       |
| Time less than $100,000                                                             |       | 97,471            |       | 94,686                |       |
| Time deposits of $100,000 or more                                                   |       | 69,992            |       | 58,701                |       |
| Total Deposits                                                                      |       | 227,444           |       | 202,422               |       |
|                                                                                |       |              |       |                  |       |
| Revolving line of credit                                                            |       | 2,850             |       | 2,850                 |       |
| Federal Home Loan Bank Borrowed Funds                                               |       | 34,000            |       | 29,000                |       |
| Federal Reserve Bank Borrowed Funds                                                 |       | —            |       | 10,000                |       |
| Junior Subordinated Debt Securities                                                 |       | 8,248             |       | 8,248                 |       |
| Payable for Investment Securities Purchased                                         |       | 298               |       | —                |       |
| Interest Payable and Other Liabilities                                              |       | 4,997             |       | 4,625                 |       |
| Total Liabilities                                                                   |       | 277,837           |       | 257,145               |       |
|                                                                                |       |              |       |                  |       |
| Shareholders’ Equity:                                                          |       |              |       |                  |       |
| Common Stock - No Par Value                                                         |       |              |       |                  |       |
| Authorized 10,000,000 in 2010 and 2009                                              |       |              |       |                  |       |
| Outstanding:1,785,891 in 2009 and 1,783,230 in  2009                                |       | 5,094        |       | 5,088            |       |
| Retained Earnings                                                                   |       | 10,755            |       | 11,092                |       |
| Accumulated Other Comprehensive Income (Loss)                                       |       | 392               |       | (30                   | )          |
| Total Shareholders’ Equity                                                     |       | 16,241            |       | 16,150                |       |
| Total Liabilities & Shareholders’ Equity                              |       | $                 | 294,078    |                  | $          | 273,295 |   |

 

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

 

3

----

Table of Contents

 

NORTHERN CALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 
| ** **                                                              | ** ** | **THREE-MONTH**   | ** ** | **SIX-MONTH**     | ** ** |
|-------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                              | ** ** | **PERIOD ENDING** | ** ** | **PERIOD ENDING** | ** ** |
| ** **                                                              | ** ** | **June 30**  | ** ** | **June 30**  | ** ** |
| **(in  thousands except share data)**                                   | ** ** | **2010**          | ** ** | **2009**          | ** ** | **2010** | ** ** | **2009** | ** ** |
| INTEREST INCOME:                                                        |       |              |       |              |       |   |   |   |   |
| Loans                                                                   |       | $                 | 2,494      |              | $          | 2,697 |   | $ | 5,065 |   | $ | 5,689 |   |
| Time deposits with other financial institutions                         |       | 15                |       | 6                 |       | 20 |   | 11 |   |
| Investment securities                                                   |       | 771               |       | 1,319             |       | 1,549 |   | 2,758 |   |
| Total Interest Income                                                   |       | 3,280             |       | 4,022             |       | 6,634 |   | 8,458 |   |
|                                                                    |       |              |       |              |       |   |   |   |   |
| INTEREST EXPENSE:                                                       |       |              |       |              |       |   |   |   |   |
| Interest-bearing transaction accounts                                   |       | 5                 |       | 6                 |       | 10 |   | 12 |   |
| Savings and time deposit accounts                                       |       | 550               |       | 891               |       | 1,148 |   | 1,836 |   |
| Time deposits in denominations of $100,000 or more                      |       | 418               |       | 523               |       | 813 |   | 1,068 |   |
| Notes payable and other                                                 |       | 517               |       | 753               |       | 1,012 |   | 1,549 |   |
| Total Interest Expense                                                  |       | 1,490             |       | 2,173             |       | 2,983 |   | 4,465 |   |
|                                                                    |       |              |       |              |       |   |   |   |   |
| Net Interest Income                                                     |       | 1,790             |       | 1,849             |       | 3,651 |   | 3,993 |   |
| Provision for loan losses                                               |       | —            |       | 396               |       | — |   | 646 |   |
| Net interest income, after provision for loan  losses                   |       | 1,790             |       | 1,453             |       | 3,651 |   | 3,347 |   |
|                                                                    |       |              |       |              |       |   |   |   |   |
| NON-INTEREST INCOME:                                                    |       |              |       |              |       |   |   |   |   |
| Service charges on deposit accounts                                     |       | 115               |       | 154               |       | 238 |   | 345 |   |
| Income from sales and servicing of Small Business  Administration Loans |       | 58                |       | 59                |       | 121 |   | 97 |   |
| Gain on sales of investment securities                                  |       | 282               |       | 976               |       | 418 |   | 1,135 |   |
| Other income                                                            |       | 1,096             |       | 1,521             |       | 2,275 |   | 2,726 |   |
| Total non-interest income                                               |       | 1,551             |       | 2,710             |       | 3,052 |   | 4,303 |   |
|                                                                    |       |              |       |              |       |   |   |   |   |
| NON-INTEREST EXPENSE:                                                   |       |              |       |              |       |   |   |   |   |
| Salaries and Employee Benefits                                          |       | 880               |       | 772               |       | 1,796 |   | 1,570 |   |
| Occupancy and Equipment Expense                                         |       | 253               |       | 254               |       | 518 |   | 515 |   |
| Foreclosed assets, net                                                  |       | 347               |       | 221               |       | 1,082 |   | 629 |   |
| Professional Fees                                                       |       | 428               |       | 380               |       | 836 |   | 527 |   |
| Prepayment fees on borrowings                                           |       | —            |       | 350               |       | — |   | 431 |   |
| Data Processing                                                         |       | 60                |       | 91                |       | 136 |   | 180 |   |
| Litigation Settlement                                                   |       | 880               |       | —            |       | 880 |   | — |   |
| Other general and administrative                                        |       | 1,079             |       | 1,400             |       | 2,213 |   | 2,546 |   |
| Total non-interest expenses                                             |       | 3,927             |       | 3,468             |       | 7,461 |   | 6,398 |   |
|                                                                    |       |              |       |              |       |   |   |   |   |
| Income (loss) before tax provision (benefit)                            |       | (586              | )          | 695               |       | (758 | ) | 1,252 |   |
| Income tax provision (benefit)                                          |       | (311              | )          | 131               |       | (421 | ) | 173 |   |
| Net income (loss)                                                       |       | $                 | (275       | )                 | $          | 564 |   | $ | (337 | ) | $ | 1,079 |   |
|                                                                    |       |              |       |              |       |   |   |   |   |
| Earnings (loss) per common share                                        |       |              |       |              |       |   |   |   |   |
| Basic                                                                   |       | $                 | (0.15      | )                 | $          | 0.31 |   | $ | (0.19 | ) | $ | 0.60 |   |
| Diluted                                                                 |       | $                 | (0.15      | )                 | $          | 0.31 |   | $ | (0.19 | ) | $ | 0.60 |   |

 

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

 

4

----

Table of Contents

 

NORTHERN CALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

 
| ** **                                                                                                               | ** ** | ** **    | ** ** | ** ** | ** ** | ** **   | ** ** | **Accumulated**    | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------|------------|--------------|------------|--------------------|------------|------------|------------|
| ** **                                                                                                               | ** ** | ** **    | ** ** | ** ** | ** ** | ** **   | ** ** | **Other Compre-**  | ** ** | ** ** | ** ** |
| ** **                                                                                                               | ** ** | **Number of** | ** ** | **Common** | ** ** | **Retained** | ** ** | **hensive Income** | ** ** | ** ** | ** ** |
| **(in  thousands except share data)**                                                                                    | ** ** | **Shares**    | ** ** | **Stock**  | ** ** | **Earnings** | ** ** | **(Loss)**         | ** ** | **Total**  | ** ** |
|                                                                                                                     |       |          |       |       |       |         |       |               |       |       |       |
| Balance at December 31, 2008                                                                                        |       | 1,803,908     |       | $          | 5,173      |         | $          | 9,481              |       | $          | (302       | ) | $ | 14,352 |   |
|                                                                                                                     |       |          |       |       |       |         |       |               |       |       |       |
| Comprehensive income:                                                                                                    |       |          |       |       |       |         |       |               |       |       |       |
| Net income for the year                                                                                                  |       | —        |       | —     |       | 1,611        |       | —             |       | 1,611      |       |
| Change in net unrealized loss on AFS securities  and other assets, net of tax reclassification adjustment and tax effect |       | —        |       | —     |       | —       |       | 272                |       | 272        |       |
| Total comprehensive income                                                                                               |       |          |       |       |       |         |       |               |       | 1,883      |       |
|                                                                                                                     |       |          |       |       |       |         |       |               |       |       |       |
| Stock repurchase                                                                                                         |       | (20,678       | )          | (85        | )          | —       |       | —             |       | (85        | )          |
|                                                                                                                     |       |          |       |       |       |         |       |               |       |       |       |
| Balance at December 31, 2009 (Audited)                                                                              |       | 1,783,230     |       | 5,088      |       | 11,092       |       | (30                | )          | $          | 16,150     |   |
|                                                                                                                     |       |          |       |       |       |         |       |               |       |       |       |
| Comprehensive income:                                                                                                    |       |          |       |       |       |         |       |               |       |       |       |
| Net loss for the year                                                                                                    |       | —        |       | —     |       | (337         | )          | —             |       | (337       | )          |
| Change in net unrealized loss on AFS securities  and other assets, net of tax reclassification adjustment and tax effect |       | —        |       | —     |       | —       |       | 422                |       | 422        |       |
| Total comprehensive income                                                                                               |       |          |       |       |       |         |       |               |       | 85         |       |
|                                                                                                                     |       |          |       |       |       |         |       |               |       |       |       |
| Exercise of stock options, Including tax benefit                                                                         |       | 2,661         |       | 6          |       | —       |       | —             |       | 6          |       |
|                                                                                                                     |       |          |       |       |       |         |       |               |       |       |       |
| Balance at June 30, 2010 (Unaudited)                                                                                |       | 1,785,891     |       | $          | 5,094      |         | $          | 10,755             |       | $          | 392        |   | $ | 16,241 |   |

 

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

 

5

----

Table of Contents

 

NORTHERN CALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 
| ** **                                                                                       | ** ** | **SIX MONTH PERIOD ENDED** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                       | ** ** | **JUNE 30,**               | ** ** |
| **(in  thousands)**                                                                              | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                        |       |                       |       |   |   |
| Net income (loss)                                                                                |       | $                          | (337       | ) | $ | 1,079 |   |
| Adjustments to reconcile net income (loss) to net  cash provided (used) by operating activities: |       |                       |       |   |   |
| Depreciation and amortization expense                                                            |       | 182                        |       | 171 |   |
| Realized gain on sales of available-for-sale  securities, net                                    |       | (418                       | )          | (1,135 | ) |
| Amortization of deferred loan fees, net                                                          |       | 28                         |       | 75 |   |
| Amortization (accretion) of discounts and premiums  on investment securities, net                |       | (36                        | )          | (135 | ) |
| Provision for loan losses                                                                        |       | —                     |       | 646 |   |
| Provision for foreclosed asset losses                                                            |       | 701                        |       | 411 |   |
| Loss on sale of foreclosed assets                                                                |       | 57                         |       | — |   |
| Increase in cash surrender value of life insurance                                               |       | (63                        | )          | (63 | ) |
| Deferred income tax expense (benefit)                                                            |       | (184                       | )          | 676 |   |
| (Increase) decrease in assets:                                                                   |       |                       |       |   |   |
| Trading assets                                                                                   |       | 63                         |       | 137 |   |
| Loans held for sale                                                                              |       | (2,071                     | )          | (1,172 | ) |
| Interest receivable                                                                              |       | (254                       | )          | 326 |   |
| Other assets                                                                                     |       | 984                        |       | 310 |   |
| Increase (decrease) in liabilities:                                                              |       |                       |       |   |   |
| Interest payable                                                                                 |       | 208                        |       | (376 | ) |
| Other liabilities                                                                                |       | 239                        |       | 67 |   |
| Net cash provided (used) by operating activities                                                 |       | (901                       | )          | 1,017 |   |
|                                                                                             |       |                       |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                                                        |       |                       |       |   |   |
| Net change in time deposits with other financial  institutions                                   |       | (3,000                     | )          | 301 |   |
| Activity in available-for sale securities                                                        |       |                       |       |   |   |
| Sales                                                                                            |       | 10,707                     |       | 64,959 |   |
| Maturities, prepayments, and calls                                                               |       | 482                        |       | (1,546 | ) |
| Purchases                                                                                        |       | (4,217                     | )          | (60,017 | ) |
| Net (increase) decrease in loans                                                                 |       | 832                        |       | (1,783 | ) |
| Proceeds from loan sales                                                                         |       | 252                        |       | — |   |
| Proceeds from sale of other real estate owned                                                    |       | 2,326                      |       | — |   |
| Investment in other real estate owned                                                            |       | —                     |       | (914 | ) |
| Proceeds from sale of equipment                                                                  |       | 31                         |       | — |   |
| Additions to bank premises and equipment                                                         |       | (284                       | )          | (24 | ) |
| Net cash provided by investing activities                                                        |       | 7,129                      |       | 976 |   |
|                                                                                             |       |                       |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                                                        |       |                       |       |   |   |
| Net increase in deposits                                                                         |       | 25,022                     |       | 13,156 |   |
| Proceeds from borrowings                                                                         |       | 5,000                      |       | 15,000 |   |
| Repayments on borrowing, net                                                                     |       | (10,000                    | )          | (40,000 | ) |
| Proceeds from exercise of stock options                                                          |       | 6                          |       | — |   |
| Repurchase of common stock                                                                       |       | —                     |       | (85 | ) |
| Net cash provided (used) by financing activities                                                 |       | 20,028                     |       | (11,929 | ) |
|                                                                                             |       |                       |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                            |       | 26,256                     |       | (9,936 | ) |
|                                                                                             |       |                       |       |   |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING**                                                        |       | 12,251                     |       | 16,348 |   |
|                                                                                             |       |                       |       |   |   |
| **CASH AND CASH EQUIVALENTS, ENDING**                                                            |       | $                          | 38,507     |   | $ | 6,412 |   |

 

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

 

6

----

Table of Contents

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

(NOTE 1) NATURE OFBUSINESS AND BASIS OF PRESENTATION

 

*Nature of Business*

 

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

 

TheCorporation owns 100% of the Bank which operates five full service branches inMonterey County, California. The Corporation owns 100% of the common stock oftwo unconsolidated special purpose business trusts, “Northern CaliforniaBancorp, Inc. Trust I” and “Northern California Bancorp, Inc. TrustII”.

 

*Basisof Presentation*

 

Theinterim condensed consolidated financial statements of Northern CaliforniaBancorp, Inc. and Monterey County Bank are unaudited and reflect alladjustments (consisting only of normal recurring adjustments), which are, inthe opinion of management, necessary for a fair presentation, in all materialrespects, of the consolidated financial position and operating results of theCorporation for the interim periods.  The results of operations for thesix months ended June 30, 2010 are not necessarily indicative of theresults to be expected for the entire fiscal year ending December 31,2010.  The year-end consolidated balance sheet dataat December 31, 2009 was derived from the audited financial statements.  All material intercompany balances andtransactions have been eliminated in consolidation.

 

Thisfinancial information should be read in conjunction with the audited financialstatements and notes thereto included in the Corporation’s Form 10-K forthe fiscal year ended December 31, 2009.

 

**(NOTE 2)  CRITICAL ACCOUNTINGPOLICIES**

 

Thepreparation of financial statements in accordance with accounting principlesgenerally accepted in the United States of America requires management to makea number of judgments, estimates and assumptions that affect the reportedamount of assets, liabilities, income and expenses in the Corporation’sfinancial statements and accompanying notes. Management believes that the judgments, estimates and assumptions usedin preparation of the Corporation’s financial statements are appropriate giventhe factual circumstances as of June 30, 2010.

 

Variouselements of the Corporation’s accounting policies, by their nature, areinherently subject to estimation techniques, valuation assumptions and othersubjective assessments.  Criticalaccounting policies are those that involve the most complex and subjectivedecisions and assessments and have the greatest potential impact on theCorporation’s results of operation.  Inparticular, management has identified the following accounting policy that, dueto judgments, estimates and assumptions inherent in this policy, and thesensitivity of the Corporation’s financial statements to those judgments,estimates and assumptions, is critical to an understanding of the Corporation’sfinancial statements.  This policyrelates to the methodology 

 

7

----

Table of Contents

 

thatdetermines the Corporation’s allowance for loan losses.  Management has discussed the development andselection of this critical accounting policy with the Corporation’s AuditCommittee of the Board of Directors. Although Management believes the level of the allowance at June 30,2010 is adequate to absorb losses inherent in the loan portfolio, a decline inthe regional economy may result in increasing losses that cannot reasonably bepredicted at this time.  For furtherinformation regarding the allowance for loan losses see “Provision andAllowance for Loan Losses” included elsewhere herein.

 

Anothercritical accounting policy relates to the valuation of other real estate owned(OREO). Assets acquired through, or in lieu of, loan foreclosure are held for saleand are initially recorded at fair value less cost to sell at the date offoreclosure, establishing a new cost basis. Subsequent to foreclosure,valuations are periodically performed by management and the assets are carriedat the lower of carrying amount or fair value less estimated cost to sell. Anywrite-down to fair value at the time of transfer to OREO is charged to theallowance for loan losses. Property is evaluated regularly to ensure that therecorded amount is supported by its current fair value and that valuationallowances to reduce the carrying amount to fair value less estimated costs todispose are recorded as necessary. Revenue and expenses from operations of OREOand changes in the valuation allowance are included in net expenses from OREO.

 

(NOTE 3) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

InAugust 2009, the Financial Accounting Standards Board (FASB) issuedAccounting Standards Update (ASU) No. 2009-05, *Fair Value Measurements and Disclosures (Topic 820) — MeasuringLiabilities at Fair Value.*  This ASU provides amendmentsfor fair value measurements of liabilities.  It providesclarification that in circumstances in which a quoted price in an active marketfor the identical liability is not available, a reporting entity is required tomeasure fair value using one or more techniques.  ASU 2009-05 alsoclarifies that when estimating a fair value of a liability, a reporting entityis not required to include a separate input or adjustment to other inputsrelating to the existence of a restriction that prevents the transfer of theliability.  ASU 2009-05 is effective for the periods beginning after October 1,2009.  The adoption of ASU 2009-05 did not have a material impact on theCorporation’s consolidated financial statements.

 

InJanuary 2010, the FASB issued ASU No. 2010-06, *Fair ValueMeasurements and Disclosures (Topic 820):  Improving Disclosuresabout Fair Value Measurements*.  ASU 2010-06 revises twodisclosure requirements concerning fair value measurements and clarifies twoothers.  It requires separate presentation of significant transfersinto and out of Levels 1 and 2 of the fair value hierarchy and disclosure ofthe reasons for such transfers.  It will also require thepresentation of purchases, sales, issuances, and settlements within Level 3 ona gross basis rather than a net basis.  The amendments also clarifythat disclosures should be disaggregated by class of asset or liability andthat disclosures about inputs and valuation techniques should be provided forboth recurring and non-recurring fair valuemeasurements.   These new disclosure requirements becameeffective on January 1, 2010, except for the requirement concerning grosspresentation of Level 3 activity, which is effective for fiscal years beginningafter December 15, 2010.  There was no significant effect to theCorporation’s financial statement disclosure upon adoption of this ASU.

 

InJune 2009, the FASB issued ASU 2009-16 (formerly**Statementof Financial Accounting Standards (SFAS) No. 166), *Accounting for Transfers of Financial Assets, anamendment of FASB Statement No. 140*.  ASU 2009-16amends the de-recognition accounting and disclosure guidance relating to SFAS No. 140.  ASU2009-16 eliminates the exemption from consolidation

 

8

----

Table of Contents

 

forqualifying special purpose entities (QSPEs), and requires a transferor toevaluate all existing QSPEs to determine whether they must be consolidated inaccordance with ASU 2009-16.  It also amends the sale recognition rules forsales of participating interests in loans. ASU 2009-16 is effective as of thebeginning of the first annual reporting period that begins after November 15,2009.  As a result of the adoption of ASU 2009-16, the Corporationdelays the accounting recognition of sales of the guaranteed portion of SBAloans for 90 days.  The Corporation alsoensures the proportionate sharing of cash flows prior to recognizing the saleof participation interests in loans.

 

InJune 2009, the FASB issued ASU 2009-17 (formerly SFAS No. 167), *Improvements to Financial Reporting by EnterprisesInvolved with Variable Interest Entities.*This Statement amends ASCTopic 810, *Consolidation* to require an enterpriseto perform an analysis and ongoing reassessments to determine whether theenterprise’s variable interest or interests give it a controlling financialinterest in a variable interest entity, and amends certain guidance fordetermining whether an entity is a variable interest entity. It also requiresenhanced disclosures that will provide users of financial statements with moretransparent information about an enterprise’s involvement in a variableinterest entity. This Statement, which became effective for the Corporation on January 1,2010, did not have an impact on its consolidated financial statements as theCorporation has no interests in any variable interest entities.

 

InFebruary 2010, the FASBissued ASU 2010-09, *Subsequent Events (Topic 855):  Amendmentsto Certain Recognition and Disclosure Requirements*.  Theamendments remove the requirement for an SEC registrant to disclose the datethrough which subsequent events were evaluated, as this requirement would havepotentially conflicted with SEC reporting requirements.  Removal ofthe disclosure requirement did not have an affect on the nature or timing ofsubsequent events evaluations performed by the Corporation.  ASU2010-09 became effective upon issuance.

 

(NOTE4) STOCK BASED COMPENSATION

 

The Corporation’s compensation cost relating to share-based paymenttransactions is recognized in the financial statements based upon the fairvalue of the equity or liability instruments issued. Based on the stock-basedcompensation awards outstanding for the six months ended June 30, 2010 and2009, there was no stock-based compensation to expense.

 

Underthe Corporation’s 1998 Stock Option Plan, the Corporation may grant incentivestock options and non-qualified stock options to directors, officers, andemployees of the Corporation and its subsidiary, so long as the Corporationowns a majority of the equity interest of such subsidiary.  Incentive stock options are granted at fairvalue of the common stock on the date of grant. However, an incentive stock option granted to an individual owning 10%or more of the Corporation’s stock after such grant must have an exercise priceof at least 110%****of such fair market value and anexercise period of not more than five years. Non-qualified stock options may be granted at prices not lower than 85%of the fair market value of the common stock on the date of grant.  The Board of Directors is authorized todetermine when options become exercisable within a period not exceeding 10years from the date of grant.  Under thePlan, 64,661 shares of common stock had been reserved for the granting of theseoptions.  At June 30, 2010, 23,500options were outstanding.  During 2010,2,661 options were exercised by officers, employees, and board members.  As of June 30, 2010, all options havebeen vested and all related compensation expense had been formerly expensed.

 

9

----

Table of Contents

 

Nofurther options may be granted under the 1998 Stock Option Plan.  The plan provided that options could begranted for a period of ten years from the date the plan was adopted by theBoard.  The Board adopted the plan on April 16,1998.  The plan remains in effect untilall options granted under the Plan have been satisfied or expired.

 

Under the Corporation’s 2007 Stock Option Plan, the Corporation maygrant incentive stock options and non-qualified stock options to directors,officers, and employees of the Corporation and its subsidiary, so long as theCorporation owns a majority of the equity interest of such subsidiary.  Incentive stock options are granted at fairvalue of the common stock on the date of grant. However, an incentive stock option granted to an individual owning 10%or more of the Corporation’s stock after such grant must have an exercise priceof at least 110% of such fair market value and an exercise period of not morethan five years.  The Board of Directorsis authorized to determine when options become exercisable within a period notexceeding 10 years from the date of grant. Under the Plan, 300,000 shares of common stock have been reserved forthe granting of these options.  At June 30,2010, no options have been granted under the 2007 stock option plan.  Thus, no pre-tax stock-based compensationexpense was required for the six months ended June 30, 2010 and 2009.

 

(NOTE 5) EARNINGS (LOSS) PER SHARE

 

Basic earnings (loss) per share represents income (loss) available tocommon stockholders divided by the weighted-average number of common sharesoutstanding during the period.  Dilutedearnings (loss) per share reflect additional common shares that would have beenoutstanding, if potential dilutive common shares had been issued, as well asany adjustment to income that would result from the assumed issuance.  Potential common shares that may be issued bythe Corporation relate to outstanding stock options and warrants and aredetermined using the treasury stock method.

 

The weighted-average number of shares used in computing basic anddiluted earnings (loss) per share is as follows:

 
| ** **                              | ** ** | **Earnings (Loss) per Share  Calculation**  | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                              | ** ** | **For the three months ended June 30** | ** ** |
| ** **                              | ** ** | **2010**                                    | ** ** | **2009** | ** ** |
| ** **                              | ** ** | ** **                                  | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| **(in  thousands except per**           | ** ** | **Net**                                     | ** ** | **Average** | ** ** | **Per Share** | ** ** | **Net** | ** ** | **Average** | ** ** | **Per Share** | ** ** |
| **share  data)**                        | ** ** | **(Loss)**                                  | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic (loss) earnings per share         |       | $                                           | (275       | ) | 1,785,891 |   | $ | (0.15 | ) | $ | 564 |   | 1,794,918 |   | $ | 0.31 |   |
|                                    |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Effect of dilutive shares:              |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| assumed exercise of outstanding options |       | —                                      |       | 1,212 |   | — |   | — |   | 1,256 |   | — |   |
|                                    |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Diluted (loss) earnings per share       |       | $                                           | (275       | ) | 1,781,103 |   | $ | (0.15 | ) | $ | 564 |   | 1,796,173 |   | $ | 0.31 |   |

 

10

----

Tableof Contents

 
| ** **                                 | ** ** | **Earnings (Loss) per Share**

**Calculation**

**For the six months ended June 30** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **2010**                                                                                                                          | ** ** | **2009** | ** ** |
| **(in  thousands except per  share data)** | ** ** | **Net  (Loss)**                                                                                                                   | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic (loss) earnings per share            |       | $                                                                                                                                 | (337       | ) | 1,783,733 |   | $ | (0.19 | ) | $ | 1,079 |   | 1,799,338 |   | $ | 0.60 |   |
|                                       |       |                                                                                                                              |       |   |   |   |   |   |   |   |   |   |   |
| Effect of dilutive shares:                 |       |                                                                                                                              |       |   |   |   |   |   |   |   |   |   |   |
| assumed exercise of outstanding options    |       | —                                                                                                                            |       | 1,874 |   | — |   | — |   | 1,256 |   | — |   |
| Diluted (loss) earnings per share          |       | $                                                                                                                                 | (337       | ) | 1,785,607 |   | $ | (0.19 | ) | $ | 1,079 |   | 1,800,594 |   | $ | 0.60 |   |

 

(NOTE 6) INVESTMENT SECURITIES

 

Thefollowing table presents investment securities, available for sale at June 30,2010 and December 31, 2009:

 
| ** **                          | ** ** | **June 30, 2010**     | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| ** **                          | ** ** | **Amortized  Cost**        | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Securities Available for  Sale      |       |                       |       |   |   |   |   |   |   |
| Mortgage Backed Securities          |       | $                          | 790        |   | $ | 89 |   | $ | — |   | $ | 879 |   |
| State/Local Agency Securities       |       | 52,297                     |       | 1,695 |   | (1,163 | ) | 52,829 |   |
| Government Agency Securities        |       | 2,994                      |       | 38 |   | — |   | 3,032 |   |
|                                |       |                       |       |   |   |   |   |   |   |
| Total securities available for sale |       | $                          | 56,081     |   | $ | 1,822 |   | $ | (1,163 | ) | $ | 56,740 |   |

 
| ** **                          | ** ** | **December 31, 2009** | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| ** **                          | ** ** | **Amortized  Cost**        | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Securities Available for  Sale      |       |                       |       |   |   |   |   |   |   |
| Mortgage Backed Securities          |       | $                          | 1,534      |   | $ | — |   | $ | (44 | ) | $ | 1,490 |   |
| State/Local Agency Securities       |       | 53,000                     |       | 1,501 |   | (1,427 | ) | 53,074 |   |
| Government Agency Securities        |       | 7,988                      |       | — |   | (139 | ) | 7,849 |   |
|                                |       |                       |       |   |   |   |   |   |   |
| Total securities available for sale |       | $                          | 62,522     |   | $ | 1,501 |   | $ | (1,610 | ) | $ | 62,413 |   |

 

Inaddition, the Corporation maintains a trading account, at fair value,consisting of marketable securities.  At June 30,2010 and December 31, 2009 the account value was $90,000 and $153,000,respectively.

 

11

----

Table of Contents

 

Theamortized cost and fair value of debt securities by contractual maturity dateat June 30, 2010 follows:

 
| ** **                             | ** ** | **Available for Sale** | ** ** |
|----------------------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **Amortized**          | ** ** | **Fair** | ** ** |
| **(Dollars in thousands)**             | ** ** | **Cost**               | ** ** | **Value** | ** ** |
|                                   |       |                   |       |   |   |
| Due after five years through ten years |       | $                      | 2,994      |   | $ | 3,032 |   |
| Due after ten years                    |       | 53,087                 |       | 53,708 |   |
|                                   |       |                   |       |   |   |
|                                   |       | $                      | 56,081     |   | $ | 56,740 |   |

 

Proceeds from maturities and sales of investment securities for the sixmonths ended June 30, 2010, and 2009 were $11,037,000, and $64,959,000,respectively.  Realized gains for sixmonths ended June 30, 2010, and 2009 were $418,000, and $1,135,000,respectively.

 

AtJune 30, 2010 and December 31, 2009, U.S. Government and MortgageBacked obligations with a carrying value of $3,911,000 and $8,761,000,respectively, were pledged to secure advances from the Federal Home Loan Bank.

 

AtJune 30, 2010 and December 31, 2009 State/Local Agency obligationswith a carrying value of $13,778,000 and $20,462,000, respectively, werepledged to secure loans from the Federal Reserve Bank.

 

InJune 2010, the Bank purchased debt securities totaling $298,000 that hadsettlement dates in July 2010.  TheBank had recorded the investment securities purchased as of the trade date andhad recorded the corresponding payable for investment securities purchased of$298,000 at June 30, 2010.

 

Information pertaining to securities with gross unrealized losses at June 30,2010, aggregated by investment category and length of time that individualsecurities have been in a continuous loss position follows:

 
| ** **                      | ** ** | **Less  than 12 Months**    | ** ** | **12  Months or More** | ** ** | **Total**       | ** ** |
|---------------------------------|------------|-----------------------------|------------|------------------------|------------|-----------------|------------|
| ** **                      | ** ** | **Fair  Value**             | ** ** | **Unrealized  Loss**   | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** |
|                            |       | **(Dollars  in thousands)** |       |
|                            |       |                        |       |                   |       |            |       |   |   |   |   |   |   |
| Securities  Available for Sale: |       |                        |       |                   |       |            |       |   |   |   |   |   |   |
| State/Local  Agency Securities  |       | $                           | 5,804      |                   | $          | (88             | )          | $ | 10,289 |   | $ | (1,075 | ) | $ | 16,093 |   | $ | (1,163 | ) |
|                                 |            |                             |            |                        |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

12

----

Table ofContents

 

Information pertaining to securities with gross unrealized losses at December 31,2009, aggregated by investment category and length of time that individualsecurities have been in a continuous loss position follows:

 
| ** **                      | ** ** | **Less  than 12 Months**    | ** ** | **12  Months or More** | ** ** | **Total**       | ** ** |
|---------------------------------|------------|-----------------------------|------------|------------------------|------------|-----------------|------------|
| ** **                      | ** ** | **Fair  Value**             | ** ** | **Unrealized  Loss**   | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** |
| ** **                      | ** ** | **(Dollars  in thousands)** | ** ** |
| Securities  Available for Sale: |       |                        |       |                   |       |            |       |   |   |   |   |   |   |
| Government  Agency Securities   |       | $                           | 7,849      |                   | $          | (139            | )          | $ | — |   | $ | — |   | $ | 7,849 |   | $ | (139 | ) |
| Mortgage  Backed Securities     |       | 1,491                       |       | (44                    | )          | —          |       | — |   | 1,491 |   | (44 | ) |
| State/Local  Agency Securities  |       | 8,827                       |       | (245                   | )          | 8,889           |       | (1,182 | ) | 17,716 |   | (1,427 | ) |
|                            |       |                        |       |                   |       |            |       |   |   |   |   |   |   |
| Total                           |       | $                           | 18,167     |                   | $          | (428            | )          | $ | 8,889 |   | $ | (1,182 | ) | $ | 27,056 |   | $ | (1,610 | ) |

 

Management evaluates securities for other-than-temporary impairment atleast on a quarterly basis, and more frequently when economic or marketconcerns warrant such evaluation. Consideration is given to (1) the lengthof time and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer, and (3) theBank does not have the intent to sell the security; and it is more likely thannot it will not have to sell the security before recovery of its cost basis.

 

OnJune 30, 2010, thirty two securities had an unrealized loss with aggregatedepreciation of 6.74% from the Bank’s amortized cost basis. On December 31,2009, forty securities had an unrealized loss with aggregate depreciation of5.62% from the Bank’s amortized cost basis. The unrealized losses relateprimarily to securities issued by agencies of the United States and securitiesissued by local government agencies. Since the Bank has the ability to hold these securities until estimatedmaturity, no decline is deemed to be other than temporary.

 

13

----

Table of Contents

 

(NOTE 7) LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Thefollowing table presents information on loans and the allowance for loan lossesat June 30, 2010 and December 31, 2009:

 
| ** **                            | ** ** | **JUNE 30** | ** ** | **DECEMBER 31** | ** ** |
|---------------------------------------|------------|-------------|------------|-----------------|------------|
| **(dollars  in thousands)**           | ** ** | **2010**    | ** ** | **2009**        | ** ** |
| Commercial and Industrial             |       | $           | 31,430     |            | $          | 31,389 |   |
| Construction                          |       | 1,265       |       | 8,705           |       |
| Real Estate - Mortgage                |       | 120,925     |       | 121,887         |       |
| Installment                           |       | 647         |       | 2,746           |       |
| Government Guaranteed Loans Purchased |       | 12          |       | 16              |       |
|                                  |       | 154,279     |       | 164,743         |       |
| Allowance for loan losses             |       | (3,251      | )          | (3,529          | )          |
| Deferred origination fees, net        |       | (196        | )          | (217            | )          |
| Net Loans                             |       | $           | 150,832    |            | $          | 160,997 |   |
|                                  |       |        |       |            |       |
| Balance at Beginning of Period        |       | $           | 3,529      |            | $          | 2,413 |   |
| Recoveries                            |       | —      |       | 77              |       |
| Provision for Loan Losses             |       | —      |       | 3,368           |       |
| Loans Charged Off                     |       | (278        | )          | (2,329          | )          |
| Balance at End of Period              |       | $           | 3,251      |            | $          | 3,529 |   |

 

The following table summarizes the Bank’s investment in loans for whichimpairment has been recognized as of and for the periods ended June 30,2010 and December 31, 2009. Impaired loans consist of the loans on non-accrual status.  There were no loans past due 90 days or moreand still accruing as of June 30, 2010 and December 31, 2009.

 
| ** **                                                                                                                    | ** ** | **June 30, 2010**     | ** ** | **December 31, 2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                                                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Total impaired loans which as a result of  write-down or the fair value of the collateral, did not have a specific  allowance |       | $                          | 5,037      |                       | $          | 4,399 |   |
| Impaired loans which have a specific allowance                                                                                |       | 2,054                      |       | 3,681                      |       |
| ** **                                                                                                                    | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| Total impaired loans                                                                                                          |       | $                          | 7,091      |                       | $          | 8,080 |   |
|                                                                                                                          |       |                       |       |                       |       |
| Total specific allowance on impaired loans                                                                                    |       | $                          | 165        |                       | $          | 357 |   |
|                                                                                                                          |       |                       |       |                       |       |
| Average recorded investment in impaired loans  during the period                                                              |       | $                          | 6,404      |                       | $          | 6,490 |   |
| Income recognized on impaired loans during the  period                                                                        |       | $                          | —     |                       | $          | — |   |

 

14

----

Table of Contents

 

(NOTE 8) FORECLOSED ASSETS

 

Asof June 30, 2010 and 2009, foreclosed assets totaled $20,227,000 and$14,333,000, respectively, net of valuation allowance. Based on propertyvalues, a valuation allowance of $1,252,000 and $1,010,000 was deemed necessaryat June 30, 2010 and December 31, 2009, respectively.

 

Duringthe six months ended June 30, 2010 three properties were sold for$2,926,000, with a loss on sale of $57,000. One property valued at $520,000 was acquired through trade on oneproperties sold during the six months ended June 30, 2010.  There were no sales of foreclosed assetsduring the six months ended June 30, 2009.

 

Operatingexpenses for foreclosed assets totaled $1,082,000 and $629,000 for the sixmonths ended June 30, 2010 and 2009, respectively.

 

(NOTE 9) FAIR VALUE MEASUREMENTS:

 

Authoritativeguidance establishes a hierarchy for measuring fair value under generallyaccepted accounting principles (GAAP) in the United States of America andapplies to all financial assets and liabilities that are being measured andreported at fair value on a recurring and non-recurring basis. Fair value ismeasured in levels, which are described in more detail below, and is determinedbased on the observability and reliability of the assumptions used to determinefair value.

 

**Level 1:** Valuation for assets andliabilities traded in active exchange markets. Valuations are obtained fromreadily available pricing sources for market transactions involving identicalassets or liabilities.

 

**Level 2:** Valuation for assets andliabilities traded in less active dealer or broker markets. Valuations areobtained from third party pricing services for identical or comparable assetsor liabilities.

 

**Level 3:** Valuation for assets andliabilities that are derived from other valuation methodologies, includingoption pricing models, discounted cash flow models, and similar techniques, andnot based on market exchange, dealer, or broker traded transactions. Thesevaluations incorporate certain assumptions and projections by management indetermining the fair value assigned to such assets or liabilities.

 

TheCorporation measures and reports available-for-sale securities at fair value ona recurring basis. The following tables show the balances of these assets basedon the designated levels at June 30, 2010 and December 31, 2009.

 
| ** **                       | ** ** | **At June 30, 2010** | ** ** |
|----------------------------------|------------|---------------------------|------------|
| **(dollars  in thousands)**      | ** ** | **Total**                 | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Investment securities — AFS |       | $                         | 56,740     |   | $ | — |   | $ | 56,740 |   | $ | — |   |
|                                  |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **At December 31, 2009** | ** ** |
|----------------------------------|------------|-------------------------------|------------|
| **(dollars  in thousands)**      | ** ** | **Total**                     | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Investment securities — AFS |       | $                             | 66,498     |   | $ | — |   | $ | 66,498 |   | $ | — |   |
|                                  |            |                               |            |  |  |  |  |  |  |  |  |  |  |

 

15

----

Table ofContents

 

Fairvalues of investment securities available for sale are based on brokerquotes.  Such third party information wasnot adjusted by management; thus, the fair values of investment securitiesavailable for sale are classified as level 2.

 

TheCorporation is also required, from time to time, to measure certain otherassets at fair value on a non-recurring basis in accordance with GAAP. Duringthe six months ended June 30, 2010, the Corporation measured collateraldependent impaired loans, loans held for sale, and Other Real Estate Owned(OREO) at fair value. The assets are measured at fair value on a non-recurringbasis and the following table provides the assets’ designated levels, as wellas the fair value losses recognized during the six months ended June 30,2010 and the year ended December 31, 2009.

 
| ** **                 | ** ** | **At June 30, 2010** | ** ** |
|----------------------------|------------|---------------------------|------------|
| **(dollars in thousands)** | ** ** | **Total**                 | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** | **Losses for the  six months ended  June 30, 2010** | ** ** |
| Impaired loans             |       | $                         | 5,037      |   | $ | — |   | $ | — |   | $ | 5,037 |   | $ | — |   |
| Loans held for sale        |       | 4,287                     |       | — |   | 4,287 |   | — |   | — |   |
| OREO                       |       | 20,227                    |       | — |   | — |   | 20,227 |   | 383 |   |
|                       |       | $                         | 29,551     |   | $ | — |   | $ | 4,287 |   | $ | 25,264 |   | $ | 383 |   |

 
| ** **                 | ** ** | **At December 31, 2009** | ** ** |
|----------------------------|------------|-------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Total**                     | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** | **Losses for the  six months ended  June 30, 2010** | ** ** |
| Impaired loans             |       | $                             | 6,662      |   | $ | — |   | $ | — |   | $ | 6,662 |   | $ | 357 |   |
| Loans held for sale        |       | 2,216                         |       | — |   | 2,216 |   | — |   | — |   |
| OREO                       |       | 14,333                        |       | — |   | — |   | 14,333 |   | — |   |
|                       |       | $                             | 23,221     |   | $ | — |   | $ | 4,287 |   | $ | 20,995 |   | $ | 357 |   |

 

*Impaired Loans*

 

Collateral-dependent impaired loans are carried at the fair value ofthe collateral, less estimated costs to sell. The fair value of collateral isdetermined based on appraisals. In some cases, adjustments were made to theappraised values for various factors including age of the appraisal, age ofcomparables included in the appraisal, and known changes in the market and inthe collateral. When significant adjustments were based on unobservable inputs,the resulting fair value measurement has been categorized as a Level 3measurement. Otherwise, collateral-dependent impaired loans are categorizedunder Level 2.

 

Impaired loans that are not collateral dependent are carried at thepresent value of expected future cash flows discounted at the loan’s effectiveinterest rate. Troubled debt restructurings are also carried at the presentvalue of expected future cash flows. However, expected cash flows for troubleddebt restructurings are discounted using the loan’s original effective interestrate rather than the modified interest rate. Since fair value of these loans isbased on management’s own projection of future cash flows, the fair valuemeasurements are categorized as Level 3 measurements.

 

16

----

Tableof Contents

 

*Loans Held for Sale*

 

Loans held for sale are required to be measured at the lower of cost orfair value. Management obtains quotes or bids on all or part of these loansdirectly from the purchasing financial institutions, which are a level 2inputs. Premiums received or to be received on the quotes or bids areindicative of the fact that cost is lower than fair value. At June 30,2010, the fair value of loans held for sale was greater than cost; therefore,the entire balance of loans held for sale was recorded at cost.

 

*Foreclosed Assets*

 

Assets acquired through foreclosure or other proceedings are initiallyrecorded at fair value at the date of foreclosure less estimated costs ofdisposal, which establishes a new cost. After foreclosure, valuations areperiodically performed, and foreclosed assets held for sale are carried at thelower of cost or fair value, less estimated costs of disposal. All foreclosedassets are real properties. The fair values of real properties initially aredetermined based on appraisals. In some cases, adjustments were made to theappraised values for various factors including age of the appraisal, age ofcomparables included in the appraisal, and known changes in the market or inthe collateral. Subsequent valuations of the real properties are based onmanagement estimates or on updated appraisals. Foreclosed assets arecategorized under Level 3 when significant adjustments are made by managementto appraised values based on unobservable inputs. Otherwise, foreclosed assetsare categorized under Level 2 if their values are based solely on appraisals.

 

Currentauthoritative guidance requires interim reporting period disclosure about thefair value of financial instruments, including assets, liabilities andoff-balance sheet items for which it is practicable to estimate fair value. Thefair value estimates are made based upon relevant market information, ifavailable, and upon the characteristics of the financial instrumentsthemselves. Because no market exists for a significant portion of theCorporation’s financial instruments, fair value estimates are based uponjudgments regarding future expected loss experience, current economicconditions, risk characteristics of various financial instruments and otherfactors. The estimated fair value of the Corporation’s financial instruments asof June 30, 2010 and December 31, 2010 is shown below.

 
| ** **                                | ** ** | **June 30, 2010** | ** ** | **December 31,29010** | ** ** |
|-------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| **(dollars  in thousands)**               | ** ** | **Carrying  Amount**   | ** ** | **Fair  Value**            | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
|                                      |       |                   |       |                       |       |   |   |   |   |
| Financial Assets                          |       |                   |       |                       |       |   |   |   |   |
| Cash and cash equivalents                 |       | 4,516                  |       | 4,516                      |       | 12,251 |   | 12,251 |   |
| Interest Bearing Deposits                 |       | 36,991                 |       | 36,991                     |       | 5,256 |   | 5,256 |   |
| Investment Securities, available for sale |       | 56,740                 |       | 56,740                     |       | 62,413 |   | 62,413 |   |
| Other Investments                         |       | 3,960                  |       | 3,960                      |       | 4,085 |   | 4,085 |   |
| Trading Assets                            |       | 90                     |       | 90                         |       | 153 |   | 153 |   |
| Loans, held for sale                      |       | 4,287                  |       | 4,287                      |       | 2,216 |   | 2,216 |   |
| Loans, net                                |       | 150,832                |       | 179,950                    |       | 160,997 |   | 163,839 |   |
| Accrued interest receivable               |       | 1,625                  |       | 1,625                      |       | 1,371 |   | 1,371 |   |
|                                      |       |                   |       |                       |       |   |   |   |   |
| Financial Liabilities                     |       |                   |       |                       |       |   |   |   |   |
| Deposits                                  |       | 227,444                |       | 227,835                    |       | 202,422 |   | 205,699 |   |
| Long-term debt                            |       | 42,248                 |       | 42,991                     |       | 37,248 |   | 46,779 |   |
| Short-term debt                           |       | 2,850                  |       | 2,850                      |       | 12,850 |   | 12,850 |   |
| Accrued Interest Payable                  |       | 1,482                  |       | 1,482                      |       | 1,274 |   | 1,274 |   |

 

17

----

Tableof Contents

 

(NOTE 10) OFF-BALANCESHEET COMMITMENTS:

 

TheBank is a party to financial instruments with off-balance-sheet risk in thenormal course of business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit.  Suchcommitments involve, to varying degrees, elements of credit and interest raterisk in excess of the amount recognized in the consolidated balance sheets.

 

TheBank’s exposure to credit loss is represented by the contractual amount ofthese commitments.  The Bank uses thesame credit policies in making commitments as it does for on-balance-sheet instruments.

 

At June 30, 2010 and December 31, 2009, such commitments toextend credit were $14,264,000 and $14,839,000, respectively, of undisbursedlines of credit, undisbursed loans in process, and commitment letters.

 

The Bank has two letters of credit issued byFederal Home Loan Bank of San Francisco. One letter of credit in the amount of$330,000, expiring April 17, 2011, is used to secure local agencydeposits.  The beneficiary of the letterof credit is the Administrator of Local Agency Security, Department ofFinancial Institutions.  The other letterof credit in the amount of $1,300,000, expiring February 17, 2019, hasMasterCard International Inc. as the beneficiary.

 
| **ITEM  2:** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|--------------|-------------------------------------------------------------------------------------------------|

 

**Statements Regarding Forward-Looking Information**

 

Except for historical information contained herein, the mattersdiscussed or incorporated by reference in this report contain forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended (the “Securities Act”), and Section 21E of the SecuritiesExchange Act of 1934 (the “Exchange Act”), that involve substantial risks anduncertainties.  When used in this report, or in the documents incorporatedby reference herein, the words “anticipate,” “believe,” “estimate,” “may,” “intend,”“expect,” and similar expressions identify certain of such forward-lookingstatements.  Actual results of the Corporation and the Bank could differmaterially from such forward-looking statements contained herein.  Factorsthat could cause future results to vary from current expectations include, butare not limited to, the following: changes in economic conditions (bothgenerally and more specifically in the markets in which the Bank operates);changes in interest rates, deposit flows, loan demand, real estate values andcompetition; changes in accounting principles, policies or guidelines and ingovernment legislation and regulation (which change from time to time and overwhich the Bank has no control); other factors affecting the Bank’s operations,markets, products and services; and other risks detailed in this Form 10-Qand in the Bank’s other reports filed with the Federal Deposit InsuranceCorporation (FDIC) and pursuant to the rules and regulations of theSecurities and Exchange Commission.  Readers are cautioned not to placeundue reliance on these forward-looking statements, which reflect management’sanalysis only as of the date hereof.  The Corporation undertakes no obligationto publicly revise these forward-looking statements to reflect events orcircumstances that arise after the date thereof.

 

18

----

Tableof Contents

 

**OVERVIEW OF THE RESULTS OF OPERATION AND FINANCIAL CONDITION**

 

**Results of Operations Summary**

 

**Second quarter 2010 compared to second quarter 2009**

 

Netloss for the quarter ended June 30, 2010 was $275,000 compared with netincome of $564,000 for the quarter ended June 30, 2009. Basic loss pershare for the second quarter of 2010 was ($0.15), compared to basic earnings of$0.31 for the second quarter of 2009. The Corporation’s annualized return onaverage equity was (6.76%) and annualized return on average assets was (0.38%)for the quarter ended June 30, 2010, compared to a return on averageequity of 14.50% and a return on assets of 0.74% for same quarter in 2009. Theprimary reasons for the change in net income during the quarter of 2010 are asfollows:

 

The net interest income decreased from $1,849,000 to $1,790,000, dueprimarily to a decline of $33,569,000 in interest-earning assets while interestbearing liabilities declined $31,461,000. As a result, net interest income decreased $59,000 or 3.08% during thethree months ended June 30, 2010.

 

No provision for loan losses was recorded during the second quarter of2010 compared to a provision of $396,000 during the first quarter of 2009.

 

Total non-interest income was $1,551,000 during the second quarter of2010 compared to $2,710,000 during the second quarter of 2009.  The decrease of $1,159,000 was due primarilyto decreases of $694,000 in gains on sales of investment securities and$425,000 in other income.

 

Total non-interest expense was $3,927,000 during the second quarter of2010 compared to $3,468,000 during the second quarter of 2009.  The increase of $459,000 was due primarily toaccruing an estimated litigation settlement expense of $880,000 and increasesof $126,000 in expenses related to foreclosed assets and $108,000 in salariesand employee benefits, partially offset by a decrease of $350,000 in prepaymentfees on borrowings and a decrease of $321,000 in other general andadministrative expense.

 

**Six months ended June 30, 2010 compared to the same period in 2009**

 

Netloss for the six months ended June 30, 2010 was $337,000 compared with netincome of $1,079,000 for the six months ended June 30, 2009. Basic lossper share for the second quarter of 2010 was $(0.19), compared to basicearnings of $0.60 for the six months ended June 30, 2009. The Corporation’sannualized return on average equity was (4.09%) and annualized return onaverage assets was (0.24%) for the six months ended June 30, 2010,compared to a return on average equity of 13.87% and a return on assets of0.69% for the six months ended June 30, 2009. The primary reasons for thechange in net income during the six months ended June 30, 2010 are asfollows:

 

Net interest income decreased from $3,993,000 to $3,651,000, due primarilyto a decline of $1,931,000 in interest-earning assets while interest bearingliabilities increased $5,405,000.  As aresult, net interest income decreased $342,000 or (8.56%) during the six monthsended June 30, 2010.

 

19

----

Table ofContents

 

No provision for loan losses was during the second quarter of 2010compared to a provision of $646,000 during the six months ended June 30,2009.

 

Total non-interest income was $3,052,000 during the six months ended June 30,2010 compared to $4,303,000 during the six months ended June 30,2009.  The decrease of $1,251,000 was dueprimarily to decreases of $717,000 in gains on sales of investment securitiesand $451,000 in other income.

 

Total non-interest expense was $7,461,000 during the six months ended June 30,2010 compared to $6,398,000 during the six months ended June 30,2009.  The increase of $1,063,000 was dueprimarily to accruing and estimated litigation settlement expense of $880,000and increases of $453,000 in expenses related to foreclosed assets, $309,000professional fees and $226,000 in salaries and employee benefits, partiallyoffset by a decrease of $431,000 in prepayment fees on borrowings.

 

The following table sets forth certain selected financial data andratios of the Corporation for the three months and six months ended June 30,2010 and 2009.

 
| ** **                                           | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| **(in  thousands except share data)**                | ** ** | **2010**                            | ** ** | **2009**                          | ** ** | **2010** | ** ** | **2009** | ** ** |
| Summary of Operating Results:                        |       |                                |       |                              |       |   |   |   |   |
| Total interest income                                |       | $                                   | 3,280      |                              | $          | 4,022 |   | $ | 6,634 |   | $ | 8,458 |   |
| Total interest expense                               |       | 1,490                               |       | 2,173                             |       | 2,983 |   | 4,465 |   |
| Net interest income                                  |       | 1,790                               |       | 1,849                             |       | 3,651 |   | 3,993 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Provision for loan losses                            |       | —                              |       | 396                               |       | — |   | 646 |   |
| Net interest income after provision for loan  losses |       | 1,790                               |       | 1,453                             |       | 3,651 |   | 3,347 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Total non-interest income                            |       | 1,551                               |       | 2,710                             |       | 3,052 |   | 4,303 |   |
| Total non-interest expenses                          |       | 3,927                               |       | 3,468                             |       | 7,461 |   | 6,398 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Income (loss) before provision (benefit)             |       | (586                                | )          | 695                               |       | (758 | ) | 1,252 |   |
| Income tax provision (benefit)                       |       | (311                                | )          | 131                               |       | (421 | ) | 173 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Net income (loss)                                    |       | $                                   | (275       | )                                 | $          | 564 |   | $ | (337 | ) | $ | 1,079 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Per Common Share Data:                               |       |                                |       |                              |       |   |   |   |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Net income - Basic (1)                               |       | $                                   | (0.15      | )                                 | $          | 0.31 |   | $ | (0.19 | ) | $ | 0.60 |   |
| Net income - Diluted (2)                             |       | (0.15                               | )          | 0.31                              |       | (0.19 | ) | 0.60 |   |
| Book value, end of period                            |       | 9.09                                |       | 9.25                              |       | 8.82 |   | 9.33 |   |
| Avg shares outstanding                               |       | 1,785,891                           |       | 1,814,642                         |       | 1,783,733 |   | 1,799,338 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Balance Sheet Data:                                  |       |                                |       |                              |       |   |   |   |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Total loans, net of unearned income (3)              |       | $                                   | 155,119    |                              | $          | 165,259 |   | $ | 155,119 |   | $ | 165,259 |   |
| Total assets                                         |       | 294,078                             |       | 293,599                           |       | 294,078 |   | 293,599 |   |
| Total deposits                                       |       | 227,444                             |       | 202,886                           |       | 227,444 |   | 202,886 |   |
| Stockholders’ equity                            |       | 16,241                              |       | 16,640                            |       | 16,241 |   | 16,440 |   |

 

20

----

Table of Contents

 
| ** **                                                 | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **2010**                            | ** ** | **2009**                          | ** ** | **2010** | ** ** | **2009** | ** ** |
| Selected Financial Ratios:                                 |       |                                |       |                              |       |   |   |   |   |
|                                                       |       |                                |       |                              |       |   |   |   |   |
| Return on average assets (4) (5)                      |       | (.38                                | )%         | 0.74                              | %          | (0.24 | )% | 0.69 | % |
| Return on average stockholders’ equity  (4) (5)  |       | (6.76                               | )%         | 14.50                             | %          | (4.09 | )% | 13.87 | % |
| Net interest spread                                        |       | 3.11                                | %          | 2.81                              | %          | 3.26 | % | 3.11 | % |
| Net yield on interest earning assets (4)                   |       | 3.30                                | %          | 3.08                              | %          | 3.44 | % | 6.58 | % |
| Avg shareholders’ equity to average assets (4)        |       | 5.58                                | %          | 5.12                              | %          | 5.81 | % | 5.00 | % |
| Risked-Based capital ratios                                |       |                                |       |                              |       |   |   |   |   |
| Tier 1                                                     |       | 10.36                               | %          | 9.44                              | %          | 10.07 | % | 9.44 | % |
| Total                                                      |       | 13.66                               | %          | 12.51                             | %          | 13.44 | % | 12.51 | % |
| Total loans to total deposits at end of period (3)         |       | 69.59                               | %          | 83.02                             | %          | 69.59 | % | 83.02 | % |
| Allowance for loan losses to total loans at end of  period |       | 2.05                                | %          | 1.74                              | %          | 2.05 | % | 1.74 | % |
| Nonperforming loans to total loans at end of  period (3)   |       | 2.62                                | %          | 4.09                              | %          | 2.62 | % | 4.09 | % |
| Net charge-offs to average loans                           |       | 0.17                                | %          | 0.08                              | %          | 0.17 | % | 0.08 | % |

 

----

(1)   Basic earningsper share amounts were computed on the basis of the weighted average number ofshares of common stock outstanding during the year.  The weighted average number of common sharesused for this computation was 1,785,891 and 1,794,918 for the three monthsended June 30, 2010 and 2009, respectively.  The weighted average number of common sharesused for this computation was 1,783,733 and 1,799,338 for the six months ended June 30,2010 and 2009, respectively.

 

(2)   Dilutedearnings per share amounts were computed on the basis of the weighted averagenumber of shares of common stock and common stock equivalents outstandingduring the year.  Common stockequivalents include director/employee stock options. The weighted averagenumber of common shares used for this computation was 1,787,103 and 1,796,173for the three months ended June 30, 2010 and 2009, respectively.  The weighted average number of shares usedfor this computation was 1,786,692 and 1,800,594 for the three months and thesix months ended June 30, 2010 and 2009, respectively.

 

(3)   Includes loans being heldfor sale.

 

(4)   Averages are ofdaily balances.

 

(5)   Calculated on an annualizedbasis.

 

**NET INTEREST INCOME**

 

Net interest income, the difference between (a) interest and feesearned on interest-earning assets and (b) interest paid oninterest-bearing liabilities, is the most significant component of the Bank’searnings.  Changes in net interest incomefrom period to period result from increases or decreases in the averagebalances of interest-earning assets and interest-earning liabilities, theavailability of particular sources of funds and changes in prevailing interestrates.

 

Net interest income for the quarter ended June 30, 2010 was $1,790,000compared to $1,849,000 for the quarter ended June 30, 2009, which was adecrease of $59,000 primarily resulting from decreases of $203,000 in intereston loans and $548,000 in interest on investment securities, partially offset bydecreases interest expense of $341,000 on savings and time deposit accounts,$236,000 on notes payable and other borrowings and $105,000 on time deposits of$100,000 or more.

 

21

----

Table of Contents

 

Net interest income for the six months ended June 30, 2010 was$3,651,000 compared to $3,993,000 for the six months ended June 30, of2009, which was a decrease of $342,000 primarily resulting from decreases of$624,000 in interest on loans and $1,209,000 in interest on investmentsecurities, partially offset by decreases interest expense of $688,000 onsavings and time deposit accounts, $537,000 on notes payable and otherborrowings and $255,000 on time deposits of $100,000 or more.

 

**DISTRIBUTION, RATE AND YIELD ANALYSIS OF NET INTEREST INCOME:**

 

Thefollowing tables show the consolidated average balances of earning assets, andinterest-bearing liabilities; the amount of interest income and interest expense;the average yield or rate for each category of average interest-earning assetsand average interest-bearing liabilities; and the net interest income and thenet interest spread for the periods indicated. Yields are computed on a tax-equivalent basis, resulting in adjustmentsto interest earned on municipal bonds of $291,000 and $268,000 for the threemonths ended and $587,000 and $511,000 for the six months June 30, 2010and 2009, respectively.  Non-accrualloans and overdrafts are included in average loan balances.  Average loans are presented net of unearnedincome.

 

22

----

Table of Contents

 
| ** **                                                  | ** ** | **Three Months Ended June 30, 2010** | ** ** | **Three Months Ended June 30, 2009** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| **(dollars  in thousands)**                                 | ** ** | **Average  Balance**                      | ** ** | **Interest**                              | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** |
| Assets:                                                     |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Loans                                                       |       | $                                         | 158,513    |                                      | $          | 2,494 |   | 6.29 | % | $ | 168,463 |   | $ | 2,697 |   | 6.40 | % |
| Time deposits - in other banks                              |       | 27,427                                    |       | 15                                        |       | 0.22 | % | 12,680 |   | 6 |   | 0.19 | % |
| Investment securities - taxable                             |       | 13,052                                    |       | 121                                       |       | 3.71 | % | 49,108 |   | 725 |   | 5.91 | % |
| Investment securities - nontaxable                          |       | 53,440                                    |       | 941                                       |       | 7.04 | % | 44,321 |   | 862 |   | 7.78 | % |
| Total interest-earning assets                               |       | 252,432                                   |       | 3,571                                     |       | 5.66 | % | 274,572 |   | 4,290 |   | 6.25 | % |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Allowance for credit losses                                 |       | (3,378                                    | )          |                                      |       |   | ** ** | (2,579 | ) |   |   |   |   |
| Non-interest bearing assets:                                |       |                                      |       |                                      |       |   | ** ** |   |   |   |   |   |   |
| Cash and due from banks                                     |       | 4,960                                     |       |                                      |       |   | ** ** | 6,563 |   |   |   |   |   |
| Premises and equipment                                      |       | 5,044                                     |       |                                      |       |   | ** ** | 4,892 |   |   |   |   |   |
| Accrued interest receivable                                 |       | 1,477                                     |       |                                      |       |   | ** ** | 1,610 |   |   |   |   |   |
| Other assets                                                |       | 31,104                                    |       |                                      |       |   | ** ** | 18,726 |   |   |   |   |   |
| Total average assets                                        |       | $                                         | 291,639    |                                      |       |   |   | ** ** | $ | 303,784 |   |   |   |   |   |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity:                  |       |                                      |       |                                      |       |   | ** ** |   |   |   |   |   |   |
| Interest-bearing liabilities:                               |       |                                      |       |                                      |       |   | ** ** |   |   |   |   |   |   |
| Interest-bearing demand                                     |       | $                                         | 15,140     |                                      | $          | 4 |   | 0.11 | % | $ | 16,067 |   | $ | 5 |   | 0.12 | % |
| Money market savings                                        |       | 1,869                                     |       | 1                                         |       | 0.21 | % | 1,328 |   | 1 |   | 0.30 | % |
| Savings deposits                                            |       | 7,625                                     |       | 9                                         |       | 0.47 | % | 5,360 |   | 7 |   | 0.52 | % |
| Time deposits >$100M                                     |       | 67,358                                    |       | 418                                       |       | 2.48 | % | 55,302 |   | 523 |   | 3.78 | % |
| Time deposits <$100M                                     |       | 96,858                                    |       | 541                                       |       | 2.23 | % | 98,607 |   | 884 |   | 3.59 | % |
| Other Borrowing                                             |       | 45,098                                    |       | 517                                       |       | 4.59 | % | 76,396 |   | 753 |   | 3.94 | % |
| Total interest-bearing liabilities                          |       | 233,948                                   |       | 1,490                                     |       | 2.55 | % | 253,060 |   | 2,173 |   | 3.43 | % |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Non-interest bearing liabilities:                           |       |                                      |       |                                      |       |   | ** ** |   |   |   |   |   |   |
| Noninterest-bearing checking                                |       | 37,256                                    |       |                                      |       |   | ** ** | 29,423 |   |   |   |   |   |
| Accrued interest payable                                    |       | 1,315                                     |       |                                      |       |   | ** ** | 1,464 |   |   |   |   |   |
| Other liabilities                                           |       | 2,858                                     |       |                                      |       |   | ** ** | 4,280 |   |   |   |   |   |
| Total Liabilities                                           |       | 275,377                                   |       |                                      |       |   | ** ** | 88,227 |   |   |   |   |   |
| Total shareholders equity                                   |       | 16,262                                    |       |                                      |       |   | ** ** | 15,557 |   |   |   |   |   |
| Total average liabilities and shareholders equity           |       | $                                         | 291,639    |                                      |       |   |   | ** ** | $ | 303,784 |   |   |   |   |   |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Net interest income                                         |       |                                      |       | $                                         | 2,081      |   |   | ** ** |   |   | $ | 2,117 |   |   |   |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Interest income as a percentage of average earning  assets  |       |                                      |       |                                      |       | 5.66 | % |   |   |   |   | 6.25 | % |
| Interest expense as a percentage of average  earning assets |       |                                      |       |                                      |       | 2.36 | % |   |   |   |   | 3.17 | % |
| Net yield on interest earning assets                        |       |                                      |       |                                      |       | 3.30 | % |   |   |   |   | 3.08 | % |
| Net interest spread                                         |       |                                      |       |                                      |       | 3.11 | % |   |   |   |   | 2.81 | % |

 

23

----

Table of Contents

 
| ** **                                                  | ** ** | **Six Months Ended June 30, 2010** | ** ** | **Six Months Ended June 30, 2009** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| **(dollars  in thousands)**                                 | ** ** | **Average  Balance**                    | ** ** | **Interest**                            | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** |
| Assets:                                                     |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Loans                                                       |       | $                                       | 161,089    |                                    | $          | 5,065 |   | 6.29 | % | $ | 170,665 |   | $ | 5,689 |   | 6.67 | % |
| Time deposits - in other banks                              |       | 19,180                                  |       | 20                                      |       | 0.21 | % | 3,754 |   | 11 |   | 0.59 | % |
| Investment securities - taxable                             |       | 13,066                                  |       | 244                                     |       | 3.73 | % | 56,984 |   | 1,623 |   | 5.70 | % |
| Investment securities - nontaxable                          |       | 53,090                                  |       | 1,892                                   |       | 7.13 | % | 42,253 |   | 1,646 |   | 7.79 | % |
| Total interest-earning assets                               |       | 246,425                                 |       | 7,221                                   |       | 5.86 | % | 273,656 |   | 8,969 |   | 6.55 | % |
|                                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Allowance for credit losses                                 |       | (3,452                                  | )          |                                    |       |   | ** ** | (2,489 | ) |   |   |   |   |
| Non-interest bearing assets:                                |       |                                    |       |                                    |       |   | ** ** |   |   |   |   |   |   |
| Cash and due from banks                                     |       | 4,966                                   |       |                                    |       |   | ** ** | 14,118 |   |   |   |   |   |
| Premises and equipment                                      |       | 4,978                                   |       |                                    |       |   | ** ** | 4,926 |   |   |   |   |   |
| Accrued interest receivable                                 |       | 1,417                                   |       |                                    |       |   | ** ** | 1,759 |   |   |   |   |   |
| Other assets                                                |       | 29,417                                  |       |                                    |       |   | ** ** | 19,039 |   |   |   |   |   |
| Total average assets                                        |       | $                                       | 283,751    |                                    |       |   |   | ** ** | $ | 311,009 |   |   |   |   |   |
|                                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity:                  |       |                                    |       |                                    |       |   | ** ** |   |   |   |   |   |   |
| Interest-bearing liabilities:                               |       |                                    |       |                                    |       |   | ** ** |   |   |   |   |   |   |
| Interest-bearing demand                                     |       | $                                       | 15,252     |                                    | $          | 8 |   | 0.10 | % | $ | 14,945 |   | $ | 10 |   | 0.13 | % |
| Money market savings                                        |       | 1,875                                   |       | 2                                       |       | 0.21 | % | 1,465 |   | 2 |   | 0.27 | % |
| Savings deposits                                            |       | 7,181                                   |       | 18                                      |       | 0.50 | % | 5,622 |   | 14 |   | 0.50 | % |
| Time deposits >$100M                                     |       | 63,552                                  |       | 813                                     |       | 2.56 | % | 55,582 |   | 1,068 |   | 3.84 | % |
| Time deposits <$100M                                     |       | 97,308                                  |       | 1,130                                   |       | 2.32 | % | 97,050 |   | 1,822 |   | 3.75 | % |
| Other Borrowing                                             |       | 44,407                                  |       | 1,012                                   |       | 4.56 | % | 84,643 |   | 1,549 |   | 3.66 | % |
| Total interest-bearing liabilities                          |       | 229,575                                 |       | 2,983                                   |       | 2.60 | % | 259,307 |   | 4,465 |   | 3.44 | % |
|                                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Non-interest bearing liabilities:                           |       |                                    |       |                                    |       |   | ** ** |   |   |   |   |   |   |
| Noninterest-bearing checking                                |       | 33,390                                  |       |                                    |       |   | ** ** | 31,662 |   |   |   |   |   |
| Accrued interest payable                                    |       | 1,310                                   |       |                                    |       |   | ** ** | 1,611 |   |   |   |   |   |
| Other liabilities                                           |       | 2,982                                   |       |                                    |       |   | ** ** | 2,872 |   |   |   |   |   |
| Total Liabilities                                           |       | 267,257                                 |       |                                    |       |   | ** ** | 295,452 |   |   |   |   |   |
| Total shareholders equity                                   |       | 16,494                                  |       |                                    |       |   | ** ** | 15,557 |   |   |   |   |   |
| Total average liabilities and shareholders equity           |       | $                                       | 283,751    |                                    |       |   |   | ** ** | $ | 311,009 |   |   |   |   |   |
|                                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Net interest income                                         |       |                                    |       | $                                       | 4,238      |   |   | ** ** |   |   | $ | 4,504 |   |   |   |
| Interest income as a percentage of average earning  assets  |       |                                    |       |                                    |       | 5.86 | % |   |   |   |   | 6.55 | % |
| Interest expense as a percentage of average  earning assets |       |                                    |       |                                    |       | 2.42 | % |   |   |   |   | 6.53 | % |
| Net yield on interest earning assets                        |       |                                    |       |                                    |       | 3.44 | % |   |   |   |   | 6.58 | % |
| Net interest spread                                         |       |                                    |       |                                    |       | 3.26 | % |   |   |   |   | 3.11 | % |

 

24

----

Tableof Contents

 

**Rate and Volume Analysis:**

 

The following tables show the increase or decrease in interest income,interest expense and net interest income, resulting from changes in rates andvolumes, for the three months and six months ended June 30, 2010 comparedwith the same periods in 2009.

 
| ** **                                  | ** ** | **Increase (decrease) in the three months ended  June 30, 2010 compared with June 30, 2009** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **(dollars  in thousands)**                 | ** ** | **Volume**                                                                                             | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase (decrease) in interest income:     |       |                                                                                                   |       |   |   |   |   |
| Loans                                       |       | $                                                                                                      | (159       | ) | $ | (44 | ) | $ | (203 | ) |
| Time deposits - in other banks              |       | 7                                                                                                      |       | 2 |   | 9 |   |
| Investment securities - taxable             |       | (532                                                                                                   | )          | (72 | ) | (604 | ) |
| Investment securities - nontaxable          |       | 177                                                                                                    |       | (98 | ) | 79 |   |
|                                        |       | (507                                                                                                   | )          | (212 | ) | (719 | ) |
|                                        |       |                                                                                                   |       |   |   |   |   |
| Increase (decrease) in interest expense:    |       |                                                                                                   |       |   |   |   |   |
| Interest-bearing demand                     |       | —                                                                                                 |       | (1 | ) | (1 | ) |
| Savings deposits                            |       | 3                                                                                                      |       | (1 | ) | 2 |   |
| Time deposits >$100M                     |       | 114                                                                                                    |       | (219 | ) | (105 | ) |
| Time deposits <$100M                     |       | (16                                                                                                    | )          | (328 | ) | (344 | ) |
| Other borrowing                             |       | (308                                                                                                   | )          | 73 |   | (235 | ) |
|                                        |       | (207                                                                                                   | )          | (476 | ) | (683 | ) |
| Increase (decrease) in net interest income: |       | $                                                                                                      | (307       | ) | $ | 264 |   | $ | 36 |   |

 
| ** **                                  | ** ** | **Increase (decrease) in the six months ended  June 30, 2010 compared with June 30, 2009** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| **(dollars  in thousands)**                 | ** ** | **Volume**                                                                                           | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase (decrease) in interest income:     |       |                                                                                                 |       |   |   |   |   |
| Loans                                       |       | $                                                                                                    | (319       | ) | $ | (305 | ) | $ | (624 | ) |
| Time deposits - in other banks              |       | 45                                                                                                   |       | (36 | ) | 9 |   |
| Investment securities - taxable             |       | (1,251                                                                                               | )          | (128 | ) | (1,379 | ) |
| Investment securities - nontaxable          |       | 422                                                                                                  |       | (176 | ) | 246 |   |
|                                        |       | (1,103                                                                                               | )          | (645 | ) | (1,748 | ) |
|                                        |       |                                                                                                 |       |   |   |   |   |
| Increase (decrease) in interest expense:    |       |                                                                                                 |       |   |   |   |   |
| Interest-bearing demand                     |       | —                                                                                               |       | (2 | ) | (2 | ) |
| Money market savings                        |       | 1                                                                                                    |       | (1 | ) | — |   |
| Savings deposits                            |       | 4                                                                                                    |       | — |   | 4 |   |
| Time deposits >$100M                     |       | 153                                                                                                  |       | (408 | ) | (255 | ) |
| Time deposits <$100M                     |       | 5                                                                                                    |       | (697 | ) | (692 | ) |
| Other borrowing                             |       | (737                                                                                                 | )          | 200 |   | (537 | ) |
|                                        |       | (574                                                                                                 | )          | (908 | ) | (1,482 | ) |
| Increase (decrease) in net interest income: |       | $                                                                                                    | (529       | ) | $ | 263 |   | $ | (266 | ) |

 

25

----

Table of Contents

 

**Provision and Allowance for Loan and Lease Losses**

 

TheCorporation maintains a detailed, systematic analysis and procedural disciplineto determine the amount of the allowance for loan losses (“ALLL”).  TheALLL is based on estimates and is intended to be adequate to provide forprobable losses inherent in the loan portfolio.  This processinvolves deriving probable loss estimates that are based on individual loan lossestimation, historical loss rates and management’s judgment.

 

TheCorporation employs several methodologies for estimating probablelosses.  Methodologies are determined based on a number of factors,including type of asset, risk rating, concentrations, and collateral value.

 

TheCorporation calculates the required ALLL on a quarterly basis and makesadjusting entries as needed. The review of the adequacy of the allowancetakes into consideration such factors as concentrations of credit, changes inthe growth, size and composition of the loan portfolio, overall and individualportfolio quality, review of specific problem loans, collateral, guarantees andeconomic conditions that may affect the borrowers’ ability to pay and/or thevalue of the underlying collateral.  Additional factors consideredinclude: geographic location of borrowers, changes in the Corporation’sproduct-specific credit policy and lending staff experience.  Theseestimates depend on subjective factors and, therefore, contain inherent uncertainties.

 

TheCorporation’s ALLL is maintained at a level believed adequate by management toabsorb known and inherent probable losses on existing loans.  Aprovision for loan losses is charged to expense.  The allowance ischarged for losses when management believes that full recovery on the loan isunlikely.  Generally, the Corporation charges off any loan classifiedas a “loss”; portions of loans which are deemed to be uncollectible; overdraftswhich have been outstanding for more than 90 days; and all other unsecuredloans past due 120 or more days.  Subsequent recoveries, if any, arecredited to the ALLL.

 

Although no assurance can be given that actual losses will not exceedthe amount provided for in the allowance, Management believes that the allowanceis adequate to provide for all estimated credit losses in light of all knownrelevant factors. At June 30, 2010 and 2009 the Bank’s allowance stood at2.05 percent and 1.74 percent of total loans, respectively.

 

No provision was made to the ALLL during the six months ended June 30,2010 compared to $646,000 for the same period in 2009.  Loans charged off during the six months endedJune 30, 2010 totaled $278,000 compared to $134,000 for the same period in2009.  No recoveries were made during thesix months ended June 30, 2010 while $1,000 was made for the same periodin 2009.

 

The Bank’s non-performing (delinquent 90 days or more and onnon-accrual) net loans as a percentage of total loans were 2.62 percent and4.09 percent as of the end of June 30, 2010 and 2009, respectively.

 

**Non-Interest Income**

 

Total non-interest income for the three months ended June 30, 2010was $1,551,000 compared with $2,710,000 for the same period in 2009.  The decrease of $1,159,000 was due primarilyto decreases of $694,000 in gains on sales of investment securities and$581,000 in

 

26

----

Table of Contents

 

merchantdiscount fees, partially offset by an increase of $185,000 in creditcard/stored value card program fees.

 

Total non-interest income for the six months ended June 30, 2010was $3,052,000 compared with $4,303,000 for the same period in 2009.  The decrease of $1,251,000 was due primarilyto decreases of $764,000 in merchant discount fees and $717,000 in gains onsales of investment securities, partially offset by an increase of $330,000 incredit card/stored value card program fees.

 

**Non-Interest Expense**

 

Salary and benefits expense for the three months and six months ended June 30,2010 increased $108,000 and $226,000 compared with the same periods in2009.  The increase was due to theaddition of a Credit Administration Officer, a loan processor and a senioraccounting position.

 

Total occupancy and equipment expense for the three months and sixmonths ended June 30, 2010 was $253,000 and $518,000 resulting in anominal change when compared to the same period in 2009.

 

Professional fees for the three months ended June 30, 2010 were$428,000 compared to $380,000 for the same period in 2009.  Professional fees for the six months ended June 30,2010 were $836,000 compared to $527,000 for the same period in 2009. Theincreases were primarily due to increases in accounting/audit expense and legalfees associated with lawsuits related to various loans and loan collectionexpense.

 

Data processing expense for the three months and six months ended June 30,2010 was $60,000 and $136,000, respectively; representing decreases of $31,000and 44,000 when compared the same period in 2009.

 

During the three and six months ended June 30, 2010 no prepaymentfees were paid on borrowing compared with $350,000 and $431,000, respectivelyfor the same periods in 2009.

 

Duringthe second quarter an estimated litigation settlement expense was funded in theamount of $880,000.  See Item 1 LegalProceedings Section for addition information.

 

Othergeneral and administrative expenses for the three months ended June 30,2010 totaled $1,079,000 compared with $1,400,000 for the same period in 2009,which is an decrease of $321,000. Significant changes occurred in the following categories: decreases inmerchant credit card processing expense of $350,000, business development of$25,000, ATM expense of $20,000, loan expense of $14,000 and advertisingexpense of $11,000; while increases in FDIC insurance premiums of $75,000,other losses of $26,000 and MCB business card expense of $16,000.

 

Othergeneral and administrative expenses for the for the six months ended June 30,2010 totaled $2,213,000 compared with $2,546,000 for the same period in 2009,which is a decrease of $333,000. Significant changes occurred in the following categories: decreases inmerchant credit card processing expense of $485,000, ATM expense of $34,000,insurance expense of $24,000, miscellaneous expense of $18,000, businessdevelopment expense of $18,000, credit card program expense of $18,000, banksecurity of $17,000 and advertising expense of $11,000; while

 

27

----

Table of Contents

 

increasesin FDIC insurance premiums of $157,000, other losses of $74,000, MCB businesscard expense of $39,000, entertainment and meals of $11,000 and loan expense of$10,000; while.

 

OREOexpenses and provision for losses on foreclosed assets for the three months andsix months ended June 30, 2010 totaled $347,000 and $1,082,000,respectively compared to $221,000 and $629,000 during the same period in 2009.

 

**Provision for Income Taxes**

 

Thetax provision (benefit) was ($421,000) for the six months ended June 30,2010 compared to $173,000 for the same period in 2009, representing (55.54%)and 13.82% of pre-tax income for those periods. The decrease in the effective tax rate for 2010 is a direct result ofthe Bank’s investing in tax-exempt securities and decreasing income.

 

Theamount of the tax provision is determined by applying the Corporation’sstatutory income tax rates to pre-tax book income, adjusted for permanentdifferences between pre-tax book income and actual taxable income. Suchpermanent differences include but are not limited to tax-exempt interestincome; increases in the cash surrender value of bank-owned life insurance,certain other expenses that are not allowed as tax deductions, and tax credits.

 

Deferredtax assets and liabilities are measured using the enacted tax rates expected toapply to taxable income in the periods in which the deferred tax asset orliability is expected to be realized or settled.  The Bank maintains a valuation allowance withrespect to deferred tax assets due to the uncertainty surrounding therealization of certain net deferred tax assets.

 

**LOANS**

 

Average loans represented 65.37% of average earning assets and 56.77% ofaverage total assets for the six months ended June 30, 2010 compared with62.36% and 54.87%, respectively during 2009. For the six months ended June 30,2010, average loans decreased 3.52% to $161,089,000 from $170,665,000 for thesame period in 2009.  Average real estateloans increased $2,016,000 (1.68%), average commercial loans increased $125,000(0.36%); while average construction loans decreased $11,695,000 (80.16%) andaverage installment loans decreased $22,000 (1.49%).

 

The Bank’s commercial and industrial loans are generally made for thepurpose of providing working capital, financing the purchase of equipment orinventory, and other business purposes. Such loans generally have maturities ofone year or longer.  Short-term businessloans are generally intended to finance current transactions and typicallyprovide for monthly interest payments with principal being payable at maturityor at 90-day intervals. Term loans (usually for a term of two to five years)normally provide for monthly installments of principal and interest.  The Bank from time to time utilizes accountsreceivable and inventory as security for loans.

 

The Bank is a recognized leader for Small Business Administration (SBA)lending in Monterey County, and holds SBA’s coveted Preferred LenderStatus.  Generally, SBA loans areguaranteed, by the SBA, for 75 to 90 percent of their principal amount, whichcan be retained in the loan portfolio or sold to investors.  Such loans are made at floating interestrates, generally with longer terms (up to 25 years) than are available on aconventional loan basis to small businesses.  The unguaranteed portion ofthe loans, although generally supported by collateral, is considered to be morerisky than conventional commercial loans because they may be based upon

 

28

----

Table of Contents

 

credit standards the Bank would not otherwise apply, such as lower cashflow coverage, or longer repayment terms.

 

The Bank’s real estate loan portfolio consists of both real estateconstruction loans and real estate mortgage loans.  The Bank has initiated a program to generatemore commercial and industrial real estate loans, which generally yield higherreturns than normal commercial loans. The Bank has also developed a broker program for generating residentialreal estate loans.  Real estateconstruction loans are made for a much shorter term, and often at higherinterest rates, than conventional single-family residential real estateloans.  The cost of administering suchloans is often higher than for other real estate loans, as principal is drawnon periodically as construction progresses.

 

The Bank also makes real estate loans secured by a first deed of truston single family residential properties and commercial and industrial realestate.  California commercial banks arepermitted, depending on the type and maturity of the loan, to lend up to 90percent of the fair market value of real property (or more if the loan isinsured either by private mortgage insurers or governmental agencies).  In certain instances, the appraised value mayexceed the actual amount that could be realized on foreclosure, or declines inmarket value subsequent to making the loan can impair the Bank’s security.

 

Consumerloans are made for the purpose of financing the purchase of various types ofconsumer goods, home improvement loans, auto loans and other personalloans.  Consumer installment loansgenerally provide for monthly payments of principal and interest, at a fixedrate.  Most of the Bank’s consumerinstallment loans are generally secured by the personal property beingpurchased.  The Bank generally makesconsumer loans to those customers with a prior banking relationship with theBank.

 

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

 

The Bank’s present policy is to cease accruing interest on loans whichare past due as to principal or interest 90 days or more, except for loanswhich are well secured or when collection of interest and principal is deemedlikely.  When a loan is placed onnon-accrual, previously accrued and unpaid interest is generally reversed outof income unless adequate collateral from which to collect the principal andinterest on the loan is available and in the process of collection.

 

In relation to SBA loans sold, the Bank generally repurchases from thesecondary market the guaranteed portion of SBA guaranteed loans when thoseloans are placed on non-accrual status. After the foreclosure and collection process is complete, the SBA reimbursesthe Bank for this principal balance. Therefore, although these balances do not earn interest during thisperiod, they generally do not result in a loss of principal to the Bank.

 

The following table presents information with respect to loans which,as of the dates indicated, were past due 90 days or more or were placed onnon-accrual status and foreclosed assets (referred to collectively as “non-performingassets”):

 

29

----

Table of Contents

 
| ** **                                                           | ** ** | **As of**                  | ** ** | **As of**             | ** ** |
|----------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                           | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
| ** **                                                           | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2009** | ** ** |
| ** **                                                           | ** ** | **(Dollars in thousands)** | ** ** | ** **            | ** ** |
| Accruing, past due 90 days or more:                                  |       |                       |       |                  |       |   |   |
| Real Estate                                                          |       | $                          | —     |                  | $          | — |   | $ | — |   |
| Commercial                                                           |       | —                     |       | —                |       | — |   |
| Installment                                                          |       | —                     |       | —                |       | — |   |
| Other                                                                |       | —                     |       | —                |       | — |   |
| Total accruing                                                       |       | —                     |       | —                |       | — |   |
|                                                                 |       |                       |       |                  |       |   |   |
| Nonaccrual Loans:                                                    |       |                       |       |                  |       |   |   |
| Real Estate                                                          |       | 2,216                      |       | 5,320                 |       | 5,137 |   |
| Commercial                                                           |       | 1,939                      |       | 1,563                 |       | 2,943 |   |
| Installment                                                          |       | —                     |       | —                |       | — |   |
| Other                                                                |       | —                     |       | —                |       | — |   |
| Total nonaccrual                                                     |       | 4,155                      |       | 6,883                 |       | 8,080 |   |
|                                                                 |       |                       |       |                  |       |   |   |
| Total nonperforming loans                                            |       | 4,155                      |       | 6,883                 |       | 8,080 |   |
| Other Real Estate Owned                                              |       | 20,227                     |       | 12,020                |       | 14,333 |   |
| Total nonperforming assets                                           |       | $                          | 24,382     |                  | $          | 18,903 |   | $ | 22,413 |   |
|                                                                 |       |                       |       |                  |       |   |   |
| Total loans end of period                                            |       | $                          | 158,566    |                  | $          | 168,422 |   | $ | 166,742 |   |
|                                                                 |       |                       |       |                  |       |   |   |
| Ratio of nonperforming loans to total loans at end  of period        |       | 2.62                       | %          | 4.09                  | %          | 4.85 | % |
| Ratio nonperforming assets to total Loans and OREO  at end of period |       | 13.64                      | %          | 10.47                 | %          | 12.38 | % |

 

30

----

Table ofContents

 

Summary of Loan Loss Experience

 
| ** **                                                                     | ** ** | **Six months**             | ** ** | **Year ended**        | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                                     | ** ** | **Ended June 30,**    | ** ** | **December 31,** | ** ** |
| ** **                                                                     | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2009** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Average loans outstanding                                                      |       | $                          | 161,089    |                  | $          | 170,665 |   | $ | 169,853 |   |
|                                                                           |       |                       |       |                  |       |   |   |
| Total loans outstanding at end of the period                                   |       | $                          | 158,566    |                  | $          | 168,442 |   | $ | 166,742 |   |
|                                                                           |       |                       |       |                  |       |   |   |
| Allowance, beginning of period                                                 |       | $                          | 3,529      |                  | $          | 2,413 |   | $ | 2,413 |   |
|                                                                           |       |                       |       |                  |       |   |   |
| Loans charged off during period:                                               |       |                       |       |                  |       |   |   |
| Commercial                                                                     |       | 251                        |       | 13                    |       | 358 |   |
| Installment                                                                    |       | —                     |       | 35                    |       | 37 |   |
| Real Estate                                                                    |       | 27                         |       | 86                    |       | 1,908 |   |
| Other                                                                          |       | —                     |       | —                |       | 26 |   |
| Total charge offs                                                              |       | 278                        |       | 134                   |       | 2,329 |   |
|                                                                           |       |                       |       |                  |       |   |   |
| Recoveries during period:                                                      |       |                       |       |                  |       |   |   |
| Commercial                                                                     |       | —                     |       | 1                     |       | 2 |   |
| Installment                                                                    |       | —                     |       | —                |       | — |   |
| Real Estate                                                                    |       | —                     |       | —                |       | 75 |   |
| Other                                                                          |       | —                     |       | —                |       | — |   |
| Total recoveries                                                               |       | —                     |       | 1                     |       | 77 |   |
|                                                                           |       |                       |       |                  |       |   |   |
| Net loans charged off during the period                                        |       | 278                        |       | 133                   |       | 2,252 |   |
|                                                                           |       |                       |       |                  |       |   |   |
| Provision for loan losses                                                      |       | —                     |       | 646                   |       | 3,368 |   |
| Allowance, end of period                                                       |       | $                          | 3,251      |                  | $          | 2,926 |   | $ | 3,529 |   |
|                                                                           |       |                       |       |                  |       |   |   |
| Ratio of net loans charged off to average loans  outstanding during the period |       | 0.17                       | %          | 0.08                  | %          | 1.33 | % |
|                                                                           |       |                       |       |                  |       |   |   |
| Ratio of allowance to total loans at end of period                             |       | 2.05                       | %          | 1.74                  | %          | 2.12 | % |
|                                                                           |       |                       |       |                  |       |   |   |
| Ratio of nonperforming loans to allowance for loan  losses at end of period    |       | 127.81                     | %          | 235.24                | %          | 251.75 | % |

 

31

----

Table of Contents

 

Thefollowing table provides a breakdown of the allowance for loan losses bycategories as of the dates indicated:

 
| ** **                                   | ** ** | **As of June 30,**    | ** ** | **As of**                                     | ** ** |
|----------------------------------------------|------------|----------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2010**                   | ** ** | **2009**                                      | ** ** | **December 31, 2009** | ** ** |
| **Balance  at End of Period Applicable to:** | ** ** | **Amount**                 | ** ** | **% of  Loans in  Category  to Total  Loans** | ** ** | **Amount** | ** ** | **% of  Loans in  Category  to Total  Loans** | ** ** | **Amount** | ** ** | **% of  Loans in  Category  to Total  Loans** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Construction                                 |       | $                          | 3          |                                          | 0.8        | % | $ | 77 |   | 6.6 | % | $ | 338 |   | 5.2 | % |
| Commercial                                   |       | 737                        |       | 22.5                                          | %          | 446 |   | 21.4 | % | 995 |   | 20.1 | % |
| Installment                                  |       | 66                         |       | 0.4                                           | %          | 60 |   | 0.4 | % | 9 |   | 1.7 | % |
| Real Estate                                  |       | 2,328                      |       | 76.3                                          | %          | 2,330 |   | 71.6 | % | 2 174 |   | 73.0 | % |
| Unallocated                                  |       | 117                        |       | —                                        |       | 13 |   | — |   | 13 |   | — |   |
| Total allowance for loan and lease losses    |       | $                          | 3,251      |                                          | 100.0      | % | $ | 2,926 |   | 100.0 | % | $ | 3,529 |   | 100.0 | % |
|                                         |       |                       |       |                                          |       |   |   |   |   |   |   |   |   |
| Total loans end of period                    |       | $                          | 158,566    |                                          |       |   | $ | 168,442 |   |   |   | $ | 166,742 |   |   |   |

 

**Non-performing Assets**

 

The following table presents information with respect to nonperformingassets, as of the dates indicated. The non-accrual loans are net of theguaranteed portion of SBA loans and the OREO was acquired throughforeclosure.  The OREO was recorded atfair value less selling costs on the date of acquisition.

 
| ** **                                                     | ** ** | **As of**                  | ** ** | **As of**             | ** ** |
|----------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **Ended June 30,**    | ** ** | **December 31,** | ** ** |
| ** **                                                     | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2009** | ** ** |
| ** **                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Nonperforming loans                                            |       | $                          | 4,155      |                  | $          | 6,883 |   | $ | 8,080 |   |
| Other real estate owned, net (1)                               |       | 20,227                     |       | 12,020                |       | 14,333 |   |
| Total nonperforming assets                                     |       | $                          | 24,282     |                  | $          | 18,903 |   | $ | 22,413 |   |
|                                                           |       |                       |       |                  |       |   |   |
| Nonperforming loans to total gross loans                       |       | 2.62                       | %          | 4.09                  | %          | 4.85 | % |
| Nonperforming assets to total loans and OREO at  end of period |       | 13.64                      | %          | 10.47                 | %          | 12.38 | % |

 

----

(1) net of reserve for foreclosed assets losses of $1,252,000 as ofJune 30, 2010, $413,000 as of June 30, 2009 and $1,010,000 as ofDecember 31, 2009.

 

**Deposits**

 

Average interest bearing and non-interest-bearing deposits for the sixmonths ended June 30, 2010 were $218,558,000 an increase of 18.77%compared with the same period in 2009. Average certificates of deposit represented 73.60% of average depositsfor the six months ended June 30, 2010 compared with 73.98% for the sameperiod in 2009.  Average interest bearingchecking, money market and savings accounts as a group were 11.12% of averagedeposits for the six months ended June 30, 2010 compared with 10.68% forthe same period in 2009.  Averagenon-interest bearing deposits represented 15.28% of average deposits for thesix months ended June 30, 2010 compared with 15.35% for the same period in2009.

 

32

----

Table of Contents

 

Thefollowing table sets forth the scheduled maturities of the Corporation’s timedeposits in denominations of $100,000 or greater at June 30, 2010:

 

Maturitiesof Time Deposits of$100,000 or More

(Dollars in Thousands)

 
| Three months or less                  |   | $      | 10,184 |   |
|---------------------------------------|--------|--------|--------|--------|
| Over three months through six months  |   | 18,854 |   |
| Over six months through twelve months |   | 17,775 |   |
| Over twelve months                    |   | 23,179 |   |
| Total                                 |   | $      | 69,992 |   |

 

**Borrowings**

 

The Corporation has a line of credit with Marshall & IlsleyBank in the amount of $3,000,000, at a floating interest rate based on theone-month LIBOR Rate plus 3.75% with a floor rate of 6.50% and a maturity dateof October 30, 2010.  At June 30,2010, $2,850,000 was outstanding on the line of credit.

 

The Bank has lines of credit from the Federal Reserve Bank of SanFrancisco and the Federal Home Loan Bank (FHLB) of San Francisco with remainingavailable borrowing capacity on June 30, 2010 of $10,876,000 and $755,000,respectively.  The Federal Reserve Bankdiscount window line is secured by a portion of the Bank’s investmentsecurities at June 30, 2010.  At June 30,2010, the total book value of securities pledged to the Federal Reserve Bankwas $13,779,000 with no outstanding loan balance.  The Federal Home Loan Bank line of credit hasa maximum borrowing capacity of 20% of the Bank’s total assets, adjustedquarterly.  The Federal Home Loan Bankline of credit is secured by a blanket lien on the Bank’s loan and securitiesat June 30, 2010.  The totalprincipal balance at June 30, 2010 of pledged loans and securities at theFederal Home Loan Bank was $158,566,000 and $3,911,000, respectively.

 

The following table provides information on eleven FHLB advancesoutstanding at June 30, 2010.

 
| ** ** | ** ** | ** ** | ** ** | **Funding** | ** ** | **Maturity** | ** ** |
|------------|------------|------------|------------|-------------|------------|--------------|------------|
| **Amount** | ** ** | **Rate**   | ** ** | **Date**    | ** ** | **Date**     | ** ** |
| $          | 5,000,000  |       | 4.96       | %           | 11/14/05   |         | 11/15/10   |   |
| 1,750,000  |       | 4.74       | %          | 1/26/06     |       | 1/26/11      |       |
| 2,250,000  |       | 4.75       | %          | 1/26/06     |       | 1/26/11      |       |
| 3,500,000  |       | 5.51       | %          | 7/17/06     |       | 7/18/11      |       |
| 1,500,000  |       | 5.52       | %          | 7/17/06     |       | 7/18/11      |       |
| 1,000,000  |       | 5.22       | %          | 8/25/06     |       | 8/25/11      |       |
| 5,000,000  |       | 5.21       | %          | 7/30/07     |       | 7/30/12      |       |
| 3,000,000  |       | 4.85       | %          | 10/1/07     |       | 10/1/12      |       |
| 5,000,000  |       | 1.75       | %          | 3/15/10     |       | 3/15/13      |       |
| 5,000,000  |       | 5.01       | %          | 9/18/07     |       | 9/18/14      |       |
| 1,000,000  |       | 7.72       | %          | 6/1/00      |       | 6/3/30       |       |
| $          | 34,000,000 |       |       |        |       |         |       |   |

 

The Bank has two letters of credit issued byFederal Home Loan Bank of San Francisco. One letter of credit in the amount of$330,000, expiring April 17, 2011, is used to secure local agencydeposits.  The beneficiary of the letterof credit is the Administrator of Local Agency

 

33

----

Table of Contents

 

Security, Department of FinancialInstitutions.  The other letter of creditin the amount of $1,300,000, expiring February 17, 2019 has MasterCardInternational Inc. as the beneficiary.

 

**Capital Resources**

 

The Corporation maintains capital to comply with regulatoryrequirements, to provide a margin of safety for its depositors andstockholders, and to provide for future growth and the ability to paydividends.  At June 30, 2010,shareholders’ equity was $16,241,000 versus $16,150,000 at December 31,2009.  The Corporation paid no cashdividends to shareholders for the six months ended June 30, 2010 and forthe year ended December 31, 2009. The Bank paid no cash dividends to the Corporation for the six months June 30,2010 and $500,000 in dividends for the year ended December 31, 2009.

 

The FDIC and Federal Reserve Board have adopted capital adequacyguidelines for use in their examination and regulation of banks and bankholding companies.  If the capital of abank or bank holding company falls below the minimum levels established bythese guidelines, it may be denied approval to acquire or establish additionalbanks or non-bank businesses, or the FDIC or Federal Reserve Board may takeother administrative actions.  The guidelinesemploy two measures of capital:  (1) risk-basedcapital and (2) leverage capital.

 

In general, the risk-based capital guidelines provide detaileddefinitions of which obligations will be treated as capital, and assigndifferent weights to various assets and off-balance sheet items, depending uponthe perceived degree of credit risk associated with each asset.  Each asset is assigned to one of fourrisk-weighted categories.  For example, 0percent for cash and unconditionally guaranteed government securities; 20percent for deposits with other banks and fed funds; 50 percent for state bondsand certain residential real estate loans; and 100 percent for commercial loansand other assets.  Capital is categorizedas either Tier 1 capital, consisting of common stock and retained earnings (ordeficit), or Tier 2 capital, which includes limited-life preferred stock andallowance for loan losses (subject to certain limitations).  The guidelines also define and set minimumcapital requirements to maintain Tier 1 capital of at least 4.0% and total capitalof 8.0% of risk-adjusted assets. The Bank had a Tier 1 capital to totalrisk-adjusted assets capital ratio of 13.59% and 12.12% at June 30, 2010and 2009, respectively.  The Bank’s Tier1 capital exceeds the minimum regulatory requirement by $18,300,000.  The Bank had a Total Risk-Based capital torisk-adjusted assets ratio of 14.84% and 13.38% at June 30, 2010 and 2009,respectively.  The Bank’s TotalRisk-Based capital exceeds the minimum regulatory requirement by $13,000,000.

 

TheTier 1 leverage capital ratio guidelines require a minimum leverage capitalratio of 4.0% of Tier 1 capital to total assets less goodwill.  The Bank had a leverage capital ratio of8.93% and 8.35% at June 30, 2010 and 2009, respectively.  The Bank’s Tier 1 leverage capital exceedsthe minimum regulatory requirement by $14,300,000.

 

Underregulatory guidelines, the $8 million in Trust Preferred Securities outstandingqualify as Tier 1 capital up to 25% of Tier 1 capital.  Any additional Trust Preferred Securitieswill qualify as Tier 2 capital.

 

TheCorporation’s Board of Directors approved a stock repurchase program pursuantto which the Corporation, from time to time and at management’s discretion, mayrepurchase up to $500,000 of the Corporation’s outstanding shares.  The Corporation did not repurchase any sharesof stock during the six months ended June 30, 2010.  The Corporation repurchased 20,678 shares ofcommon stock at an average cost of $4.20 per share in open market transactionsduring 2009.

 

34

----

Table of Contents

 

TheCorporation repurchased 46,010 shares of common stock at an average cost of$7.51 per share in open market transactions during 2008.

 

InOctober 2008, the Board and the holders of more than a majority of ourissued and outstanding common stock approved by written consent, an amendmentto the Corporation’s articles of incorporation (the “Amendment”).  The Amendment authorizes the Corporation toissue up to 10,000,000 shares of preferred stock, which may be issued from timeto time in one or more series as determined by the Board.  The Board is authorized to designate allrights, preferences, privileges and restrictions attendant to each series aswell as the number of shares authorized for issuance in each series of thepreferred stock, which matters shall be expressed in resolutions adopted by theBoard and filed with the Secretary of State of the state of California.  Additionally, the Amendment authorizes theCorporation to issue an additional 7,500,000 shares of common stock for a totalof 10,000,000 shares of common stock authorized for issuance after theAmendment.  The Amendment became effectiveJanuary 23, 2009. There were no shares issued as of June 30, 2010.

 

**Other Regulatory Matters**

 

TheFDIC has submitted a proposed Consent Order, including proposed monetarypayments, related to its 2008 Consumer Compliance Examination, which wascompleted in 2009.  The FDIC has allegedthe existence of certain violations of consumer laws and regulations for creditcard programs operated by third party vendors. The Bank denies committing such alleged violations and hopes thatongoing negotiations with the FDIC will result in a mutually agreeableresolution to this matter.  If a mutuallyagreeable resolution cannot be reached, the Bank anticipates that the FDIC willinstitute an administrative proceeding, at which the Bank would continue todeny the allegations and oppose the imposition of the monetary payments.  The financial and non-financial impact ofthis matter is not known as of the balance sheet date or as of the issuancedate of this report; however, no assurance can be given that the costs ofdefense and/or the monetary payments that might ultimately imposed won’t bematerial.

 

**Liquidity**

 

Liquidity represents the ability to provide sufficient cash flows orcash resources in a manner that enables an entity to meet its obligations in atimely fashion and adequately provide for anticipated future cash needs.

 

For the Bank, liquidity considerations involve the capacity to meetexpected and potential requirements of depositors seeking access to balancesand to provide for the credit demands of borrowing customers.  In the ordinary course of the Bank’sbusiness, funds are generated from the repayment of loans, maturities withinthe investment securities portfolio and the acquisition of deposit balances andshort-term borrowings.  In addition, theBank has a line of credit from the Federal Home Loan Bank of San Francisco ofapproximately $58,456,000, based on 20 percent of the Bank’s total assets asreported in the most recent quarterly Consolidated Reports of Condition andIncome for a bank with Domestic Offices Only. The line of credit is subject to pledging of acceptable collateral. At June 30,2010, $755,000 in excess collateral was pledged.  The Bank has a borrowing line with theFederal Reserve Bank of San Francisco secured****aportion of the Bank’s securities, with available overnight borrowing of$10,876,000 at June 30, 2010.

 

As a matter of policy, the Bank seeks to maintain a level of liquidassets, including marketable investment securities, equal to a least 15 percentof total assets (“total liquidity”). Additionally the Bank maintains secondarysources of liquidity (borrowing lines from other

 

35

----

Tableof Contents

 

institutions)equal to at least an additional 10 percent of assets.  Within these ratios, the Bank generally hasexcess funds available to sell as federal funds on a daily basis, and is ableto fund its own liquidity needs without the need of short-term borrowing.  The Bank’s total liquidity at June 30,2010 and 2009 was 34.28% and 34.89%, respectively, while its average loan toaverage deposit ratio for such years was 73.80% and 90.85%, respectively.

 

Brokereddeposits are deposit instruments, such as certificates of deposit, depositnotes, bank investment contracts and certain municipal investment contractsthat are issued through brokers and dealers who then offer and/or sell thesedeposit instruments to one or more investors. Additionally, deposits on which a financial institution pays an interestrate significantly higher than prevailing rates are considered to be brokereddeposits.  Federal law and regulation restrictsbanks from soliciting or accepting brokered deposits, unless the bank is wellcapitalized under Federal guidelines. The Bank has received notice from the FDIC that its capitalclassification has been designated as adequately capitalized; therefore theBank is prohibited from accepting new or renewing any brokered deposits. TheBank had $61,232,000 in brokered deposits at June 30, 2010 compared with$1,025,000 in brokered deposits at June 30, 2009.

 

**Deferralof Interest Payments on Trust Preferred Securities**

 

The Corporation has exercised its rights in accordance with Section 2.11Extension of Interest Payment Period of the Indentures dated March 27,2003 for Northern California Bancorp, Inc. Trust I and November 3,2003 for Northern California Bancorp, Inc. Trust II to defer interestpayments for an undetermined period of time, not to exceed twenty (20)consecutive quarterly payments.  Thedeferral of interest payments on Northern California Bancorp, Inc. Trust Iwas effective with the October 7, 2009 interest payment.  The deferral of interest payments on NorthernCalifornia Bancorp, Inc. Trust II was effective with the November 8,2009 interest payment.

 

**InterestRate Risk**

 

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

 

The purpose of asset/liability management is to provide stable netinterest income growth by protecting the Bank’s earnings from undue interestrate risk.  The Bank expects to generateearnings from increasing loan volume, appropriate loan pricing and expensecontrol and not from trying to accurately forecast interest rates.  Another important function of asset/liabilitymanagement is managing the risk/return relationships between interest raterisk, liquidity, market risk and capital adequacy.  The Bank gives priority to liquidity concernsfollowed by capital adequacy, then interest rate risk and market risk in theinvestment portfolio.  The policy of theBank is to control the exposure of the Bank’s earnings to changing interestrates by generally maintaining a position within a narrow range around an “earningsneutral position.” An earnings neutral position is defined as the mix of assetsand liabilities that generate a net interest margin that is not affected byinterest rate changes.  However,Management does not believe that the Bank can maintain a totally earningsneutral position.  Further, the actualtiming of repricing of assets and liabilities does not always correspond to thetiming assumed by the Bank for analytical purposes.  Therefore, changes in market rates ofinterest will generally impact the Bank’s net interest income and net interestmargin for long or short periods of time.

 

36

----

Table of Contents

 

TheBank monitors its interest rate risk on a quarterly basis through the use of amodel which calculates the effect on earnings of changes in the fed fundsrate.  The model converts a fed fundsrate change into rate changes for each major class of asset and liability, thensimulates the bank’s net interest margin based on the bank’s actual repricingover a one year period, assuming that maturities are reinvested in instrumentsidentical to those maturing during the period. The following table shows the affect on net interest income of variousrate shocks, expressed in basis points, at June 30, 2010.  The table includes one projection for adecrease in rates, as the Federal Funds target rate is currently between 0% and0.25%.

 
| **Rate  Shock Increase in  Basis Points** | ** ** | **Percent Increase in Net  Interest Income** | ** ** |
|-------------------------------------------|------------|----------------------------------------------|------------|
| -25                                       |       | -1.2                                         | %          |
| 100                                       |       | 5.5                                          | %          |
| 200                                       |       | 11.4                                         | %          |
| 300                                       |       | 17.3                                         | %          |
| 400                                       |       | 23.3                                         | %          |

 

**Item 4T. Controls and Procedures**

 

(a) TheCorporation’s Chief Executive Officer and its Chief Financial Officer, afterevaluating the effectiveness of the Bank’s disclosure controls and proceduresas defined in Exchange Act Rules 13a-15(e) promulgated under theExchange Act as of the end of the period covered by this report (the “EvaluationDate”) have concluded that as of the Evaluation Date, the Corporation’sdisclosure controls and procedures were adequate and effective to ensure thatmaterial information relating to the Corporation would be made known to them byothers within the Bank, particularly during the period in which this report wasbeing prepared.  Disclosure controls andprocedures are designed to ensure that information required to be disclosed byus in the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

(b) Changes in Internal Controls: In the quarter ended June 30, 2010, the Corporation did not makeany significant changes in, nor take any corrective actions regarding, itsinternal controls or other factor that could significantly affect thesecontrols.

 

37

----

Table of Contents

 

**PART II-OTHER INFORMATION**

 

**Item 1.  Legal Proceedings.**

 

The Bank, its Chief Executive Officer and Chief Credit Officer werenamed as defendants in a lawsuit filed July 27, 2009 in the MontereyCounty Superior Court by Bank of the Orient. The lawsuit involves claims related to loan participations purchasedfrom the Bank and seeks rescission of the participation agreements or damagesand attorneys’ fees and costs.  While theaction was originally filed in the Superior Court under the terms of theparticipation agreements the matter has been submitted to arbitration throughthe American Arbitration Association.

 

The parties have reached a tentative settlement of the claims raised inthe litigation.  Under the tentativesettlement the Bank will reacquire Bank of the Orient’s interest in four of theloan participations and the collateral securing the loans.  This will result in a one-time after taxcharge to the Bank’s capital of $390,000. The Bank anticipates that the settlement will be consummated by December 31,2010.

 

The Bank, its Chief Financial Officer and a former Senior VicePresident were named as defendants in a lawsuit filed February 26, 2009 inMonterey County Superior Court, Civil Division, by Tighorn Financial Services,LLC (“Tighorn”).  The lawsuit seeks tocompel the Bank to continue its credit card sponsorship program with Tighornand the servicing of a credit card portfolio under a card sponsorship agreementwith a third party.  The suit alsoalleges that Tighorn was misled into entering the credit card sponsorshipagreement. For its part, the Bank has responded by contending that it properlyterminated the sponsorship agreement pursuant to termination provisionscontained in the parties’ Agreement, and that the Bank properly gave Tighornwritten notice of termination of the Agreement in June 2008.  The Bank has filed a counter claim fordamages and equitable relief against Tighorn, and the Bank’s Chief financialOfficer has filed cross-complaints against two Tighorn representatives and athird party claiming indemnity and equitable apportionment under Californialaw.   .

 

The Bank, Chief Executive Officer and Chief Credit Officer were namedas defendants in a lawsuit filed April 29, 2009 in the Monterey CountySuperior Court’s, by First Foundation Bank. The lawsuit involves claims related to two loan participations purchasedby First Foundation Bank from Monterey County Bank.  The lawsuit seeks to rescind theparticipation agreements, payment of all principal and interest, damages,attorneys’ fees and costs.

 

While the action was originally filed in the Superior Court, under theterms of the participation agreements, the matter has been submitted toarbitration through the American Arbitration Association.

 

MontereyCounty Bank was named as defendant in two separate actions filed June 17, 2008and June 26, 2008 to foreclose mechanic’s liens on site improvementsperformed in the amounts of $1.5 million and $6.0 million, respectively. Theactions assert that the mechanic’s liens have priority over the Bank’s Deeds ofTrust against various lots in the subdivision that were benefited by the siteimprovements. In the legal counsel’s opinion the Bank does not have anyexposure in these matters because the priority of its trust deeds are insuredby policies of title insurance.

 

Northern California Bancorp, Inc, Monterey County Bank and theChief Executive Officer among other unrelated parties were named as defendantsin a lawsuit filed July 22, 2010 in the Monterey County Superior Court bySouth Valley Developers, Inc. and Paseo Vista LLC. The

 

38

----

Table of Contents

 

lawsuit seeks a declaration of the parties’ respective obligationsunder a profit participation agreement in which the bank is a successor ininterest as well as for breach of contract and fraud related to a loan extendedto one of the plaintiffs and for injunctive relief pending the declaratoryjudgment.

 

Although the amount of any ultimate liability with respect to the aboveproceedings cannot be determined, in the opinion of management, any suchliability will not have a material effect on the consolidated financialposition of the Corporation and its subsidiary, except as previously addressedabove.

 

**Item 2.  Unregistered Sales ofEquity Securities and Use of Proceeds**

 

None

 

**Item 3.  Defaults upon SeniorSecurities**

 

None

 

**Item 4.  Submission of Matters toa Vote of Security Holders.**

 

None

 

**Item 5.  Other Information.**

 

None

 

**Item 6.  Exhibits**

 
| A.     | EXHIBITS |
|--------|----------|
|   |     |   |
|   | 31.1     | Certification  of the Chief Executive Officer of Northern California Bancorp, Inc.  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|   |     |   |
|   | 31.2     | Certification of the Chief Financial Officer of  Northern California Bancorp, Inc. pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |     |   |
|   | 32.1     | Certification of the Chief Executive Officer of  Northern California Bancorp, Inc. pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|   |     |   |
|   | 32.2     | Certification of the Chief Financial Officer of  Northern California Bancorp, Inc. pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

39

----

Table of Contents

 

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                        | NORTHERN  CALIFORNIA BANCORP, INC. |
|-----------------------------|-----------------------------------------|
|                        |                                    |   |
| Date:  August 19, 2010 |                                    | By: | /s/  Charles T. Chrietzberg, Jr. |
|                        |                                    | Charles  T. Chrietzberg, Jr. |
|                        |                                    | Chairman  of the Board & |
|                        |                                    | Chief  Executive Officer |
|                        |                                    |   |
|                        |                                    |   |
| Date:  August 19, 2010 |                                    | By: | /s/  Bruce N. Warner |
|                        |                                    | Bruce  N. Warner |
|                        |                                    | Chief  Financial Officer and |
|                        |                                    | Principal  Accounting Officer |

 

40

----