Tableof Contents

 

 

 

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

**Washington,D.C.  20549**

** **

**FORM 10-Q**

 

**x****     ****Quarterly report under Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

 

**for thequarterly period ended June 30, 2009**

 

**o****        ****Transition report under Section 13 or 15(d) of the SecuritiesExchange Act of 1934 (No fee required)**

 

**for the period from                 to                **

 

**Commission File Number 0-27666**

 

**NORTHERN CALIFORNIA BANCORP, INC.**

(Name of Small Business Issuer in its Charter)

 

**Incorporated in the State of California**

**IRS Employer Identification Number 77-0421107**

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

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

 

Check whether theissuer: (1) filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act during the past 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90days.      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 checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act. Yes  o  No  x

 

As of August 10,2009, the Corporation had 1,783,230 shares of common stock outstanding.

 

 

 

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TABLE OF CONTENTS

 
| **Facing Page**       | 1                                                                                           |
|-----------------------|---------------------------------------------------------------------------------------------|
| **Table of Contents** | 2                                                                                           |
| **PART I**       | Financial Information                                                                       | 3-7 |
| Item 1                | Financial Statements                                                                        |   |
|                  | Consolidated  Balance Sheets                                                                | 3-4 |
|                  | Consolidated  Statements of Operations                                                      | 5 |
|                  | Consolidated****Statements****of  Changes in Shareholders’ Equity                      | 6 |
|                  | Consolidated  Statements of Cash Flows                                                      | 7 |
|                  | Summary of  Accounting Policies                                                             | 8-15 |
| Item 2                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 16-37 |
| 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                                | 38 |
| Item 3                | Defaults Upon  Senior Securities                                                            | 38 |
| Item 4                | Submission of  Matters to a Vote of Security Holders                                        | 38 |
| Item 5                | Other Information                                                                           | 39 |
| Item 6                | Exhibits                                                                                    | 39 |
| Signatures            | 39                                                                                          |
| Certifications        | 40-43                                                                                       |

 

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**PART I-FINANCIALINFORMATION**

 

Item 1.        FINANCIALSTATEMENTS

 

NORTHERNCALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATEDBALANCE SHEETS

 
| ** **                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(in thousands except share  data)**                                               | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                          | ** ** | **(Unaudited)**   | ** ** | **(Audited)**         | ** ** |
| ASSETS:                                                                             |       |              |       |                  |       |
| Cash  and Due From Banks                                                            |       | $                 | 6,412      |                  | $          | 16,348 |   |
| Time  Deposits with other Financial Institutions                                    |       | 3,199             |       | 3,500                 |       |
| Trading  Assets                                                                     |       | 224               |       | 361                   |       |
| Investment  Securities, available for sale (AFS)(Note 5)                            |       | 89,542            |       | 93,353                |       |
| Other  Investments (Note 6)                                                         |       | 4,067             |       | 3,852                 |       |
| Loans  Held for Sale, at lower of cost or market                                    |       | 2,822             |       | 1,650                 |       |
| Loans,  net of allowance for loan losses of $2,926 in 2009; $2,413 in 2008 (Note 7) |       | 162,437           |       | 165,530               |       |
| Bank  Premises and Equipment, Net                                                   |       | 4,843             |       | 4,988                 |       |
| Cash  Surrender Value of Life Insurance                                             |       | 4,032             |       | 3,969                 |       |
| Other  Real Estate Owned                                                            |       | 12,020            |       | 7,364                 |       |
| Interest  Receivable and Other Assets                                               |       | 4,001             |       | 5,286                 |       |
| Total  Assets                                                                       |       | $                 | 293,599    |                  | $          | 306,201 |   |
|                                                                                |       |              |       |                  |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY:                                         |       |              |       |                  |       |
|                                                                                |       |              |       |                  |       |
| Non  interest-bearing demand                                                        |       | $                 | 29,974     |                  | $          | 25,812 |   |
| Interest-bearing  demand                                                            |       | 15,224            |       | 14,240                |       |
| Savings                                                                             |       | 5,890             |       | 6,159                 |       |
| Time  less than $100,000                                                            |       | 97,571            |       | 88,188                |       |
| Time  in denominations of $100,000 or more                                          |       | 54,227            |       | 55,331                |       |
| Total  Deposits                                                                     |       | 202,886           |       | 189,730               |       |
|                                                                                |       |              |       |                  |       |
| Short-term  borrowed funds                                                          |       | 18,000            |       | 18,000                |       |
| Federal  Home Loan Bank Borrowed Funds                                              |       | 41,500            |       | 66,500                |       |
| Junior  Subordinated Debt Securities                                                |       | 8,248             |       | 8,248                 |       |
| Payable  for Investment Securities Purchased                                        |       | —            |       | 3,050                 |       |
| Interest  Payable and Other Liabilities                                             |       | 6,325             |       | 6,321                 |       |
| Total  Liabilities                                                                  |       | 276,959           |       | 291,849               |       |

 

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| ** **                                                                                                                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(in thousands except share  data)**                                                                                                    | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                               | ** ** | **(Unaudited)**   | ** ** | **(Audited)**         | ** ** |
| Shareholders’  Equity:                                                                                                              |       |              |       |                  |       |
| Common  Stock - No Par Value  Authorized: 10,000,000 in 2009 and 2,500,000 in 2008  Outstanding: 1,783,230 in 2009 and 1,803,908 in 2008 |       | 5,088             |       | 5,173                 |       |
| Retained  Earnings                                                                                                                       |       | 10,560            |       | 9,481                 |       |
| Accumulated  Other Comprehensive Income (Loss) (Note 8)                                                                                  |       | 992               |       | (302                  | )          |
| Total  Shareholders’ Equity                                                                                                         |       | 16,640            |       | 14,352                |       |
| Total  Liabilities & Shareholders’ Equity                                                                                  |       | $                 | 293,599    |                  | $          | 306,201 |   |
|                                                                                                                                          |            |                   |            |                       |            |  |  |

 

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NORTHERNCALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF OPERATIONS (UNAUDITED)

 
| ** **                                                              | ** ** | **THREE-MONTH PERIOD  ENDED** | ** ** | **SIX-MONTH PERIOD  ENDED** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** **                                                              | ** ** | **June 30**              | ** ** | **June 30**            | ** ** |
| **(in thousands except share  data)**                                   | ** ** | **2009**                      | ** ** | **2008**                    | ** ** | **2009** | ** ** | **2008** | ** ** |
| INTEREST  INCOME:                                                       |       |                          |       |                        |       |   |   |   |   |
| Loans                                                                   |       | $                             | 2,697      |                        | $          | 2,963 |   | $ | 5,689 |   | $ | 6,711 |   |
| Time  deposits with other financial institutions                        |       | 5                             |       | —                      |       | 10 |   | 12 |   |
| Investment  securities                                                  |       | 1,319                         |       | 965                         |       | 2,758 |   | 1,722 |   |
| Federal  funds sold                                                     |       | 1                             |       | 47                          |       | 1 |   | 151 |   |
| Total  Interest Income                                                  |       | 4,022                         |       | 3,975                       |       | 8,458 |   | 8,596 |   |
|                                                                    |       |                          |       |                        |       |   |   |   |   |
| INTEREST  EXPENSE:                                                      |       |                          |       |                        |       |   |   |   |   |
| Interest-bearing  transaction accounts                                  |       | 6                             |       | 12                          |       | 12 |   | 24 |   |
| Savings  and time deposit accounts                                      |       | 891                           |       | 831                         |       | 1,836 |   | 1,673 |   |
| Time  deposits in denominations of $100,000 or more                     |       | 523                           |       | 711                         |       | 1,068 |   | 1,482 |   |
| Notes  payable and other                                                |       | 1,103                         |       | 863                         |       | 1,980 |   | 1,727 |   |
| Total  Interest Expense                                                 |       | 2,523                         |       | 2,417                       |       | 4,896 |   | 4,906 |   |
|                                                                    |       |                          |       |                        |       |   |   |   |   |
| Net  Interest Income                                                    |       | 1,499                         |       | 1,558                       |       | 3,562 |   | 3,690 |   |
| Provision  for loan losses                                              |       | 396                           |       | —                      |       | 646 |   | — |   |
| Net  interest income, after provision for loan losses                   |       | 1,103                         |       | 1,558                       |       | 2,916 |   | 3,690 |   |
|                                                                    |       |                          |       |                        |       |   |   |   |   |
| NON-INTEREST  INCOME:                                                   |       |                          |       |                        |       |   |   |   |   |
| Service  charges on deposit accounts                                    |       | 154                           |       | 241                         |       | 345 |   | 404 |   |
| Income  from sales and servicing of Small Business Administration Loans |       | 59                            |       | 51                          |       | 97 |   | 216 |   |
| Other  income                                                           |       | 2,497                         |       | 935                         |       | 3,861 |   | 2,397 |   |
| Total  non-interest income                                              |       | 2,710                         |       | 1,227                       |       | 4,303 |   | 3,017 |   |
|                                                                    |       |                          |       |                        |       |   |   |   |   |
| NON-INTEREST  EXPENSE:                                                  |       |                          |       |                        |       |   |   |   |   |
| Salaries  and Employee Benefits                                         |       | 772                           |       | 899                         |       | 1,570 |   | 2,004 |   |
| Occupancy  and Equipment Expense                                        |       | 254                           |       | 234                         |       | 515 |   | 472 |   |
| Foreclosed  assets, net                                                 |       | 221                           |       | 532                         |       | 629 |   | 532 |   |
| Professional  Fees                                                      |       | 464                           |       | 63                          |       | 527 |   | 117 |   |
| Data  Processing                                                        |       | 91                            |       | 90                          |       | 180 |   | 191 |   |
| Other  general and administrative                                       |       | 1,316                         |       | 963                         |       | 2,546 |   | 1,691 |   |
| Total  non-interest expenses                                            |       | 3,118                         |       | 2,781                       |       | 5,967 |   | 5,007 |   |
|                                                                    |       |                          |       |                        |       |   |   |   |   |
| Income  before income tax provision                                     |       | 695                           |       | 4                           |       | 1,252 |   | 1,700 |   |
| Income  tax provision                                                   |       | 131                           |       | 68                          |       | 173 |   | 844 |   |
| Net  income (loss)                                                      |       | $                             | 564        |                        | $          | (64 | ) | $ | 1,079 |   | $ | 856 |   |
| Earnings  (loss) per common share                                       |       |                          |       |                        |       |   |   |   |   |
| Basic                                                                   |       | $                             | 0.313      |                        | $          | (0.035 | ) | $ | 0.600 |   | $ | 0.465 |   |
| Diluted                                                                 |       | $                             | 0.313      |                        | $          | (0.034 | ) | $ | 0.599 |   | $ | 0.461 |   |

 

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NORTHERN CALIFORNIA BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OFCHANGES 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, 2007                                                                                        |       | 1,845,918      |       | $          | 5,502      |         | $          | 8,831               |       | $          | 101        |   | $ | 14,434 |   |
|                                                                                                                      |       |           |       |       |       |         |       |                |       |       |       |
| Cumulative  effect - application of new accounting standard EITF 06-4 and EITF 06-10                                      |       | —         |       | —     |       | (362         | )          | —              |       | (362       | )          |
|                                                                                                                      |       |           |       |       |       |         |       |                |       |       |       |
| Comprehensive  income:                                                                                                    |       |           |       |       |       |         |       |                |       |       |       |
| Net  income for the year                                                                                                  |       | —         |       | —     |       | 1,462        |       | —              |       | 1,462      |       |
| Change  in net unrealized gain on AFS securities and other assets, net of tax  reclassification adjustment and tax effect |       | —         |       | —     |       | —       |       | (403                | )          | (403       | )          |
| Total  comprehensive income                                                                                               |       |           |       |       |       |         |       |                |       | 1,059      |       |
| Stock  repurchase                                                                                                         |       | (46,010        | )          | (341       | )          | —       |       | —              |       | (341       | )          |
| $0.25  per share dividend                                                                                                 |       | —         |       | —     |       | (450         | )          | —              |       | (450       | )          |
| Exercise  of stock options, Including tax benefit                                                                         |       | 4,000          |       | 12         |       | —       |       | —              |       | 12         |       |
|                                                                                                                      |       |           |       |       |       |         |       |                |       |       |       |
| Balance  at December 31, 2008 (Audited)                                                                              |       | 1,803,908      |       | 5,173      |       | 9,481        |       | (302                | )          | $          | 14,352     |   |
|                                                                                                                      |       |           |       |       |       |         |       |                |       |       |       |
| Comprehensive  income:                                                                                                    |       |           |       |       |       |         |       |                |       |       |       |
| Net  income for the year                                                                                                  |       | —         |       | —     |       | 1,079        |       | —              |       | 1,079      |       |
| Change  in net unrealized loss on AFS securities and other assets, net of tax  reclassification adjustment and tax effect |       | —         |       | —     |       | —       |       | 1,294               |       | 1,294      |       |
| Total  comprehensive income                                                                                               |       |           |       |       |       |         |       |                |       | 2,373      |       |
|                                                                                                                      |       |           |       |       |       |         |       |                |       |       |       |
| Stock  repurchase                                                                                                         |       | (20,678        | )          | (85        | )          | —       |       | —              |       | (85        | )          |
|                                                                                                                      |       |           |       |       |       |         |       |                |       |       |       |
| Balance  at June 30, 2009 (Unaudited)                                                                                |       | 1,783,230      |       | $          | 5,088      |         | $          | 10,560              |       | $          | 992        |   | $ | 16,640 |   |

 

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NORTHERNCALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF CASH FLOWS (UNAUDITED)

SIX MONTHS ENDEDJUNE 30, 2009 AND 2008

 
| ** **                                                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                           |       |     |       |     |       |
| Net  income                                                                        |       | $        | 1,079      |     | $          | 856 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |     |       |     |       |
| Depreciation  and amortization expense                                             |       | 171      |       | 154      |       |
| Realized  (gain) loss on sales of AFS, net                                         |       | (1,135   | )          | (449     | )          |
| Amortization  of deferred loan fees, net                                           |       | 75       |       | 243      |       |
| Amortization (accretion) of discounts and premiums on investment  securities, net  |       | (135     | )          | (93      | )          |
| Provision  for loan losses                                                         |       | 646      |       | —   |       |
| Provision  for foreclosed asset losses                                             |       | 411      |       | 532      |       |
| Increase  in cash surrender value of life insurance                                |       | (63      | )          | (61      | )          |
| Deferred  income tax benefit                                                       |       | 676      |       | 103      |       |
| (Increase)  decrease in assets:                                                    |       |     |       |     |       |
| Trading  assets                                                                    |       | 137      |       | 480      |       |
| Loans  held for sale                                                               |       | (1,172   | )          | 1,636    |       |
| Interest  receivable                                                               |       | 326      |       | (685     | )          |
| Other  assets                                                                      |       | 310      |       | 2,817    |       |
| Increase  (decrease) in liabilities:                                               |       |     |       |     |       |
| Interest  payable                                                                  |       | (376     | )          | (327     | )          |
| Other  liabilities                                                                 |       | 67       |       | 1,468    |       |
| Net  cash provided by operating activities                                         |       | 1,017    |       | 6,674    |       |
|                                                                               |       |     |       |     |       |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                           |       |     |       |     |       |
| Net  change in time deposits with other financial institutions                     |       | 301      |       | —   |       |
| Activity  in AFS securities                                                        |       |     |       |     |       |
| Sales                                                                              |       | 64,959   |       | 33,119   |       |
| Maturities,  prepayments, and calls                                                |       | (1,546   | )          | (770     | )          |
| Purchases                                                                          |       | (60,017  | )          | (63,705  | )          |
| Net  increase in loans                                                             |       | (1,783   | )          | (9,771   | )          |
| Loan  sales                                                                        |       | —   |       | 14,252   |       |
| Investment  in other real estate owned                                             |       | (914     | )          | —   |       |
| Additions  to bank premises and equipment                                          |       | (24      | )          | (364     | )          |
| Net  cash provided (used) by investing activities                                  |       | 976      |       | (27,239  | )          |
|                                                                               |       |     |       |     |       |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                           |       |     |       |     |       |
| Net  increase in deposits                                                          |       | 13,156   |       | 9,558    |       |
| Proceeds  from borrowings                                                          |       | 15,000   |       | 8,250    |       |
| Repayments  on borrowing, net                                                      |       | (40,000  | )          | (294     | )          |
| Proceeds  from exercise of stock options                                           |       | —   |       | 12       |       |
| Repurchase  of common stock                                                        |       | (85      | )          | —   |       |
| Net  cash provided (used) by financing activities                                  |       | (11,929  | )          | 17,526   |       |
|                                                                               |       |     |       |     |       |
| Net  decrease in cash and cash equivalents                                         |       | (9,936   | )          | (3,039   | )          |
|                                                                               |       |     |       |     |       |
| **CASH AND CASH EQUIVALENTS, BEGINNING**                                           |       | 16,348   |       | 20,153   |       |
|                                                                               |       |     |       |     |       |
| **CASH AND CASH EQUIVALENTS, ENDING**                                              |       | $        | 6,412      |     | $          | 17,114 |   |

 

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**SUMMARY OF ACCOUNTING POLICIES**

 

(NOTE 1) NATURE OFBUSINESS AND ****BASIS OFPRESENTATION****

 

*Nature of Business*

 

Northern CaliforniaBancorp, 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.

 

The Corporation owns 100%of Monterey County Bank (the “Bank”) which operates five full service branchesin Monterey County, California. The Corporation owns 100% of the common stockof two unconsolidated special purpose business trusts, “Northern CaliforniaBancorp, Inc. Trust I” and “Northern California Bancorp, Inc. TrustII”.

 

*Basisof Presentation*

 

Theinterim condensed financial statements of Northern California Bancorp, Inc.and Monterey County Bank are unaudited and reflect all adjustments(consisting only of normal recurring adjustments), which are, in the opinion ofmanagement, necessary for a fair presentation, in all material respects, of thefinancial position and operating results of the Corporation for the interimperiods.  The results of operations for the six months ended June 30,2009 are not necessarily indicative of the results to be expected for theentire fiscal year ending December 31, 2009.  The year-endbalance sheet data at December 31, 2008 was derived from the auditedfinancial statements.  All materialintercompany balances and transactions 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, 2008.

 

(NOTE 2) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

In April 2009, the Financial AccountingStandards Board (FASB) issued Financial Staff Position (FSP) FAS 107-1 and APB28-1, “Interim Disclosures about Fair Value of Financial Instruments.” FSP FAS107-1 and APB 28-1 amends Statement of Financial Accounting Standards (SFAS) No. 107,“Disclosures about Fair Value of Financial Instruments,” to require disclosuresabout fair value of financial instruments for interim reporting periods ofpublicly traded companies as well as in annual financial statements. Inaddition, the FSP amends APB Opinion No. 28, “Interim Financial Reporting,”to require those disclosures in summarized financial information at interimreporting periods. The FSP is effective for interim periods ending after June 15,2009, with earlier adoption permitted for periods ending after March 15,2009. The impact of adopting FSP FAS 107-1 and APB 28-1 in the second quarterof 2009 did not have a material impact on its Corporation’s consolidatedfinancial statements.

 

InJune 2009, the FASB issued SFAS No. 167, *Amendments to FASB Interpretation No. 46(R).*ThisStatement amends FASB Interpretation 46(R) to require an enterprise toperform 

 

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ananalysis and ongoing reassessments to determine whether the enterprises variableinterest or interests give it a controlling financial interest in a variableinterest entity and amends certain guidance for determining whether an entityis a variable interest entity. It also requires enhanced disclosures that willprovide users of financial statements with more transparent information aboutan enterprises involvement in a variable interest entity. This Statement iseffective as of the beginning of each reporting entity’s first annual reportingperiod that begins after November 15, 2009 and for all interim reportingperiods after that and is not anticipated to have any impact on the Corporation’sconsolidated financial statements as the Corporation has no interests in anyvariable interest entities.

 

InJune 2009, the FASB issued SFAS No. 166, *Accounting for Transfers of Financial Assets — an amendment of FASBStatement No. 140.*This Statement amends SFAS No. 140 andremoves the concept of a qualifying special-purpose entity from SFAS No. 140and removes the exception from applying FASB Interpretation No. 46(revised December 2003), *Consolidationof Variable Interest Entities,*on qualifying special-purposeentities. This Statement is effective as of the beginning of each reportingentity’s first annual reporting period that begins after November 15,2009, for interim periods within that first annual reporting period and forinterim and annual reporting periods thereafter and is not anticipated to haveany impact on the Corporation’s consolidated financial statements.

 

InMay 2009, the FASB issued SFAS No. 165, *Subsequent Events.*The objective of this Statement is toestablish general standards of accounting for and disclosure of events thatoccur after the balance sheet date but before financial statements are issuedor are available to be issued. In particular, this Statement sets forth theperiod after the balance sheet date during which management of a reportingentity should evaluate events or transactions that may occur for potentialrecognition or disclosure in the financial statements, the circumstances underwhich an entity should recognize events or transactions occurring after thebalance sheet date in its financial statements, and the disclosures that anentity should make about events or transactions that occurred after the balancesheet date. This Statement is effective for financial statements issued forinterim and annual periods ending after June 15, 2009 and did not have anyimpact on the Corporation’s consolidated financial statements. The Corporationevaluated subsequent events through the filing date of our quarterly 10-Q withthe Securities and Exchange Commission.

 

InApril 2009, the FASB issued Staff Position No. 157-4, *Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly*(FSP FAS No. 157-4).This FSP provides additional guidance for estimating fair value in accordancewith FASB Statement No. 157, *Fair ValueMeasurements*, when the volume and level of activity for the asset orliability have significantly decreased. It also includes guidance onidentifying circumstances that indicate a transaction is not orderly. Itemphasizes that even if there has been a significant decrease in the volume andlevel of activity for the asset or liability and regardless of the valuationtechnique(s) used, the objective of a fair value measurement remains thesame. Fair value is the price that would be received in the sale of an asset,or paid to transfer a liability, in an orderly transaction (that is, not aforced liquidation or distressed sale) between market participants at themeasurement date under current market conditions. This FSP is to be appliedprospectively and is effective for interim and annual reporting periods endingafter June 15, 2009. The adopting of FSP FAS No. 157-4 in the secondquarter of 2009 did not have a material impact on the Corporation’sconsolidated financial statements.

 

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InApril 2009, the FASB issued Staff Position FAS No. 115-2 and FAS124-2, *Recognition and Presentation ofOther-Than-Temporary Impairments*(FSP FAS No. 115-2 and FAS124-2). This FSP amends the other-than-temporary impairment guidance in U.S.GAAP for debt securities to make the guidance more operational and to improvethe presentation and disclosure of other-than-temporary impairments on debt andequity securities in the financial statements. This FSP does not amend existingrecognition and measurement guidance related to other-than-temporaryimpairments of equity securities. This FSP is effective for interim and annualreporting periods ending after June 15, 2009, with early adoptionpermitted for periods ending after March 15, 2009. The impact of adoptingFSP FAS No. 115-2 and FAS 124-2 in the second quarter of 2009 did not havea material impact on the Corporation’s consolidated financial statements.

 

(NOTE3) STOCK BASED COMPENSATION

 

Effective January 1, 2006, the Company adopted SFAS No. 123(R),Share-Based Payment,**whichrequires that compensation cost relating to share-based payment transactions berecognized in the financial statements with measurement 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, 2009 and2008, 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, 2009, 26,161options were outstanding.  During 2009,no options were granted or exercised by officers, employees, and board members;while 36,000 options expired.  As of June 30,2009, all options have been vested and all related compensation expense hadbeen formerly expensed.

 

No further options may begranted under the 1998 Stock Option Plan.  The planprovided that options could be granted for a period of ten years from the datethe plan was adopted by the Board.  TheBoard adopted the plan on April 16, 1998. The plan remains in effect until all options granted under the Plan havebeen satisfied or expired.

 

**Under the Corporation’s 2007 Stock Option Plan, theCorporation may grant incentive**stockoptionsand non-qualified stock options to directors, officers, and employees of theCorporationandits subsidiary, so long as the Corporation owns a majority of the equityinterest of suchsubsidiary.  Incentive stock options are granted at fairvalue of the common stock on the date ofgrant.  However, anincentive stock option granted to an individual owning 10% or more of theCorporation’s stock after such grant must have an exercise price of at least110% of such fair market value and an exercise period of not more than fiveyears.  The Board of Directors isauthorized to determine when options become exercisable within a period notexceeding 10 

 

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**years from the date of grant.  Under the Plan, 300,000 shares of commonstock have been reserved for the granting of these options.  At June 30, 2009, no options have beengranted under the 2007 stock option plan. Thus,** no pre-tax stock-based compensation expense was requiredfor the six months ended June 30, 2009 and 2008.

** **

(NOTE 4) EARNINGS PER SHARE

 

**Basic earnings per share represent income available tocommon stockholders divided by the weighted-average number of common sharesoutstanding during the period.  Dilutedearnings 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 Bank relate to outstanding stock options and warrants and are determinedusing the treasury stock method.**

** **

**The weighted-average number of shares used in computingbasic and diluted earnings per share is as follows:**

 
| ** **                                                         | ** ** | **Earnings per share Calculation**        | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                         | ** ** | **For the six months ended June 30** | ** ** |
| ** **                                                         | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                                                         | ** ** | ** **                                | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| **(in thousands except per**                                       | ** ** | **Net**                                   | ** ** | **Average** | ** ** | **Per Share** | ** ** | **Net** | ** ** | **Average** | ** ** | **Per Share** | ** ** |
| **share  data)**                                                   | ** ** | **Income**                                | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic  earnings per share                                          |       | $                                         | 1,079      |   | 1,799,338 |   | $ | 0.600 |   | $ | 856 |   | 1,840,880 |   | $ | 0.465 |   |
|                                                               |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Effect  of dilutive shares assumed exercise of outstanding options |       | —                                    |       | 1,256 |   | (0.001 | ) | — |   | 14,365 |   | (0.004 | ) |
| Diluted  earnings per share                                        |       | $                                         | 1,079      |   | 1,800,594 |   | $ | 0.599 |   | $ | 856 |   | 1,855,245 |   | $ | 0.461 |   |

 

(NOTE 5) INVESTMENT SECURITIES

 

Thefollowing table presents the investment securities, available for sale at June 30,2009 and December 31, 2008:

 
| ** **                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**  | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Available  for sale:        |       |              |       |                  |       |
| Corporate  Debt Securities  |       | $                 | 12,211     |                  | $          | 5,866 |   |
| State/Local  Agency         |       | 49,266            |       | 40,551                |       |
| Mortgage  Backed Securities |       | 18,225            |       | 3,892                 |       |
| U.S.  government Agencies   |       | 9,840             |       | 43,044                |       |
|                        |       | $                 | 89,542     |                  | $          | 93,353 |   |

 

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(NOTE 6) OTHER INVESTMENTS

 

Thefollowing table presents the other investment securities at June 30, 2009and December 31, 2008:

 
| ** **                                       | ** ** | **June 30,** | ** ** | **December  31,** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| **(dollars in thousands)**                       | ** ** | **2009**          | ** ** | **2008**               | ** ** |
| AT  Services LLC                                 |       | $                 | —     |                   | $          | 20 |   |
| Federal  Home Loan Bank stock, restricted        |       | 3,332             |       | 3,097                  |       |
| Independent  Bankers Financial Corporation       |       | 51                |       | 51                     |       |
| Visa,  Inc Class “B” Stock        |       | 426               |       | 426                    |       |
| Metrocities  Mortgage, LLC                       |       | 10                |       | 10                     |       |
| Northern  California Bancorp, Inc. Trust I  |       | 93                |       | 93                     |       |
| Northern  California Bancorp, Inc. Trust II |       | 155               |       | 155                    |       |
|                                             |       | $                 | 4,067      |                   | $          | 3,852 |   |

 

(NOTE 7) LOANS AND ALLOWANCE FOR POSSIBLE LOANLOSSES

 

Thefollowing table presents information on loans and the allowance for possibleloan losses at June 30, 2009 and December 31, 2008:

 
| ** **                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**             | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Commercial  and Industrial             |       | $                 | 33,283     |                  | $          | 28,237 |   |
| Construction                           |       | 11,042            |       | 16,040                |       |
| Real  Estate - Mortgage                |       | 120,602           |       | 122,951               |       |
| Installment                            |       | 673               |       | 966                   |       |
| Government  Guaranteed Loans Purchased |       | 20                |       | 24                    |       |
|                                   |       | 165,620           |       | 168,218               |       |
| Allowance  for loan losses             |       | (2,926            | )          | (2,413                | )          |
| Deferred  origination fees, net        |       | (257              | )          | (275                  | )          |
| Net  Loans                             |       | $                 | 162,437    |                  | $          | 165,530 |   |
|                                   |       |              |       |                  |       |
| Balance  at Beginning of Period        |       | $                 | 2,413      |                  | $          | 2,028 |   |
| Recoveries                             |       | 1                 |       | 3                     |       |
| Provision  for Possible Loan Losses    |       | 646               |       | 1,132                 |       |
| Loans  Charged Off                     |       | (134              | )          | (750                  | )          |
| Balance  at End of Period              |       | $                 | 2,926      |                  | $          | 2,413 |   |

 

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(NOTE 8) COMPREHENSIVE INCOME (LOSS):

 

The components of other comprehensive income (loss) and related taxeffects for the six month period ended June 30, 2009 and the year ended December 31,2008 are as follows:

 
| ** **                                                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                                                 | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Unrealized holding gains (losses) on AFS  securities and other assets, net |       | $                 | 1,218      |                  | $          | (284 | ) |
| Reclassification for (gains) losses realized in  income                    |       | 1,135             |       | (449                  | )          |
| Net unrealized gains (losses)                                              |       | 2,353             |       | (733                  | )          |
| Tax effect                                                                 |       | (1,059            | )          | 330                   |       |
|                                                                       |       |              |       |                  |       |
| Other comprehensive income (loss) net of tax                               |       | $                 | 1,294      |                  | $          | (403 | ) |

 

The components of accumulated othercomprehensive income (loss) and related tax effects are as follows:

 
| ** **                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                                          | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Unrealized holding gains (losses) on available for  sale securities |       | $                 | 1,751      |                  | $          | (577 | ) |
| Unrealized holding gains on available for                           |       |              |       |                  |       |
| sale asset strip receivable                                         |       | 53                |       | 27                    |       |
| Tax effect                                                          |       | (812              | )          | 248                   |       |
|                                                                |       |              |       |                  |       |
| Accumulated other comprehensive income (loss)                       |       | $                 | 992        |                  | $          | (302 | ) |
|                                                                |       |              |       |                  |       |
| (NOTE 9) SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:        |       |              |       |                  |       |
|                                                                |       |              |       |                  |       |
| ** **                                                          | ** ** | **June 30**  | ** ** |
| ** **                                                          | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Payments during the period ending:                                  |       |              |       |                  |       |
| Interest                                                            |       | $                 | 5,000      |                  | $          | 5,000 |   |
| Income Taxes                                                        |       | $                 | 410        |                  | $          | 1,064 |   |
|                                                                |       |              |       |                  |       |
| Noncash Investing and Financing Activities:                         |       |              |       |                  |       |
| Transfer of loans to other real estate owned                        |       | $                 | 4,155      |                  | $          | 2,668 |   |

 

(NOTE 10) FAIR VALUE MEASUREMENTS:

 

Effective January 1, 2008, the Corporation adopted SFAS No. 157,which establishes a hierarchy for measuring fair value under U.S generally acceptedaccounting principles (GAAP). This standard applies to all financial assets andliabilities that are being measured and reported at fair value on a recurringand non-recurring basis. Fair value is measured in levels, which are describedin more detail below, and is determined based on the observability andreliability of the assumptions used to determine fair value.

 

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**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 in determining thefair value assigned to such assets or liabilities.

 

The Corporation measures and reports available-for-sale securities andmortgage servicing rights at fair value on a recurring basis. The followingtable shows the balances of these assets based on the SFAS No. 157designated levels.

 
| ** **                                 | ** ** | **At June 30, 2009** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|
| **(dollars in thousands)**                 | ** ** | **Total**                 | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Investment securities – AFS and other |       | $                         | 89,542     |   | $ | — |   | $ | 89,542 |   | $ | — |   |
|                                            |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

The Corporation may also be required, from time to time, to measure certainother non-financial assets at fair value on a non-recurring basis in accordancewith GAAP. During the six months ended June 30, 2009, the Corporationmeasured collateral dependent impaired loans and Other Real Estate Owned (OREO)at fair value. The assets are measured at fair value on a non-recurring basisand the following table provides the assets’ SFAS No. 157 designatedlevels, as well as the fair value losses recognized during the six months endedJune 30, 2009.

 
| **(dollars in  thousands)** | ** ** | **Total** | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** | **Losses for the  six months  ended June  30, 2009** | ** ** |
|-----------------------------|------------|-----------|------------|---------------|------------|---------------|------------|---------------|------------|------------------------------------------------------|------------|
| Impaired loans              |       | $         | 6,883      |          | $          | —        |       | $             | —     |                                                 | $          | 6,883 |   | $ | 134 |   |
| OREO                        |       | 12,020    |       | —        |       | —        |       | 12,020        |       | 413                                                  |       |
|                        |       | $         | 18,903     |          | $          | —        |       | $             | —     |                                                 | $          | 18,903 |   | $ | 547 |   |

 

FASBStaff Position FAS No. 107-1 and ABP 28-1, require interim reportingperiod disclosure about the fair value of financial instruments, includingassets, liabilities and off-balance sheet items for which it is practicable toestimate fair value. The fair value estimates are made based upon relevant marketinformation, if available, and upon the characteristics of the financialinstruments themselves. Because no market exists for a significant portion ofthe Corporation’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, 2009 is shown below.

 

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| ** **                                      | ** ** | **June 30, 2009** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **Carrying**           | ** ** | **Fair** | ** ** |
| **(dollars in thousands)**                      | ** ** | **Amount**             | ** ** | **Value** | ** ** |
| Financial Assets:                               |       |                   |       |   |   |
| Cash and cash equivalents                       |       | $                      | 6,412      |   | $ | 6,412 |   |
| Time deposits with other financial institutions |       | 3,199                  |       | 3,199 |   |
| Trading assets                                  |       | 224                    |       | 224 |   |
| Investment securities , available for sale      |       | 89,542                 |       | 89,542 |   |
| Other investments                               |       | 4,067                  |       | 4,067 |   |
| Loans, held for sale                            |       | 2,822                  |       | 2,822 |   |
| Loans, net                                      |       | 162,437                |       | 191,787 |   |
| Other real estate owned                         |       | 12,020                 |       | 12,020 |   |
| Accrued interest receivable                     |       | 1,804                  |       | 1,804 |   |
|                                            |       |                   |       |   |   |
| Financial Liabilities:                          |       |                   |       |   |   |
| Deposits                                        |       | 202,886                |       | 204,630 |   |
| Long-term debt                                  |       | 49,748                 |       | 54,254 |   |
| Short-term debt                                 |       | 18,000                 |       | 18,000 |   |
| Accrued interest payable                        |       | 1,458                  |       | 1,458 |   |
|                                                 |            |                        |            |  |  |  |  |

 

(NOTE 11) OFF-BALANCESHEET COMMITMENTS:

 

The Bank is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments include commitmentsto extend credit.  Such commitmentsinvolve, to varying degrees, elements of credit and interest rate risk inexcess of the amount recognized in the consolidated balance sheets.

 

The Bank’s exposure tocredit loss is represented by the contractual amount of these commitments.  The Bank uses the same credit policies inmaking commitments as it does for on-balance-sheet instruments.

 

**At June 30, 2009 and December 31, 2008, suchcommitments to extend credit were $15,286,000 and $13,941,000, respectively, ofundisbursed lines of credit, undisbursed loans in process, and commitmentletters.**

** **

**The Bank has two letters of credit issued by FederalHome 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 $650,000, expiring February 17, 2019, hasMasterCard International Inc. as the beneficiary.**

 

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**ITEM 2:**                      MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

** **

**StatementsRegarding Forward-Looking Information**

** **

**Except for historicalinformation contained herein, the matters discussed or incorporated byreference in this report contain forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, as amended (the “SecuritiesAct”), and Section 21E of the Securities Exchange Act of 1934 (the “ExchangeAct”), that involve substantial risks and uncertainties.  When used inthis report, or in the documents incorporated by reference herein, the words “anticipate,”“believe,” “estimate,” “may,” “intend,” “expect,” and similar expressionsidentify certain of such forward-looking statements.  Actual results ofMonterey County Bank could differ materially from such forward-lookingstatements contained herein.  Factors that could cause future results tovary from current expectations include, but are not limited to, the following:changes in economic conditions (both generally and more specifically in themarkets in which the Bank operates); changes in interest rates, deposit flows,loan demand, real estate values and competition; changes in accountingprinciples, policies or guidelines and in government legislation and regulation(which change from time to time and over which the Bank has no control); otherfactors affecting the Bank’s operations, markets, products and services; andother risks detailed in this Form 10-Q and in the Bank’s other reportsfiled with the Federal Deposit Insurance Corporation and pursuant to the rules andregulations of the Securities and Exchange Commission.  Readers arecautioned not to place undue reliance on these forward-looking statements,which reflect management’s analysis only as of the date hereof.  TheCorporation undertakes no obligation to publicly revise these forward-lookingstatements to reflect events or circumstances that arise after the datethereof.**

** **

**CRITICALACCOUNTING POLICIES**

 

The preparation of financialstatements in accordance with accounting principles generally accepted in theUnited States of America requires management to make a number of judgments,estimates and assumptions that affect the reported amount of assets,liabilities, income and expenses in the Corporation’s financial statements andaccompanying notes.  Management believesthat the judgments, estimates and assumptions used in preparation of theCorporation’s financial statements are appropriate given the factualcircumstances as of June 30, 2009.

 

Various elements of the Corporation’s accounting policies, by theirnature, are inherently subject to estimation techniques, valuation assumptionsand other subjective assessments. Critical accounting policies are those that involve the most complex andsubjective decisions and assessments and have the greatest potential impact onthe Corporation’s results of operation. In particular, management has identified one 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 that determines the Corporation’s allowance for loanlosses.  Management has discussed the developmentand selection 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 30,2009 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 further 

 

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informationregarding the allowance for loan losses see “Provision and Allowance for LoanLosses” included elsewhere herein.

 

**OVERVIEWof the Results of Operations and Financial Condition**

 

**Results of OperationsSummary**

** **

**Second quarter 2009 compared to second quarter 2008**

** **

Netincome for the quarter ended June 30, 2009 was $564,000 compared with anet loss of $64,000 for the quarter ended June 30, 2008. Basic earnings(loss) per share for the second quarter of 2009 were $0.313, compared to$(0.035) for the second quarter of 2008. The Corporation’s annualized return onaverage equity was 14.50% and annualized return on average assets was 0.74% forthe quarter ended June 30, 2009, compared to a return on average equity of(1.78%) and a return on assets of (0.10%) for same quarter in 2008. The primaryreasons for the change in net income during the second quarter of 2009 are asfollows:

 

The net interestspread increased from 2.12% to 2.26%, due primarily to rate paid oninterest-bearing liabilities declining 41 basis points, partially offset by adecline of 27 basis points in the yield on interest-earning assets.  As a result, net interest income decreased$59,000 or 3.79% during the three months ended June 30, 2009.  The rate paid on interest-bearing liabilitiesduring the second quarter of 2009 increased by 53 basis points as a result ofmanagement’s decision to prepay $13,000,000 of Federal Home Bank advances.

 

The provision forloan losses was $396,000 during the second quarter of 2009 compared to noprovision for loan losses during the second quarter of 2008.  The increase was due to continued economicpressures, particularly in the real estate industry in the Corporation’s marketarea.

 

Total non-interestincome was $2,710,000 during the second quarter of 2009 compared to $1,227,000during the second quarter of 2008.  Theincrease of $1,483,000 was due primarily to an increase of $756,000 in gains onsales of securities, and an increase of $525,000 in merchant discount feesduring the second quarter of 2009.

 

Total non-interestexpense was $3,118,000 during the second quarter of 2009 compared to $2,781,000during the second quarter of 2008.  Theincrease of $337,000 was due primarily to professional fees increasing $401,000,other general and administrative expenses increasing $353,000, while expensesrelated to foreclosed assets decreased $311,000, and salaries and employeebenefits decreased $127,000.

 

**Firsthalf of 2009 compared to the first half of 2008**

 

For the six monthsended June 30, 2009 net income was $1,079,000, compared to $856,000 forthe six months ended June 30, 2008, an increase of 26.11%.  Basic earnings per share forthe six months ended June 30, 2009 were $0.600, compared to $0.465 for thesix months ended June 30, 2008. The Corporation’s annualized return onaverage equity was 13.87% and annualized return on average assets was 0.69% forthe quarter ended June 30, 2009, compared to a return on average equity of11.80% and a return on assets of 0.65% for same

 

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period in 2008. The primary reasons for the change in net income duringthe first half of 2009 are as follows:

 

Net interestincome for the six months ended June 30, 2009 declined $128,000.  Net interest spread increased from 2.57% to2.77%, due primarily to rate paid on interest-bearing liabilities declining 75basis points, partially offset by a decline of 55 basis points in the yield oninterest-earning assets.  The rate paidon interest-bearing liabilities during the first half of 2009 was increased by34 basis points as a result of management’s decision to prepay $25,000,000 ofFederal Home Bank advances during the six months ended June 30, 2009.

 

The provision forloan losses was $646,000 during the first half of 2009 compared to no provisionfor loan losses during the first half of 2008. The increase was due to continued economic pressures, particularly in thereal estate industry in the Corporation’s market area.

 

Total non-interestincome was $4,303,000 during the first half of 2009 compared to $3,017,000during the first half of 2008.  Theincrease of $1,286,000 was due primarily to increases of $686,000 in gains onsales of securities, $945,000 in merchant discount fees, a mark to market lossof $41,000 on trading assets compared to a loss of $585,000 in 2008, partiallyoffset by income of $694,000 related to the Visa, Inc. initial publicstock offering booked in 2008.

 

Total non-interestexpense was $5,967,000 during the first half of 2009 compared to $5,007,000during the first half of 2008.  Theincrease of $960,000 was due primarily to professional fees increasing$410,000, other general and administrative expenses increasing $855,000,expenses related to foreclosed assets increasing $97,000, and salaries andemployee benefits decreasing $434,000.

 

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The followingtable sets forth certain selected financial data and ratios of the Corporationfor the three months and six months ended June 30, 2009 and 2008.

 
| ** **                                           | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| **(in thousands except share data)**                 | ** ** | **2009**                            | ** ** | **2008**                          | ** ** | **2009** | ** ** | **2008** | ** ** |
| Summary  of Operating Results:                       |       |                                |       |                              |       |   |   |   |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Total  interest income                               |       | $                                   | 4,022      |                              | $          | 3,975 |   | $ | 8,458 |   | $ | 8,596 |   |
| Total  interest expense                              |       | 2,523                               |       | 2,417                             |       | 4,896 |   | 4,906 |   |
| Net  interest income                                 |       | 1,499                               |       | 1,558                             |       | 3,562 |   | 3,690 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Provision  for possible loan losses                  |       | 396                                 |       | —                            |       | 646 |   | — |   |
| Net  interest income after provision for loan losses |       | 1,103                               |       | 1,558                             |       | 2,916 |   | 3,690 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Total  non-interest income                           |       | 2,710                               |       | 1,227                             |       | 4,303 |   | 3,017 |   |
| Total  non-interest expenses                         |       | 3,118                               |       | 2,781                             |       | 5,967 |   | 5,007 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Income  before taxes                                 |       | 695                                 |       | 4                                 |       | 1,252 |   | 1,700 |   |
| Provision  for income taxes                          |       | 131                                 |       | 68                                |       | 173 |   | 844 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Net  income (loss)                                   |       | $                                   | 564        |                              | $          | (64 | ) | $ | 1,079 |   | $ | 856 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Per  Common Share Data:                              |       |                                |       |                              |       |   |   |   |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Net  income - Basic (1)                              |       | $                                   | 0.313      |                              | $          | (0.035 | ) | $ | 0.600 |   | $ | 0.465 |   |
| Net  income - Diluted (2)                            |       | 0.313                               |       | (0.034                            | )          | 0.599 |   | 0.461 |   |
| Book  value, end of period                           |       | 9.25                                |       | 7.18                              |       | 9.33 |   | 7.18 |   |
| Avg  shares outstanding (3)                          |       | 1,814,642                           |       | 1,835,038                         |       | 1,799,338 |   | 1,840,880 |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Balance  Sheet Data:                                 |       |                                |       |                              |       |   |   |   |   |
|                                                 |       |                                |       |                              |       |   |   |   |   |
| Total  loans, net of unearned income (4)             |       | $                                   | 165,259    |                              | $          | 159,188 |   | $ | 165,259 |   | $ | 159,188 |   |
| Total  assets                                        |       | 293,599                             |       | 266,833                           |       | 293,599 |   | 266,833 |   |
| Total  deposits                                      |       | 202,886                             |       | 176,891                           |       | 202,886 |   | 176,891 |   |
| Stockholders’  equity                           |       | 16,640                              |       | 13,031                            |       | 16,640 |   | 13,031 |   |

 

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| ** **                                                     | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                                     | ** ** | **2009**                            | ** ** | **2008**                          | ** ** | **2009** | ** ** | **2008** | ** ** |
| Selected  Financial Ratios:                                    |       |                                |       |                              |       |   |   |   |   |
| Return  on average assets (5) (6)                         |       | 0.74                                | %          | (0.10                             | )%         | 0.69 | % | 0.65 | % |
| Return  on average stockholders’ equity (5) (6)      |       | 14.50                               | %          | (1.78                             | )%         | 13.87 | % | 11.80 | % |
| Net  interest spread                                           |       | 2.26                                | %          | 2.12                              | %          | 2.77 | % | 2.57 | % |
| Net  yield on interest earning assets (5)                      |       | 2.57                                | %          | 2.63                              | %          | 2.97 | % | 3.11 | % |
| Avg  shareholders’ equity to average assets (5)           |       | 5.12                                | %          | 5.40                              | %          | 5.00 | % | 5.51 | % |
| Risked-Based  capital ratios                                   |       |                                |       |                              |       |   |   |   |   |
| Tier  1                                                        |       | 9.44                                | %          | 9.25                              | %          | 9.44 | % | 9.25 | % |
| Total                                                          |       | 12.51                               | %          | 13.70                             | %          | 12.51 | % | 13.70 | % |
| Total  loans to total deposits at end of period (4)            |       | 81.45                               | %          | 89.99                             | %          | 81.45 | % | 89.99 | % |
| Allowance  for loan losses to total loans at end of period (4) |       | 1.74                                | %          | 1.26                              | %          | 1.74 | % | 1.26 | % |
| Nonperforming  loans to total loans at end of period (4)       |       | 4.09                                | %          | 2.60                              | %          | 4.09 | % | 2.60 | % |
| Net  charge-offs to average loans (4)                          |       | 0.08                                | %          | 0.00                              | %          | 0.08 | % | 0.00 | % |

 

----

(1)         Basic earnings per share amounts werecomputed on the basis of the weighted average number of shares of common stockoutstanding during the year.  Theweighted average number of common shares used for this computation was1,799,338 and 1,840,880 for June 30, 2009 and 2008, respectively.

 

(2)         Diluted earnings per share amounts werecomputed on the basis of the weighted average number of shares of common stockand common stock equivalents outstanding during the year.  Common stock equivalents includedirector/employee stock options. The weighted average number of shares used forthis computation was 1,800,594 and 1,855,245 for June 30, 2009 and 2008,respectively.

 

(3)   Weighted average common shares.

 

(4)   Includes loans being held for sale.

 

(5)   Averages are of daily balances.

 

(6)   Calculated on an annualized basis.

 

**NETINTEREST INCOME**

 

Netinterest income, the difference between (a) interest and fees earned oninterest-earning assets and (b) interest paid on interest-bearingliabilities, is the most significant component of the Bank’s earnings.  Changes in net interest income from period toperiod result from increases or decreases in the average balances ofinterest-earning assets and interest-earning liabilities, the availability ofparticular sources of funds and changes in prevailing interest rates.

 

Net interest income forthe second quarter of 2009 was $1,499,000 compared to $1,558,000 for the secondquarter of 2008, which was a decrease of $59,000 primarily resulting from thepayment of $350,000 in prepayment fees on $13,000,000 of Federal Home Loanadvances prepaid during the second quarter; partially offset by a 14 basispoints increase in the net interest spread. Net interest income for the six months ended June 30, 2009 was$3,562,000 compared to $3,690,000 for the same period in 2008, which was adecrease of $128,000 primarily resulting from the payment of $431,000 inprepayment fees on $25,000,000 of Federal

 

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Home Loans advances prepaid during thefirst half of 2009; partially offset by a 20 basis points increase in the netinterest spread.

 

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

 

The following tables showthe consolidated average balances of earning assets, and interest-bearingliabilities; the amount of interest income and interest expense; the averageyield or rate for each category of average interest-earning assets and averageinterest-bearing liabilities; and the net interest income and the net interestspread for the periods indicated.  Yields are computed on a tax-equivalentbasis, resulting in adjustments to interest earned on municipal bonds of$267,000 and $77,000 for the three months ended and $510,000 and $135,000 forthe six months ended June 30, 2009 and 2008, respectively.  Non-accrual loans and overdrafts are includedin average loan balances.  Average loansare presented net of unearned income.

 

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| ** **                                                  | ** ** | **Three Months Ended June 30, 2009** | ** ** | **Three Months Ended June 30, 2008** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                  | ** ** | **Average**                               | ** ** | ** **                                | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| **(dollars in thousands)**                                  | ** ** | **Balance**                               | ** ** | **Interest**                              | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Assets:                                                     |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Loans                                                       |       | $                                         | 168,463    |                                      | $          | 2,697 |   | 6.41 | % | $ | 166,770 |   | $ | 2,963 |   | 7.11 | % |
| Time  deposits - in other banks                             |       | 12,680                                    |       | 5                                         |       | 0.16 | % | — |   | — |   | 0 | % |
| Investment  securities - taxable                            |       | 49,108                                    |       | 725                                       |       | 5.91 | % | 58,725 |   | 796 |   | 5.42 | % |
| Investment  securities - nontaxable                         |       | 44,321                                    |       | 861                                       |       | 7.77 | % | 14,000 |   | 246 |   | 7.03 | % |
| Federal  funds sold                                         |       | —                                    |       | 1                                         |       | 0.00 | % | 9,076 |   | 47 |   | 2.07 | % |
| Total  interest-earning assets                              |       | 274,572                                   |       | 4,289                                     |       | 6.25 | % | 248,571 |   | 4,052 |   | 6.52 | % |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Allowance  for credit losses                                |       | (2,579                                    | )          |                                      |       |   |   | (2,097 | ) |   |   |   |   |
| Non-interest  bearing assets:                               |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Cash  and due from banks                                    |       | 6,563                                     |       |                                      |       |   |   | 5,348 |   |   |   |   |   |
| Premises  and equipment                                     |       | 4,892                                     |       |                                      |       |   |   | 4,983 |   |   |   |   |   |
| Accrued  interest receivable                                |       | 1,610                                     |       |                                      |       |   |   | 1,639 |   |   |   |   |   |
| Other  assets                                               |       | 18,726                                    |       |                                      |       |   |   | 7,656 |   |   |   |   |   |
| Total  average assets                                       |       | $                                         | 303,784    |                                      |       |   |   |   | $ | 266,100 |   |   |   |   |   |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Liabilities  and Shareholders’ Equity:                 |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                              |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Interest-bearing  demand                                    |       | $                                         | 16,067     |                                      | $          | 5 |   | 0.13 | % | $ | 14,022 |   | $ | 9 |   | 0.26 | % |
| Money  market savings                                       |       | 1,328                                     |       | 1                                         |       | 0.24 | % | 1,822 |   | 3 |   | 0.66 | % |
| Savings  deposits                                           |       | 5,360                                     |       | 7                                         |       | 0.49 | % | 5,528 |   | 14 |   | 1.01 | % |
| Time  deposits >$100M                                    |       | 55,302                                    |       | 523                                       |       | 3.78 | % | 60,032 |   | 711 |   | 4.74 | % |
| Time  deposits <$100M                                    |       | 98,607                                    |       | 884                                       |       | 3.59 | % | 71,304 |   | 817 |   | 4.58 | % |
| Other  Borrowing                                            |       | 76,396                                    |       | 1,103                                     |       | 5.78 | % | 66,983 |   | 863 |   | 5.15 | % |
| Total  interest-bearing liabilities                         |       | 253,060                                   |       | 2,523                                     |       | 3.99 | % | 219,691 |   | 2,417 |   | 4.40 | % |
|                                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Non-interest  bearing liabilities:                          |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  checking                               |       | 29,423                                    |       |                                      |       |   |   | 25,188 |   |   |   |   |   |
| Accrued  interest payable                                   |       | 1,464                                     |       |                                      |       |   |   | 2,102 |   |   |   |   |   |
| Other  liabilities                                          |       | 4,280                                     |       |                                      |       |   |   | 4,753 |   |   |   |   |   |
| Total  Liabilities                                          |       | 288,227                                   |       |                                      |       |   |   | 251,734 |   |   |   |   |   |
| Total  shareholders equity                                  |       | 15,557                                    |       |                                      |       |   |   | 14,366 |   |   |   |   |   |
| Total  average liabilities and shareholders equity          |       | $                                         | 303,784    |                                      |       |   |   |   | $ | 266,100 |   |   |   |   |   |
| Net  interest income                                        |       |                                      |       | $                                         | 1,766      |   |   |   |   |   | $ | 1,635 |   |   |   |
| Interest  income as a percentage of average earning assets  |       |                                      |       |                                      |       | 6.25 | % |   |   |   |   | 6.52 | % |
| Interest  expense as a percentage of average earning assets |       |                                      |       |                                      |       | 3.68 | % |   |   |   |   | 3.89 | % |
| Net  yield on interest earning assets                       |       |                                      |       |                                      |       | 2.57 | % |   |   |   |   | 2.63 | % |
| Net  interest spread                                        |       |                                      |       |                                      |       | 2.26 | % |   |   |   |   | 2.12 | % |

 

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| ** **                                                  | ** ** | **Six Months Ended June 30, 2009** | ** ** | **Six Months Ended June 30, 2008** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                  | ** ** | **Average**                             | ** ** | ** **                              | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| **(dollars in thousands)**                                  | ** ** | **Balance**                             | ** ** | **Interest**                            | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Assets:                                                     |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Loans                                                       |       | $                                       | 170,665    |                                    | $          | 5,689 |   | 6.67 | % | $ | 169,528 |   | $ | 6,711 |   | 7.92 | % |
| Time  deposits – in other banks                        |       | 3,754                                   |       | 10                                      |       | 0.55 | % | 739 |   | 12 |   | 3.34 | % |
| Investment  securities – taxable                       |       | 56,984                                  |       | 1,623                                   |       | 5.69 | % | 52,311 |   | 1,422 |   | 5.44 | % |
| Investment  securities – nontaxable                    |       | 42,253                                  |       | 1,646                                   |       | 7.79 | % | 12,530 |   | 435 |   | 6.94 | % |
| Federal  funds sold                                         |       | —                                  |       | —                                  |       | — |   | 10,977 |   | 151 |   | 2.75 | % |
| Total  interest-earning assets                              |       | 273,656                                 |       | 8,968                                   |       | 6.55 | % | 246,085 |   | 8,731 |   | 7.10 | % |
|                                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Allowance  for credit losses                                |       | (2,489                                  | )          |                                    |       |   |   | (2,063 | ) |   |   |   |   |
| Non-interest  bearing assets:                               |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Cash  and due from banks                                    |       | 14,118                                  |       |                                    |       |   |   | 6,361 |   |   |   |   |   |
| Premises  and equipment                                     |       | 4,926                                   |       |                                    |       |   |   | 4,940 |   |   |   |   |   |
| Accrued  interest receivable                                |       | 1,759                                   |       |                                    |       |   |   | 1,407 |   |   |   |   |   |
| Other  assets                                               |       | 19,039                                  |       |                                    |       |   |   | 6,562 |   |   |   |   |   |
| Total  average assets                                       |       | $                                       | 311,009    |                                    |       |   |   |   | $ | 263,292 |   |   |   |   |   |
|                                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Liabilities  and Shareholders’ Equity:                 |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest  Bearing Liabilities:                              |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest-bearing  demand                                    |       | $                                       | 14,945     |                                    | $          | 10 |   | 0.14 | % | $ | 13,804 |   | $ | 17 |   | 0.25 | % |
| Money  market savings                                       |       | 1,465                                   |       | 2                                       |       | 0.24 | % | 1,759 |   | 6 |   | 0.73 | % |
| Savings  deposits                                           |       | 5,622                                   |       | 14                                      |       | 0.49 | % | 5,902 |   | 31 |   | 1.06 | % |
| Time  deposits >$100M                                    |       | 55,582                                  |       | 1,068                                   |       | 3.84 | % | 60,862 |   | 1,482 |   | 4.87 | % |
| Time  deposits <$100M                                    |       | 97,050                                  |       | 1,822                                   |       | 3.76 | % | 69,094 |   | 1,642 |   | 4.75 | % |
| Other  Borrowing                                            |       | 84,643                                  |       | 1,980                                   |       | 4.68 | % | 65,297 |   | 1,728 |   | 5.29 | % |
| Total  interest-bearing liabilities                         |       | 259,307                                 |       | 4,896                                   |       | 3.78 | % | 216,718 |   | 4,906 |   | 4.53 | % |
|                                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Non-interest  bearing liabilities:                          |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  checking                               |       | 31,662                                  |       |                                    |       |   |   | 25,690 |   |   |   |   |   |
| Accrued  interest payable                                   |       | 1,611                                   |       |                                    |       |   |   | 2,060 |   |   |   |   |   |
| Other  liabilities                                          |       | 2,872                                   |       |                                    |       |   |   | 4,313 |   |   |   |   |   |
| Total  Liabilities                                          |       | 295,452                                 |       |                                    |       |   |   | 248,781 |   |   |   |   |   |
| Total  shareholders equity                                  |       | 15,557                                  |       |                                    |       |   |   | 14,511 |   |   |   |   |   |
| Total  average liabilities and shareholders equity          |       | $                                       | 311,009    |                                    |       |   |   |   | $ | 263,292 |   |   |   |   |   |
| Net  interest income                                        |       |                                    |       | $                                       | 4,072      |   |   |   |   |   | $ | 3,825 |   |   |   |
| Interest  income as a percentage of average earning assets  |       |                                    |       |                                    |       | 6.55 | % |   |   |   |   | 7.10 | % |
| Interest  expense as a percentage of average earning assets |       |                                    |       |                                    |       | 3.58 | % |   |   |   |   | 3.99 | % |
| Net  yield on interest earning assets                       |       |                                    |       |                                    |       | 2.97 | % |   |   |   |   | 3.11 | % |
| Net  interest spread                                        |       |                                    |       |                                    |       | 2.77 | % |   |   |   |   | 2.57 | % |

 

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**Rate andVolume 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, 2009 comparedwith the same period in 2008.

 
| ** **                                | ** ** | **Increase (decrease) in the three months ended**       | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **June 30, 2009 compared with June 30, 2008** | ** ** |
| **(dollars in thousands)**                | ** ** | **Volume**                                              | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase  (decrease) in interest income:  |       |                                                    |       |   |   |   |   |
| Loans                                     |       | $                                                       | 30         |   | $ | (296 | ) | $ | (266 | ) |
| Time  deposits - in other banks           |       | 5                                                       |       | — |   | 5 |   |
| Invest  securities - taxable              |       | (130                                                    | )          | 59 |   | (71 | ) |
| Invest  securities - nontaxable           |       | 533                                                     |       | 82 |   | 615 |   |
| Federal  funds sold                       |       | (46                                                     | )          | — |   | (46 | ) |
|                                      |       | 392                                                     |       | (155 | ) | 237 |   |
|                                      |       |                                                    |       |   |   |   |   |
| Increase  (decrease) in interest expense: |       |                                                    |       |   |   |   |   |
| Interest-bearing  demand                  |       | 1                                                       |       | (5 | ) | (4 | ) |
| Money  market savings                     |       | (1                                                      | )          | (1 | ) | (2 | ) |
| Savings  deposits                         |       | —                                                  |       | (7 | ) | (7 | ) |
| Time  deposits >$100M                  |       | (56                                                     | )          | (132 | ) | (188 | ) |
| Time  deposits <$100M                  |       | 313                                                     |       | (246 | ) | 67 |   |
| Other  Borrowing                          |       | 121                                                     |       | 119 |   | 240 |   |
|                                      |       | 378                                                     |       | (272 | ) | 106 |   |
| Increase  in net interest income:         |       | $                                                       | 14         |   | $ | 117 |   | $ | 131 |   |

 
| ** **                                | ** ** | **Increase (decrease) in the six months ended**         | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **June 30, 2009 compared with June 30, 2008** | ** ** |
| **(dollars in thousands)**                | ** ** | **Volume**                                              | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase  (decrease) in interest income:  |       |                                                    |       |   |   |   |   |
| Loans                                     |       | $                                                       | 45         |   | $ | (1,067 | ) | $ | (1,022 | ) |
| Time  deposits - in other banks           |       | 49                                                      |       | (51 | ) | (2 | ) |
| Invest  securities - taxable              |       | 127                                                     |       | 74 |   | 201 |   |
| Invest  securities - nontaxable           |       | 1,032                                                   |       | 178 |   | 1,210 |   |
| Federal  funds sold                       |       | (151                                                    | )          | — |   | (151 | ) |
|                                      |       | 1,102                                                   |       | (866 | ) | 236 |   |
|                                      |       |                                                    |       |   |   |   |   |
| Increase  (decrease) in interest expense: |       |                                                    |       |   |   |   |   |
| Interest-bearing  demand                  |       | 1                                                       |       | (9 | ) | (8 | ) |
| Money  market savings                     |       | (1                                                      | )          | (3 | ) | (4 | ) |
| Savings  deposits                         |       | (1                                                      | )          | (16 | ) | (17 | ) |
| Time  deposits >$100M                  |       | (129                                                    | )          | (286 | ) | (415 | ) |
| Time  deposits <$100M                  |       | 665                                                     |       | (484 | ) | 181 |   |
| Other  Borrowing                          |       | 512                                                     |       | (260 | ) | 252 |   |
|                                      |       | 1,047                                                   |       | (1,058 | ) | (11 | ) |
| Increase  in net interest income:         |       | $                                                       | 55         |   | $ | 192 |   | $ | 247 |   |

 

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**Provisionand Allowance for Loan Losses**

 

TheCorporation maintains a detailed, systematic analysis and procedural disciplineto determine the amount of the allowance for loan losses (“ALL”).  TheALL 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 loanloss estimation, 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 ALL on a monthly basis and makes adjustingentries quarterly. The review of the adequacy of the allowance takes intoconsideration such factors as concentrations of credit, changes in the growth,size and composition of the loan portfolio, overall and individual portfolioquality, review of specific problem loans, collateral, guarantees and economicconditions that may affect the borrowers’ ability to pay and/or the value ofthe underlying collateral.  Additional factors considered include:geographic location of borrowers, changes in the Company’s product-specificcredit policy and lending staff experience.  These estimates dependon subjective factors and, therefore, contain inherent uncertainties.

 

TheCorporation’s ALL 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 Company charges off any loan classified asa “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 ALL.

 

Although noassurance can be given that actual losses will not exceed the amount providedfor in the allowance, Management believes that the allowance is adequate toprovide for all estimated credit losses in light of all known relevant factors.At June 30, 2009 and 2008 the Bank’s allowance stood at 1.74 percent and 1.26percent of total loans, respectively.

 

Provisions made toALLL during the six months ended June 30, 2009 were $646,000 compared tono provisions for the same period in 2008. Loans charged off during the six months ended June 30, 2009 totaled$134,000 compared to no charge offs for the same period in 2008.  Recoveries totaled $1,000 during the sixmonths ended June 30, 2009 and 2008.

 

During the sixmonths ended June 30, 2009, $4,155,000 of loans secured by real estatewere foreclosed and transferred to other real estate owned and $914,000 wasfunded for the completion of a construction project in other real estate owned.

 

TheBank’s non-performing (delinquent 90 days or more and on non-accrual) net loansas a percentage of total loans were 4.09 percent and 2.60 percent as of the endof June 30, 2009 and 2008, respectively. The significant increase in non-accrual loans is primarily attributableto the continued economic slowdown and the softening of the real estate market.

 

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**Non-InterestIncome**

 

Total non-interestincome for the second quarter 2009 was $2,710,000 compared with $1,227,000 for the sameperiod in 2008.  The increase of$1,483,000 was due primarily to an increase of $756,000 in gains on sales ofsecurities and an increase of $525,000 in merchant discount fees during thesecond quarter of 2009.

 

Total non-interestincome was $4,303,000 during the first half of 2009 compared to $3,017,000during the first half of 2008.  Theincrease of $1,286,000 was due primarily to increases of $686,000 in gains onsales of securities, $945,000 in merchant discount fees, a mark to market lossof $41,000 on trading assets compared to a loss of $585,000 in 2008, partiallyoffset by income of $694,000 related to the Visa, Inc. initial publicstock offering booked in 2008.

 

**Non-InterestExpense**

 

Salary andbenefits expense for the second quarter of 2009 decreased $127,000 compared with thesame period in 2008.  Salary and benefitsexpense for the first half of 2009 decreased $434,000 compared with the same period in2008.  The decreases were due toelimination of bonus accruals and the elimination of three positions during thefourth quarter of 2008.

 

Total occupancyand equipment expense for the second quarter of 2009 was $254,000 compared to $234,000 forthe same period in 2008.  The increasewas primarily due to increases of $20,000 in rental expense and an $8,000increase in depreciation expense, partially offset by a $9,000 decrease injanitorial expense.  Total occupancy andequipment expense for the six months ended June 30, 2009 was $515,000 compared to $472,000 forthe same period in 2008.  The increasewas primarily due to increases of $24,000 in rental expense and an $18,000increase in depreciation expense.

 

Professional feesfor the second quarter of 2009 were $464,000 compared to $63,000 for the sameperiod in 2008.  Professional fees forthe six months ended June 30, 2009 were $527,000 compared to $117,000 for the sameperiod in 2008.  The increases wereprimarily due to increases in accounting/audit expense and loan collectionexpense.

 

Data processingexpense for the second quarter of 2009 was $91,000 compared to $90,000 for thesame period in 2008.  Data processingexpense for the six months ended June 30, 2009 was $180,000 compared to $191,000 forthe same period in 2008, which was a decrease of $11,000 primarily due tocontinued efforts control expenses.

 

Other general andadministrative expenses for the second quarter of 2009 totaled $1,316,000 compared with$963,000 for the same period in 2008, which is an increase of $353,000.  Significant changes occurred in the followingcategories; increases occurred in merchant credit card processing expense of $392,000,FDIC insurance premiums of $82,000, and loan expense of $30,000,while decreasesoccurred in other operational charge offs $22,000,stationery/supplies of $17,000, club account expense $12,000, messenger andfreight of $7,000 and director fees of $5,000.

 

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Other general andadministrative expenses for the first half of 2009 totaled $2,546,000 compared with$1,691,000 for the same period in 2008, which is an increase of $855,000.  Significant changes occurred in the followingcategories; increases occurred in merchant credit card processing expense of $650,000,FDIC insurance premiums of $97,000, loan expense of $45,000,ATM expense of $20,000, credit card program of $18,000, security expense of$17,000 and in 2008 a credit of $110,000 resulted from the reversal of anaccrued loss reserve for Visa, Inc. lawsuit settlement; while decreases occurred in businessdevelopment expense of $28,000, stationery/supplies of $20,000, postage of$16,000, messenger and freight of $13,000 and advertising of $12,000.

 

OREO expenses andprovision for possible losses on OREO for the second quarter and first half of2009 totaled $221,000 and $629,000, respectively compared to $532,000 inprovisions during the same periods in 2008.

 

**Provisionfor Income Taxes**

 

Thetax provision was $173,000 for the six months ended June 30, 2009 comparedto tax provision of $844,000 for the same period in 2008, representing 13.82%and 49.65% of pre-tax income for those periods. The decrease in the effective tax rate for 2009 is a direct result ofthe Bank’s investing in tax-exempt securities and recognition of a tax benefitfor losses on trading assets.

 

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 interest income;increases in the cash surrender value of bank-owned life insurance, certainother 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 loansrepresented 62.36% of average earning assets and 54.87% of average total assetsfor the six months ended June 30, 2009 compared with 68.89% and 64.39%, respectively during2008. For the six months ended June 30, 2009, average loans increased 0.67% to$170,665,000 from $169,528,000 for the same period in 2008.  Average real estate loans increased$4,617,000 (4.01%), average construction loans decreased $8,279,000 (36.20%),average commercial loans increased $4,237,000 (13.85%), and average installmentloans increased $562,000 (62.03%).

 

The Bank’scommercial and industrial loans are generally made for the purpose of providingworking capital, financing the purchase of equipment or inventory, and otherbusiness purposes. Such loans generally have maturities of one year orlonger.  Short-term business loans aregenerally intended to finance current transactions and typically provide formonthly interest payments with principal being payable at maturity or at 90-dayintervals. Term loans (usually for a term of two to five years) normallyprovide for monthly installments of principal and interest.  The Bank from time to time utilizes accountsreceivable and inventory as security for loans.

 

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The Bank is arecognized leader for Small Business Administration (SBA) lending in MontereyCounty, and holds SBA’s coveted Preferred Lender Status.  Generally, SBA loans are guaranteed, by theSBA, for 75 to 85 percent of their principal amount, which can be retained inthe loan portfolio or sold to investors. Such loans are made at floating interest rates, generally with longerterms (up to 25 years) than are available on a conventional loan basis to smallbusinesses.  The unguaranteed portion of the loans, although generallysupported by collateral, is considered to be more risky than conventionalcommercial loans because they may be based upon credit standards the Bank wouldnot otherwise apply, such as lower cash flow coverage, or longer repaymentterms.

 

The Bank’s realestate loan portfolio consists of both real estate construction loans and realestate mortgage loans.  The Bank hasinitiated a program to generate more commercial and industrial real estateloans, which generally yield higher returns than normal commercial loans.  The Bank has also developed a broker programfor generating residential real estate loans. Real estate construction loans are made for a much shorter term, andoften at higher interest rates, than conventional single-family residentialreal estate loans.  The cost ofadministering such loans is often higher than for other real estate loans, asprincipal is drawn on periodically as construction progresses.

 

The Bank alsomakes real estate loans secured by a first deed of trust on single familyresidential properties and commercial and industrial real estate.  California commercial banks are permitted,depending on the type and maturity of the loan, to lend up to 90 percent of thefair market value of real property (or more if the loan is insured either byprivate 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.

 

Consumer loans are madefor the purpose of financing the purchase of various types of consumer goods,home improvement loans, auto loans and other personal loans.  Consumer installment loans generally providefor monthly payments of principal and interest, at a fixed rate.  Most of the Bank’s consumer installment loansare generally secured by the personal property being purchased.  The Bank generally makes consumer loans tothose customers with a prior banking relationship with the Bank.

 

**Non-performingand Non-accrual Loans**

 

The Bank’s presentpolicy is to cease accruing interest on loans which are past due as to principalor interest 90 days or more, except for loans which are well secured or whencollection of interest and principal is deemed likely.  When a loan is placed on non-accrual,previously accrued and unpaid interest is generally reversed out of incomeunless adequate collateral from which to collect the principal of, and intereston, the loan appears to be available.

 

In relation to SBAloans sold, the Bank generally repurchases from the secondary market theguaranteed portion of SBA guaranteed loans when those loans are placed onnon-accrual status.  After theforeclosure and collection process is complete, the SBA reimburses the Bank forthis principal balance.  Therefore,although these balances do not earn interest during this period, they generallydo not result in a loss of principal to the Bank.  The information provided in the followingtable is net of the $3,107,000 guaranteed by the Small Business Administration.

 

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The followingtable presents information with respect to loans which, as of the datesindicated, were past due 90 days or more or were placed on non-accrual status(referred to collectively as “non-performing loans”):

 
| ** **                                                              | ** ** | **Six months as of**       | ** ** | **Twelve months as of** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------|------------|
| ** **                                                              | ** ** | **June 30,**          | ** ** | **December 31,**   | ** ** |
| ** **                                                              | ** ** | **2009**                   | ** ** | **2008**                | ** ** | **2008** | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** ** | ** **              | ** ** |
| Accruing, past due 90 days or more:                                     |       |                       |       |                    |       |   |   |
| Real Estate                                                             |       | $                          | —     |                    | $          | — |   | $ | — |   |
| Commercial                                                              |       | —                     |       | —                  |       | — |   |
| Installment                                                             |       | —                     |       | —                  |       | — |   |
| Other                                                                   |       | —                     |       | —                  |       | — |   |
| Total accruing                                                          |       | —                     |       | —                  |       | — |   |
|                                                                    |       |                       |       |                    |       |   |   |
| Nonaccrual Loans:                                                       |       |                       |       |                    |       |   |   |
| Real Estate                                                             |       | 5,320                      |       | 2,640                   |       | 6,876 |   |
| Commercial                                                              |       | 1,563                      |       | 1,394                   |       | 215 |   |
| Installment                                                             |       | —                     |       | 155                     |       | — |   |
| Other                                                                   |       | —                     |       | —                  |       | — |   |
| Total nonaccrual                                                        |       | 6,883                      |       | 4,189                   |       | 7,091 |   |
|                                                                    |       |                       |       |                    |       |   |   |
| Total nonperforming                                                     |       | 6,883                      |       | 4,189                   |       | 7,091 |   |
| OREO                                                                    |       | 12,020                     |       | 2,668                   |       | 7,364 |   |
|                                                                    |       | $                          | 18,903     |                    | $          | 6,857 |   | $ | 14,455 |   |
|                                                                    |       |                       |       |                    |       |   |   |
| Total loans end of period                                               |       | 168,442                    |       | 161,533                 |       | 169,868 |   |
|                                                                    |       |                       |       |                    |       |   |   |
| Ratio of nonperforming loans to total loans at end  of period           |       | 4.09                       | %          | 2.60                    | %          | 4.18 | % |
|                                                                    |       |                       |       |                    |       |   |   |
| Ratio of nonperforming assets to total loans and  OREO at end of period |       | 10.47                      | %          | 4.18                    | %          | 8.16 | % |

 

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Summaryof Loan Loss Experience

 
| ** **                                                                     | ** ** | ** **                 | ** ** | ** **            | ** ** | **As of the** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                                                     | ** ** | **As of the period**       | ** ** | **Year ended**        | ** ** |
| ** **                                                                     | ** ** | **Ended June 30,**    | ** ** | **December 31,** | ** ** |
| ** **                                                                     | ** ** | **2009**                   | ** ** | **2008**              | ** ** | **2008**      | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Average loans outstanding                                                      |       | $                          | 170,665    |                  | $          | 169,528       |       | $ | 166,960 |   |
|                                                                           |       |                       |       |                  |       |          |       |
| Total loans outstanding at end of the period                                   |       | $                          | 168,442    |                  | $          | 161,533       |       | $ | 169,868 |   |
|                                                                           |       |                       |       |                  |       |          |       |
| Allowance, beginning of period                                                 |       | $                          | 2,413      |                  | $          | 2,028         |       | $ | 2,028 |   |
|                                                                           |       |                       |       |                  |       |          |       |
| Loans charged off during period:                                               |       |                       |       |                  |       |          |       |
| Commercial                                                                     |       | 13                         |       | —                |       | 187           |       |
| Installment                                                                    |       | 35                         |       | —                |       | —        |       |
| Real Estate                                                                    |       | 86                         |       | —                |       | 563           |       |
| Other                                                                          |       | —                     |       | —                |       | —        |       |
| Total charge offs                                                              |       | 134                        |       | —                |       | 750           |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Recoveries during period:                                                      |       |                       |       |                  |       |          |       |
| Commercial                                                                     |       | 1                          |       | 1                     |       | 3             |       |
| Installment                                                                    |       | —                     |       | —                |       | —        |       |
| Real Estate                                                                    |       | —                     |       | —                |       | —        |       |
| Other                                                                          |       | —                     |       | —                |       | —        |       |
| Total recoveries                                                               |       | 1                          |       | 1                     |       | 3             |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Net Loans charged off during the period                                        |       | 133                        |       | (1                    | )          | 747           |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Additions to allowance for possible loan losses                                |       | 646                        |       | —                |       | 1,132         |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Allowance, end of period                                                       |       | $                          | 2,926      |                  | $          | 2,029         |       | $ | 2,413 |   |
|                                                                           |       |                       |       |                  |       |          |       |
| Ratio of net loans charged off to average loans  outstanding during the period |       | 0.08                       | %          | 0.00                  | %          | 0.45          | %          |
|                                                                           |       |                       |       |                  |       |          |       |
| Ratio of allowance to total loans at end of period                             |       | 1.74                       | %          | 1.26                  | %          | 1.42          | %          |
|                                                                           |       |                       |       |                  |       |          |       |
| Ratio of nonperforming loans to allowance for loan  losses at end of period    |       | 235.24                     | %          | 48.44                 | %          | 293.82        | %          |

 

**Non-performingAssets**

 

The followingtable presents information with respect to nonperforming assets, as of thedates indicated. The non-accrual loans are net of the guaranteed portion of SBAloans and the

 

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OREO was acquiredthrough foreclosure.  The OREO wasrecorded at fair value less selling costs on the date of acquisition.

** **
| ** **                                                              | ** ** | ** **                 | ** ** | ** **            | ** ** | **As of the** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                                              | ** ** | **As of the period**       | ** ** | **Year ended**        | ** ** |
| ** **                                                              | ** ** | **Ended June 30,**    | ** ** | **December 31,** | ** ** |
| ** **                                                              | ** ** | **2009**                   | ** ** | **2008**              | ** ** | **2008**      | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Nonaccrual loans                                                        |       | $                          | 6,883      |                  | $          | 4,189         |       | $ | 7,091 |   |
| Other real estate owned, net (1)                                        |       | 12,020                     |       | 2,668                 |       | 7,364         |       |
| Total nonperforming assets                                              |       | $                          | 18,903     |                  | $          | 6,857         |       | $ | 14,455 |   |
|                                                                    |       |                       |       |                  |       |          |       |
| Nonperforming loans to total gross loans                                |       | 4.09                       | %          | 2.60                  | %          | 4.18          | %          |
| Nonperforming assets to total gross loans plus  other real estate owned |       | 10.47                      | %          | 4.18                  | %          | 8.16          | %          |

 

----

(1) netof reserve for foreclosed assets losses of $413,000

 

**Deposits**

 

Average interestbearing and non-interest bearing deposits for the six months ended June 30,2009 were$206,326,000 an increase of 16.50% compared with the same period in 2008.  Average certificates of deposit represented73.98% of average deposits for the six months ended June 30, 2009 compared with 73.38% for the same periodin 2008.  Average interest bearingchecking, money market and savings accounts as a group were 10.68% of averagedeposits for the six months ended June 30, 2009 compared with 12.12% for the same periodin 2008.  Average non-interest bearingdeposits represented 15.35% of average deposits for the six months ended June 30,2009 compared with14.51% for the same period in 2008.

 

The following table setsforth the scheduled maturities of the Corporation’s time deposits indenominations of $100,000 or greater at June 30, 2009:

 

Maturities of TimeDeposits of

$100,000 or More

(Dollars in Thousands)

 
| Three months or less                  |   | $      | 12,387 |   |
|---------------------------------------|--------|--------|--------|--------|
| Over three months through six months  |   | 16,448 |   |
| Over six months through twelve months |   | 14,868 |   |
| Over twelve months                    |   | 10,524 |   |
| Total                                 |   | $      | 54,227 |   |

 

**Borrowing**

** **

**The Corporation has a line of credit with Marshall &Ilsley Bank in the amount of $3,000,000, at a floating interest rate based onthe one-month LIBOR Rate plus 3.75% with a**

 

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**floor rate of 6.50% and a maturity date of November 15,2009.  At June 30, 2009, the line ofcredit was fully advanced.**

** **

**The Bank has lines of credit from the Federal Home LoanBank (FHLB) of San Francisco, the Federal Reserve Bank of San Francisco, Bankof the West, Marshall & Ilsley Bank and The Independent Bank withremaining available borrowing capacity on June 30, 2009 of $683,000,$16,881,000, $4,500,000, $5,000,000 and $5,000,000, respectively.  The Federal Home Loan Bank line of credit hasa maximum borrowing capacity of 25% of the Bank’s total assets, adjustedquarterly.  The Federal Home Loan Bankline of credit is secured by a portion of the Bank’s real estate secured loansand securities at June 30, 2009. The total principal balance at June 30, 2009 of pledged loans andsecurities at the Federal Home Loan Bank was $39,728,000 and $27,727,000,respectively.  The Federal Reserve Bankdiscount window line is secured by a portion of the Bank’s securities at June 30,2009.  At June 30, 2009, the totalmarket value of securities pledged to the Federal Reserve Bank was $31,881,000with an outstanding loan balance of $15,000,000. **The loan bears an interest rateof 0.50% and a maturity date of July 9, 2009.

** **

**The following table providesinformation on fourteen FHLB advances outstanding at June 30, 2009.**

** **
| ** ** | ** ** | ** ** | ** ** | **Funding** | ** ** | **Maturity** | ** ** |
|------------|------------|------------|------------|-------------|------------|--------------|------------|
| **Amount** | ** ** | **Rate**   | ** ** | **Date**    | ** ** | **Date**     | ** ** |
| $          | 1,000,000  |       | 7.72       | %           | 6/1/00     |         | 6/3/30     |   |
| 5,000,000  |       | 4.96       | %          | 11/14/05    |       | 11/15/10     |       |
| 2,250,000  |       | 4.75       | %          | 1/26/06     |       | 1/26/11      |       |
| 1,750,000  |       | 4.72       | %          | 1/26/06     |       | 1/26/11      |       |
| 1,500,000  |       | 5.52       | %          | 7/17/06     |       | 7/18/11      |       |
| 3,500,000  |       | 5.49       | %          | 7/17/06     |       | 7/18/11      |       |
| 1,000,000  |       | 5.22       | %          | 8/25/06     |       | 8/25/11      |       |
| 5,000,000  |       | 5.20       | %          | 7/30/07     |       | 7/30/12      |       |
| 2,500,000  |       | 4.88       | %          | 8/20/07     |       | 8/20/10      |       |
| 5,000,000  |       | 5.00       | %          | 9/18/07     |       | 9/18/14      |       |
| 3,000,000  |       | 4.84       | %          | 10/1/07     |       | 10/1/12      |       |
| 2,000,000  |       | 3.32       | %          | 5/14/08     |       | 5/16/11      |       |
| 5,000,000  |       | 3.57       | %          | 10/2/08     |       | 10/4/10      |       |
| 3,000,000  |       | 3.26       | %          | 11/21/08    |       | 11/2/11      |       |
| $          | 41,500,000 |       |       |        |       |         |       |   |

** **

**The**Bank of the West, Marshall & Ilsley Bank and TheIndependent Bank federal funds lines of credit are unsecured.  The Bank did not utilize any overnightborrowings in 2009 or 2008.

** **

**The Bank has two letters of credit issued by FederalHome 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 of FinancialInstitutions.  The other letter of creditin the amount of $650,000, expiring February 17, 2019, has MasterCardInternational Inc. as the beneficiary.**

 

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**CapitalResources**

 

The Corporation maintains capital tocomply with regulatory requirements, to provide a margin of safety for itsdepositors and stockholders, and to provide for future growth and the ability topay dividends.  At June 30, 2009,shareholders’ equity was $16,640,000 versus $14,352,000 at December 31,2008.  The Corporation paid no cashdividends to shareholders for the six months ended June 30, 2009and $450,000 for the year ended December 31, 2008.  The Bank paid cash dividends to theCorporation of $500,000 for the six months ended June 30, 2009and no dividends for the year ended December 31, 2008.

 

The FDIC andFederal Reserve Board have adopted capital adequacy guidelines for use in theirexamination and regulation of banks and bank holding companies.  If the capital of a bank or bank holdingcompany falls below the minimum levels established by these guidelines, it maybe denied approval to acquire or establish additional banks or non-bank businesses,or the FDIC or Federal Reserve Board may take other administrativeactions.  The guidelines employ twomeasures of capital:  (1) risk-basedcapital and (2) leverage capital.

 

In general, therisk-based capital guidelines provide detailed definitions of which obligationswill be treated as capital, and assign different weights to various assets andoff-balance sheet items, depending upon the perceived degree of credit riskassociated with each asset.  Each assetis assigned to one of four risk-weighted categories.  For example, 0 percent for cash andunconditionally guaranteed government securities; 20 percent for deposits withother banks and fed funds; 50 percent for state bonds and certain residentialreal estate loans; and 100 percent for commercial loans and other assets.  Capital is categorized as either Tier 1capital, consisting of common stock and retained earnings (or deficit), or Tier2 capital, which includes limited-life preferred stock and allowance for loanlosses (subject to certain limitations). The guidelines also define and set minimum capital requirements tomaintain Tier 1 capital of at least 4 % and total capital of 8.0% ofrisk-adjusted assets. The Bank had a Tier 1 capital to total risk-adjustedassets capital ratio of 12.12% and 11.30% at June 30, 2009 and 2008,respectively.  The Bank’s Tier 1 capitalexceeds the minimum regulatory requirement by $16,918,000.  The Bank had a Total Risk-Based capital torisk-adjusted assets ratio of 13.38% and 12.42% at June 30, 2009 and 2008,respectively.  The Bank’s TotalRisk-Based capital exceeds the minimum regulatory requirement by $11,194,000.

 

The Tier 1 leveragecapital ratio guidelines require a minimum leverage capital ratio of 4% of Tier1 capital to total assets less goodwill. The Bank had a leverage capital ratio of 8.35% and 8.10% at June 30,2009 and 2008, respectively.  The Bank’sTier 1 leverage capital exceeds the minimum regulatory requirement by$13,154,000.  The Bank has initiated aplan to increase the leverage capital ratio to a minimum of 9% through earningsand by reducing its asset size.

 

Under regulatoryguidelines, the $8 million in Trust Preferred Securities outstanding qualify asTier 1 capital up to 25% of Tier 1 capital. Any additional Trust Preferred Securities will qualify as Tier 2capital.

 

The Corporation’s Boardof Directors approved a stock repurchase program pursuant to which theCorporation, from time to time and at management’s discretion, may repurchaseup to $500,000 of the Corporation’s outstanding shares.  The Corporation repurchased 20,678 shares 

 

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of common stock at anaverage cost of $4.20 per share in open market transactions during the sixmonths ending June 30, 2009.  TheCorporation repurchased 46,010 shares of common stock at an average cost of$7.51 per share in open market transactions during 2008.

 

In October 2008, the Board and the holders of more than a majorityof our issued and outstanding common stock approved by written consent, anamendment to 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 as wellas the number of shares authorized for issuance in each series of the preferredstock, which matters shall be expressed in resolutions adopted by the Board andfiled 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 becameeffective January 23, 2009. There were no shares issued as of June 30,2009.

 

## **Other Regulatory Matters**

 

TheFederal Deposit Insurance Corporation requested the Bank consent to aregulatory order resulting from its 2008 Consumer Compliance Examination, whichwas completed in 2009.  The Bank does notagree with some of the provisions of the draft order and is seeking expertopinions regarding the matters at issue. As a result of the Bank’s refusal to sign the order in accord with theFDIC’s time frame, the FDIC has indicated to the Bank that it will proceed withthe Administrative Hearing process to issue the order. The FDIC is assertingthat three credit and debit card programs operated by third-party vendorsviolated certain provision of Federal law, which the Bank disputes, and theFDIC is demanding that the Bank make restitution to affected customers and besubjected to a civil money penalty as a result of the alleged violations.  The Bank also believes that restitution andcivil money penalty are inappropriate under the circumstances.  The FDIC is presently investigating the Bank’sinvolvement in the subject card programs utilizing its subpoena powers pursuantto statutory authority.  The financialand non-financial impact of this matter is not known as of the balance sheetdate and as of the issuance date of this report.

 

## **Liquidity**

 

Liquidity representsthe ability to provide sufficient cash flows or cash resources in a manner thatenables an entity to meet its obligations in a timely fashion and adequatelyprovide for anticipated future cash needs.

 

For the Bank,liquidity considerations involve the capacity to meet expected and potentialrequirements of depositors seeking access to balances and to provide for thecredit demands of borrowing customers. In the ordinary course of the Bank’s business, funds are generated fromthe repayment of loans, maturities within the investment securities portfolioand the acquisition of deposit balances and short-term borrowings.  In addition, the Bank has a line of creditfrom the Federal Home Loan Bank of San Francisco of approximately $68,222,000,based on 25 percent of the Bank’s total assets as reported in the most recentquarterly Consolidated Reports of Condition and Income for a bank with DomesticOffices Only.  The line of credit issubject to pledging of acceptable collateral. The Bank has a borrowing line with the Federal Reserve Bank of SanFrancisco secured****a portion of the Bank’ssecurities, with

 

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available borrowingof $16,881,000 at June 30, 2009.  Additionallythe Bank has unsecured federal funds lines of credit with Bank of theWest of $4,500,000, Marshall & Ilsley Bank of $5,000,000 and TheIndependent Bank of $5,000,000 to meet temporary liquidity requirements.  Available borrowingcapacities on June 30, 2009 were $4,500,000, $5,000,000 and $5,000,000,respectively.

 

As a matter of policy, the Bank seeks tomaintain a level of liquid assets, including marketable investment securities,equal to a least 15 percent of total assets (“total liquidity”). Additionallythe Bank maintains secondary sources of liquidity (borrowing lines from otherinstitutions) 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, 2009 and 2008was 34.89% and 33.04%, respectively, while its average loan to average depositratio for such years was 82.72% and 95.72%, respectively.

 

Brokered deposits aredeposit instruments, such as certificates of deposit, deposit notes, bankinvestment contracts and certain municipal investment contracts that are issuedthrough brokers and dealers who then offer and/or sell these depositinstruments 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 regulationrestricts banks from soliciting or accepting brokered deposits, unless the bankis well capitalized under Federal guidelines. The Bank had $1,025,000 in brokered deposits through the Certificate ofDeposit Account Registry Service (CDARS) at June 30, 2009 compared with nobrokered deposits at June 30, 2008.

 

**InterestRate Risk**

 

Management of interest rate sensitivity(asset/liability management) involves matching and repricing rates ofinterest-earning assets with interest-bearing liabilities in a manner designedto optimize net interest income within the constraints imposed by regulatoryauthorities, liquidity determinations and capital considerations.  The Bank instituted formal asset/liabilitypolicies at the end of 1989.

 

The purpose forasset/liability management is to provide stable net interest income growth byprotecting the Bank’s earnings from undue interest rate risk.  The Bank expects to generate earnings fromincreasing loan volume, appropriate loan pricing and expense control and notfrom 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 will be to control the exposure of the Bank’s earnings to changinginterest rates by generally maintaining a position within a narrow range aroundan “earnings neutral position.” An earnings neutral position is defined as themix of assets and liabilities that generate a net interest margin that is notaffected by interest 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.

 

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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 followingtable shows the affect on net interest income of a 100 and a 200 basis pointrate shock at June 30, 2009.  Thetable does not include projections for decreases in rates, as the Federal Fundstarget rate is currently between 0% and 0.25%.

 
| **Rate Shock Increase in  Basis Points** | ** ** | **Percent Increase in Net  Interest Income** | ** ** |
|------------------------------------------|------------|----------------------------------------------|------------|
| 100                                      |       | 4.1                                          | %          |
| 200                                      |       | 10.0                                         | %          |

 

**Investment Securities**

 

Thefollowing table sets forth the book and market value of the investmentsecurities, AFS at June 30, 2009:

 
| ** **                         | ** ** | **INVESTMENT PORTFOLIO MIX** | ** ** |
|------------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **JUNE 30, 2009**            | ** ** |
| **(dollars in thousands)**         | ** ** | **Book Value**               | ** ** | **Market Value** | ** ** |
|                               |       |                         |       |   |   |
| Corporate Debt Securities          |       | $                            | 11,826     |   | $ | 12,211 |   |
| State/Local Agency Bonds           |       | 48,278                       |       | 49,266 |   |
| Mortgage  Backed Securities        |       | 17,727                       |       | 18,225 |   |
| U.S.  Government Agency Securities |       | 10,000                       |       | 9,840 |   |
| Total                              |       | $                            | 87,791     |   | $ | 89,542 |   |

 

The following table sets forth the book and market value of the otherinvestments at June 30, 2009

 
| ** **                                      | ** ** | **INVESTMENT PORTFOLIO MIX** | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **JUNE 30, 2009**            | ** ** |
| ** **                                      | ** ** | **Book Value**               | ** ** | **Market Value** | ** ** |
|                                            |       |                         |       |   |   |
| Metrocities Mortgage, LLC                       |       | $                            | 10         |   | $ | 10 |   |
| Federal Home Loan Bank stock, restricted        |       | 3,332                        |       | 3,332 |   |
| Northern California Bancorp, Inc. Trust I  |       | 93                           |       | 93 |   |
| Northern California Bancorp, Inc. Trust II |       | 155                          |       | 155 |   |
| Independent Bankers Financial Corporation       |       | 51                           |       | 51 |   |
| Visa, Inc. Stock                           |       | 426                          |       | 426 |   |
|                                            |       | $                            | 4,067      |   | $ | 4,067 |   |

 

In addition, the Corporation maintains a trading account, at fairvalue, consisting of marketable securities. At June 30, 2009 and December 31, 2008 the account value was$224,000 and $361,000, respectively.

 

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The contractualmaturities of investment securities as well as yields based on amortized costof those securities at June 30, 2009 are shown below.  Actual maturities may differ from contractualmaturities because issuers have the right to call or prepay obligations with orwithout call or prepayment penalties.

 
| ** **                     | ** ** | ** **            | ** ** | ** **      | ** ** | **After  one year to** | ** ** | **After  five years to** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|-----------------------|------------|-----------------|------------|------------------------|------------|--------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **One year  or less** | ** ** | **five  years** | ** ** | **ten  years**         | ** ** | **After  ten years**     | ** ** | **Total**  | ** ** |
| **(Dollars in thousands)**     | ** ** | **Amount**            | ** ** | **Yield**       | ** ** | **Amount**             | ** ** | **Yield**                | ** ** | **Amount** | ** ** | **Yield**  | ** ** | **Amount** | ** ** | **Yield**  | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| Available-for-sale             |       |                  |       |            |       |                   |       |                     |       |       |       |       |       |       |       |       |       |   |   |   |   |
| Corporate  Debt Securities     |       | $                     | 1,985      |            | 9.88       | %                      | $          | 10,226                   |       | 7.74       | %          | $          | —     |       | 0.00       | %          | $          | — |   | 0.00 | % | $ | 12,211 |   | 8.10 | % |
| Mortgage  Backed Securities    |       | —                |       | 0.00            | %          | —                 |       | 0.00                     | %          | 3,671      |       | 7.29       | %     | 14,554     |       | 6.08       | %     | 18,225 |   | 6.33 | % |
| State/Local  Agency Securities |       | —                |       | 0.00            | %     | —                 |       | 0.00                     | %     | 393        |       | 4.91       | %          | 48,873     |       | 4.53       | %          | 49,266 |   | 4.54 | % |
| U.S.  Government Agencies      |       | —                |       | 0.00            | %          | —                 |       | 0.00                     | %          | —     |       | 0.00       | %          | 9,840      |       | 5.18       | %          | 9,840 |   | 5.18 | % |
|                           |       | $                     | 1,985      |            | 9.88       | %                      | $          | 10,226                   |       | 7. 74      | %          | $          | 4,064      |       | 7.05       | %          | $          | 73,267 |   | 4.93 | % | $ | 89,542 |   | 5.45 | % |

 

**Item 4T.  Controls and Procedures**

 

(a) The Bank’sChief Executive Officer and its Chief Financial Officer, after evaluating theeffectiveness of the Bank’s disclosure controls and procedures as defined inExchange Act Rules 13a-15(e) promulgated under the Exchange Act as ofthe end of the period covered by this report (the “Evaluation Date”) haveconcluded that as of the Evaluation Date, the Bank’s disclosure controls andprocedures were adequate and effective to ensure that material informationrelating to the Bank would be made known to them by others within the Bank,particularly during the period in which this report was being prepared.  Disclosure controls and procedures aredesigned to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the Securitiesand Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed byus in the reports that we file under the Exchange Act is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

(b) Changesin Internal Controls:  In the quarterended June 30,2009, the Company did not make anysignificant changes in, nor take any corrective actions regarding, its internalcontrols or other factor that could significantly affect these controls.

 

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**PART II-OTHERINFORMATION**

 

**Item1.  Legal Proceedings.**

 

The Corporation, the Bank and Charles T. Chrietzberg, Jr. were named as defendants in a lawsuit filed November 3, 2008 in the Monterey County Court-Civil Division by Golden State Bank.  The lawsuit involves claims related to loan participations purchased by Golden State Bank from Monterey County Bank.  The lawsuit seeks to compel arbitration of the issues, rescission of the participation agreements, payment of all principal and interest, damages, attorneys’ fees and costs.

 

The defendants have reviewed the lawsuit, categorically deny all of the allegations and will vigorously defend the suit.  The parties have agreed to have this matter decided by binding arbitration.

 

The Bank was named as defendant in a lawsuit filed February 26, 2009 in Monterey County Court-Civil Division by Tighorn Financial Services, LLC (“Tighorn”).  The lawsuit seeks to compel the Bank to continue its credit card sponsorship and the servicing of a credit card portfolio under a card sponsorship agreement with Tighorn.  Pursuant to termination provisions contained in the parties’ agreement, the Bank gave Tighorn written notice of termination of the agreement in June 2008.

 

The Bank, Charles T. Chrietzberg, Jr. and Timothy M. Leveque were named as defendants in a lawsuit filed April 29, 2009 in the Monterey County Court-Civil Division by First Foundation Bank.  The lawsuit involves claims related to two loan participations purchased by First Foundation Bank from Monterey County Bank.  The lawsuit seeks to the rescission of the participation agreements, payment of all principal and interest, damages, attorneys’ fees and costs.

 

The Bank has reviewed the lawsuit, categorically denies all of the allegations, believes it gave proper notice, and will vigorously defend the suit.

 

Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of management, any such liability will not have a material effect on the consolidated financial position of the Corporation or the Bank.

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None

 

**Item3.  Defaults upon Senior Securities**

 

None

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders.**

** **

None

 

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#### **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. |

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|                        | NORTHERN CALIFORNIA  BANCORP, INC. |
|-----------------------------|------------------------------------|
|                        |                               |
| Date: August 13,  2009 | By:                           | /s/ Charles T.  Chrietzberg, Jr. |
|                        |                               | Charles T.  Chrietzberg, Jr. |
|                        |                               | Chairman of the  Board & |
|                        |                               | Chief Executive Officer |
|                        |                               |   |
| Date: August 13,  2009 | By:                                | /s/ Bruce N. Warner |
|                        |                               | Bruce N. Warner |
|                        |                               | Chief  Financial Officer and |
|                        |                               | Principal  Accounting Officer |

 

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