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 Securities Exchange Act of  1934** |
|-------|---------------------------------------------------------------------------------------------------|

 

**for the quarterly period ended March 31,2010**

 
| **o** | **Transition  report under Section 13 or 15(d) of the Securities Exchange Act of  1934 (No fee required)** |
|-------|----------------------------------------------------------------------------------------------------------------------|

 

**for the periodfrom         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

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files). Yes o  No o

 

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

 
| 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 May 10,2010, the Corporation had 1,785,891 shares of common stock outstanding.

 

 

 

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TABLE OF CONTENTS

 
| **Facing  Page**       | 1                                                                                           |
|------------------------|---------------------------------------------------------------------------------------------|
| **Table  of Contents** | 2                                                                                           |
| **PART I**        | Financial Information                                                                       | 3-6 |
| Item 1                 | Financial Statements                                                                        |   |
|                   | Consolidated  Balance Sheets                                                                | 3 |
|                   | Consolidated  Statements of Operations                                                      | 4 |
|                   | Consolidated****Statements****of  Changes in Shareholders’ Equity                      | 5 |
|                   | Consolidated  Statements of Cash Flows                                                      | 6 |
|                   | Notes  to Consolidated Financial Statements                                                 | 7-17 |
| Item 2                 | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 18-34 |
| Item 3                 | (Not Applicable)                                                                            |   |
| Item 4T                | Controls and  Procedures                                                                    | 34 |
|                   |                                                                                        |   |
| **PART II**       | Other Information                                                                           |   |
| Item 1                 | Legal Proceedings                                                                           | 35 |
| Item 2                 | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 35 |
| Item 3                 | Defaults  Upon Senior Securities                                                            | 36 |
| Item 4                 | Submission  of Matters to a Vote of Security Holders                                        | 36 |
| Item 5                 | Other Information                                                                           | 36 |
| Item 6                 | Exhibits                                                                                    | 36 |
| Signatures             | 36                                                                                          |
| Certifications         | 37-40                                                                                       |

 

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**PART I-FINANCIALINFORMATION**

 

### Item1.            FINANCIAL STATEMENTS

###  

NORTHERNCALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATEDBALANCE SHEETS

 
| ** **                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(in  thousands except share data)**                                               | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                                                                          | ** ** | **(Unaudited)**    | ** ** | **(Audited)**         | ** ** |
| ASSETS:                                                                             |       |               |       |                  |       |
| Cash  and Due From Banks                                                            |       | $                  | 29,782     |                  | $          | 12,251 |   |
| Trading  Assets                                                                     |       | 78                 |       | 153                   |       |
| Investment  Securities, available for sale (Note 6)                                 |       | 61,394             |       | 62,413                |       |
| Other  Investments (Note 6)                                                         |       | 4,085              |       | 4,085                 |       |
| Loans  Held for Sale, at lower of cost or market                                    |       | 2,375              |       | 2,216                 |       |
| Loans,  net of allowance for loan losses of $3,418 in 2010; $3,529 in 2009 (Note 7) |       | 149,599            |       | 160,997               |       |
| Bank  Premises and Equipment, Net                                                   |       | 5,097              |       | 4,909                 |       |
| Cash  Surrender Value of Life Insurance                                             |       | 4,129              |       | 4,097                 |       |
| Other  Real Estate Owned (Note 8)                                                   |       | 22,517             |       | 14,333                |       |
| Interest  Receivable and Other Assets                                               |       | 6,770              |       | 7,841                 |       |
| Total  Assets                                                                       |       | $                  | 285,826    |                  | $          | 273,295 |   |
|                                                                                |       |               |       |                  |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY:                                         |       |               |       |                  |       |
| Non  interest-bearing demand                                                        |       | $                  | 35,759     |                  | $          | 25,781 |   |
| Interest-bearing  demand                                                            |       | 16,504             |       | 16,984                |       |
| Savings                                                                             |       | 6,891              |       | 6,270                 |       |
| Time  less than $100,000                                                            |       | 98,193             |       | 94,686                |       |
| Time  in denominations of $100,000 or more                                          |       | 63,351             |       | 58,701                |       |
| Total  Deposits                                                                     |       | 220,698            |       | 202,422               |       |
|                                                                                |       |               |       |                  |       |
| Revolving  line of credit                                                           |       | 2,850              |       | 2,850                 |       |
| Federal  Home Loan Bank Borrowed Funds                                              |       | 34,000             |       | 29,000                |       |
| Federal  Reserve Bank Borrowed Funds                                                |       | —             |       | 10,000                |       |
| Junior  Subordinated Debt Securities                                                |       | 8,248              |       | 8,248                 |       |
| Payable  for Investment Securities Purchased                                        |       | 513                |       | —                |       |
| Interest  Payable and Other Liabilities                                             |       | 2,808              |       | 4,625                 |       |
| Total  Liabilities                                                                  |       | 269,117            |       | 257,145               |       |
|                                                                                |       |               |       |                  |       |
| Shareholders’  Equity:                                                         |       |               |       |                  |       |
| Common  Stock - No Par Value                                                        |       |               |       |                  |       |
| Authorized  10,000,000 in 2010 and 2009                                             |       |               |       |                  |       |
| Outstanding:1,785,891  in 2010 and 1,783,230 in 2009                                |       | 5,094              |       | 5,088                 |       |
| Retained  Earnings                                                                  |       | 11,031             |       | 11,092                |       |
| Accumulated  Other Comprehensive Income (Loss) (Note 9)                             |       | 584                |       | (30                   | )          |
| Total  Shareholders’ Equity                                                    |       | 16,709             |       | 16,150                |       |
| Total  Liabilities & Shareholders’ Equity                             |       | $                  | 285,826    |                  | $          | 273,295 |   |

 

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

 

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NORTHERNCALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF OPERATIONS (UNAUDITED)

 
| ** **                                                              | ** ** | **THREE-MONTH PERIOD ENDED** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                              | ** ** | **March 31,**           | ** ** |
| **(in  thousands except for per share data)**                           | ** ** | **2010**                     | ** ** | **2009** | ** ** |
| INTEREST  INCOME:                                                       |       |                         |       |   |   |
| Loans                                                                   |       | $                            | 2,571      |   | $ | 2,992 |   |
| Time  deposits with other financial institutions                        |       | 3                            |       | 5 |   |
| Investment  securities                                                  |       | 778                          |       | 1,439 |   |
| Total  Interest Income                                                  |       | 3,352                        |       | 4,436 |   |
|                                                                    |       |                         |       |   |   |
| INTEREST  EXPENSE:                                                      |       |                         |       |   |   |
| Interest-bearing  transaction accounts                                  |       | 5                            |       | 6 |   |
| Savings  and time deposit accounts                                      |       | 598                          |       | 945 |   |
| Time  deposits in denominations of $100,000 or more                     |       | 395                          |       | 545 |   |
| Notes  payable and other                                                |       | 495                          |       | 796 |   |
| Total  Interest Expense                                                 |       | 1,493                        |       | 2,292 |   |
|                                                                    |       |                         |       |   |   |
| Net  Interest Income                                                    |       | 1,859                        |       | 2,144 |   |
| Provision  for loan losses                                              |       | —                       |       | 250 |   |
| Net  interest income, after provision for loan losses                   |       | 1,859                        |       | 1,894 |   |
|                                                                    |       |                         |       |   |   |
| NON-INTEREST  INCOME:                                                   |       |                         |       |   |   |
| Service  charges on deposit accounts                                    |       | 123                          |       | 191 |   |
| Income  from sales and servicing of Small Business Administration Loans |       | 63                           |       | 38 |   |
| Gain  on sales of investment securities                                 |       | 136                          |       | 158 |   |
| Other  income                                                           |       | 1,179                        |       | 939 |   |
| Total  non-interest income                                              |       | 1,501                        |       | 1,326 |   |
|                                                                    |       |                         |       |   |   |
| NON-INTEREST  EXPENSE:                                                  |       |                         |       |   |   |
| Salaries  and Employee Benefits                                         |       | 916                          |       | 798 |   |
| Occupancy  and Equipment Expense                                        |       | 265                          |       | 261 |   |
| Foreclosed  assets, net                                                 |       | 734                          |       | 141 |   |
| Professional  Fees                                                      |       | 408                          |       | 146 |   |
| Prepayment  fees on borrowings                                          |       | —                       |       | 81 |   |
| Data  Processing                                                        |       | 76                           |       | 89 |   |
| Other  general and administrative                                       |       | 1,132                        |       | 1,147 |   |
| Total  non-interest expenses                                            |       | 3,531                        |       | 2,663 |   |
|                                                                    |       |                         |       |   |   |
| Income  before tax provision (benefit)                                  |       | (171                         | )          | 557 |   |
| Income  tax provision (benefit)                                         |       | (110                         | )          | 42 |   |
| Net  income (loss)                                                      |       | $                            | (61        | ) | $ | 515 |   |
|                                                                    |       |                         |       |   |   |
| Earnings  (loss) per common share                                       |       |                         |       |   |   |
| Basic                                                                   |       | $                            | (0.03      | ) | $ | 0.29 |   |
| Diluted                                                                 |       | $                            | (0.03      | ) | $ | 0.29 |   |

 

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

 

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NORTHERN CALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATED STATEMENTS OFCHANGES IN SHAREHOLDERS’ EQUITY

** **
| ** **                                                                                                                | ** ** | ** **     | ** ** | ** ** | ** ** | ** **   | ** ** | **Accumulated**          | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|----------------|------------|------------|------------|--------------|------------|--------------------------|------------|------------|------------|
| ** **                                                                                                                | ** ** | ** **     | ** ** | ** ** | ** ** | ** **   | ** ** | **Other  Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                                                                | ** ** | **Number  of** | ** ** | **Common** | ** ** | **Retained** | ** ** | **Income**               | ** ** | ** ** | ** ** |
| **(in  thousands except share data)**                                                                                     | ** ** | **Shares**     | ** ** | **Stock**  | ** ** | **Earnings** | ** ** | **(Loss)**               | ** ** | **Total**  | ** ** |
|                                                                                                                      |       |           |       |       |       |         |       |                     |       |       |       |   |   |   |   |
| Balance  at December 31, 2008                                                                                        |       | 1,803,908      |       | $          | 5,173      |         | $          | 9,481                    |       | $          | (302       | ) | $ | 14,352 |   |
|                                                                                                                      |       |           |       |       |       |         |       |                     |       |       |       |
| Comprehensive  income:                                                                                                    |       |           |       |       |       |         |       |                     |       |       |       |
| Net  income for the year                                                                                                  |       | —         |       | —     |       | 1,611        |       | —                   |       | 1,611      |       |
| Change  in net unrealized loss on AFS securities and other assets, net of tax  reclassification adjustment and tax effect |       | —         |       | —     |       | —       |       | 272                      |       | 272        |       |
| Total  comprehensive income                                                                                               |       |           |       |       |       |         |       |                     |       | 1,883      |       |
|                                                                                                                      |       |           |       |       |       |         |       |                     |       |       |       |
|  Stock  repurchase                                                                                                   |       | (20,678        | )          | (85        | )          | —       |       | —                   |       | (85        | )          |
|                                                                                                                      |       |           |       |       |       |         |       |                     |       |       |       |
| Balance  at December 31, 2009 (Audited)                                                                              |       | 1,783,230      |       | 5,088      |       | 11,092       |       | (30                      | )          | $          | 16,150     |   |
|                                                                                                                      |       |           |       |       |       |         |       |                     |       |       |       |
| Comprehensive  income:                                                                                                    |       |           |       |       |       |         |       |                     |       |       |       |
| Net  loss for the quarter                                                                                                 |       | —         |       | —     |       | (61          | )          | —                   |       | (61        | )          |
| Change  in net unrealized loss on AFS securities and other assets, net of tax  reclassification adjustment and tax effect |       | —         |       | —     |       | —       |       | 614                      |       | 614        |       |
| Total  comprehensive income                                                                                               |       |           |       |       |       |         |       |                     |       | 553        |       |
|                                                                                                                      |       |           |       |       |       |         |       |                     |       |       |       |
| Exercise  of stock options, Including tax benefit                                                                         |       | 2,661          |       | 6          |       | —       |       | —                   |       | 6          |       |
|                                                                                                                      |       |           |       |       |       |         |       |                     |       |       |       |
| Balance  at March 31, 2010 (Unaudited)                                                                               |       | 1,785,891      |       | $          | 5,094      |         | $          | 11,031                   |       | $          | 584        |   | $ | 16,709 |   |

 

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

 

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NORTHERNCALIFORNIA BANCORP, INC.

AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF CASH FLOWS (UNAUDITED)

 
| ** **                                                                            | ** ** | **THREE MONTH PERIOD ENDED  MARCH 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **(in  thousands)**                                                                   | ** ** | **2010**                                     | ** ** | **2009** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                              |       |                                         |       |   |   |
| Net  income (loss)                                                                    |       | $                                            | (61        | ) | $ | 515 |   |
| Adjustments  to reconcile net income (loss) to net cash used by operating activities: |       |                                         |       |   |   |
| Depreciation  and amortization expense                                                |       | 88                                           |       | 86 |   |
| Realized  gain on sales of available-for-sale securities, net                         |       | (136                                         | )          | (158 | ) |
| Amortization  of deferred loan fees, net                                              |       | 28                                           |       | 291 |   |
| Amortization  (accretion) of discounts and premiums on investment securities, net     |       | (21                                          | )          | (53 | ) |
| Provision  for loan losses                                                            |       | —                                       |       | 250 |   |
| Provision  for foreclosed asset losses                                                |       | 649                                          |       | — |   |
| Gain  on sale of foreclosed assets                                                    |       | (23                                          | )          | — |   |
| Increase  in cash surrender value of life insurance                                   |       | (32                                          | )          | (33 | ) |
| Deferred  income tax benefit                                                          |       | (184                                         | )          | (87 | ) |
| (Increase)  decrease in assets:                                                       |       |                                         |       |   |   |
| Trading  assets                                                                       |       | 75                                           |       | 43 |   |
| Loans  held for sale                                                                  |       | (159                                         | )          | (967 | ) |
| Interest  receivable                                                                  |       | 83                                           |       | 430 |   |
| Other  assets                                                                         |       | 1,170                                        |       | (1,722 | ) |
| Increase  (decrease) in liabilities:                                                  |       |                                         |       |   |   |
| Interest  payable                                                                     |       | (24                                          | )          | (103 | ) |
| Other  liabilities                                                                    |       | (1,793                                       | )          | 612 |   |
| Net  cash used by operating activities                                                |       | (340                                         | )          | (896 | ) |
|                                                                                  |       |                                         |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                              |       |                                         |       |   |   |
| Net  change in time deposits with other financial institutions                        |       | —                                       |       | (2,000 | ) |
| Activity  in available-for sale securities                                            |       |                                         |       |   |   |
| Sales                                                                                 |       | 2,768                                        |       | 26,744 |   |
| Maturities,  prepayments, and calls                                                   |       | 74                                           |       | (467 | ) |
| Purchases                                                                             |       | (539                                         | )          | (30,925 | ) |
| Net  (increase) decrease in loans                                                     |       | 2,077                                        |       | (3,737 | ) |
| Proceeds  from loan sales                                                             |       | 252                                          |       | — |   |
| Proceeds  from sale of other real estate owned                                        |       | 229                                          |       | — |   |
| Investment  in other real estate owned                                                |       | —                                       |       | (232 | ) |
| Proceeds  from sale of equipment                                                      |       | —                                       |       | 1 |   |
| Additions  to bank premises and equipment                                             |       | (272                                         | )          | (7 | ) |
| Net  cash provided (used) by investing activities                                     |       | 4,589                                        |       | (10,623 | ) |
|                                                                                  |       |                                         |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                              |       |                                         |       |   |   |
| Net  increase in deposits                                                             |       | 18,276                                       |       | 19,487 |   |
| Proceeds  from borrowings                                                             |       | 5,000                                        |       | — |   |
| Repayments  on borrowing, net                                                         |       | (10,000                                      | )          | (12,000 | ) |
| Proceeds  from exercise of stock options                                              |       | 6                                            |       | — |   |
| Net  cash provided by financing activities                                            |       | 13,282                                       |       | 7,487 |   |
|                                                                                  |       |                                         |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                                 |       | 17,531                                       |       | (4,032 | ) |
|                                                                                  |       |                                         |       |   |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING**                                              |       | 12,251                                       |       | 16,348 |   |
|                                                                                  |       |                                         |       |   |   |
| **CASH AND CASH EQUIVALENTS, ENDING**                                                 |       | $                                            | 29,782     |   | $ | 12,316 |   |

 

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

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

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

 

**(NOTE2)  CRITICAL ACCOUNTING 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 March 31, 2010.

 

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 

 

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Corporation’s financial statements. This policy relates to the methodology that determines the Corporation’sallowance for loan losses.  Managementhas discussed the development and selection of this critical accounting policywith the Corporation’s Audit Committee of the Board of Directors.  Although Management believes the level of theallowance at March 31, 2010 is adequate to absorb losses inherent in theloan portfolio, a decline in the regional economy may result in increasinglosses that cannot reasonably be predicted at this time.  For further information regarding theallowance for loan losses see “Provision and Allowance for Loan Losses”included elsewhere herein.

 

Another critical accountingpolicy relates to the valuation of other real estate owned (OREO).Assetsacquired through, or in lieu of, loan foreclosure are held for sale and areinitially recorded at fair value less cost to sell at the date of foreclosure,establishing a new cost basis. Subsequent to foreclosure, valuations areperiodically performed by management and the assets are carried at the lower ofcarrying amount or fair value less estimated cost to sell. Any write-down tofair value at the time of transfer to OREO is charged to the allowance for loanlosses. Property is evaluated regularly to ensure that the recorded amount issupported by its current fair value and that valuation allowances to reduce thecarrying amount to fair value less estimated costs to dispose are recorded asnecessary. Revenue and expenses from operations of OREO and changes in thevaluation allowance are included in net expenses from OREO.

 

(NOTE 3) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

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

 

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

 

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InJune 2009, the FASB issued ASU 2009-16 (formerly**Statementof Financial Accounting Standards (SFAS) No. 166), *Accounting for Transfers of Financial Assets, anamendment of FASB Statement No. 140*.  ASU 2009-16amends the de-recognition accounting and disclosure guidance relating to SFAS No. 140.  ASU2009-16 eliminates the exemption from consolidation for qualifying specialpurpose entities (QSPEs), and requires a transferor to evaluate all existingQSPEs to determine whether they must be consolidated in accordance with ASU2009-16.  It also amends the sale recognition rules for sales ofparticipating interests in loans. ASU 2009-16 is effective as of the beginningof the first annual reporting period that begins after November 15,2009.  As a result of the adoption of ASU 2009-16, the Corporationdelays the accounting recognition of sales of the guaranteed portion of SBAloans for 90 days.  The Corporation alsoensures the proportionate sharing of cash flows prior to recognizing the saleof participation interests in loans.

 

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

 

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

 

(NOTE4) STOCK BASED COMPENSATION

 

TheCorporation’s compensation cost relating to share-based payment transactions isrecognized in the financial statements based upon the fair value of the equityor liability instruments issued. Based on the stock-based compensation awardsoutstanding for the three months ended March 31, 2010 and 2009, there wasno 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 March 

 

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31, 2010, 23,500 options were outstanding.  During 2010, 2,661 options were exercised byofficers, employees, and board members. As of March 31, 2010, all options have been vested and all relatedcompensation expense had been 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 stock**options and non-qualified stock options to directors,officers, and employees of the Corporationand its subsidiary, so long as the Corporation owns amajority of the equity interest of suchsubsidiary. Incentive stock options are granted at fair value of the common stock onthe date ofgrant.  However, an incentive stock option granted toan individual owning 10% or more of the Corporation’s stock after such grantmust have an exercise price of at least 110% of such fair market value and anexercise period of not more than five years. The Board of Directors is authorized to determine when options becomeexercisable within a period not exceeding 10 years from the date of grant.  Under the Plan, 300,000 shares of commonstock have been reserved for the granting of these options.  At March 31, 2010, no options have beengranted under the 2007 stock option plan. Thus, no pre-tax stock-based compensation expense was requiredfor the three months ended March 31, 2010 and 2009.

** **

(NOTE 5) EARNINGS (LOSS) PER SHARE

 

**Basic earnings (loss) per share represent income (loss)available to common stockholders divided by the weighted-average number of commonshares outstanding during the period. Diluted earnings (loss) per share reflect additional common shares thatwould have been outstanding, if potential dilutive common shares had beenissued, as well as any adjustment to income that would result from the assumedissuance.  Potential common shares thatmay be issued by the Corporation relate to outstanding stock options andwarrants and are determined using the treasury stock method.**

** **

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

 
| ** **                               | ** ** | **Earnings (Loss) per Share   Calculation**  | ** ** |
|------------------------------------------|------------|----------------------------------------------|------------|
| ** **                               | ** ** | **For the three months ended March 31** | ** ** |
| ** **                               | ** ** | **2010**                                     | ** ** | **2009** | ** ** |
| ** **                               | ** ** | ** **                                   | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| **(in  thousands except per**            | ** ** | **Net**                                      | ** ** | **Average** | ** ** | **Per Share** | ** ** | **Net** | ** ** | **Average** | ** ** | **Per Share** | ** ** |
| **share  data)**                         | ** ** | **(Loss)**                                   | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic  earnings (loss) per share         |       | $                                            | (61        | ) | 1,783,733 |   | $ | (.03 | ) | $ | 515 |   | 1,803,908 |   | $ | 0.29 |   |
|                                     |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Effect  of dilutive shares:              |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| assumed  exercise of outstanding options |       | —                                       |       | 2,727 |   | — |   | — |   | — |   | — |   |
|                                     |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Diluted  (loss) earnings per share       |       | $                                            | (61        | ) | 1,786,460 |   | $ | (.03 | ) | $ | 515 |   | 1,803,908 |   | $ | 0.29 |   |

 

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(NOTE 6) INVESTMENT SECURITIES

 

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

 
| ** **                          | ** ** | **March 31, 2010**    | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| ** **                          | ** ** | ** **                 | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                          | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Securities Available for  Sale      |       |                       |       |   |   |   |   |   |   |
| Mortgage Backed Securities          |       | $                          | 863        |   | $ | 79 |   | $ | — |   | $ | 942 |   |
| State/Local Agency Securities       |       | 51,533                     |       | 1,921 |   | (1,119 | ) | 52,335 |   |
| Government Agency Securities        |       | 7,991                      |       | 126 |   | — |   | 8,117 |   |
|                                |       |                       |       |   |   |   |   |   |   |
| Total securities available for sale |       | $                          | 60,387     |   | $ | 2,126 |   | $ | (1,119 | ) | $ | 61,394 |   |

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

 

Inaddition, the Corporation maintains a trading account, at fair value,consisting of marketable securities.  At March 31,2010 and December 31, 2009 the account value was $78,000 and $153,000,respectively.

 

Theamortized cost and fair value of debt securities by contractual maturity dateat March 31, 2010 follows:

 
| ** **                             | ** ** | **Available for Sale**     | ** ** |
|----------------------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | **Amortized**              | ** ** | **Fair** | ** ** |
| ** **                             | ** ** | **Cost**                   | ** ** | **Value** | ** ** |
| ** **                             | ** ** | **(Dollars in thousands)** | ** ** |
|                                   |       |                       |       |   |   |
| Due after five years through ten years |       | $                          | 1,000      |   | $ | 1,000 |   |
| Due after ten years                    |       | 59,387                     |       | 60,394 |   |
|                                   |       |                       |       |   |   |
|                                   |       | $                          | 60,387     |   | $ | 61,394 |   |

 

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Proceeds from maturity and sales of investment securities for the threemonths ended March 31, 2010, and 2009 were $2,768,000, and $26,744,000,respectively.  Realized gains for threemonths ended March 31, 2010, and 2009 were $136,000, and $158,000,respectively.

 

AtMarch 31, 2010 and December 31, 2009, U.S. Government and MortgageBacked obligations with a carrying value of $8,854,000 and $8,761,000,respectively, were pledged to secure advances from the FHLB.

 

AtMarch 31, 2010 and December 31, 2009 State/Local Agency obligationswith a carrying value of $20,604,000 and $20,462,000, respectively, werepledged to secure loans from the Federal Reserve Bank.

 

InMarch 2010, the Bank purchased debt securities totaling $513,000 that hadsettlement dates in April 2010.  TheBank had recorded the investment securities purchased as of the trade date andhad recorded the corresponding payable for investment securities purchased of$513,000 at March 31, 2010.

 

Information pertaining to securities with grossunrealized losses at March 31, 2010, aggregated by investment category andlength of time that individual securities have been in a continuous lossposition follows:

 
| ** **                     | ** ** | **Fair**                   | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** |
|--------------------------------|------------|----------------------------|------------|----------------|------------|-----------|------------|----------------|------------|-----------|------------|----------------|------------|
| ** **                     | ** ** | **Value**                  | ** ** | **Loss**       | ** ** | **Value** | ** ** | **Loss**       | ** ** | **Value** | ** ** | **Loss**       | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
|                           |       |                       |       |           |       |      |       |           |       |      |       |           |       |
| Securities Available for Sale: |       |                       |       |           |       |      |       |           |       |      |       |           |       |
| State/Local Agency Securities  |       | $                          | 8,827      |           | $          | (90       | )          | $              | 8,889      |      | $          | (1,029         | )          | $ | 17,716 |   | $ | (1,119 | ) |
|                                |            |                            |            |                |            |           |            |                |            |           |            |                |            |  |  |  |  |  |  |

 

Information pertaining to securities with grossunrealized losses at December 31, 2009, aggregated by investment categoryand length of time that individual securities have been in a continuous lossposition follows:

 

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

 

Managementevaluates securities for other-than-temporary impairment at least on aquarterly basis, and more frequently when economic or market concerns warrantsuch evaluation. Consideration is given to (1) the length of time and theextent to which the fair value has been less than cost, (2) the financialcondition and near-term prospects of the issuer, and (3) the Bank does not have the intent to sellthe security; and it is more likely than not it will not have to sell thesecurity before recovery of its cost basis.

 

OnMarch 31, 2010, twenty six securities had an unrealized loss withaggregate depreciation of 7.45% from the Bank’s amortized cost basis. On December 31,2009, forty securities had an unrealized loss with aggregate depreciation of5.62% from the Bank’s amortized cost basis. The unrealized losses relate to amortgage backed security issued by federally sponsored agencies, which arefully secured by conforming residential loans, securities issued by agencies ofthe United States and securities issued by local government agencies.  Since the Bank has the ability to hold thesesecurities until estimated maturity, no decline is deemed to be other thantemporary.

 

(NOTE 7) LOANS AND ALLOWANCE FOR LOAN LOSSES

 

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

 
| ** **                             | ** ** | **MARCH 31** | ** ** | **DECEMBER 31** | ** ** |
|----------------------------------------|------------|-------------------|------------|-----------------|------------|
| **(dollars  in thousands)**            | ** ** | **2010**          | ** ** | **2009**        | ** ** |
| Commercial  and Industrial             |       | $                 | 30,467     |            | $          | 31,389 |   |
| Construction                           |       | 2,769             |       | 8,705           |       |
| Real  Estate - Mortgage                |       | 119,336           |       | 121,887         |       |
| Installment                            |       | 628               |       | 2,746           |       |
| Government  Guaranteed Loans Purchased |       | 16                |       | 16              |       |
|                                   |       | 153,216           |       | 164,743         |       |
| Allowance  for loan losses             |       | (3,418            | )          | (3,529          | )          |
| Deferred  origination fees, net        |       | (199              | )          | (217            | )          |
| Net  Loans                             |       | $                 | 149,599    |            | $          | 160,997 |   |
|                                   |       |              |       |            |       |
| Balance  at Beginning of Period        |       | $                 | 3,529      |            | $          | 2,413 |   |
| Recoveries                             |       | —            |       | 77              |       |
| Provision  for Loan Losses             |       | —            |       | 3,368           |       |
| Loans  Charged Off                     |       | (111              | )          | (2,629          | )          |
| Balance  at End of Period              |       | $                 | 3,418      |            | $          | 3,529 |   |

 

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

 
| ** **                                                                                                                    | ** ** | **March 31, 2010**    | ** **  | **December 31, 2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|-------------|----------------------------|------------|
| ** **                                                                                                                    | ** ** | **(Dollars in thousands)** | ** **  |
| Total impaired  loans which as a result of write-down or the fair value of the collateral,  did not have a specific allowance | ** ** | $                          |  1,357 | ** **                 | $          |  4,399 | ** ** |
| Impaired loans which have a specific allowance                                                                                |       | 2,312                      |        | 3,681                      |       |
|                                                                                                                          |       |                       |        |                       |       |
| Total impaired loans                                                                                                          |       | $                          | 3,669       |                       | $          | 8,080 |   |
|                                                                                                                          |       |                       |        |                       |       |
| Total specific allowance on impaired loans                                                                                    |       | $                          | 210         |                       | $          | 357 |   |
|                                                                                                                          |       |                       |        |                       |       |
| Average recorded investment in impaired loans  during the period                                                              |       | $                          | 5,696       |                       | $          | 6,490 |   |
| Income recognized on impaired loans during the  period                                                                        |       | $                          | —      |                       | $          | — |   |

 

## **(Note8) FORECLOSED ASSETS**

 

Asof March 31, 2010 and 2009, foreclosed assets totaled $22,517,000 and$14,733,000, respectively, net of valuation allowance. Based on propertyvalues, a valuation allowance of $1,636,000 and $1,010,000 was deemed necessaryat March 31, 2010 and December 31, 2009, respectively.

 

Duringthe three months ended March 31, 2010 one property was sold for $225,000,with a gain on sale of $23,000.  Therewere no sales of foreclosed assets during the three months ended March 31,2009.

 

Subsequentto March 31, 2010, one property valued at $2,365,000 sold, resulting in adeferred gain of $74,000.  The Bankaccepted a property valued at $520,000 as a trade-in on the property sold.

 

Operatingexpenses for foreclosed assets totaled $734,000 and $141,000 for the threemonths ended March 31, 2010 and 2009, respectively.

 

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(NOTE 9) FAIR VALUE MEASUREMENTS:

 

Authoritative guidance establishes a hierarchy for measuring fair valueunder generally accepted accounting principles (GAAP) in the United States ofAmerica and applies to all financial assets and liabilities that are beingmeasured and reported at fair value on a recurring and non-recurring basis.Fair value is measured in levels, which are described in more detail below, andis determined based on the observability and reliability of the assumptionsused to determine fair value.

 

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

 

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

 

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

 

The Corporation measures and reports available-for-sale securities atfair value on a recurring basis. The following table shows the balances ofthese assets based on the designated levels.

 

 
| ** **                       | ** ** | **At March 31, 2010** | ** ** |
|----------------------------------|------------|----------------------------|------------|
| **(dollars  in thousands)**      | ** ** | **Total**                  | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Investment securities — AFS |       | $                          | 61,394     |   | $ | — |   | $ | 61,394 |   | $ | — |   |
|                                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |

 

The Corporation is also required, from time to time, to measure certainother assets at fair value on a non-recurring basis in accordance with GAAP.During the three months ended March 31, 2010, the Corporation measuredcollateral dependent impaired loans, loans held for sale, and Other Real EstateOwned (OREO) at fair value. The assets are measured at fair value on anon-recurring basis and the following table provides the assets’ designatedlevels, as well as the fair value losses recognized during the three months endedMarch 31, 2010.

 
| **(dollars in  thousands)** | ** ** | **Total** | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** | **Losses for the  three months  ended March 31,  2010** | ** ** |
|-----------------------------|------------|-----------|------------|---------------|------------|---------------|------------|---------------|------------|--------------------------------------------------------------|------------|
| Impaired loans              |       | $         | 3,669      |          | $          | —        |       | $             | —     |                                                         | $          | 3,669 |   | $ | — |   |
| Loans held for sale         |       | 2,375     |       | —        |       | 2,375         |       | —        |       | —                                                       |       |
| OREO                        |       | 22,517    |       | —        |       | —        |       | 22,517        |       | 633                                                          |       |
|                        |       | $         | 26,186     |          | $          | —        |       | $             | 2,375      |                                                         | $          | 26,186 |   | $ | 1,108 |   |

 

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*Impaired Loans*

 

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

 

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

 

*Loans Held for Sale*

 

Loansheld for sale are required to be measured at the lower of cost or fair value.Management obtains quotes or bids on all or part of these loans directly fromthe purchasing financial institutions, which are a level 2 inputs. Premiumsreceived or to be received on the quotes or bids are indicative of the factthat cost is lower than fair value. At March 31, 2010, the fair value ofloans held for sale was greater than cost; therefore, the entire balance ofloans held for sale was recorded at cost.

 

*Foreclosed Assets*

 

Assetsacquired through foreclosure or other proceedings are initially recorded atfair value at the date of foreclosure less estimated costs of disposal, whichestablishes a new cost. After foreclosure, valuations are periodicallyperformed, and foreclosed assets held for sale are carried at the lower of costor fair value, less estimated costs of disposal. All foreclosed assets are realproperties. The fair values of real properties initially are determined basedon appraisals. In some cases, adjustments were made to the appraised values forvarious factors including age of the appraisal, age of comparables included inthe appraisal, and known changes in the market or in the collateral. Subsequentvaluations of the real properties are based on management estimates or onupdated appraisals. Foreclosed assets are categorized under Level 3 whensignificant adjustments are made by management to appraised values based onunobservable inputs. Otherwise, foreclosed assets are categorized under Level 2if their values are based solely on appraisals.

 

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

 

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otherfactors. The estimated fair value of the Corporation’s financial instruments asof March 31, 2010 is shown below.

 
| ** **                                  | ** ** | **March 31, 2010** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **Carrying**            | ** ** | **Fair** | ** ** |
| **(dollars  in thousands)**                 | ** ** | **Amount**              | ** ** | **Value** | ** ** |
| Financial Assets:                           |       |                    |       |   |   |
| Cash and cash equivalents                   |       | $                       | 29,782     |   | $ | 29,782 |   |
| Trading assets                              |       | 78                      |       | 78 |   |
| Investment securities, available for sale   |       | 61,394                  |       | 61,394 |   |
| Other investments                           |       | 4,085                   |       | 4,085 |   |
| Loans, held for sale                        |       | 2,375                   |       | 2,375 |   |
| Loans, net                                  |       | 149,599                 |       | 183,127 |   |
| Accrued interest receivable                 |       | 1,288                   |       | 1,288 |   |
|                                        |       |                    |       |   |   |
| Financial Liabilities:                      |       |                    |       |   |   |
| Deposits                                    |       | 220,698                 |       | 221,179 |   |
| Long-term debt                              |       | 42,248                  |       | 43,064 |   |
| Short-term debt                             |       | 2,850                   |       | 2,850 |   |
| Payable for investment securities purchased |       | 513                     |       | 513 |   |
| Accrued interest payable                    |       | 1,249                   |       | 1,249 |   |
|                                             |            |                         |            |  |  |  |  |

 

(NOTE 10) 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 includecommitments to extend credit.  Suchcommitments involve, to varying degrees, elements of credit and interest raterisk in excess of the amount recognized in the consolidated balance sheets.

 

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 March 31, 2010 and December 31, 2009, suchcommitments to extend credit were $14,945,000 and $14,839,000, 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 $1,300,000, expiring February 17, 2019, hasMasterCard International Inc. as the beneficiary.**

 

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| **ITEM 2:** | **MANAGEMENT’S DISCUSSION 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 ofthe Corporation and the 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 (FDIC) and pursuant to therules and regulations of the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-lookingstatements, which reflect management’s analysis only as of the datehereof.  The Corporation undertakes no obligation to publicly revise theseforward-looking statements to reflect events or circumstances that arise afterthe date thereof.**

** **

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

 

**Results of OperationsSummary**

** **

Thenet loss for the quarter ended March 31, 2010 was $61,000 compared withnet income of $515,000 for the quarter ended March 31, 2009. Basic lossper share for the first quarter of 2010 were ($0.03), compared to basicearnings of $0.29 for the first quarter of 2009. The Corporation’s annualizedreturn on average equity was (1.50%) and annualized return on average assetswas (0.09%) for the quarter ended March 31, 2010, compared to a return onaverage equity of 13.98% and a return on assets of 0.65% for same quarter in2009. The primary reasons for the change in net income during the quarter of2010 are as follows:

 

The net interestincome decreased from $4,436,000 to $3,352,000, due primarily to a decline of$45,795,000 in interest-earning assets while interest bearing liabilitiesdeclined $43,161,000.  As a result, netinterest income decreased $285,000 or 13.29% during the three months ended March 31,2010.

 

No provision forloan losses was during the first quarter of 2010 compared to a provision of$250,000 during the first quarter of 2009.

 

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Total non-interestincome was $1,501,000 during the first quarter of 2010 compared to $1,326,000during the first quarter of 2009.  Theincrease of $175,000 was due primarily to an increase of $177,000 in creditcard program fees.

 

Total non-interestexpense was $3,531,000 during the first quarter of 2010 compared to $2,663,000during the first quarter of 2009.  Theincrease of $868,000 was due primarily to increases of $593,000 in expensesrelated to foreclosed assets, $262,000 in professional fees and $118,000 insalaries and employee benefits.

 

The followingtable sets forth certain selected financial data and ratios of the Corporationfor the three months ended March 31, 2010 and 2009.

 
| ** **                                           | ** ** | **Three Months Ended March 31** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| **(in  thousands except share data)**                | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| Summary  of Operating Results:                       |       |                                 |       |   |   |
|                                                 |       |                                 |       |   |   |
| Total  interest income                               |       | $                                    | 3,352      |   | $ | 4,436 |   |
| Total  interest expense                              |       | 1,493                                |       | 2,292 |   |
| Net  interest income                                 |       | 1,859                                |       | 2,144 |   |
|                                                 |       |                                 |       |   |   |
| Provision  for loan losses                           |       | —                               |       | 250 |   |
| Net  interest income after provision for loan losses |       | 1,859                                |       | 1,894 |   |
|                                                 |       |                                 |       |   |   |
| Total  non-interest income                           |       | 1,501                                |       | 1,326 |   |
| Total  non-interest expenses                         |       | 3,531                                |       | 2,663 |   |
|                                                 |       |                                 |       |   |   |
| Income  before provision (benefit)                   |       | (171                                 | )          | 557 |   |
| Income  tax provision (benefit)                      |       | (110                                 | )          | 42 |   |
|                                                 |       |                                 |       |   |   |
| Net  income (loss)                                   |       | $                                    | (61        | ) | $ | 515 |   |
|                                                 |       |                                 |       |   |   |
| Per  Common Share Data:                              |       |                                 |       |   |   |
|                                                 |       |                                 |       |   |   |
| Net  income — Basic (1)                         |       | $                                    | (0.03      | ) | $ | 0.29 |   |
| Net  income — Diluted (2)                       |       | $                                    | (0.03      | ) | 0.29 |   |
| Book  value, end of period                           |       | 9.36                                 |       | 7.86 |   |
| Avg  shares outstanding (3)                          |       | 1,783,733                            |       | 1,803,908 |   |
|                                                 |       |                                 |       |   |   |
| Balance  Sheet Data:                                 |       |                                 |       |   |   |
|                                                 |       |                                 |       |   |   |
| Total  loans, net                                    |       | $                                    | 151,974    |   | $ | 168,217 |   |
| Total  assets                                        |       | 285,826                              |       | 312,472 |   |
| Total  deposits                                      |       | 220,698                              |       | 209,217 |   |
| Stockholders’  equity                           |       | 16,709                               |       | 14,177 |   |

 

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| ** **                                                     | ** ** | **Three Months Ended March 31** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                     | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| Selected  Financial Ratios:                                    |       |                                 |       |   |   |
|                                                           |       |                                 |       |   |   |
| Return  on average assets (5) (6)                         |       | (0.09                                | )%         | 0.65 | % |
| Return  on average stockholders’ equity (5) (6)      |       | (1.50                                | )%         | 13.98 | % |
| Net  interest spread                                           |       | 3.38                                 | %          | 3.09 | % |
| Net  yield on interest earning assets (5)                      |       | 3.58                                 | %          | 3.34 | % |
| Avg  shareholders’ equity to average assets (5)           |       | 5.90                                 | %          | 4.68 | % |
| Risked-Based  capital ratios                                   |       |                                 |       |   |   |
| Tier  1                                                        |       | 10.48                                | %          | 8.37 | % |
| Total                                                          |       | 13.80                                | %          | 11.62 | % |
| Total  loans to total deposits at end of period (4)            |       | 68.86                                | %          | 80.40 | % |
| Allowance  for loan losses to total loans at end of period (4) |       | 2.20                                 | %          | 1.54 | % |
| Nonperforming  loans to total loans at end of period (4)       |       | 2.36                                 | %          | 3.08 | % |
| Net  charge-offs to average loans (4)                          |       | 0.07                                 | %          | 0.02 | % |

 

----

(1)          Basic earnings per share amounts were computed on thebasis of the weighted average number of shares of common stock outstandingduring the year.  The weighted averagenumber of common shares used for this computation was 1,783,733 and 1,803,908for the three months ended March 31, 2010 and 2009, respectively.

 

(2)          Diluted earnings per share amounts were computed onthe basis of the weighted average number of shares of common stock and commonstock equivalents outstanding during the year. Common stock equivalents include director/employee stock options. Theweighted average number of shares used for this computation was 1,786,460 and1,803,908 for the three months ended March 31, 2010 and 2009,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 first quarter of 2010 was $1,859,000 compared to $2,144,000 for the firstquarter of 2009, which was a decrease of $285,000 primarily resulting fromdecreases of $421,000 in interest on loans and $661,000 in interest oninvestment securities, partially offset by decreases interest expense of$347,000 on savings and time deposit accounts, $301,000 on notes payable andother borrowings and $150,000 on time deposits of $100,000 or more.

 

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**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$294,000 and $244,000 for the three months ended March 31, 2010 and 2009,respectively.  Non-accrual loans andoverdrafts are included in average loan balances.  Average loans are presented net of unearnedincome.

 

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| ** **                                                  | ** ** | **Three Months Ended March 31, 2010** | ** ** | **Three Months Ended March 31, 2009** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **Average**                                | ** ** | ** **                                 | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| **(dollars  in thousands)**                                 | ** ** | **Balance**                                | ** ** | **Interest**                               | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Assets:                                                     |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
|                                                        |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Loans                                                       |       | $                                          | 163,693    |                                       | $          | 2,571 |   | 6.28 | % | $ | 172,891 |   | $ | 2,992 |   | 6.92 | % |
| Time  deposits - in other banks                             |       | 10,842                                     |       | 3                                          |       | 0.11 | % | 8,188 |   | 5 |   | 0.24 | % |
| Investment  securities - taxable                            |       | 13,081                                     |       | 123                                        |       | 3.76 | % | 64,903 |   | 898 |   | 5.53 | % |
| Investment  securities - nontaxable                         |       | 52,737                                     |       | 949                                        |       | 7.20 | % | 40,166 |   | 785 |   | 7.82 | % |
| Total  interest-earning assets                              |       | 240,353                                    |       | 3,646                                      |       | 6.07 | % | 286,148 |   | 4,680 |   | 6.54 | % |
|                                                        |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Allowance  for credit losses                                |       | (3,527                                     | )          |                                       |       |   |   | (2,398 | ) |   |   |   |   |
| Non-interest  bearing assets:                               |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash  and due from banks                                    |       | 4,972                                      |       |                                       |       |   |   | 8,299 |   |   |   |   |   |
| Premises  and equipment                                     |       | 4,911                                      |       |                                       |       |   |   | 4,959 |   |   |   |   |   |
| Accrued  interest receivable                                |       | 1,446                                      |       |                                       |       |   |   | 1,910 |   |   |   |   |   |
| Other  assets                                               |       | 27,410                                     |       |                                       |       |   |   | 16,051 |   |   |   |   |   |
| Total  average assets                                       |       | $                                          | 275,565    |                                       |       |   |   |   | $ | 314,969 |   |   |   |   |   |
|                                                        |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Liabilities  and Shareholders’ Equity:                 |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                              |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Interest-bearing  demand                                    |       | $                                          | 15,365     |                                       | 4          |   | 0.10 | % | $ | 13,811 |   | 5 |   | 0.14 | % |
| Money  market savings                                       |       | 1,882                                      |       | 1                                          |       | 0.21 | % | 1,604 |   | 1 |   | 0.25 | % |
| Savings  deposits                                           |       | 6,730                                      |       | 8                                          |       | 0.48 | % | 5,885 |   | 7 |   | 0.48 | % |
| Time  deposits >$100M                                    |       | 59,703                                     |       | 395                                        |       | 2.65 | % | 55,866 |   | 545 |   | 3.90 | % |
| Time  deposits <$100M                                    |       | 97,764                                     |       | 590                                        |       | 2.41 | % | 95,477 |   | 938 |   | 3.93 | % |
| Other  Borrowing                                            |       | 41,019                                     |       | 495                                        |       | 4.83 | % | 92,981 |   | 796 |   | 3.42 | % |
| Total  interest-bearing liabilities                         |       | 222,463                                    |       | 1,493                                      |       | 2.68 | % | 265,624 |   | 2,292 |   | 3.45 | % |
|                                                        |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Non-interest  bearing liabilities:                          |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  checking                               |       | 29,460                                     |       |                                       |       |   |   | 28,134 |   |   |   |   |   |
| Accrued  interest payable                                   |       | 1,090                                      |       |                                       |       |   |   | 1,725 |   |   |   |   |   |
| Other  liabilities                                          |       | 6,290                                      |       |                                       |       |   |   | 4,755 |   |   |   |   |   |
| Total  Liabilities                                          |       | 259,303                                    |       |                                       |       |   |   | 300,238 |   |   |   |   |   |
| Total  shareholders equity                                  |       | 16,262                                     |       |                                       |       |   |   | 14,731 |   |   |   |   |   |
| Total  average liabilities and shareholders equity          |       | $                                          | 275,565    |                                       |       |   |   |   | $ | 314,969 |   |   |   |   |   |
|                                                        |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Net  interest income                                        |       |                                       |       | $                                          | 2,153      |   |   |   |   |   | $ | 2,388 |   |   |   |
| Interest  income as a percentage of average earning assets  |       |                                       |       |                                       |       | 6.07 | % |   |   |   |   | 6.54 | % |
| Interest  expense as a percentage of average earning assets |       |                                       |       |                                       |       | 2.48 | % |   |   |   |   | 3.20 | % |
| Net yield  on interest earning assets                       |       |                                       |       |                                       |       | 3.58 | % |   |   |   |   | 3.34 | % |
| Net  interest spread                                        |       |                                       |       |                                       |       | 3.38 | % |   |   |   |   | 3.09 | % |

 

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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 ended March 31, 2010 compared with the sameperiod in 2009.

 
| ** **                                   | ** ** | **Increase (decrease) in the three months ended**         | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                   | ** ** | **March 31, 2010 compared with March 31, 2009** | ** ** |
| **(dollars  in thousands)**                  | ** ** | **Volume**                                                | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Increase  (decrease) in interest income:     |       |                                                      |       |   |   |   |   |
| Loans                                        |       | $                                                         | (159       | ) | $ | (262 | ) | $ | (421 | ) |
| Time  deposits - in other banks              |       | 2                                                         |       | (4 | ) | (2 | ) |
| Investment  securities - taxable             |       | (717                                                      | )          | (58 | ) | (775 | ) |
| Investment  securities - nontaxable          |       | 246                                                       |       | (82 | ) | 164 |   |
|                                         |       | (628                                                      | )          | (406 | ) | (1,034 | ) |
|                                         |       |                                                      |       |   |   |   |   |
| Increase  (decrease) in interest expense:    |       |                                                      |       |   |   |   |   |
| Interest-bearing  demand                     |       | 1                                                         |       | (2 | ) | (1 | ) |
| Money  market savings                        |       | —                                                    |       | — |   | — |   |
| Savings  deposits                            |       | 1                                                         |       | — |   | 1 |   |
| Time  deposits >$100M                     |       | 37                                                        |       | (188 | ) | (151 | ) |
| Time  deposits <$100M                     |       | 22                                                        |       | (371 | ) | (349 | ) |
| Other  Borrowing                             |       | (445                                                      | )          | 146 |   | (299 | ) |
|                                         |       | (384                                                      | )          | (415 | ) | (799 | ) |
| Increase  (decrease) in net interest income: |       | $                                                         | (244       | ) | $ | 9 |   | $ | (235 | ) |

 

**Provisionand Allowance for Loan and Lease Losses**

 

TheCorporation maintains a detailed, systematic analysis and procedural disciplineto determine the amount of the allowance for loan losses (“ALLL”).  TheALLL is based on estimates and is intended to be adequate to provide forprobable losses inherent in the loan portfolio.  This processinvolves deriving probable loss estimates that are based on individual 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 ALLL on a quarterly basis and makesadjusting entries as needed. The review of the adequacy of the allowancetakes into consideration such factors as concentrations of credit, changes inthe growth, size and composition of the loan portfolio, overall and individualportfolio quality, review of specific problem loans, collateral, guarantees andeconomic conditions that may affect the borrowers’ ability to pay and/or thevalue of the underlying collateral.  Additional factors consideredinclude: geographic location of borrowers, changes in the Corporation’sproduct-specific credit policy and lending staff experience.  Theseestimates depend on subjective factors and, therefore, contain inherentuncertainties.

 

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

 

Although 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 March 31, 2010 and 2009 the Bank’s allowance stood at 2.20 percent and 1.54percent of total loans, respectively.

 

No provision wasmade to the ALLL during the three months ended March 31, 2010 compared to$250,000 for the same period in 2009. Loans charged off during the three months ended March 31, 2010totaled $111,000 compared to $31,000 for the same period in 2009.  No recoveries were made during the threemonths ended March 31, 2010 while $1,000 was made for thesame period in 2009.

 

TheBank’s non-performing (delinquent 90 days or more and on non-accrual) net loansas a percentage of total loans were 2.36 percent and 3.08 percent as of the endof March 31, 2010 and 2009, respectively.

 

**Non-InterestIncome**

 

Total non-interestincome for the three months ended March 31, 2010 was $1,501,000 compared with $1,326,000for the same period in 2009.  Theincrease of $175,000 was due primarily to an increase of $177,000 in creditcard/stored value card program fees.

 

**Non-InterestExpense**

 

Salary andbenefits expense for the three months ended March 31, 2010 increased $118,000 compared with the sameperiod in 2009.  The increase was due tothe addition of a Credit Administration Officer, a loan processor and a senioraccounting position.

 

Total occupancyand equipment expense for the three months ended March 31, 2010 was $265,000 compared to $261,000 for thesame period in 2009.

 

Professional feesfor the three months ended March 31, 2010 were $408,000 compared to $146,000 forthe same period in 2009.  The increaseswere primarily due to increases in accounting/audit expense and legal feesassociated with lawsuits related to various loans and loan collection expense.

 

Data processingexpense for the three months ended March 31, 2010 was $76,000 compared to $89,000 for thesame period in 2009.

 

Other general andadministrative expenses for the for the three months ended March 31,2010 totaled$1,132,000 compared with $1,147,000 for the same period in 2009, which is andecrease of $15,000.  Significant changesoccurred in the following categories; decreases in merchant credit card processing expenseof $135,000, insurance expense of $19,000, ATM 

 

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expense of $14,000, credit card program expense of $12,000 andmiscellaneous expense of  $12,000, whileincreases occurred in FDIC insurance premiums of $83,000, other losses of$48,000, loan expense of $24,000 and $23,000 in MCB business card expense.

 

OREO expenses andprovision for losses on foreclosed assets for the three months ended March 31,2010 totaled $734,000 compared to $141,000 during the same period in 2009.

 

**Provisionfor Income Taxes**

 

Thetax benefit was $110,000 for the three months ended March 31, 2010compared to tax provision of $42,000 for the same period in 2009, representing(64.33%) and 7.54% of pre-tax income for those periods.  The decrease in the effective tax rate for2010 is a direct result of the Bank’s investing in tax-exempt securities anddecreasing income.

 

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

 

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

 

**LOANS**

 

Average loansrepresented 68.10% of average earning assets and 59.40% of average total assetsfor the three months ended March 31, 2010 compared with 60.42% and 54.89%,respectively during 2009. For the three months ended March 31,2010, average loansdecreased 5.32% to $163,693,000 from $172,891,000 for the same period in2009.  Average real estate loansincreased $1,495,000 (14.25%), average commercial loans increased $228,000(0.64%), and average installment loans increased $698,000 (45.06%), whileaverage construction loans decreased $11,619,000 (72.45%).

 

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.

 

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 90 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

 

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credit standardsthe Bank would not otherwise apply, such as lower cash flow coverage, or longerrepayment terms.

 

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 family residentialproperties 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 toprincipal or interest 90 days or more, except for loans which are well securedor when collection 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 and interest onthe loan is available and in the process of collection.

 

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.

 

At March 31,2010 the Corporation had one restructured loan with an outstanding principalbalance of $897,000.  The loan has beenperforming in  accordance with the loan’srestructured terms since it was restructured in 2009, and it yields a marketrate of interest.  Therefore, the loan isno longer considered a troubled debt restructuring.

 

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 statusand foreclosed assets (referred to collectively as “non-performing assets”):

 

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| ** **                                                           | ** ** | **As of****March 31,** | ** ** | **As of  December 31,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                           | ** ** | **2010**                    | ** ** | **2009**                     | ** ** | **2009** | ** ** |
|                                                                 |       | **(Dollars  in thousands)** |       |                         |       |
|                                                                 |       |                        |       |                         |       |   |   |
| Accruing, past due 90 days or more:                                  |       |                        |       |                         |       |   |   |
|                                                                 |       |                        |       |                         |       |   |   |
| Real Estate                                                          |       | $                           | —     |                         | $          | — |   | $ | — |   |
| Commercial                                                           |       | —                      |       | —                       |       | — |   |
| Installment                                                          |       | —                      |       | —                       |       | — |   |
| Other                                                                |       | —                      |       | —                       |       | — |   |
| Total accruing                                                       |       | —                      |       | —                       |       | — |   |
|                                                                 |       |                        |       |                         |       |   |   |
| Nonaccrual Loans:                                                    |       |                        |       |                         |       |   |   |
| Real Estate                                                          |       | 706                         |       | 4,746                        |       | 5,137 |   |
| Commercial                                                           |       | 2,963                       |       | 520                          |       | 2,943 |   |
| Installment                                                          |       | —                      |       | —                       |       | — |   |
| Other                                                                |       | —                      |       | —                       |       | — |   |
| Total nonaccrual                                                     |       | 3,669                       |       | 5,266                        |       | 8,080 |   |
|                                                                 |       |                        |       |                         |       |   |   |
| Total nonperforming loans                                            |       | 3,669                       |       | 5,266                        |       | 8,080 |   |
| Other Real Estate Owned                                              |       | 22,517                      |       | 10,722                       |       | 14,333 |   |
| Total nonperforming assets                                           |       | $                           | 26,186     |                         | $          | 15,988 |   | $ | 22,413 |   |
|                                                                 |       |                        |       |                         |       |   |   |
| Total loans end of period                                            |       | $                           | 155,591    |                         | $          | 171,125 |   | $ | 166,742 |   |
|                                                                 |       |                        |       |                         |       |   |   |
| Ratio of nonperforming loans to total loans at end  of period        |       | 2.36                        | %          | 3.08                         | %          | 4.85 | % |
| Ratio nonperforming assets to total Loans and OREO  at end of period |       | 14.70                       | %          | 8.79                         | %          | 12.38 | % |

 

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Summary of Loan Loss Experience

 
| ** **                                                                     | ** ** | ** **                 | ** ** | ** **            | ** ** | **As of the** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                                                     | ** ** | **As of the three months** | ** ** | **Year ended**        | ** ** |
| ** **                                                                     | ** ** | **Ended March 31,**   | ** ** | **December 31,** | ** ** |
| ** **                                                                     | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2009**      | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Average loans outstanding                                                      |       | $                          | 163,693    |                  | $          | 172,891       |       | $ | 169,853 |   |
|                                                                           |       |                       |       |                  |       |          |       |
| Total loans outstanding at end of the period                                   |       | $                          | 155,591    |                  | $          | 171,125       |       | $ | 166,742 |   |
|                                                                           |       |                       |       |                  |       |          |       |
| Allowance, beginning of period                                                 |       | 3,529                      |       | 2,413                 |       | 2,413         |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Loans charged off during period:                                               |       |                       |       |                  |       |          |       |
| Commercial                                                                     |       | 84                         |       | 29                    |       | 358           |       |
| Installment                                                                    |       | —                     |       | 2                     |       | 37            |       |
| Real Estate                                                                    |       | 27                         |       | 0                     |       | 1,908         |       |
| Other                                                                          |       | —                     |       | 0                     |       | 26            |       |
| Total charge offs                                                              |       | 111                        |       | 31                    |       | 2,329         |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Recoveries during period:                                                      |       |                       |       |                  |       |          |       |
| Commercial                                                                     |       | —                     |       | 1                     |       | 2             |       |
| Installment                                                                    |       | —                     |       | —                |       | —        |       |
| Real Estate                                                                    |       | —                     |       | —                |       | 75            |       |
| Other                                                                          |       | —                     |       | —                |       | —        |       |
| Total recoveries                                                               |       | —                     |       | 1                     |       | 77            |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Net loans charged off during the period                                        |       | 111                        |       | 30                    |       | 2,252         |       |
|                                                                           |       |                       |       |                  |       |          |       |
| Provision for loan losses                                                      |       | —                     |       | 250                   |       | 3,368         |       |
| Allowance, end of period                                                       |       | $                          | 3,418      |                  | $          | 2,633         |       | $ | 3,529 |   |
|                                                                           |       |                       |       |                  |       |          |       |
| Ratio of net loans charged off to average loans  outstanding during the period |       | 0.07                       | %          | 0.02                  | %          | 1.33          | %          |
|                                                                           |       |                       |       |                  |       |          |       |
| Ratio of allowance to total loans at end of period                             |       | 2.20                       | %          | 1.54                  | %          | 2.12          | %          |
|                                                                           |       |                       |       |                  |       |          |       |
| Ratio of nonperforming loans to allowance for loan  losses at end of period    |       | 107.33                     | %          | 200.08                | %          | 251.75        | %          |

 

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The following tableprovides a breakdown of the allowance for loan losses by categories as of thedates indicated:

 
| ** **                                   | ** ** | **As of  the Period ended March 31,** | ** ** | **As of  the Year ended**                     | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2010**                                   | ** ** | **2009**                                      | ** ** | **December 31,  2009** | ** ** |
| **Balance at End of Period  Applicable to:** | ** ** | **Amount**                                 | ** ** | **% of  Loans in  Category  to Total  Loans** | ** ** | **Amount** | ** ** | **% of  Loans in  Category  to Total  Loans** | ** ** | **Amount** | ** ** | **% of  Loans in  Category  to Total  Loans** | ** ** |
| ** **                                   | ** ** | **(Dollars  in thousands)**                | ** ** |
| Construction                                 |       | $                                          | 102        |                                          | 1.8        | % | $ | 114 |   | 8.9 | % | $ | 338 |   | 5.2 | % |
| Commercial                                   |       | 802                                        |       | 21.1                                          | %          | 645 |   | 19.9 | % | 995 |   | 20.1 | % |
| Installment                                  |       | 58                                         |       | 0.4                                           | %          | 58 |   | 1.0 | % | 9 |   | 1.7 | % |
| Real Estate                                  |       | 2,200                                      |       | 76.7                                          | %          | 1,655 |   | 70.2 | % | 2 174 |   | 73.0 | % |
| Unallocated                                  |       | 256                                        |       | —                                        |       | 161 |   | — |   | 13 |   | — |   |
| Total allowance for loan and lease losses    |       | $                                          | 3,418      |                                          | 100.0      | % | $ | 2,633 |   | 100.0 | % | $ | 3,529 |   | 100.0 | % |
|                                         |       |                                       |       |                                          |       |   |   |   |   |   |   |   |   |
| Total loans end of period                    |       | $                                          | 155,591    |                                          |       |   | $ | 171,125 |   |   |   | $ | 166,742 |   |   |   |

 

**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 OREO was acquired through foreclosure.  The OREO was recorded at fair value lessselling costs on the date of acquisition.

 
| ** **                                                     | ** ** | ** **                  | ** ** | ** **            | ** ** | **As of the** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                                     | ** ** | **As of the period**        | ** ** | **Year ended**        | ** ** |
| ** **                                                     | ** ** | **Ended March 31,**    | ** ** | **December 31,** | ** ** |
| ** **                                                     | ** ** | **2010**                    | ** ** | **2009**              | ** ** | **2009**      | ** ** |
| ** **                                                     | ** ** | **(Dollars  in thousands)** | ** ** |
| Nonperforming loans                                            |       | $                           | 3,669      |                  | $          | 5,266         |       | $ | 8,080 |   |
| Other real estate owned, net (1)                               |       | 22,517                      |       | 10,722                |       | 14,333        |       |
| Total nonperforming assets                                     |       | $                           | 26,186     |                  | $          | 15,988        |       | $ | 22,413 |   |
|                                                           |       |                        |       |                  |       |          |       |
| Nonperforming loans to total gross loans                       |       | 2.36                        | %          | 3.08                  | %          | 4.85          | %          |
| Nonperforming assets to total loans and OREO at  end of period |       | 14.70                       | %          | 8.79                  | %          | 12.38         | %          |

 

----

(1) net of reserve for foreclosed assets losses of $1,636,000 asof March 31, 2010, $0 as of March 31, 2009 and $1,010,000 as of December 31,2009.

 

**Deposits**

 

Average interestbearing and non-interest-bearing deposits for the three months ended March 31,2010 were$210,904,000 an increase of 5.04% compared with the same period in 2009.  Average certificates of deposit represented74.66% of average deposits for the three months ended March 31,2010 compared with75.35% for the same period in 2009. Average interest bearing checking, money market and savings accounts asa group were 11.38% of average deposits for the three months ended March 31,2010 compared with10.61% for the same period in 2009.  Averagenon-interest bearing deposits represented 13.97% of average deposits for thethree months ended March 31, 2010 compared with 14.01% for the same period in 2009.

 

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The following table setsforth the scheduled maturities of the Corporation’s time deposits indenominations of $100,000 or greater at March 31, 2010:

 

**Maturities of Time Deposits of**

**$100,000 or More**

(Dollars in Thousands)

 

| Three months or less                  |   | $      | 12,857 |   |
|---------------------------------------|--------|--------|--------|--------|
| Over three months through six months  |   | 9,598  |   |
| Over six months through twelve months |   | 22,704 |   |
| Over twelve months                    |   | 18,192 |   |
| Total                                 |   | $      | 63,351 |   |

** **

**Borrowings**

** **

**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 floor rate of 6.50% and a maturitydate of April 30, 2010.  At March 31,2010, $2,850,000 was outstanding on the line of credit.  Based on discussions with the lender it isanticipated the line of credit will be renewed with the same terms through April 30,2011.**

** **

**The Bank has lines of credit from the Federal Reserve Bankof San Francisco and the Federal Home Loan Bank (FHLB) of San Francisco withremaining available borrowing capacity on March 31, 2010 of $12,398,000and $422,000, respectively.  The FederalReserve Bank discount window line is secured by a portion of the Bank’sinvestment securities at March 31, 2010. At March 31, 2010, the total book value of securities pledged tothe Federal Reserve Bank was $20,604,000 with no outstanding loan balance.  The Federal Home Loan Bank line of credit hasa maximum borrowing capacity of 20% of the Bank’s total assets, adjustedquarterly.  The Federal Home Loan Bankline of credit is secured by a portion of the Bank’s real estate secured loansand securities at March 31, 2010. The total principal balance at March 31, 2010 of pledged loans andsecurities at the Federal Home Loan Bank was $46,243,000 and $8,556,000,respectively.**

 

**The following table providesinformation on eleven FHLB advances outstanding at March 31, 2010.**

 

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

 

30

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**Table of Contents**

** **

**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 $1,300,000, expiring February 17, 2019 has MasterCardInternational Inc. as the beneficiary.**

** **

**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 March 31, 2010,shareholders’ equity was $16,709,000 versus $16,150,000 at December 31,2009.  The Corporation paid no cashdividends to shareholders for the three months ended March 31, 2010and for the year ended December 31, 2009.  The Bank paid no cash dividends to theCorporation for the three months March 31, 2010and $500,000 in dividends for the year ended December 31, 2009.

 

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-bankbusinesses, 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 4.0% and total capital of 8.0% ofrisk-adjusted assets. The Bank had a Tier 1 capital to total risk-adjustedassets capital ratio of 13.74% and 10.89% at March 31, 2010 and 2009,respectively.  The Bank’s Tier 1 capitalexceeds the minimum regulatory requirement by $18,478,000.  The Bank had a Total Risk-Based capital torisk-adjusted assets ratio of 15.00% and 12.11% at March 31, 2010 and2009, respectively.  The Bank’s TotalRisk-Based capital exceeds the minimum regulatory requirement by $13,274,000.

 

The Tier 1 leveragecapital ratio guidelines require a minimum leverage capital ratio of 4.0% ofTier 1 capital to total assets less goodwill. The Bank had a leverage capital ratio of 9.50% and 7.53% at March 31,2010 and 2009, respectively.  The Bank’sTier 1 leverage capital exceeds the minimum regulatory requirement by$15,088,000.

 

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.

 

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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 did not repurchase any sharesof stock during the three months ended March 31, 2010.  The Corporation repurchased 20,678 shares ofcommon stock at an average cost of $4.20 per share in open market transactionsduring 2009.  The Corporation repurchased46,010 shares of common stock at an average cost of $7.51 per share in openmarket 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 aswell as the number of shares authorized for issuance in each series of thepreferred stock, which matters shall be expressed in resolutions adopted by theBoard and filed with the Secretary of State of the state of California.  Additionally, the Amendment authorizes theCorporation to issue an additional 7,500,000 shares of common stock for a totalof 10,000,000 shares of common stock authorized for issuance after theAmendment.  The Amendment becameeffective January 23, 2009. There were no shares issued as of March 31,2010.

 

## **Other Regulatory Matters**

## ** **

TheFDIC has submitted a proposed Consent Order, including proposed monetarypayments, related to its 2008 Consumer Compliance Examination, which wascompleted in 2009.  The FDIC has allegedthe existence of certain violations of consumer laws and regulations.  The Bank denies committing such allegedviolations.  The Bank hopes thatnegotiations with the FDIC will result in a mutually agreeable resolution tothis matter.  If a mutually agreeableresolution cannot be reached, the Bank anticipates that the FDIC will institutean administrative hearing, at which the Bank would continue to oppose thepending allegations.  The financial andnon-financial impact of this matter is not known as of the balance sheet dateand as of the issuance date of this report.

 

## **Liquidity**

## ** **

Liquidityrepresents the ability to provide sufficient cash flows or cash resources in amanner that enables an entity to meet its obligations in a timely fashion andadequately provide 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 $54,431,000,based on 20 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. At March 31, 2010, $422,000in excess collateral was pledged.  TheBank has a borrowing line with the Federal Reserve Bank of San Franciscosecured****a portion of the Bank’s securities,with available borrowing of $12**,**398,000 at March 31, 2010.

 

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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 March 31, 2010 and 2009was 32.88% and 33.35%, respectively, while its average loan to average depositratio for such years was 77.61% and 86.11%, 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 brokered deposits.  Federal law and regulation restricts banksfrom soliciting or accepting brokered deposits, unless the bank is wellcapitalized under Federal guidelines. The Bank had $62,856,000 in brokered deposits at March 31, 2010compared with $2,656,000 in brokered deposits at March 31, 2009. The Corporation will be reducing its reliance on brokered deposits bynot opening or renewing any deposits classified as brokered.

 

**Deferralof Interest Payments on Trust Preferred Securities**

 

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

 

**InterestRate Risk**

 

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

 

33

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Bank can maintaina totally earnings neutral position. Further, the actual timing of repricing of assets and liabilities doesnot always correspond to the timing assumed by the Bank for analyticalpurposes.  Therefore, changes in marketrates of interest will generally impact the Bank’s net interest income and netinterest margin for long or short periods of time.

 

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 various rate shocks, expressedin basis points, at March 31, 2010. The table includes one projection for a decrease in rates, as theFederal Funds target rate is currently between 0% and 0.25%.

 
| **Rate Shock Increase in  Basis Points** | ** ** | **Percent Increase in Net  Interest Income** | ** ** |
|------------------------------------------|------------|----------------------------------------------|------------|
| -25                                      |       | 0.7                                          | %          |
| 100                                      |       | -0.8                                         | %          |
| 200                                      |       | -0.7                                         | %          |
| 300                                      |       | -0.6                                         | %          |
| 400                                      |       | -0.3                                         | %          |

 

**Item 4T.  Controls and Procedures**

** **

(a) The Corporation’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 Corporation’s disclosure controlsand procedures were adequate and effective to ensure that material informationrelating to the Corporations would be made known to them by others within theBank, particularly during the period in which this report was beingprepared.  Disclosure controls andprocedures are designed to ensure that information required to be disclosed byus in the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

(b) Changesin Internal Controls:  In the quarterended March 31,2010, the Corporation 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 Bank, Chief Executive Officer and Chief Credit Officer were named as defendants in a lawsuit filed July 27, 2009 in the Monterey County Superior Court’s Civil Division, by Bank of the Orient.  The lawsuit involves claims related to loan participations purchased by Bank of the Orient from Monterey County Bank.  The lawsuit seeks rescission of the participation agreements, payment of all principal and interest, damages, attorneys’ fees and costs.

 

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

 

The Bank, its Chief Financial Officer and a former Sr. Vice-president were named as defendant in a lawsuit filed February 26, 2009 in Monterey County Superior Court-Civil Division by Tighorn Financial Services, LLC (“Tighorn”).  The lawsuit seeks to compel Monterey County Bank to continue its credit card sponsorship and the servicing of a credit card portfolio under a card sponsorship agreement with the third party.  The suit also alleges that Tighorn was misled into entering the credit card sponsorship agreement.   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, Chief Executive Officer and Chief Credit Officer were named as defendants in a lawsuit filed April 29, 2009 in the Monterey County Superior Court’s 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 rescind the participation agreements, payment of all principal and interest, damages, attorneys’ fees and costs.

 

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

 

Monterey County Bank wasnamed as defendant in two separate actions filed June 17, 2008 and June 26,2008 to foreclose mechanic’s liens on site improvements performed in theamounts of $1.5 million and $6.0 million, respectively. The actions assert thatthe mechanic’s liens have priority over the Bank’s Deeds of Trust againstvarious lots in the subdivision that were benefited by the site improvements.In the legal counsel’s opinion the Bank does not have any exposure in thesematters because the priority of its trust deeds are insured by policies oftitle insurance.

 

Although the amount of any ultimate liability with respect to the above 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 and its subsidiary.

 

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

 

None

 

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**Item3.  Defaults upon Senior Securities**

 

None

 

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

** **

None

 

#### **Item 5.  Other Information.**

####  

None

 

#### **Item 6.  Exhibits**

####  

A.                                   EXHIBITS

 

31.1                         Certification of the Chief ExecutiveOfficer of Northern California Bancorp, Inc. pursuant to Section 302of the Sarbanes-Oxley Act of 2002.

 

31.2                         Certificationof the Chief Financial Officer of Northern California Bancorp, Inc.pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1                         Certificationof the Chief Executive Officer of Northern California Bancorp, Inc.pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2                         Certificationof 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: May 13, 2010 | By:                                | /s/ Charles T.  Chrietzberg, Jr. |
|                    | Charles  T. Chrietzberg, Jr.  |
|                    | Chairman  of the Board &  |
|                    | Chief  Executive Officer           |
|                    |                               |
|                    |                               |
| Date: May 13, 2010 | By:                                | /s/ Bruce N. Warner |
|                    | Bruce  N. Warner                   |
|                    | Chief Financial Officer and        |
|                    | Principal Accounting Officer       |

 

36

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