UNITED
STATES


SECURITIES
& EXCHANGE COMMISSION


Washington,
D.C. 20549


__________________________





FORM
10-Q





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




For
Quarter Ended June 30, 2008





OR




0
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the transition period from _________to ________




Commission
file number:  0-49892





PACIFIC
STATE BANCORP


(Exact
Name of Registrant as Specified in its Charter)








California
            61-1407606(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      No.)





1899
W. March Lane, Stockton, CA 95207


(Address
of Principal Executive Offices) (Zip Code)


Registrant’s
Telephone Number, including Area Code (209) 870-3200





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports,) and (2) has been subject to such filing requirements for
the past 90 days. Yes  ý   No 
0





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


Large
accelerated filer 0                                                                
Accelerated filer  0                                           Non
–accelerated filer  0  Smaller
reporting company   ý





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes  0   No ý





Indicate
the number of shares outstanding of each of the registrant issuer’s classes of
common stock, as of the latest practicable date:





Title
      of Class
            Shares
      outstanding as of May 14, 2008Common
      Stock
              No
      Par Value
            3,703,207


-1-


PART
I. FINANCIAL INFORMATION


ITEM
I. FINANCIAL STATEMENTS





PACIFIC
STATE BANCORP AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS


Unaudited
            
            June
      30,
            
            
            December
      31,(Dollars
      in thousands)
            
            2008
            
            
            2007ASSETSCash
      and due from banks
            
            $
            16,079
            
            
            $
            13,794Federal
      funds sold
            
            
            35,091
            
            
            
            31,880Total
      cash and cash equivalents
            
            
            51,170
            
            
            
            45,674Interest
      bearing deposits at other banks
            
            
            -
            
            
            
            3,000Investment
      securities
            
            
            47,441
            
            
            
            41,352Loans,
      less allowance for loan losses of $3,427 in 2008 and $3,948 in
      2007
            
            
            321,502
            
            
            
            308,458Premises
      and equipment, net
            
            
            15,234
            
            
            
            14,269Company
      owned life insurance
            
            
            8,160
            
            
            
            8,025Accrued
      interest receivable and other assets
            
            
            10,407
            
            
            
            10,296Total
      assets
            
            $
            453,914
            
            
            $
            431,074LIABILITIES
      ANDSHAREHOLDERS'
      EQUITYDeposits:Non-interest
      bearing
            
            $
            67,123
            
            
            $
            67,071Interest
      bearing
            
            
            304,281
            
            
            
            274,750Total
      deposits
            
            
            371,404
            
            
            
            341,821Other
      borrowings
            
            
            35,000
            
            
            
            40,000Subordinated
      debentures
            
            
            8,764
            
            
            
            8,764Accrued
      interest payable and other liabilities
            
            
            3,791
            
            
            
            6,453Total
      liabilities
            
            
            418,959
            
            
            
            397,038Commitments
      and contingenciesShareholders'
      equity:Preferred
      stock - 2,000,000 shares authorized; none issued or
      outstanding
            
            
            -
            
            
            
            -Common
      stock - no par value; 24,000,000 shares authorized; issued and outstanding
      –3,715,598 shares in 2008 and 3,707,698 shares in 2007
            
            
            10,645
            
            
            
            10,418Retained
      earnings
            
            
            25,678
            
            
            
            24,004Accumulated
      other comprehensive loss, net of taxes
            
            
            (1,368
            )
            
            
            (386
            )Total
      shareholders' equity
            
            
            34,955
            
            
            
            34,036Total
      liabilities and shareholders' equity
            
            $
            453,914
            
            
            $
            431,074





See notes
to unaudited condensed consolidated financial statements


-2-


PACIFIC
STATE BANCORP


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS





Unaudited
            
            Three
      Months Ended June 30,
            
            
            Six
      Months Ended June 30,(Dollars
      in thousands, except per share data)
            
            2008
            
            
            2007
            
            
            2008
            
            
            2007Interest
      income:Interest
      and fees on loans
            
            $
            6,201
            
            
            $
            7,300
            
            
            $
            12,677
            
            
            $
            14,142Interest
      on Federal funds sold
            
            
            141
            
            
            
            348
            
            
            
            256
            
            
            
            669Interest
      on investment securities
            
            
            892
            
            
            
            484
            
            
            
            1,602
            
            
            
            827Total
      interest income
            
            
            7,234
            
            
            
            8,132
            
            
            
            14,535
            
            
            
            15,638Interest
      expense:Interest
      on deposits
            
            
            2,860
            
            
            
            3,239
            
            
            
            5,658
            
            
            
            6,156Interest
      on other borrowings
            
            
            418
            
            
            
            55
            
            
            
            848
            
            
            
            121Interest
      on subordinated debentures
            
            
            108
            
            
            
            185
            
            
            
            262
            
            
            
            377Total
      interest expense
            
            
            3,386
            
            
            
            3,479
            
            
            
            6,768
            
            
            
            6,654Net
      interest income before provision for loan losses
            
            
            3,848
            
            
            
            4,653
            
            
            
            7,767
            
            
            
            8,984Provision
      for loan losses
            
            
            600
            
            
            
            55
            
            
            
            810
            
            
            
            220Net
      interest income after provision for loan losses
            
            
            3,248
            
            
            
            4,598
            
            
            
            6,957
            
            
            
            8,764Non-interest
      income:Service
      charges
            
            
            223
            
            
            
            217
            
            
            
            460
            
            
            
            438Gain
      on sale of loans
            
            
            132
            
            
            
            19
            
            
            
            151
            
            
            
            28Other
      income
            
            
            242
            
            
            
            470
            
            
            
            458
            
            
            
            926Total
      non-interest income
            
            
            597
            
            
            
            706
            
            
            
            1,069
            
            
            
            1,392Non-interest
      expenses:Salaries
      and employee benefits
            
            
            1,282
            
            
            
            1,506
            
            
            
            2,550
            
            
            
            2,988Occupancy
            
            
            302
            
            
            
            277
            
            
            
            565
            
            
            
            563Furniture
      and equipment
            
            
            195
            
            
            
            200
            
            
            
            374
            
            
            
            367Other
      expenses
            
            
            1,046
            
            
            
            1,019
            
            
            
            1,831
            
            
            
            1,783Total
      non-interest expenses
            
            
            2,825
            
            
            
            3,002
            
            
            
            5,320
            
            
            
            5,701Income
      before provision for income taxes
            
            
            1,020
            
            
            
            2,302
            
            
            
            2,706
            
            
            
            4,455Provision
      for income taxes
            
            
            441
            
            
            
            904
            
            
            
            1,033
            
            
            
            1,720Net
      income
            
            $
            579
            
            
            $
            1,398
            
            
            $
            1,673
            
            
            $
            2,735Basic
      earnings per share
            
            $
            0.16
            
            
            $
            0.38
            
            
            $
            0.45
            
            
            $
            0.75Diluted
      earnings per share
            
            $
            0.15
            
            
            $
            0.35
            
            
            $
            0.43
            
            
            $
            0.68








See notes
to unaudited condensed consolidated financial statements


-3-


PACIFIC
STATE BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS


For
the Six Month Periods Ended June 30, 2008 and 2007




Unaudited
              (Dollars in thousands)
            
            2008
            
            
            2007Cash
      flows from operating activities:Net
      income
            
            $
            1,673
            
            
            $
            2,735Provision
      for loan losses
            
            
            810
            
            
            
            220Net
      increase in deferred loan origination costs
            
            
            (1
            )
            
            
            (20
            )Depreciation,
      amortization and accretion
            
            
            80
            
            
            
            (3
            )Gain
      on sale of loans, net
            
            
            (151
            )
            
            
            (28
            )Stock-based
      compensation expense
            
            
            171
            
            
            
            127Increase
      in Company owned life insurance, net
            
            
            (135
            )
            
            
            (119
            )Decrease
      (increase) in accrued interest receivable and other assets
            
            
            557
            
            
            
            (637
            )(Decrease)
      increase  in accrued interestpayable
      and other liabilities
            
            
            (2,661
            )
            
            
            1,113Net
      cash provided by operating activities
            
            
            343
            
            
            
            3,388Cash
      flows from investing activities:Decrease
      in interest bearing deposits at other banks
            
            
            3,000
            
            
            
            -Purchases
      of available-for-sale investment securities
            
            
            (21,102
            )
            
            
            (24,477
            )Proceeds
      from matured and called available-for-sale investment
      securities
            
            
            12,735
            
            
            
            9,070Proceeds
      from principal repayments from available-for-sale government-guaranteed
      mortgage-backed securities
            
            
            730
            
            
            
            1,558Proceeds
      from principal repayments from held-to-maturity government-guarantee
      mortgage-backed securities
            
            
            20
            
            
            
            1Purchase
      of FRB and FHLB stock
            
            
            (14
            )
            
            
            -Net
      increase in loans
            
            
            (13,641
            )
            
            
            (8,992
            )Purchases
      of premises and equipment
            
            
            (1,214
            )
            
            
            (1,384
            )Net
      cash used in investing activities
            
            
            (19,486
            )
            
            
            (24,224
            )Cash
      flows from financing activities:Net decrease
      in demand, interest-bearing and savings deposits
            
            
            (3,170
            )
            
            
            (23,253
            )Net
      increase in time deposits
            
            
            32,753
            
            
            
            35,114Proceeds
      from exercise of stock options
            
            
            56
            
            
            
            181Net
      (decrease) increase in other borrowings
            
            
            (5,000
            )
            
            
            3,600Net
      cash provided by financing Activities
            
            
            24,639
            
            
            
            15,642Increase
      (decrease) in cash and cash equivalents
            
            
            5,496
            
            
            
            (5,194
            )Cash
      and cash equivalents at beginning of period
            
            
            45,674
            
            
            
            50,615Cash
      and cash equivalents at end of period
            
            $
            51,170
            
            
            $
            45,421





-4-


Pacific
State Bancorp and Subsidiary


NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)


1.
GENERAL





Pacific
State Bancorp is a holding company with one bank subsidiary, Pacific State Bank,
(the “Bank”), and two unconsolidated subsidiary grantor trusts, Pacific State
Statutory Trusts II and III.  Pacific State Bancorp commenced
operations on June 24, 2002 after acquiring all of the outstanding shares of
Pacific State Bank.  The Bank is a California state chartered bank
formed November 2, 1987. The Bank is a member of the Federal Reserve System. The
Bank’s primary source of revenue is interest on loans to customers who are
predominantly small to middle-market businesses and middle-income
individuals.  Pacific State Statutory Trusts II and III are
unconsolidated, wholly owned statutory business trusts formed in March 2004 and
June 2007, respectively for the exclusive purpose of issuing and selling trust
preferred securities.





The Bank
conducts a general commercial banking business, primarily in the five county
region that comprises Alameda, Calaveras, San Joaquin, Stanislaus and Tuolumne
counties, and offers commercial banking services to residents and employers of
businesses in the Bank’s service area, including professional firms and small to
medium sized retail and wholesale businesses and manufacturers.  The
Company as of June 30, 2008 had 83 employees, including 20 officers. The Bank
does not engage in any non-bank lines of business. The business of the Bank is
not to any significant degree seasonal in nature.  The Bank has no
operations outside California and has no material amount of loans or deposits
concentrated among any one or few persons, groups or industries.  The
Bank operates nine branches with its Administrative Office located at 1899 W.
March Lane, in Stockton, California; additional branches are located in downtown
Stockton and in the communities of Angels Camp, Arnold, Groveland, Lodi,
Modesto, Tracy and Hayward, California.  Pacific State Bancorp common
stock trades on the NASDAQ Global Market under the symbol of
“PSBC”.





-5-




2. BASIS
OF PRESENTATION AND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





In the
opinion of management, the unaudited condensed consolidated financial statements
contain all adjustments (consisting of only normal recurring adjustments)
necessary to present fairly the consolidated financial position of Pacific State
Bancorp (the "Company") at June 30, 2008 and December 31, 2007, and the results
of its operations for the three and six month periods ended June 30, 2008 and
2007, and its cash flows for the six month periods ended June 30, 2008 and 2007
in conformity with the instructions to Form 10-Q and Article 10 of Regulation
S-X of the Securities and Exchange Commission (“SEC”).





Certain
disclosures normally presented in the notes to the consolidated financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America for annual financial statements have been
omitted.  The Company believes that the disclosures in the interim
condensed consolidated financial statements are adequate to make the information
not misleading. These interim condensed consolidated financial statements should
be read in conjunction with the consolidated financial statements and notes
thereto included in the Company's 2007 Annual Report to
Shareholders.   The results of operations for the three month and
six month periods ended June 30, 2008 may not necessarily be indicative of the
operating results for the full year.





In
preparing such financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the balance sheet and revenues and expenses for the
period.  Actual results could differ significantly from those
estimates.  Material estimates that are particularly susceptible to
significant changes in the near term relate to the determination of the
allowance for loan losses, the provision for income taxes and the estimated fair
value of investment securities.





Management
has determined that all of the commercial banking products and services offered
by the Company are available in each branch of the Bank, that all branches are
located within the same economic environment and that management does not
allocate resources based on the performance of different lending or transaction
activities. Accordingly, the Company and its subsidiary operate as one business
segment. No customer accounts for more than 10% of the revenue for the Bank or
the Company.





-6-




3.
LOANS





Outstanding
loans are summarized below:





June
      30,
            
            
            December
      31,2008
            
            
            2007(In
      thousands)Commercial
            
            $
            85,979
            
            
            $
            83,012Agricultural
            
            
            15,326
            
            
            
            12,646Real
      estate - commercial mortgage
            
            
            134,929
            
            
            
            121,157Real
      estate - construction
            
            
            74,298
            
            
            
            80,168Installment
            
            
            14,188
            
            
            
            15,215Gross
      loans
            
            
            324,720
            
            
            
            312,198Deferred
      loan origination (fees) costs, net
            
            
            209
            
            
            
            208Allowance
      for loan losses
            
            
            (3,427
            )
            
            
            (3,948
            )Net
      loans
            
            $
            321,502
            
            
            $
            308,458





4.
COMMITMENTS AND CONTINGENCIES





The
Company is party to claims and legal proceedings arising in the ordinary course
of business.  In the opinion of the Company’s management, the ultimate
liability with respect to such proceedings will not have a materially adverse
effect on the financial condition or results of operations of the Company as a
whole.





In the
normal course of business there are outstanding various commitments to extend
credit which are not reflected in the financial statements, including loan
commitments of approximately $69,037,000 and $121,255,000 and stand-by letters
of credit of $2,863,000 and $3,491,000 at June 30, 2008 and December 31, 2007,
respectively.  However, all such commitments will not necessarily
culminate in actual extensions of credit by the Company.





Approximately
$14,491,000 of the loan commitments outstanding at June 30, 2008 are for real
estate loans and are expected to fund within the next twelve
months.  The remaining commitments primarily relate to revolving lines
of credit or other commercial loans, and many of these are expected to expire
without being drawn upon.  Therefore, the total commitments do not
necessarily represent future cash requirements.  Each potential
borrower and the necessary collateral are evaluated on an individual
basis.  Collateral varies, but may include real property, bank
deposits, debt or equity securities or business assets.





Stand-by
letters of credit are commitments written to guarantee the performance of a
customer to a third party.  These guarantees are issued primarily
relating to purchases of inventory by commercial customers and are typically
short term in nature.  Credit risk is similar to that involved in
extending loan commitments to customers and accordingly, evaluation and
collateral requirements similar to those for loan commitments are
used.  Virtually all such commitments are collateralized. The deferred
liability related to the Company’s stand-by letters of credit was not
significant at June 30, 2008 and December 31, 2007.




-7-




5.
EARNINGS PER SHARE COMPUTATION





Basic
earnings per share are computed by dividing net income by the weighted average
common shares outstanding for the period.  Diluted earnings per share
reflect the potential dilution that could occur if outstanding stock options
were exercised.   Diluted earnings per share is computed by
dividing net income by the weighted average common shares outstanding for the
period plus the dilutive effect of outstanding options.





6.
COMPREHENSIVE INCOME





Comprehensive
income is reported in addition to net income for all periods
presented.  Comprehensive income is made up of net income plus other
comprehensive income or loss.  Other comprehensive income or loss, net
of taxes, is comprised of the unrealized gains or losses on available-for-sale
investment securities.  The following table shows comprehensive income
and its components for the periods indicated:





Three
      Months Ended
            
            
            Six
      Months Ended(in
      thousands)
            
            June
      30, 2008
            
            
            June
      30, 2007
            
            
            June
      30, 2008
            
            
            June
      30, 2007Net
      Income
            
            $
            579
            
            
            $
            1,389
            
            
            $
            1,673
            
            
            $
            2,735Other
      Comprehensive Loss:Change
      in unrealized loss onavailable
      for sale securities
            
            
            (895
            )
            
            
            (9
            )
            
            
            (982
            )
            
            
            (30
            )Reclassification
      adjustment
            
            
            11
            
            
            
            -
            
            
            
            11
            
            
            
            -Total
      Other Comprehensive Loss
            
            
            (884
            )
            
            
            (9
            )
            
            
            (971
            )
            
            
            (30
            )Total
      Comprehensive (Loss) Income
            
            $
            (305
            )
            
            $
            1,380
            
            
            $
            702
            
            
            $
            2,705





7. STOCK
–BASED COMPENSATION





Stock
Option Plan





The
Company’s only stock-based compensation plan, the Pacific State Bancorp 1997
Stock Option Plan (the “Plan”), terminated in 2007. The Plan requires that the
option price may not be less than the fair market value of the stock at the date
the option is granted, and that the stock must be paid in full at the time the
option is exercised. The options expire on a date determined by the Board of
Directors, but not later than ten years from the date of grant. The vesting
period is determined by the Board of Directors and is generally over five years.
New shares are issued upon the exercise of options





Stock
Option Compensation





There
were no stock options granted in the three and six month periods ended June 30,
2008 and June 30, 2007. Stock option compensation expense is recognized on a
straight-line basis over the vesting period of the option. For the three month
periods ended June 30, 2008 and 2007, the compensation cost recognized for stock
option compensation was $86,000 and $77,000, respectively. For the six month
periods ended June 30, 2008 and 2007, the compensation cost recognized for stock
option compensation was $171,000 and $127,000, respectively. The excess tax
benefits were not significant for the Company.





At June
30, 2008, the total compensation cost related to nonvested stock option awards
granted to employees under the Company’s stock option plans but not yet
recognized was $299,000.  .  This cost is expected to be
recognized over a weighted average remaining period of 1.7 years and will be
adjusted for subsequent changes in estimated forfeitures.




-8-




Stock
Option Activity




A summary
of option activity under the stock option plans as of June 30, 2008 and changes
during the period then ended is presented below:





Options
            
            Shares
            
            
            Weighted
      Average Exercise Price
            
            
            Weighted
      Average Remaining Contractual Term
            
            
            Aggregate
      Intrinsic Value ($000)Outstanding
      at January 1, 2008
            
            
            656,769
            
            
            $
            7.69
            
            
            5.5
      years
            
            
            $
            3,836Granted
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Exercised
            
            
            7,900
            )
            
            $
            4.02
            
            
            2.4
      Years
            
            
            $
            52Cancelled
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Outstanding
      at June 30, 2008
            
            
            648,869
            
            
            $
            7.73
            
            
            5.3
      years
            
            
            $
            260Options
      vested or expected to vest at June 30, 2008
            
            
            505,012
            
            
            $
            7.08
            
            
            4.3
      Years
            
            
            $
            543Exercisable
      at June 30, 2008
            
            
            505,012
            
            
            $
            7.08
            
            
            4.3
      Years
            
            
            $
            543





The
intrinsic value was derived from the closing market price of the Company’s
common stock of $8.13 as of June 30, 2008 and $12.57 of December 31,
2007.




8. INCOME
TAXES





In July
2006, the Financial Accounting Standards Board (FASB) issued Financial
Accounting Standards Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes—an Interpretation of FASB statement No. 109.  FIN 48 clarifies
the accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes.
FIN 48 also prescribes a recognition threshold and measurement standard for the
financial statement recognition and measurement of an income tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosures and transitions. The Company has adopted FIN 48 as of
January 1, 2007.





The
Company previously recognized income tax positions based on management’s
estimate of whether it is reasonably possible that a liability has been incurred
for unrecognized income tax benefits by applying FASB Statement No. 5,
Accountingfor
Contingencies.





The
provisions of FIN 48 have been applied to all tax positions of the Company as of
January 1, 2007.  There was no cumulative effect of applying the
provisions of FIN 48 and there was no material effect on the Company’s provision
for income taxes for the three months or six months ended June 30,
2008. The
Company applies the asset and liability method to account for income
taxes.  Deferred tax assets are calculated by applying applicable tax
laws to the differences between the financial statement basis and the tax basis
of assets and liabilities.  The effect on deferred taxes of changes in
tax laws and rates is recognized in income in the period that includes the
enactment date.  On the consolidated balance sheet, net deferred tax
assets are included in other assets.
 
 Accounting
for uncertainty in income taxes – The benefit of a tax position is recognized in
the financial statements in the period during which, based on all available
evidence, management believes it is more likely than not that the position will
be sustained upon examination, including the resolution of appeals or litigation
process, if any.  Tax positions that meet the more-likely-than-not
recognition threshold are measured as the largest amount of tax benefit that is
more than 50 percent likely of being realized upon settlement with the
applicable taxing authority.  The portion of the benefits associated
with tax positions taken that exceeds the amount measured as described above is
reflected as a liability for unrecognized tax benefits in the accompanying
balance sheet along wih any associated interest and penalties that would be
payable to the taxing authorities upon examination.  The Company
recognizes accrued interest and penalties related to unrecognized tax benefits,
if applicable, as a component of interest expense in the consolidated statements
of income.  There have been no significant change to unrecognized tax
benefits or accrued interest and penalties for the six months ended June 30,
2008.


-9-




9. NEW
ACCOUNTING PRONOUNCEMENTS





Fair
Value Measurements





In
September 2006, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 157, Fair Value Measurements ("SFAS
No. 157").  SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurement.  SFAS No. 157 also emphasizes that fair value is a
market-based measurement, not an entity-specific measurement, and sets out a
fair value hierarchy with the highest priority being quoted prices in active
markets.  Under SFAS No. 157, fair value measurements are
disclosed by level within that hierarchy.  SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007, except for
nonfinancial assets and nonfinancial liabilities that are recognized or
disclosed at fair value in the financial statements on a nonrecurring basis for
which delayed application is permitted until fiscal years beginning after
November 15, 2008.  The
Company adopted SFAS No. 157 on January 1, 2008 and, in management’s opinion,
the adoption did not have a material impact on the Company’s financial position,
results of operations or cash flows.


Fair
Value Accounting





In
February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities ("SFAS No. 159").  SFAS No. 159 permits
companies to elect to follow fair value accounting for certain financial assets
and liabilities in an effort to mitigate volatility in earnings without having
to apply complex hedge accounting provisions.  The standard also
establishes presentation and disclosure requirements designed to facilitate
comparison between entities that choose different measurement attributes for
similar types of assets and liabilities.  SFAS No. 159 is
effective for fiscal years beginning after November 15, 2007.  The
Company adopted SFAS No. 159 on January 1, 2008 and, in management’s
opinion, the adoption did not have a material impact on the Company’s financial
position, results of operations or cash flows.


Business
Combinations





In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141 (revised 2007), Business Combinations ("SFAS
No. 141(R)").  SFAS No. 141(R), among other things,
establishes principles and requirements for how the acquirer in a business
combination (i) recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquired business, (ii) recognizes and measures the
goodwill acquired in the business combination or a gain from a bargain purchase,
and (iii) determines what information to disclose to enable users of the
financial statements to evaluate the nature and financial effects of the
business combination.  The Company is required to adopt SFAS
No. 141(R) for all business combinations for which the acquisition date is
on or after January 1, 2009.  Earlier adoption is
prohibited.  This standard will change the Company’s accounting
treatment for business combinations on a prospective basis.





-10-




Noncontrolling
Interests in Consolidated Financial Statements





In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 160, Noncontrolling Interests in Consolidated Financial Statements, an
Amendment of ARB No. 51 ("SFAS No. 160").  SFAS No. 160
establishes accounting and reporting standards for noncontrolling interests in a
subsidiary and for the deconsolidation of a subsidiary.  Minority interests
will be recharacterized as noncontrolling interests and classified as a
component of equity.  It also establishes a single method of accounting for
changes in a parent's ownership interest in a subsidiary and requires expanded
disclosures.  This statement is effective for fiscal years beginning
on or after December 15, 2008, with early adoption
prohibited.  The Company does not expect the adoption of this
Statement will have a material impact on its financial position, results of
operations or cash flows.





Accounting
for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements





In
September 2006, the FASB ratified the Emerging Issues Task Force ("EITF")
conclusion under EITF Issue No. 06-4, Accounting for Deferred Compensation
and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements ("EITF 06-4").  EITF 06-4 requires that
endorsement split-dollar life insurance arrangements which provide a
postretirement benefit to an employee be recorded in accordance with FASB
Statement No. 106, Employer's Accounting for Postretirement Benefits Other
Than Pensions or APB Opinion No. 12, Omnibus Opinion—1967, based on the
substance of the agreement with the employee.  Under the provisions of
these Statements, if the employer has effectively agreed to maintain a life
insurance policy during the employee's retirement, the cost of the insurance
policy during postretirement periods should be accrued in accordance with either
Statement 106 or Opinion 12.  Similarly, if the employer has
effectively agreed to provide the employee with a death benefit, the employer
should accrue, over the service period, a liability for the actuarial present
value of the future death benefit as of the employee's expected retirement date,
in accordance with either Statement 106 or
Opinion 12.  EITF 06-4 is effective for fiscal years
beginning after December 15, 2007.  The effects of adopting
EITF 06-4 can be recorded either as (i) a change in accounting principle
through a cumulative-effect adjustment to retained earnings or to other
components of equity as of the beginning of the year of adoption, or (ii) a
change in accounting principle through retrospective application to all prior
periods.  The Company adopted the provisions of EITF 06-4 as of
January 1, 2008 and management determined that adoption will not have an
impact on the financial position, results of operations or cash flows of the
Company.





Accounting
for Collateral Assignment Split-Dollar Life Insurance Arrangements





In March
2007, the FASB ratified the consensus the EITF reached regarding EITF Issue
No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance
Arrangements ("EITF 06-10"), which provides accounting guidance for
postretirement benefits related to collateral assignment split-dollar life
insurance arrangements, whereby the employee owns and controls the insurance
policies.  The consensus concludes that an employer should recognize a
liability for the postretirement benefit in accordance with FASB Statement
No. 106, Employers' Accounting for Postretirement Benefits Other Than
Pensions, or APB Opinion No. 12, Omnibus Opinion – 1967, as well as recognize an
asset based on the substance of the arrangement with the
employee.  EITF 06-10 is effective for fiscal years beginning
after December 15, 2007, with early application permitted.  The
Company adopted the provisions of EITF 06-10 on January 1, 2008 and management
determined that adoption will not have an impact on the financial position,
results of operations or cash flows of the Company.


-11-


ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





Certain
matters discussed in this Quarterly Report are forward-looking statements that
are subject to risks and uncertainties that could cause actual results to differ
materially from those projected in the forward-looking statements. Such risks
and uncertainties include, among others (1) significant increases in competitive
pressures in the financial services industry; (2) changes in the interest rate
environment resulting in reduced margins; (3) general economic conditions,
either nationally or regionally, may be less favorable than expected, resulting
in among other things, a deterioration in credit quality; (4) changes in the
regulatory environment; (5) loss of key personnel; (6) fluctuations in the real
estate market; (7) changes in business conditions and inflation; (8) operational
risks including data processing systems failures and fraud; and (9) changes in
the securities market.  Therefore the information set forth herein
should be carefully considered when evaluating the business prospects of the
Company.





When the
Company uses in this Quarterly Report the words “anticipate”, “estimate”,
“expect”, “project”, “intend, “commit”, “believe” and similar expressions, the
Company intends to identify forward-looking statements.  Such
statements are not guarantees of performance and are subject to certain risks,
uncertainties and assumptions, including those described in this Quarterly
Report. Should one or more of the uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated, estimated, expected, projected, intended, committed or
believed.  The future results and stockholder values of the Company
may differ materially from those expressed in these forward-looking
statements.  Many factors that will determine these results and values
are beyond the Company’s ability to control or predict.  For those
statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.





INTRODUCTION





The
following discussion and analysis sets forth certain statistical information
relating to the Company as of June 30, 2008 and December 31, 2007 and for the
three and six month periods ended June 30, 2008 and 2007.  The
discussion should be read in conjunction with the unaudited condensed
consolidated financial statements and related notes included elsewhere in this
report and the consolidated financial statements and notes thereto included in
Pacific State  Bancorp’s Annual Report filed on Form 10-K for the year
ended December 31, 2007.




CRITICAL
ACCOUNTING POLICIES





There
have been no changes to the Company’s critical accounting policies from those
discussed in Management’s Discussion and Analysis of Financial Condition and
Results of Operations in the Company’s 2007 Annual Report on Form
10-K.





OVERVIEW





For the
three months ended June 30, 2008:





The
Company’s net income decreased $819 thousand or 58.6% to $579 thousand for the
second quarter of 2008 from $1,398 thousand for the same period in
2007.  The primary contributors to the decrease in net income for the
second quarter of 2008 were the (1) $805 thousand decrease in net interest
income, a (2) $545 thousand increase in provision for loan losses, and a (3)
$109 thousand decrease in non-interest income, primarily other income, compared
to the same period in 2007.  The changes above were partially offset
by decreases in non-interest expenses of $177 thousand. The decrease in
non-interest expenses consisted primarily of decreases in salaries and benefits
of $224 thousand, which was offset by an increase in occupancy, furniture and
equipment expenses of $20 thousand as well as an increase of $27 thousand in
other expenses.  The provision for income taxes decreased $463
thousand.




Basic
earnings per share decreased to $0.16 for the second quarter of 2008 down 57.9%
from $0.38 for the same period in 2007.  Diluted earnings per share
decreased to $0.15 for the second quarter of 2008 down 57.1% from the $0.35 for
the same period in 2007.





The
annualized return on average assets (“ROA”) was 0.52% for the three month period
ended June 30, 2008 compared to 1.41% for the same period in
2007.  The annualized return on average equity (“ROE”) was 6.64% for
the three month period ended June 30, 2008 compared to 18.18% for the same
period in 2007. The decrease in ROA and ROE is primarily attributable to a
decrease in net income as compared to the same period in 2007.





For the
six months ended June 30, 2008:





The
Company’s net income decreased $1,062 thousand or 38.8% to $1,673 thousand for
the six months ended June 30, 2008 from $2,735 thousand for the same period in
2007.  The primary contributors to the decrease in net income for the
six months ended June 30, 2008 were the (1) $1,217 thousand decrease in net
interest income, (2) increase in provision for loan losses of $590 thousand and
(3) $323 thousand decrease in non-interest income.  These changes were
partially offset by decreases in non-interest expenses of $381 thousand.
The decrease in non-interest expenses consisted primarily of decreases in
salaries and benefits of $438 thousand, occupancy, furniture and equipment
expenses of $9 thousand as well as an increase of $48 thousand in other
expenses.  The decrease in salaries is the result of a lower level of
bonus accrual and increased recognition of deferred loan costs.  The
provision for income taxes decreased $687 thousand.




Basic
earnings per share decreased to $0.45 for the six months ended June 30, 2008
down 40% from $0.75 for the same period in 2007.  Diluted earnings per
share decreased to $0.43 for the six months ended June 30, 2008 down 36.8% from
the $0.68 for the same period in 2007.





Total
assets at June 30, 2008 were $454 million, an increase of $23 million or 10.7%
annualized, from the $431 million at December 31, 2007.  The growth in
assets was primarily in the Company’s loan portfolio and
investments.  Loans grew $13,044 thousand or 8.5% annualized to
$321,502 thousand at June 30, 2008 from $308,458 thousand at December 31,
2007.  Investments grew $6,089 thousand or 29.6% annualized to $47,441
thousand at June 30, 2008 from $41,352 thousand at December 31,
2007.  The growth in loans and investments was funded by the net
income of $1.67 million and growth in deposits of $29.6
million.  Interest rate changes in the market and deposit growth have
allowed the Bank to prepay certain borrowings and have allowed the bank to
reduce wholesale borrowings to $35 million at June 30, 2008 from $40
million at December 31, 2007.  During July 2008, the borrowings were
further reduced to $20 million.





The
annualized return on average assets (“ROA”) was 0.77% for the six month period
ended June 30, 2008 compared to 1.42% for the same period in
2007.  The annualized return on average equity (“ROE”) was 9.60% for
the six month period ended June 30, 2008 compared to 18.29% for the same period
in 2007. The decrease in ROA and ROE is primarily attributable to a decrease in
net income as compared to the same period in 2007.





-12-


RESULTS
OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2008





Net
interest income before provision for loan losses





Three
      Months Ended June 30,(Dollars
      in thousands, except per share data)
            
            2008
            
            
            2007
            
            
            Dollar Change
            
            
            Percentage ChangeInterest
      income:Interest
      and fees on loans
            
            $
            6,201
            
            
            $
            7,300
            
            
            $
            (1,099
            )
            
            
            (15.1
            )%Interest
      on Federal funds sold
            
            
            141
            
            
            
            348
            
            
            
            (207
            )
            
            
            (59.5
            )Interest
      on investment securities
            
            
            892
            
            
            
            484
            
            
            
            408
            
            
            
            84.3Total
      interest income
            
            
            7,234
            
            
            
            8,132
            
            
            
            (898
            )
            
            
            (11.0
            )Interest
      expense:Interest
      on deposits
            
            
            2,860
            
            
            
            3,239
            
            
            
            (379
            )
            
            
            (11.7
            )Interest
      on other borrowings
            
            
            418
            
            
            
            55
            
            
            
            363
            
            
            
            660Interest
      on subordinated debentures
            
            
            108
            
            
            
            185
            
            
            
            (77
            )
            
            
            (41.6
            )Total
      interest expense
            
            
            3,386
            
            
            
            3,479
            
            
            
            (93
            )
            
            
            (2.7
            )Net
      interest income before provision for loan losses
            
            $
            3,848
            
            
            $
            4,653
            
            
            $
            (805
            )
            
            
            (17.3
            )%





Net
interest income is the interest earned on debt securities, loans (including
yield-related loan fees) and other interest-earning assets minus the interest
paid for deposits and long-term and short-term debt. The net interest margin is
the average yield on earning assets minus the average interest rate paid for
deposits and our other sources of funding.





The
decreased net interest income performance is primarily the result of the Bank
experiencing a contraction in its net interest margin.  The
contraction of the net interest margin is the result of the more rapid downward
repricing of the Bank’s interest earning assets, after the Federal Reserve rate
cuts, than the Bank’s repricing of interest bearing liabilities.  The
Bank has begun to experience a repricing of liabilities in the second quarter of
2008 which is expected to accelerate in the second half of the year,
leading to an improved net interest income result in the second half of the
year.  Repricing of time deposits led to a decrease in deposit
interest expense during May and June while average balances increased over the
same time period.





In
addition to the repricing of the interest bearing deposits, interest rate
changes in the market and deposit growth have allowed the Bank to prepay certain
borrowings and allowed the Bank to reduce wholesale borrowings to $20
million in early July from $35 million at June 30, 2008 and $40 million at
December 31, 2007.  Management believes a decreased level of borrowing
and repricing of interest bearing deposits will have its greatest impact in the
third quarter and early fourth quarter of 2008.





The
decrease in interest income was primarily attributed to decreases in the yields
on the levels of average loans.  Average loan volume for the three
months ended June 30, 2008 compared to the same time period in 2007 increased
$34 million, which was offset by a decrease of 234 basis points in the average
rate the Bank was able to charge.  Loan volume increased due to the
growth of new branches and increased penetration into existing
markets.





The
Company’s average loan balances were $329 million for the three months ended
June 30, 2008 up 11.5% from $295 million for the same period in
2007.  The Company’s average loan yield was 7.58% for the three months
ended June 30, 2008, down from the 9.92% yield experienced for the same period
in 2007.  As a
result of the decrease in yields offset by the increase in average balances
interest income decreased $1.1 million.The Company’s average
balances of investment securities increased $14 million to $51 million for the
three months ended June 30, 2008 from the $37 million for the same period in
2007. The Company’s average yield on investments increased 180 basis points to
7.00% from 5.20% for the same period in 2007.  As a result of the
increase in volume and yield, interest income from investment securities
increased $408 thousand.





The
Company’s average balances of Federal funds sold increased $1.5 million to $28.9
million for the three months ended June 30, 2008 from the $27.4 million for the
same period in 2007. The Company’s average yield on Federal funds sold decreased
330 basis points to 1.79% from 5.09% for the same period in 2007 and interest
income decreased by $219 thousand.  As a result, the overall yield on
average earning assets decreased 198 basis points to 7.09% for the three months
ended June 30, 2008, from 9.07% for the same period in 2007.





The
decrease in interest expense is primarily attributed to the change in the volume
and mix of interest bearing deposit liabilities, (the level of average time
deposits increased significantly while the levels of other interest bearing
deposits declined or remaining relatively level).  Time deposits
increased as the Company experienced disintermediation from lower yielding
transaction accounts into higher yielding time deposits.  Rates paid
on deposits were decreased during the period as market rates for deposits
decreased.





The
Company’s average balances of time deposits were $228 million for the three
months ended June 30, 2008, up $32 million, or 16.1% from $196 million for the
same period in 2007. The average rate paid on time deposits decreased 99 basis
points to 4.33% for the three months ended June 30, 2008 from 5.32% for the same
period in 2007. As a result, interest expense on time deposits decreased $150
thousand.  The Company’s average balances of interest bearing demand
deposits decreased $16 million to $69 million for the three months ended June
30, 2008 from $85 million for the same period in 2007.  The average
rate paid decreased 62 basis points to 2.33% from 2.95% for the same period in
2007. As a result, interest expense on interest bearing demand deposits
decreased $223 thousand.





The
Company’s average balances of other borrowings increased $34 million to $48
million for the three months ended June 30, 2008 from $14 million for the same
period in 2007 and the rates paid decreased 268 basis points to 4.42% for the
three months ended June 30, 2008 from 7.10% for the same period in 2007. As a
result of the increased volume offset by the decreased rates paid, interest
expense on other borrowings increased $286 thousand.  The overall
rates paid on average interest-bearing liabilities decreased 77 basis points to
3.89% for the three months ended June 30, 2008, from 4.66% for the same period
in 2007.





As a
result of the changes noted above, the net interest margin for the three months
ended June 30, 2008 decreased 142 basis points to 3.77%, from 5.19% for the same
period in 2007.





The
following table presents for the three month periods indicated the distribution
of consolidated average assets, liabilities and shareholders’
equity.  It also presents the amounts of interest income from the
interest earning assets and the resultant yields expressed in both dollars and
rate percentages.  Average balances are based on daily
averages.  Nonaccrual loans are included in the calculation of average
loans while nonaccrued interest thereon is excluded from the computation of
yields earned:





-13-





PACIFIC
      STATE BANCORPYield
      AnalysisFor
      Three Months Ended June 30,(Dollars
      in thousands)
            2008
            
            
            2007Interest
            
            
            Average
            
            
            
            
            
            Interest
            
            
            AverageAverage
            
            Income
      or
            
            
            Yield
      or
            
            
            Average
            
            
            Income
      or
            
            
            Yield
      orAssets:
            Balance
            
            Expense
            
            
            Cost
            
            
            Balance
            
            
            Expense
            
            
            CostInterest-earning
      assets:Loans(1)(2)
            
            $
            329,055
            
            
            $
            6,201
            
            
            
            7.58
            %
            
            $
            295,030
            
            
            $
            7,300
            
            
            
            9.92
            %Investment
      securities(2)
            
            
            51,341
            
            
            
            892
            
            
            
            7.00
            %
            
            
            37,310
            
            
            
            484
            
            
            
            5.20
            %Federal
      funds sold
            
            
            28,908
            
            
            
            129
            
            
            
            1.79
            %
            
            
            27,424
            
            
            
            348
            
            
            
            5.09
            %Interest
      Bearing Deposits in Banks
            
            
            1,187
            
            
            
            12
            
            
            
            4.07
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            %Total
      average earning assets
            
            $
            410,491
            
            
            $
            7,234
            
            
            
            7.09
            %
            
            $
            359,764
            
            
            $
            8,132
            
            
            
            9.07
            %Non-earning
      assets:Cash
      and due from banks
            
            
            13,669
            
            
            
            
            
            
            
            
            
            
            
            16,644Bank
      premises and equipment
            
            
            14,953
            
            
            
            
            
            
            
            
            
            
            
            12,365Other
      assets
            
            
            15,619
            
            
            
            
            
            
            
            
            
            
            
            10,480Allowance
      for loan loss
            
            
            (3,036
            )
            
            
            
            
            
            
            
            
            
            
            (2,702
            )Total
      average assets
            
            $
            451,696
            
            
            
            
            
            
            
            
            
            
            $
            396,551Liabilities
      and Shareholders' Equity:Interest-bearing
      liabilities:DepositsInterest-bearing
      Demand
            
            $
            68,752
            
            
            $
            399
            
            
            
            2.33
            %
            
            $
            84,522
            
            
            $
            622
            
            
            
            2.95
            %Savings
            
            
            5,394
            
            
            
            7
            
            
            
            0.52
            %
            
            
            5,343
            
            
            
            13
            
            
            
            0.98
            %Time
      Deposits
            
            
            227,825
            
            
            
            2,454
            
            
            
            4.33
            %
            
            
            196,233
            
            
            
            2,604
            
            
            
            5.32
            %Other
      borrowing(3)
            
            
            47,857
            
            
            
            526
            
            
            
            4.42
            %
            
            
            13,564
            
            
            
            240
            
            
            
            7.10
            %Total
      average interest-bearing liabilities
            
            $
            349,828
            
            
            $
            3,386
            
            
            
            3.89
            %
            
            $
            299,662
            
            
            $
            3,479
            
            
            
            4.66
            %Noninterest-bearing
      liabilities:Demand
      deposits
            
            
            62,853
            
            
            
            
            
            
            
            
            
            
            
            63,893Other
      liabilities
            
            
            3,923
            
            
            
            
            
            
            
            
            
            
            
            2,157Total
      average liabilities
            
            
            416,604
            
            
            
            
            
            
            
            
            
            
            
            365,712Shareholders'
      equity:
            
            
            35,092
            
            
            
            
            
            
            
            
            
            
            
            30,839Total
      average liabilities and shareholders' equity
            
            $
            451,696
            
            
            
            
            
            
            
            
            
            
            $
            396,551Net
      interest income
            
            
            
            
            
            $
            3,848
            
            
            
            
            
            
            
            
            
            
            $
            4,653Net
      interest margin(4)
            
            
            
            
            
            
            
            
            
            
            3.77
            %
            
            
            
            
            
            
            
            
            
            
            5.19
            %





(1)
            Loan
      fees included in loan interest income for the three month periods ended
      June 30, 2008 and 2007 amounted to $216 thousand and $809 thousand,
      respectively.


(2)
            Not
      computed on a tax-equivalent basis.


(3)
            For
      the purpose of this table the interest expense related to the Company’s
      junior subordinated debentures is included in other
      borrowings.


(4)
            Net
      interest income divided by the average balance of total earning
      assets.





-14-


The
following table sets forth changes in interest income and interest expense, for
the three month periods indicated and the change attributable to variance in
volume and rates:





Three
      Months ended June 30,2008
      over 2007Net(In thousands)
            
            Change
            
            
            Rate
            
            
            VolumeInterest
      Income:Loans
      and leases
            
            $
            (1,099
            )
            
            $
            (1,941
            )
            
            $
            842Investment
      securities
            
            
            408
            
            
            
            226
            
            
            
            182Federal
      funds sold
            
            
            (219
            )
            
            
            (238
            )
            
            
            19Interest
      Bearing Deposits in Banks
            
            
            12
            
            
            
            -
            
            
            
            12Total
      interest income
            
            $
            (898
            )
            
            $
            (1,953
            )
            
            $
            1,055Interest
      Expense:Interest-bearing
      Demand
            
            $
            (223
            )
            
            $
            (107
            )
            
            $
            (116
            )Savings
            
            
            (6
            )
            
            
            (6
            )
            
            
            -Time
      Deposits
            
            
            (150
            )
            
            
            (569
            )
            
            
            419Other
      borrowing
            
            
            286
            
            
            
            (321
            )
            
            
            607Total
      interest expense
            
            
            (93
            )
            
            $
            (1,003
            )
            
            $
            910Net
      interest income
            
            $
            (805
            )
            
            $
            (950
            )
            
            $
            145


(1)
            The
      volume change in net interest income represents the change in average
      balance multiplied


by the
current year’s rate.


(2)
            The
      rate change in net interest income represents the change in rate
      multiplied by the current year’s average
  balance.





Provision
for loan losses





The
Company recorded $600 thousand in provision for loan losses for the three month
period ended June 30, 2008, an increase of $545 thousand or 991% from $55
thousand for the same period in 2007.  The increase in the provision
is based on management’s assessment of the required level of
reserves.  Management assesses loan quality monthly to maintain an
adequate allowance for loan losses.  Based on the information
currently available, management believes that the allowance for loan losses is
adequate to absorb probable losses in the portfolio.  However, no
assurance can be given that the Company may not sustain charge-offs which are in
excess of the allowance in any given period.  The Company’s loan
portfolio composition and non-performing assets are further discussed under the
“Financial Condition” section below.





Non-Interest
Income





During
the three months ended June 30, 2008, total non-interest income decreased $109
thousand or 15.4% to $597 thousand, from $706 thousand for the comparable
period in 2007.  The decrease in non-interest income was primarily the
result of decreases in fee income derived from the referral of commercial
mortgage loans to third parties. The decrease was offset by an increase in the
gain on the sale of loans of $113 thousand or 594.7% to $132 thousand for the
quarter ended June 30, 2008 up from $19 thousand for the comparable period in
2007.





-15-




Non-Interest
Expenses





Non-interest
expenses consist of salaries and related employee benefits, occupancy, furniture
and equipment expenses, professional fees, appraisal fees, directors’ fees,
postage, stationary and supplies expenses, telephone expenses, data processing
expenses, advertising and promotion expense and other operating expenses.
Non-interest expense for the three months ended June 30, 2008 was $2.8 million
compared to $3.0 million for the same period in 2007, representing a decrease of
$177 thousand or 5.9%. This decrease reflects decreases in salaries and benefits
of $224 thousand or 14.9% which is the result of a bonus accrual in 2007 that
was not recorded in 2008 and increased deferred loan costs. The increase in
occupancy, furniture and equipment expense of $25 thousand is attributable to
increased costs of maintaining facilities. The increase in other expense of $27
thousand is the result of increased legal fees associated with loan
collection.





The
following table sets forth a summary of non-interest expense for the three month
periods ended June 30, 2008 and 2007:





Three
      Months Ended(In
      thousands)
            
            June
      30, 2008
            
            
            June
      30, 2007Non-interest
      Expense:Salaries
      & Benefits
            
            $
            1,282
            
            
            $
            1,506Occupancy
            
            
            302
            
            
            
            277Furniture
      and Equipment
            
            
            195
            
            
            
            200Other
      Expense
            
            
            1,046
            
            
            
            1,019Total
      Non-Interest Expenses
            
            $
            2,825
            
            
            $
            3,002





Income
Taxes





The
Company’s provision for income taxes includes both federal income and state
franchise taxes and reflects the application of federal and state statutory
rates to the Company’s net income before taxes.  The principal
difference between statutory tax rates and the Company’s effective tax rate is
the benefit derived from investing in tax-exempt securities and Company owned
life insurance.  Increases and decreases in the provision for taxes
reflect changes in the Company’s net income before tax. The Company’s effective
tax rate for the three month period ended June 30, 2008 increased to 43.2% from
39.3% for the same period in 2007.  The increase was due primarily to
adjustments made in the second quarter to the income tax
calculation.





The
following table reflects the Company’s tax provision and the related effective
tax rate for the three months periods ended June 30, 2008 and 2007:





Three
      Months Ended(In
      thousands)
            
            June
      30, 2008
            
            
            June
      30, 2007Tax
      Provision
            
            $
            441
            
            
            $
            904Effective
      Tax Rate
            
            
            43.2
            %
            
            
            39.3
            %




-16-





RESULTS
OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2008





Net
interest income before provision for loan losses





Six
      Months Ended June 30,(Dollars
      in thousands, except per share data)
            
            2008
            
            
            2007
            
            
            Dollar Change
            
            
            Percentage ChangeInterest
      income:Interest
      and fees on loans
            
            $
            12,677
            
            
            $
            14,142
            
            
            $
            (1,465
            )
            
            
            (10.4
            )%Interest
      on Federal funds sold
            
            
            256
            
            
            
            669
            
            
            
            (413
            )
            
            
            (61.7
            )Interest
      on investment securities
            
            
            1,602
            
            
            
            827
            
            
            
            775
            
            
            
            93.7Total
      interest income
            
            
            14,535
            
            
            
            15,638
            
            
            
            (1,103
            )
            
            
            (7.1
            )Interest
      expense:Interest
      on deposits
            
            
            5,658
            
            
            
            6,156
            
            
            
            (498
            )
            
            
            (8.1
            )Interest
      on other borrowings
            
            
            848
            
            
            
            121
            
            
            
            727
            
            
            
            600.8Interest
      on subordinated debentures
            
            
            262
            
            
            
            377
            
            
            
            (115
            )
            
            
            (30.5
            )Total
      interest expense
            
            
            6,768
            
            
            
            6,654
            
            
            
            114
            
            
            
            (1.7
            )Net
      interest income before provision for loan losses
            
            $
            7,767
            
            
            $
            8,984
            
            
            $
            (1,217
            )
            
            
            (13.6
            )%





The
decrease in interest income was primarily attributed to decreases in the rate
charged on the levels of average loans offset by the increase in average loan
balances.  Average loan volume for the six months ended June 30, 2008
compared to the same time period in 2007 increased $32 million, which was offset
by a decrease of 187 basis points in the average rate the Bank was able to
charge.  Loan volume increased due to the growth of new branches and
increased penetration into existing markets.


The
Company’s average loan balances were $325 million for the six months ended June
30, 2008 up 10.7% from $294 million for the same period in 2007.  The
Company’s average loan yield was 7.84% for the six months ended June 30, 2008,
down from the 9.71% yield experienced for the same period in
2007.  The Company’s average balances of investment securities
increased $18 million to $50 million for the six months ended June 30, 2008 from
the $32 million for the same period in 2007. The Company’s average yield on
investments increased 115 basis points to 6.33% from 5.18% for the same period
in 2007.  As a result of the increase in volume and yield, interest
income increased $775 thousand.




The
Company’s average balances of Federal funds sold decreased $5 million to $21
million for the six months ended June 30, 2008 from the $26 million for the same
period in 2007. The Company’s average yield on Federal funds sold decreased 266
basis points to 2.45% from 5.11% for the same period in 2007 and interest income
decreased $413 thousand.  As a result, the overall yield on average
earning assets decreased 160 basis points to 7.35% for the six months ended June
30, 2008, from 8.95% for the same period in 2007.


The
increase in interest expense is primarily attributed to the change in the volume
and mix of interest bearing liabilities, (the level of average time deposits
increased significantly while the levels of other interest bearing deposits
declined or remaining relatively level).  Time deposits increased as
the Company experienced disintermediation from lower yielding transaction
accounts into higher yielding time deposits.  Rates paid on deposits
were decreased during the period as market rates for deposits
decreased.





The
Company’s average balances of time deposits were $214 million for the six months
ended June 30, 2008, up $27 million, or 14.1% from $188 million for the same
period in 2007. The average rate paid on time deposits decreased 70 basis points
to 4.56% for the six months ended June 30, 2008 from 5.26% for the same period
in 2007. As a result, interest expense on time deposits decreased $43
thousand.  The Company’s average balances of interest bearing demand
deposits decreased $17 million to $69 million for the six months ended June 30,
2008 from $86 million for the same period in 2007.  The average rate
paid decreased 58 basis points to 2.30% from 2.88% for the same period in 2007.
As a result, interest expense on interest bearing demand deposits decreased $442
thousand.





The
Company’s average balances of other borrowings increased $34 million to $48
million for the six months ended June 30, 2008 from $14 million for the same
period in 2007 and the rates paid decreased 274 basis points to 4.60% for the
six months ended June 30, 2008 from 7.34% for the same period in 2007. As a
result of the increased volume offset by the decreased rates paid, interest
expense on other borrowings increased $612 thousand.  The overall
rates paid on average interest-bearing liabilities decreased 54 basis points to
4.04% for the six months ended June 30, 2008, from 4.58% for the same period in
2007.





As a
result of the changes noted above, the net interest margin for the six months
ended June 30, 2008 decreased 121 basis points to 3.93%, from 5.14% for the same
period in 2007.





The
following table presents for the three month periods indicated the distribution
of consolidated average assets, liabilities and shareholders’
equity.  It also presents the amounts of interest income from the
interest earning assets and the resultant yields expressed in both dollars and
rate percentages.  Average balances are based on daily
averages.  Nonaccrual loans are included in the calculation of average
loans while nonaccrued interest thereon is excluded from the computation of
yields earned:




-17-




PACIFIC
      STATE BANCORPYield
      AnalysisFor
      Six Months Ended June 30,(Dollars
      in thousands)
            2008
            
            
            2007Interest
            
            
            Average
            
            
            
            
            
            Interest
            
            
            AverageAverage
            
            Income
      or
            
            
            Yield
      or
            
            
            Average
            
            
            Income
      or
            
            
            Yield
      orAssets:
            Balance
            
            Expense
            
            
            Cost
            
            
            Balance
            
            
            Expense
            
            
            CostInterest-earning
      assets:Loans(1)(2)
            
            $
            325,236
            
            
            $
            12,677
            
            
            
            7.84
            %
            
            $
            293,728
            
            
            $
            14,142
            
            
            
            9.71
            %Investment
      securities(2)
            
            
            49,561
            
            
            
            1,559
            
            
            
            6.33
            %
            
            
            31,945
            
            
            
            821
            
            
            
            5.18
            %Federal
      funds sold
            
            
            21,037
            
            
            
            256
            
            
            
            2.45
            %
            
            
            26,393
            
            
            
            669
            
            
            
            5.11
            %Interest
      Bearing Deposits in Banks
            
            
            2,093
            
            
            
            43
            
            
            
            4.13
            %
            
            
            215
            
            
            
            6
            
            
            
            5.63
            %Total
      average earning assets
            
            $
            397,927
            
            
            $
            14,535
            
            
            
            7.35
            %
            
            $
            352,281
            
            
            $
            15,638
            
            
            
            8.95
            %Non-earning
      assets:Cash
      and due from banks
            
            
            13,482
            
            
            
            
            
            
            
            
            
            
            
            16,316Bank
      premises and equipment
            
            
            14,705
            
            
            
            
            
            
            
            
            
            
            
            12,176Other
      assets
            
            
            15,980
            
            
            
            
            
            
            
            
            
            
            
            11,454Allowance
      for loan loss
            
            
            (3,520
            )
            
            
            
            
            
            
            
            
            
            
            (2,623
            )Total
      average assets
            
            $
            438,574
            
            
            
            
            
            
            
            
            
            
            $
            389,604Liabilities
      and Shareholders' Equity:Interest-bearing
      liabilities:DepositsInterest-bearing
      Demand
            
            $
            68,917
            
            
            $
            788
            
            
            
            2.30
            %
            
            $
            86,181
            
            
            $
            1,230
            
            
            
            2.88
            %Savings
            
            
            5,376
            
            
            
            14
            
            
            
            0.52
            %
            
            
            5,468
            
            
            
            27
            
            
            
            1.00
            %Time
      Deposits
            
            
            214,217
            
            
            
            4,856
            
            
            
            4.56
            %
            
            
            187,687
            
            
            
            4,899
            
            
            
            5.26
            %Other
      borrowing(3)
            
            
            48,487
            
            
            
            1,110
            
            
            
            4.60
            %
            
            
            13,677
            
            
            
            498
            
            
            
            7.34
            %Total
      average interest-bearing liabilities
            
            $
            336,997
            
            
            $
            6,768
            
            
            
            4.04
            %
            
            $
            293,013
            
            
            $
            6,654
            
            
            
            4.58
            %Noninterest-bearing
      liabilities:Demand
      deposits
            
            
            62,229
            
            
            
            
            
            
            
            
            
            
            
            64,609Other
      liabilities
            
            
            4,309
            
            
            
            
            
            
            
            
            
            
            
            1,826Total
      average liabilities
            
            
            403,535
            
            
            
            
            
            
            
            
            
            
            
            359,448Shareholders'
      equity:
            
            
            35,039
            
            
            
            
            
            
            
            
            
            
            
            30,156Total
      average liabilities and shareholders' equity
            
            $
            438,574
            
            
            
            
            
            
            
            
            
            
            $
            389,604Net
      interest income
            
            
            
            
            
            $
            7,767
            
            
            
            
            
            
            
            
            
            
            $
            8,984Net
      interest margin(4)
            
            
            
            
            
            
            
            
            
            
            3.93
            %
            
            
            
            
            
            
            
            
            
            
            5.14
            %


(1)
            Loan
      fees included in loan interest income for the six month periods ended June
      30, 2008 and 2007 amounted to $370 thousand and $1,196 thousand,
      respectively.


(2)
            Not
      computed on a tax-equivalent basis.


(3)
            For
      the purpose of this table the interest expense related to the Company’s
      junior subordinated debentures is included in other
      borrowings.


(4)
            Net
      interest income divided by the average balance of total earning
      assets.





-18-




The
following table sets forth changes in interest income and interest expense, for
the six month periods indicated and the change attributable to variance in
volume, rates and the combination of volume and rates on the relative changes of
volume and rates:





Six
      Months ended June 30,2008
      over 2007Net(In
      thousands)
            
            Change
            
            
            Rate
            
            
            VolumeInterest
      Income:Loans
      and leases
            
            $
            (1,465
            )
            
            $
            (2,982
            )
            
            $
            1,517Investment
      securities
            
            
            738
            
            
            
            285
            
            
            
            453Federal
      funds sold
            
            
            (413
            )
            
            
            (277
            )
            
            
            (136
            )Interest
      Bearing Deposits in Banks
            
            
            37
            
            
            
            (15
            )
            
            
            52Total
      interest income
            
            $
            (1,103
            )
            
            $
            (2,989
            )
            
            $
            1,886Interest
      Expense:Interest-bearing
      Demand
            
            $
            (442
            )
            
            $
            (196
            )
            
            $
            (246
            )Savings
            
            
            (13
            )
            
            
            (13
            )
            
            
            (0
            )Time
      Deposits
            
            
            (43
            )
            
            
            (735
            )
            
            
            692Other
      borrowing
            
            
            612
            
            
            
            (655
            )
            
            
            1,267Total
      interest expense
            
            $
            114
            
            
            $
            (1,599
            )
            
            $
            1,713Net
      interest income
            
            $
            (1,217
            )
            
            $
            (1,390
            )
            
            $
            173





(1)
            The
      volume change in net interest income represents the change in average
      balance multiplied


by the
current year’s rate.


(2)
            The
      rate change in net interest income represents the change in rate
      multiplied by the current year’s average
  balance.





Provision
for loan losses





The
Company recorded $810 thousand in provision for loan losses for the six month
period ended June 30, 2008, an increase of $590 thousand or 268% from $220
thousand for the same period in 2007.  The increase in the provision
is based on management’s assessment of the required level of
reserves.  Management assesses loan quality monthly to maintain an
adequate allowance for loan losses.  Based on the information
currently available, management believes that the allowance for loan losses is
adequate to absorb probable losses in the portfolio.  However, no
assurance can be given that the Company may not sustain charge-offs which are in
excess of the allowance in any given period.  The Company’s loan
portfolio composition and non-performing assets are further discussed under the
“Financial Condition” section below.





Non-Interest
Income





During
the six months ended June 30, 2008, total non-interest income decreased $323
thousand or 23.2% to $1,069 thousand, from $1,392 thousand for the comparable
period in 2007.  The decrease in non-interest income was primarily the
result of decreases in fee income derived from the referral of commercial
mortgage loans to third parties and prepayment penalties received in 2007 that
were not received in 2008. The decrease was offset by an increase in the gain on
the sale of loans of $123 thousand or 439.3% to $151 thousand for the six months
ended June 30, 2008 up from $28 thousand for the comparable period in
2007.





-19-




Non-Interest
Expenses





Non-interest
expenses consist of salaries and related employee benefits, occupancy, furniture
and equipment expenses, professional fees, appraisal fees, directors’ fees,
postage, stationary and supplies expenses, telephone expenses, data processing
expenses, advertising and promotion expense and other operating expenses.
Non-interest expense for the six months ended June 30, 2008 was $5.3 million
compared to $5.7 million for the same period in 2007, representing a decrease of
$381 thousand or 6.7%. This decrease reflects decreases in salaries and benefits
of $438 thousand or 14.7% which is the result of a bonus accrual in 2007 that
was not recorded in 2008 and increased deferred loan costs. The increase in
occupancy, furniture and equipment expense of $7 thousand is attributable to
increased costs of maintaining facilities. The increase in other expense of $48
thousand is the result of increased legal fees associated with loan
collection.





The
following table sets forth a summary of non-interest expense for the six months
periods ended June 30, 2007 and 2006:





Six
      Months EndedJune
      30, 2008
            
            
            June
      30, 2007(In
      thousands)Non-interest
      Expense:Salaries
      & Benefits
            
            $
            2,550
            
            
            $
            2,988Occupancy
            
            
            565
            
            
            
            563Furniture
      and Equipment
            
            
            374
            
            
            
            367Other
      Expense
            
            
            1,831
            
            
            
            1,783Total
      Non-Interest Expenses
            
            $
            5,320
            
            
            $
            5,701





Income
Taxes




The
Company’s provision for income taxes includes both federal income and state
franchise taxes and reflects the application of federal and state statutory
rates to the Company’s net income before taxes.  The principal
difference between statutory tax rates and the Company’s effective tax rate is
the benefit derived from investing in tax-exempt securities and Company owned
life insurance.  Increases and decreases in the provision for taxes
reflect changes in the Company’s net income before tax. The Company’s effective
tax rate for the six month period ended June 30, 2008 remained relatively
consistent at 38.2% compared to 38.6% for the same period in
2007.  The slight decrease was primarily due to the increased level of
income derived from Enterprise Zone loans and additional tax advantaged
securities.


The
following table reflects the Company’s tax provision and the related effective
tax rate for the six months periods ended June 30, 2008 and 2007:





Six
      Months Ended(In
      thousands)
            
            June
      30, 2008
            
            
            June
      30, 2007Tax
      Provision
            
            
            1,033
            
            
            $
            1,720Effective
      Tax Rate
            
            
            38.2
            %
            
            
            38.6
            %


-20-


FINANCIAL
CONDITION





Total
assets at June 30, 2008 were $453,915,000, an increase of $22,841,000 or 5.3%
(10.7% annualized), from the $431,074,000 at December 31, 2007.  The
growth in assets was primarily in the Company’s level of loans and
investments.  Investments grew $6,089,000 or 14.7% (29.6% annualized)
to $47,441,000 at June 30 31, 2008 from $41,352,000 at December 31,
2007.  Loans grew by $13,044,000 or 4.2% (8.5% annualized) to
$321,502,000 at June 30, 2008 from $308,458,000 at December 31,
2007.  The growth in loans and investments was funded by an increase
in deposits of $29,583,000.





The
increase in deposits was comprised of an increase in non-interest bearing
deposits of $52 thousand or 0.1% (0.1% annualized) to $67.123 million at June
30, 2008 from $67.071 million at December 31, 2007.  In addition to
the non-interest bearing deposit increase, interest bearing deposits increased
$29.5 million or 10.8% (21.6% annualized) to $304.3 million at June 30, 2008
from $274.8 million at December 31, 2007.  The increase in interest
bearing deposits is the result of several successful certificate of deposit
promotions.





Loan
portfolio composition





The
Company concentrates its lending activities primarily within Calaveras, San
Joaquin, Stanislaus, Tuolumne and Alameda Counties.





The
Company manages its credit risk through diversification of its loan portfolio
and the application of underwriting policies and procedures and credit
monitoring practices. Although the Company has a diversified loan portfolio, a
significant portion of its borrowers' ability to repay the loans is dependent
upon the professional services and residential real estate development industry
sectors. Generally, the loans are secured by real estate or other assets and are
expected to be repaid from cash flows of the borrower or proceeds from the sale
of collateral.





The
following table illustrates loan balance (in thousands)and
percentage change from December 31, 2007 to June 30, 2008 by loan
category:





June
      30, 2008
            
            
            December
      31, 2007
            
            
            Dollar
      Change
            
            
            Percentage
      Change
            
            
            Annualized
      Percentage ChangeCommercial
            
            $
            85,979
            
            
            $
            83,012
            
            
            $
            2,967
            
            
            
            3.6
            %
            
            
            7.2
            %Agricultural
            
            
            15,326
            
            
            
            12,646
            
            
            
            2,680
            
            
            
            21.2
            
            
            
            42.9Real
      estate - commercial mortgage
            
            
            134,929
            
            
            
            121,157
            
            
            
            13,772
            
            
            
            11.4
            
            
            
            23.0Real
      estate - construction
            
            
            74,298
            
            
            
            80,168
            
            
            
            (5,870
            )
            
            
            (7.3
            )
            
            
            (14.8
            )Installment
            
            
            14,188
            
            
            
            15,215
            
            
            
            (1,027
            )
            
            
            (6.8
            )
            
            
            (13.7
            )Gross
      loans
            
            $
            324,720
            
            
            $
            312,198
            
            
            $
            12,522
            
            
            
            4.0
            %
            
            
            8.1
            %





The
Company continues to manage the mix in its loan portfolio consistently with its
identity as a community bank serving Northern California and the Central
Valley.  The Bank has experienced strong growth in its agricultural
and commercial real estate segments of the loan portfolio.  The strong
growth in these segments is consistent with the growth in the region where the
Bank operates.  The Bank has experienced a decline in its real estate
construction and installment segments of the loan portfolio.  These
segments have been negatively affected by the residential real estate market
decline.





-21-




Nonperforming
loans




The Bank
has experienced an increase in nonperforming loans from $432 thousand at
December 31, 2007 to $3.7 million or 1.14% of gross loans at June 30,
2008.  The increase in nonperforming loans is the result of a decline
in real estate values in the region where the Bank operates, forcing the Bank to
place certain loans into foreclosure.  Bank’s management has
immediately placed on non-accrual status any loan secured by real estate, for
which a notice of default has been delivered.  The increase in
nonperforming loans has resulted in Management increasing the provision for loan
losses over 2007 levels by $545 thousand for the quarter ended June 30, 2008 and
$590 thousand for the six months ended June 30, 2008.  At present, management believes that the level of allowance
for loan losses currently recorded is sufficient to provide for both
specifically identified and inherent probable losses.  The Bank did
not have any other real estate owned at June 30, 2008 or December 31,
2007.
 
 Management
has been proactive in working with problem customers to repay loans that have
become delinquent or have the potential to become delinquent.  In most
cases, personal guarantees and collateral value are considered sufficient to
repay outstanding principal and interest.  In the cases where
collateral value and personal guarantees have fallen short of the principal and
interest owed on the loans, management has reserved for the estimated potential
loss.  Management has ordered real estate appraisals on all new or
renewed loans and on loans which are in foreclosure that are secured by real
estate.  Management has also been proactive in ordering real estate
appraisals on loans with potential problems.  Appraisals received thus
far indicate generally that overall collateral levels remain sufficient to repay
the loans secured by the real estate in case of default.  Management
has also reviewed all home equity lines of credit for current loan to values,
credit quality and or performance issues.  If issues are identified,
the debt availability is frozen and reductions or new terms are
obtained.  Management believes that overall real estate values remain
sufficient in a declining market due to the conservative lending policies of the
Bank.


Analysis
of allowance for loan losses





In
determining the amount of the Company’s Allowance for Loan Losses (“ALL”),
management assesses the diversification of the portfolio. Each credit is
assigned a credit risk rating factor, and this factor, multiplied by the dollars
associated with the credit risk rating, is used to calculate one component of
the ALL. In addition, management estimates the probable loss on individual
credits that are receiving increased management attention due to actual or
perceived increases in credit risk.





The
Company makes provisions to the ALL on a regular basis through charges to
operations that are reflected in the Company’s statements of operations as a
provision for loan losses. When a loan is deemed uncollectible, it is charged
against the allowance. Any recoveries of previously charged-off loans are
credited back to the allowance. There is no precise method of predicting
specific losses or amounts that ultimately may be charged-off on particular
categories of the loan portfolio. Similarly, the adequacy of the ALL and the
level of the related provision for possible loan losses is determined on a
judgment basis by management based on consideration of a number of factors
including (i) economic conditions, (ii) borrowers' financial condition, (iii)
loan impairment, (iv) evaluation of industry trends, (v) industry and other
concentrations, (vi) loans which are contractually current as to payment terms
but demonstrate a higher degree of risk as identified by management, (vii)
continuing evaluation of the performing loan portfolio, (viii) monthly review
and evaluation of problem loans identified as having a loss potential, (ix)
monthly review by the Board of Directors, (x) off balance sheet risks and (xi)
assessments by regulators and other third parties. Management and the Board of
Directors evaluate the allowance and determine its desired level considering
objective and subjective measures, such as knowledge of the borrowers'
businesses, valuation of collateral, the determination of impaired loans and
exposure to potential losses.





-22-




While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions and other qualitative factors. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company’s ALL. Such agencies may require the Company to provide additions to
the allowance based on their judgment of information available to them at the
time of their examination. There is uncertainty concerning future economic
trends. Accordingly it is not possible to predict the effect future economic
trends may have on the level of the provision for loan losses in future
periods.





The
adequacy of the ALL is calculated upon three components. First is the credit
risk rating of the loan portfolio, including all outstanding loans and
leases.  Every extension of credit has been assigned a risk rating
based upon a comprehensive definition intended to measure the inherent risk of
lending money. Each rating has an assigned risk factor expressed as a reserve
percentage. Central to this assigned risk factor is the historical loss record
of the Company. Secondly, established specific reserves are available for
individual loans currently on management's watch and high-grade loan lists.
These are the estimated potential losses associated with specific borrowers
based upon the collateral and event(s) causing the risk ratings. The third
component is unallocated. This reserve is for qualitative factors that may
effect the portfolio as a whole, such as those factors described
above.





Management
believes the assigned risk grades and our methods for managing risk are
satisfactory.  Management does not believe that there were any adverse
trends indicated by the detail of the aggregate charge-offs for any of the
periods discussed.





The
following table summarizes the activity in the ALL for the periods
indicated:





Three
      Months Ended
            
            
            Six
      Months Ended(In
      thousands)
            
            June
      30,
            
            
            June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Beginning
      Balance:
            
            $
            3,629
            
            
            $
            2,646
            
            
            $
            3,948
            
            
            $
            2,478Provision
      for loan losses
            
            
            600
            
            
            
            55
            
            
            
            810
            
            
            
            220Charge-offs:Commercial
            
            
            757
            
            
            
            2
            
            
            
            1,290
            
            
            
            2Real
      Estate
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Other
            
            
            55
            
            
            
            -
            
            
            
            55
            
            
            
            -Total
      Charge-offs
            
            
            812
            
            
            
            2
            
            
            
            1,345
            
            
            
            2Recoveries:Commercial
            
            
            9
            
            
            
            -
            
            
            
            13
            
            
            
            0Other
            
            
            1
            
            
            
            -
            
            
            
            1
            
            
            
            3Total
      Recoveries
            
            
            10
            
            
            
            -
            
            
            
            14
            
            
            
            3Ending
      Balance
            
            $
            3,427
            
            
            $
            2,699
            
            
            $
            3,427
            
            
            $
            2,699ALL
      to total loans
            
            
            1.06
            %
            
            
            0.91
            %
            
            
            1.06
            %
            
            
            0.91
            %Net
      Charge-offs to average loans-annualized0.98
            %
            
            
            0.00
            %
            
            
            0.82
            %
            
            
            0.00
            %





-23-




Investment
securities





SFAS
No. 157 defines fair value, establishes a framework for measuring fair
value under GAAP, and expands disclosures about fair value measurement. Upon
adoption of SFAS No. 157, there was no cumulative effect adjustment to
beginning retained earnings and no impact on the financial statements, other
than in conjunction with the adoption of SFAS No. 159, in the three or six
months ended June 30, 2008.





In
general, fair values determined by Level 1 inputs utilize quoted prices
(unadjusted) in active markets for identical assets or liabilities that the
Company has the ability to access. Fair values determined by Level 2 inputs
utilize inputs other than quoted prices included in Level 1 that are observable
for the asset or liability, either directly or indirectly. Level 2 inputs
include quoted prices for similar assets and liabilities in active markets, and
inputs other than quoted prices that are observable for the asset or liability,
such as interest rates and yield curves that are observable at commonly quoted
intervals. Level 3 inputs are unobservable inputs for the asset or liability,
and include situations where there is little, if any, market activity for the
asset or liability. In certain cases, the inputs used to measure fair value may
fall into different levels of the fair value hierarchy. In
such cases, the level in the fair value hierarchy within which the fair
value measurement in its entirety falls has been determined based on the lowest
level input that is significant to the fair value measurement in its
entirety. The Company’s assessment of the significance of a particular
input to the fair value measurement in its entirety requires judgment, and
considers factors specific to the asset or liability.  Currently
the Company records only available for sale securities at fair
value.




Fair
values for investment securities are based on quoted market prices when
available or through the use of alternative approaches, such as matrix or model
pricing, when market quotes are not readily accessible or
available.  The company uses level 1 inputs, or quoted market prices,
to value approximately $8,722,000 of the available for sale
securities.  The remaining $38,719,000 uses level 2 inputs or matrix
pricing and model pricing.


Investment
securities increased $6.0 million to $47.4 million at June 30, 2008, from $41.4
million at December 31, 2007. Federal funds sold increased $3.2 million to $35.1
million at June 30, 2008, from $31.9 million at December 31, 2007.





The
Company’s investment in U.S. Treasury securities decreased to 21.1% of the
investment portfolio at June 30, 2008 compared to 42.3% at December 31,
2007.  Obligations of U.S. Agencies increased to 31.9% of the
investment portfolio at June 30, 2008 compared to 7.2% at December 31,
2007.  The Company’s investment in corporate bonds decreased to 40.8%
of the investment portfolio at June 30, 2008 compared to 42.8% at December 31,
2007. Tax-exempt municipal obligation bonds decreased to 6.2% of the investment
portfolio at June 30, 2008 compared to 7.7% at December 31, 2007.





Deposits





Total
deposits were $371.4 million as of June 30, 2008 an increase of $29.6 million or
8.7% from the December 31, 2007 balance of $341.8 million.  The
Company continues to manage the mix of its deposits consistent with its identity
as a community bank serving the financial needs of its
customers.  Non-interest bearing demand deposits and interest bearing
checking deposits decreased to 22.9% of total deposits down from 24.9% at
December 31, 2007.  Money market and savings accounts decreased to
15.2% of total deposits from 17.4% at December 31, 2007.  Time
deposits increased to 61.9% of total deposits from 57.7% at December 31,
2007





-24-




CAPITAL
RESOURCES





Capital
adequacy is a measure of the amount of capital needed to sustain asset growth
and act as a cushion for losses. Capital protects depositors and the deposit
insurance fund from potential losses and is a source of funds for the
investments the Company needs to remain competitive.  Historically,
capital has been generated principally from the retention of
earnings.





Overall
capital adequacy is monitored on a day-to-day basis by the Company’s management
and reported to the Company’s Board of Directors on a quarterly
basis.  The Bank’s regulators measure capital adequacy by using a
risk-based capital framework and by monitoring compliance with minimum leverage
ratio guidelines. Under the risk-based capital standard, assets reported on the
Company’s balance sheet and certain off-balance sheet items are assigned to risk
categories, each of which is assigned a risk weight.





This
standard characterizes an institution's capital as being "Tier 1" capital
(defined as principally comprising shareholders' equity and the qualifying
portion of subordinated debentures) and "Tier 2" capital (defined as principally
comprising Tier 1 capital and the remaining qualifying portion of subordinated
debentures and the qualifying portion of the ALL).





The
minimum ratio of total risk-based capital to risk-adjusted assets, including
certain off-balance sheet items, is 8%. At least one-half (4%) of the total
risk-based capital is to be comprised of Tier 1 capital; the balance may consist
of debt securities and a limited portion of the ALL.





As of
June 30, 2008 the most recent notification by the Federal Deposit Insurance
Corporation (“FDIC”) categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action.  To be categorized
as well capitalized the Bank must meet the minimum ratios as set forth below.
There are no conditions or events since that notification that management
believes have changed the Bank’s category. Management believes that the Company
met all of its capital adequacy requirements.


-25-


The
leverage ratio consists of Tier I capital divided by quarterly average
assets.  The minimum leverage ratio is 3 percent for banking
organizations that do not anticipate significant growth and that have
well-diversified risk, excellent asset quality and in general, are considered
top-rated banks. For all other institutions the minimum rate is 4%.


The
Company’s and the Bank’s risk-based capital ratios are presented
below.




Actual
            
            
            For Capital Adequacy
    Purposes
            
            
            To Be Well Capitalized Under Prompt Corrective
      Action ProvisionsJune
      30, 2008
            
            Amount
            
            
            Ratio
            
            
            Minimum Amount
            
            
            Minimum Ratio
            
            
            Minimum Amount
            
            
            Minimum RatioCompany:Total
      capital (to risk-weighted assets)
            
            $
            47,621
            
            
            
            12.2
            %
            
            $
            32,014
            
            
            
            8.0
            %
            
            
            N/A
            
            
            
            N/ATier
      1 capital (to risk weighted assets)
            
            $
            43,972
            
            
            
            11.3
            %
            
            $
            16,007
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ATier
      1 capital (to average assets)
            
            $
            43,972
            
            
            
            10.0
            %
            
            $
            17,512
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ABank:Total
      capital (to risk-weighted assets)
            
            $
            44,467
            
            
            
            11.5
            %
            
            $
            31,846
            
            
            
            8.0
            %
            
            $
            39,807
            
            
            
            10.0
            %Tier
      1 capital (to risk-weighted assets)
            
            $
            40,818
            
            
            
            10.6
            %
            
            $
            15,923
            
            
            
            4.0
            %
            
            $
            23,884
            
            
            
            6.0
            %Tier
      1 capital (to average assets)
            
            $
            40,818
            
            
            
            9.1
            %
            
            $
            17,956
            
            
            
            4.0
            %
            
            $
            22,445
            
            
            
            5.0
            %December
      31, 2007:Company:Total
      capital (to risk-weighted assets)
            
            $
            46,285
            
            
            
            12.6
            %
            
            $
            29,433
            
            
            
            8.0
            %
            
            
            N/A
            
            
            
            N/ATier
      1 capital (to risk weighted assets)
            
            $
            42,018
            
            
            
            11.4
            %
            
            $
            14,717
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ATier
      1 capital (to average assets)
            
            $
            42,018
            
            
            
            10.2
            %
            
            $
            16,524
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ABank:Total
      capital (to risk-weighted assets)
            
            $
            44,368
            
            
            
            12.1
            %
            
            $
            29,256
            
            
            
            8.0
            %
            
            $
            36,570
            
            
            
            10.0
            %Tier
      1 capital (to risk-weighted assets)
            
            $
            40,198
            
            
            
            11.0
            %
            
            $
            14,628
            
            
            
            4.0
            %
            
            $
            21,942
            
            
            
            6.0
            %Tier
      1 capital (to average assets)
            
            $
            40,198
            
            
            
            9.8
            %
            
            $
            16,428
            
            
            
            4.0
            %
            
            $
            20,535
            
            
            
            5.0
            %




-26-





LIQUIDITY





The
purpose of liquidity management is to ensure efficient and economical funding of
the Company’s assets consistent with the needs of the Company’s depositors,
borrowers and, to a lesser extent, shareholders. This process is managed not by
formally monitoring the cash flows from operations, investing and financing
activities as described in the Company’s statement of cash flows, but through an
understanding principally of depositor and borrower needs. As loan demand
increases, the Company can use asset liquidity from maturing investments along
with deposit growth to fund the new loans.





With
respect to assets, liquidity is provided by cash and money market investments
such as interest-bearing time deposits, federal-funds sold, available-for-sale
investment securities, and principal and interest payments on loans. With
respect to liabilities, liquidity is provided by core deposits, shareholders'
equity and the ability of the Company to borrow funds and to generate
deposits.





Because
estimates of the liquidity needs of the Company may vary from actual needs, the
Company maintains a substantial amount of liquid assets to absorb short-term
increases in loans or reductions in deposits. As loan demand decreases or loans
are paid off, investment assets can absorb these excess funds or deposit rates
can be decreased to run off excess liquidity. Therefore, there is some
correlation between financing activities associated with deposits and investing
activities associated with lending. The Company’s liquid assets (cash and due
from banks, federal funds sold and available-for-sale investment securities)
totaled $98.6 million or 21.7% of total assets at June 30, 2008 compared to
$87.0 million or 20.2% of total assets at December 31, 2007. The Company expects
that its primary source of liquidity will be earnings of the Company,
acquisition of core deposits, and wholesale borrowing arrangements.





ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT


MARKET
RISK





Market
risk is the risk of loss in a financial instrument arising from adverse changes
in market rates such as interest rates, commodity prices and equity
prices.  The Company’s market risk s a financial institution arises
primarily from interest rate risk exposure.  Fluctuation in interest
rates will ultimately impact both the level of income and expense recorded on a
large portion of the Company’s assets and liabilities, and the market value of
all interest earning assets and interest bearing liabilities, other than those
that possess a short term to maturity.  Based upon the nature of its
operations, the Company is not subject to fluctuations in foreign currency
exchange or commodity pricing.  However, the Company’s commercial real
estate loan portfolio, concentrated primarily in Northern California, is subject
to risks associated with the local economies.





The
fundamental objective of the Company’s management of its assets and liabilities
is to maximize the economic value of the Company while maintaining adequate
liquidity and managing exposure to interest rate risk deemed by management to be
acceptable.  Management believes an acceptable degree of exposure to
interest rate risk results from management of assets and liabilities through
using floating rate loans and deposits, maturities, pricing and mix to attempt
to neutralize the potential impact of changes in market interest
rates.  The Company’s profitability is dependent to a large extent
upon its net interest income which is the difference between its interest income
on interest earning assets, such as loans and securities, and interest expense
on interest bearing liabilities, such as deposits, trust preferred securities
and other borrowings.  The Company, like other financial institutions,
is subject to interest rate risk to the degree that its interest earning assets
reprice differently from its interest bearing liabilities.  The
Company manages its mix of assets and liabilities with the goal of limiting
exposure to interest rate risk, ensuring adequate liquidity, and coordinating
its sources and uses of funds.





The
Company seeks to control its interest rate risk exposure in a manner that will
allow for adequate levels of earnings and capital over a range of possible
interest rate environments.  The Company has adopted formal policies
and practices to monitor and manage interest rate risk exposure.  As
part of this effort, the Company measures interest rate risk utilizing both an
internal asset liability measurement system as well as independent third party
reviews to confirm the reasonableness of the assumptions used to measure and
report the Company’s interest rate risk, enabling management to make any
adjustments necessary.





Interest
rate risk is managed by the Company’s Asset Liability Committee (“ALCO”), which
includes members of senior management and several members of the Board of
Directors.  The ALCO monitors interest rate risk by analyzing the
potential impact on interest income from potential changes in interest rates and
considers the impact of alternative strategies or changes in balance sheet
structure.  The ALCO manages the Company’s balance sheet in part to
maintain the potential impact on net interest income within acceptable ranges
despite changes in interest rates.  The Company’s exposure to interest
rate risk is reviewed on at least a quarterly basis by the ALCO.





In
management’s opinion there has not been a material change in the Company’s
market risk or interest rate risk profile for the three or six months ended June
30, 2008 compared to December 31, 2007 as discussed under the caption "Liquidity
and Market Risk" and "Net Interest Income Simulation" in the Company's 2007
Annual Report to Shareholders filed as an exhibit with the Company’s 2007 Annual
Report on Form 10-K, which is incorporated here by reference.





The
following table reflects the company’s projected net interest income sensitivity
analysis based on period-end data:





June
      30, 2008Change
      in Rates
            
            Adjusted
      Net Interest Income
            
            
            Percent
      change from(in
      thousands)
            
            
            BaseUp
      200 basis points
            
            $
            16,033
            
            
            
            3.86
            %Up
      150 basis points
            
            
            15,888
            
            
            
            2.92
            %Up
      100 basis points
            
            
            15,742
            
            
            
            1.98
            %Base
      Scenario
            
            
            15,437
            
            
            
            0.00
            %Down
      100 basis points
            
            
            15,051
            
            
            
            -2.50
            %Down
      150 basis points
            
            
            14,846
            
            
            
            -3.83
            %Down
      200 basis points
            
            $
            14,629
            
            
            
            -5.23
            %


-27-




ITEM
4.    CONTROLS AND PROCEDURES




The
Company's Chief Executive Officer and Chief Financial Officer, based on their
evaluation as of the end of the period covered by this report of the Company's
disclosure controls and procedures (as defined in Exchange Act
Rule 13a—15(e)), have concluded that the Company's disclosure controls and
procedures are designed to ensure that information required to be disclosed by
the Company in its periodic SEC filings is recorded, processed and reported
within the time periods specified in the SEC's rules and forms. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated and unconsolidated subsidiaries) required to be included in the
Company's periodic SEC filings. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including
cost limitations, judgments used in decision making, assumptions regarding the
likelihood of future events, soundness of internal controls, fraud, the
possibility of human error and the circumvention or overriding of the controls
and procedures.  Accordingly, even effective disclosure controls and
procedures can provide only reasonable, and not absolute, assurance of achieving
their control objectives.




There
were no significant changes in the Company's internal controls or in other
factors during the period covered by this report that have materially affected
or could significantly affect internal control over financial
reporting.





ITEM
4T.   CONTROLS AND PROCEDURES





Not
applicable.


Part
II – Other Information





ITEM
1A RISK FACTORS





In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2007, which could materially
affect our business, financial condition or future results. The Company is not
aware of any material changes to the risks described in our Annual
Report.




ITEM
6. EXHIBITS


31.1
              Certification of Chief Executive Officer (section
      302 of the Sarbanes Oxley Act)31.2
              Certification of Chief Financial Officer (section
      302 of the Sarbanes-Oxley Act)32.1
              Certification of Chief Executive Officer pursuant to
      section 906 of the Sarbanes-Oxley Act32.2
              Certification of Chief Financial Officer pursuant to
      section 906 of the Sarbanes-Oxley
Act







SIGNATURES





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







Pacific
      State BancorpDate:
      August 14, 2008
            By:  /s/
      Steven A. RossoSteven
      A. RossoPresident
      and Chief Executive Officer





Pacific
      State BancorpDate:
      August 14, 2008
            By:  /s/
      JoAnne RobertsJoAnne
      RobertsSenior
      Vice President and Chief Financial
Officer


-28-