UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10 – KSB




[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For
the fiscal year ended December 31, 2007




OR




[  ]
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934




For
the transition period from  _______ to _______




Commission
File Number 000-51960




PACIFIC COAST NATIONAL
BANCORP


(Name of
small business issuer in its charter)




California
            
            61-1453556(State
      or other jurisdiction of
            
            (I.R.S.
      Employerincorporation
      or organization)
            
            Identification
      No.)








905 Calle
      Amanecer,  Suite 100, San Clemente,
      California
            
            92673(Address of
      principal executive offices)
            
            (Zip
      code)




(949) 361-4300(Issuer’s  telephone
      number)Securities
      registered under Section 12(b) of the Exchange Act:
NoneSecurities
      registered under Section 12(g) of the Exchange Act:Common
      Stock, par value$.01
      per share





Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act.  [    ]




Check
whether the issuer (1)  filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [X]
No [   ]




Check if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B  contained in this form, and no disclosure will be
contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to  this Form 10-KSB.  [ ]




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes
[   ] No [X]







Issuers
revenues for the fiscal year ended December 31, 2007, were
$6,106,177.




The
aggregate market value of the voting stock held by non-affiliates computed by
reference to the average bid and asked prices of such stock, as of March 10,
2008: $12,966,390. For purposes of this computation, all executive officers,
directors and 10% beneficial owners are deemed to be affiliates.  Such
determination should not be deemed to be an admission that any such person is an
affiliate.




The
number of shares of common stock, par value $0.01 share, of the issuer
outstanding as of March 10, 2008, was 2,281,700.




DOCUMENTS
INCORPORATE BY REFERENCE:  None.




Transitional
Small Business Disclosure Format:  Yes ______; No
____x_____












PACIFIC
COAST NATIONAL BANCORP




ANNUAL
REPORT ON FORM 10-KSB




INDEX






PAGEPART
      IITEM
      1. BUSINESS
            3ITEM
      2. DESCRIPTION OF PROPERTY
            40ITEM
      3. LEGAL PROCEEDINGS
            40ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
            40PART
      IIITEM
      5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
            40ITEM
      6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
    OPERATION
            42ITEM
      7. FINANCIAL STATEMENTS
            61ITEM
      8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
      FINANCIAL DISCLOSURE.
            61ITEM
      8A. CONTROLS AND PROCEDURES
            61ITEM
      8B. OTHER INFORMATION
            62PART
      IIIITEM
      9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS
      AND
              CORPORATE
      GOVERNANCE, COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
    ACT
            62ITEM
      10. EXECUTIVE COMPENSATION
            67ITEM
      11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
      RELATED STOCKHOLDER MATTERS
            76ITEM
      12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, DIRECTOR
      INDEPENDENCE
            77ITEM
      13. EXHIBITS
            78ITEM
      14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
            79






















PART
I




Introductory
Note.  Cautionary Statement Regarding Forward-Looking Information and
Risk Factors




This
report contains certain statements that are forward-looking within the meaning
of section 21E of the Securities Exchange Act of 1934, as
amended.  These statements are not guarantees of future performance
and involve certain risks, uncertainties and assumptions that are difficult to
predict.  Actual outcomes and results may differ materially from those
expressed in, or implied by, the forward-looking statements.  These
statements are often, but not always, made through the use of words or phrases
such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will
likely result,” “expect,” “will continue,” “anticipate,” “seek,” “estimate,”
“intend,” “plan,” “projection,” “would” and “outlook,” and other similar
expressions or future or conditional verbs.  Readers of this annual
report should not rely solely on the forward-looking statements and should
consider all uncertainties and risks throughout this report.  The
statements are representative only as of the date they are made, and Pacific
Coast National Bancorp (“Company”) undertakes no obligation to update any
forward-looking statement.




These
forward-looking statements, implicitly and explicitly, include the assumptions
underlying the statements and other information with respect to
our  beliefs, plans, objectives, goals, expectations, anticipations,
estimates, financial condition, results of operations, future performance and
business, including management’s expectations and estimates with respect to
revenues, expenses, return on equity, return on assets, efficiency ratio, asset
quality and other financial data and capital and performance
ratios.




Although
we believe that the expectations reflected in the forward-looking statements are
reasonable, these statements involve risks and uncertainties that are subject to
change based on various important factors, some of which are beyond our
control.  The following factors, among others, could cause
our  results or financial performance to differ materially from
our  goals, plans, objectives, intentions, expectations and other
forward-looking statements:




·
            the
      loss of key personnel;




·
            the
      failure of assumptions;




·
            changes
      in various monetary and fiscal policies and
  regulations;




·
            changes
      in policies by regulatory agencies;




·
            adverse
      changes in general economic conditions and economic conditions in Southern
      California;




·
            adverse
      changes in the local real estate market and the value of real estate
      collateral securing a substantial portion of our loan
      portfolio;




·
            changes
      in the availability of funds resulting in increased costs or reduced
      liquidity;




·
            geopolitical
      conditions, including acts or threats of terrorism, actions taken by the
      United States or other governments in response to acts or threats of
      terrorism and/or military conflicts which could impact business and
      economic in the United States and
abroad;




2


·
            changes
      in market rates and prices which may adversely impact the value of
      financial products including securities, loans, deposits, debt and
      derivative financial instruments and other similar financial
      instruments;




·
            fluctuations
      in the interest rate environment, and changes in the relative differences
      between short- and long-term interest rates, which may reduce interest
      margins and impact funding sources;




·
            changes
      in the quality or composition of our loan or investment
      portfolios;




·
            changes
      in the level of our non-performing loans and other loans of
      concern;




·
            competition
      from bank and non-bank competitors;




·
            the
      ability to develop and introduce new banking-related products, services
      and enhancements and gain market acceptance of such
    products;




·
            the
      ability to grow our core
businesses;




·
            decisions
      to change or adopt new business
strategies;




·
            changes
      in tax laws, rules and regulations and interpretations
      thereof;




·
            technological
      changes;




·
            changes
      in consumer spending and savings habits;
and




·
            management’s
      ability to manage these and other
risks.




In
addition to the factors described above, the reader’s attention is directed to
“Business - Risk Factors” set forth elsewhere in this Form 10-KSB and from time
to time in other filings with the Securities and Exchange Commission for a more
detailed and additional discussion of certain factors that could cause our
results or financial performance to differ materially from our goals, plans,
objectives, intentions, expectations and other forward-looking
statements.  New factors emerge from time to time, and it is not
possible for us to predict which factor, if any, will materialize.  In
addition, we cannot assess the potential impact of each factor on our business
or the extent to which any factor, or combination of factors, may cause actual
results for 2008 and beyond to differ materially from those contained in any
forward-looking statements.




Unless
the context indicates otherwise, as used throughout this report, the terms “we”,
“our”, “us”, or the “Company” refer to Pacific Coast National Bancorp and its
consolidated subsidiary, Pacific Coast National Bank. References to the Bank
refer to Pacific Coast National Bank.




Item
1.  Business




Overview




Pacific Coast National
Bancorp – The Company, headquartered in San Clemente, California, was
organized as a California corporation on July 2, 2003 to serve as
the  bank holding company for Pacific Coast National
Bank.  The Company became a bank holding company on May 16, 2005,
following its initial public offering, upon the acquisition of all of the issued
and outstanding shares of stock of the




3


Bank.  The
Company raised a total of $22.8 million in its initial public offering and used
$19.5 million of the proceeds of the offering to capitalize the Bank. At this
time, the Company engages in no material business operations other than owning
the Bank.




Pacific Coast National
Bank – On May 16, 2005, the Bank began banking operations as a national
bank, having received all necessary regulatory approvals. The Federal Deposit
Insurance Corporation (the “FDIC”) insures the Bank’s deposit accounts up to the
maximum amount currently allowable under federal law.  The Bank is
subject to examination and regulation by the Office of the Comptroller of the
Currency (the “OCC”) and the FDIC.  The Bank is further subject to
regulations by the Federal Reserve Board concerning reserves to be maintained
against deposits and certain other matters and is a member of the Federal
Reserve Bank of San Francisco.




The Bank
is headquartered in San Clemente, California, and currently operates two full
service retail banking offices, located in San Clemente and Encinitas,
California.  On October 21, 2007, wildfires began in several locations
throughout Southern California, including Fallbrook and Poway. These areas are
home to many of the Company's shareholders and customers. In response to the
disaster and in an effort to assist those who had been displaced by the fires, a
temporary banking office was opened in Fallbrook on November 5, 2007, and
operated for just under two months.




The Bank
offers a broad range of commercial and consumer banking services to small-to
medium-sized businesses, independent single-family residential and commercial
contractors, professional concerns and consumers.  Lending services
include commercial real estate, construction and development, commercial loans
and to a lesser extent, consumer loans, including residential second mortgage
loans.  The Bank offers a broad array of deposit services including
demand deposits, regular savings accounts, money market accounts, certificates
of deposit and individual retirement accounts.  For the convenience of
its customers, the Bank also offers credit and debit cards, online banking,
domestic and foreign wire transfers, and travelers’ and cashier’s checks. These
services are provided through a variety of delivery systems including automated
teller machines, private banking, telephone banking and Internet
banking.  The Bank concentrates on providing superior customer
services as it continues to enhance the products and services offered to its
customers. To supplement our net interest income and diversify the Bank's income
stream, we recently established a Real Estate Industries Group ("REIG") to
generate non-interest fee income by brokering commercial real estate loans in
excess of our legal lending limit or that otherwise do not meet our lending
criteria.




We
maintain a website with the address www.pacificcoastnationalbank.com.
The information contained on our website is not included as a part of, or
incorporated by reference into, this Annual Report on Form 10-KSB. Other than an
investor’s own Internet access charges, we make available free of charge through
our website our Annual Report on Form 10-KSB, quarterly reports on Form 10-QSB
and current reports on Form 8-K, and amendments to these reports, as soon as
reasonably practicable after we have electronically filed such material with, or
furnished such material to, the Securities and Exchange Commission.




Philosophy
and strategy




Pacific
Coast National Bank operates as a full-service community bank, offering
sophisticated financial products while emphasizing prompt, personalized customer
service.  We believe that this philosophy, encompassing the service
aspects of community banking, distinguishes the Bank from its
competitors.




4


Our
business strategy involves the following:




·
            Capitalizing
      on the diverse community involvement, professional expertise and personal
      and business contacts of its directors and executive
    officers;




·
            Hiring
      and retaining experienced and qualified banking
  personnel;




·
            Providing
      individualized attention with consistent, local decision-making
      authority;




·
            Utilizing
      technology and strategic outsourcing to provide a broad array of
      convenient products and services;




·
            Operating
      from highly visible and accessible banking offices in close proximity to
      concentrations of targeted commercial businesses and professionals;
      and




·
            Implementing
      a strong marketing program.




Market
opportunities




Primary service areas
- Our primary service areas are the coastal regions of south Orange County and
north San Diego County, which we serve from our two branch
locations.  Our main office and first full-service branch office is
located at 905 Calle Amanecer, Suite 100, San Clemente, California, with a
second full-service branch office at 499 North El Camino Real, Suite C-100,
Encinitas, California.  We draw most of our customer deposits and
conduct most of our lending transactions from and within our primary service
areas.




These
primary service areas represent a diverse market with a growing population and
economy.  The population growth has attracted many businesses to the
area and led to growth in the local service economy, and, while we cannot be
certain, we expect this trend to continue.




Local economy - We
believe that our banking market represents a unique market with a diversified
and growing customer base.  We also believe that our primary service
areas present an environment that will support our growth.  As a
community bank, the Bank seeks to serve the needs of the residents and
small-to-medium-sized businesses within this growing economy. The local economy
is comprised of a diverse mix of high-technology commercial endeavors as well as
defense and military expenditures. Most of the job growth, particularly in San
Diego County, has been in the high-technology area with emerging growth in the
areas of telecommunications, electronics, computers, software and biotechnology.
Median household income and per capita income for San Diego and Orange County
are above national averages, reflecting the urban nature of the market and
availability of high paying white collar and technical jobs. For January, 2008,
San Diego and Orange Counties reported preliminary unemployment rates of 5.1%
and 4.4%, respectively, as compared to the national average of 4.9% for the same
period.  For a discussion regarding the competition in our primary
service areas, see “Competition.”




Business strategy




Management philosophy
- The Bank is a full-service commercial bank dedicated to providing superior
customer service to the individuals and businesses in the communities it
serves.  We offer a sophisticated array of financial products while
emphasizing prompt, personalized customer service.  Management
believes that this philosophy, encompassing the service aspects of community
banking, distinguishes us from our larger financial-institution
competitors.  We seek to hire the most qualified and experienced
people in the market who share our commitment to customer
service.   We believe that the




5


marketplace
provides an opportunity for a locally-owned and locally-managed community bank
to acquire a significant market share by offering an alternative to the less
personal service offered by many larger banks.  Accordingly, we have
implemented the following operating and growth strategies.




Operating strategy -
In order to achieve the level of prompt, responsive service that we believe is
necessary to attract customers and to develop our image as a local bank with a
community focus, we have employed the following operating
strategies:




·
            Experienced senior
      management.  Our senior management possesses extensive
      experience in the banking industry, as well as substantial business and
      banking contacts in its primary service
areas.




·
            Quality
      employees.  We have hired, and will continue to hire,
      highly trained and seasoned staff.  Ongoing training provides
      the staff with extensive knowledge of our products and services allowing
      the first employee a customer encounters to answer most questions the
      customer may have.




·
            Community-oriented board of
      directors.  Our directors are either experienced bankers
      or local business and community leaders.  Many of our directors
      are residents of our primary service areas, and most have significant
      business ties to these areas, enabling them to be sensitive and responsive
      to the needs of the community.  Additionally, the board of
      directors represents a wide variety of business experience and community
      involvement.




·
            Highly visible
      sites.  Our main branch location is highly visible and
      located in close proximity to major traffic arteries.  The main
      branch location is located at 905 Calle Amanecer, Suite 100, San Clemente,
      California in an area that provides easy access to the Rancho San Clemente
      business park businesses. The Encinitas full-service branch office is
      located at 499 North El Camino Real, Suite C-100, Encinitas, California,
      located at the intersection of North El Camino Real and Garden View, a
      vital commercial and residential area. Management believes that these
      sites give us a presence in a market that is dominated by branch offices
      of banks headquartered out of the
area.




·
            Individual customer
      focus.  We focus on providing individual service and
      attention to our target customers, which include individuals and small- to
      medium-sized businesses. Due to personal relationships of our employees,
      officers and directors with many of our customers, we believe we are
      generally able to respond to credit requests more quickly and be more
      flexible in approving complex loans based on collateral quality and
      personal knowledge of the customer.




·
            Marketing and
      advertising.  We use a targeted marketing approach to
      attract local business owners. Specific products such as small business
      administration (“SBA”) loans are highlighted in direct mail pieces.
      Officers of the Bank are often guest speakers at local service clubs to
      discuss the benefits of being a community bank client. Marketing
      professionals are utilized to ensure that the look of our marketing
      material has a consistent, professional message that is appropriate to its
      target market.




Growth strategies -
Because we believe that the growth and expansion of our operations will be
significant factors in our success, we have implemented, or plan to implement,
the following growth strategies:




6









·
              Capitalize on our community
      orientation.  We actively market ourselves to capitalize
      on our position as an independent, locally-owned community bank to attract
      individuals and small- to medium-sized business customers that may be
      underserved by larger banking institutions in our market
    area.


·
            Employ experienced lending
      officers.  We have hired, and will continue to hire,
      experienced, well-trained lending officers knowledgeable in the local real
      estate and commercial markets.  By hiring experienced lending
      officers, we have been able to attract local businesses who appreciate
      dealing with bankers who know their
business.




·
            Offer fee-generating products
      and services.  Our range of services, pricing strategies,
      interest rates paid and charged, and hours of operation are structured to
      attract targeted customers and increase our market share.  We
      strive to offer the small business person, professional, entrepreneur and
      consumer the best deposit and loan services available while charging
      competitively for these services and utilizing technology and strategic
      outsourcing to increase fee
revenues.




Lending
services




We offer
a full range of lending products, including commercial loans to
small-to-medium-sized businesses, professionals, and consumer loans to
individuals.  Management understands that we are competing for these
loans with competitors who are well established in its primary market area and
have greater resources and lending limits.




Lending policy - Our
current loan origination activities are governed by established policies and
procedures intended to mitigate the risks inherent to the types of collateral
and borrowers financed by us. Our strategic focus includes an effective,
efficient and responsive transaction execution, which is consistent with our
relatively flat organizational structure and our reliance upon relatively few,
highly-skilled lending professionals. This results in a rapid response to credit
requests provided through local decision making and provides us with a
competitive advantage.




Our loan
approval policies provide for various levels of officer lending
authority.  When the amount of total loans to a single borrower
exceeds that of the credit underwriter’s lending authority, the loan is
recommended to the chief credit officer who maintains a higher lending limit. If
the approval amount exceeds the authority of the Chief Credit Officer the Bank’s
directors’ credit committee determines whether to approve the loan
request.  We do not make loans to any of our directors unless the loan
receives prior approval by our board of directors, excluding the interested
party, and the terms of the loan are no more favorable than would be available
to any comparable borrower.   Our current policy is not to lend
to our executive officers.




Lending limits - Our
lending activities are subject to a variety of lending
limits.  Differing limits apply based on the type of loan or the
nature of the borrower, including the borrower’s relationship to the
Bank.  In general, however, we are able to loan to any one borrower a
maximum amount equal to 15% of the Bank’s capital and surplus and allowance for
loan losses.  The legal limit will increase or decrease as the Bank’s
capital increases or decreases as a result of its earnings or losses, among
other reasons.




Credit risks - The
principal economic risk associated with each category of loans that the Bank
makes is the creditworthiness of the borrower.  Borrower
creditworthiness is affected by general economic conditions and the strength of
the relevant business market segment.  Our loan officers review the
borrower’s past credit history, past income level, debt history and, when
applicable, cash flow and determine the impact of all these factors on the
ability of the borrower to make future payments as agreed.




7


General
economic factors affecting a borrower’s ability to repay include interest,
inflation and employment rates, as well as other factors affecting a borrower’s
customers, suppliers and employees.  The well-established financial
institutions in our primary service areas make proportionately more loans to
medium-to-large-sized businesses than we originate.  Many of our
commercial loans are and/or will likely be made to small-to-medium-sized
businesses that may be less able to withstand competitive, economic and
financial pressures than larger borrowers.




Real estate loans -
The real estate portion of our  loan portfolio is comprised of the
following: mortgage loans secured typically by commercial and multi-family
residential properties, revolving lines of credit granted to consumers secured
by equity in residential properties; and construction and development loans. At
December 31, 2007, we held $75.5 million in loans secured by real estate,
representing 77.3% of gross loans receivable, and undisbursed commitments of
$15.0 million. At December 31, 2006, we held $24.8 million is loans secured by
real estate, representing 71.1% of gross loans receivable, and undisbursed
commitments of $4.7 million. The classes of real estate loans are described
below.




·
            Construction and
      development loans - Construction loans consist primarily of
      high-end, single-family residential properties, primarily located in the
      coastal communities, and commercial properties for owner-occupied, have a
      term of less than one year, have floating interest rates and commitment
      fees. Construction loans are typically made to builders that have an
      established record of successful project completion and loan repayment.
      Loan repayment for owner occupied transactions is generally from permanent
      financing with either the Bank or qualified mortgage
      lender.  Repayment of developer loans is principally derived
      from the sale of the individual units with the purchaser obtaining
      permanent financing from a qualified mortgage lender.  Repayment
      of developer loans is subject to current market conditions, mortgage rates
      and the economic environment.   The ratio of the loan
      principal to the value of the collateral as established by independent
      appraisal typically will not exceed 75%. Loans for projects that are not
      pre-sold are based on the borrower’s financial strength and cash flow
      position.  At December 31, 2007, $28.7 million of our
      construction portfolio represented projects that were not pre-sold. Loan
      proceeds are disbursed based on the percentage of completion and only
      after an experienced construction lender or third-party inspector has
      inspected the project.  At December 31, 2007, we had $31.2
      million in construction loans outstanding, representing 31.9% of gross
      loans receivable, and $11.9 million in undisbursed construction loan
      commitments, of which $28.7 million and $9.2 million represented loans and
      undisbursed construction loan commitments to developers. At December 31,
      2006, we had $3.9 million in construction loans outstanding, representing
      11.1% of gross loans receivable, and $993 thousand in undisbursed
      construction loan commitments.




·
            Commercial and
      multi-family real estate - Commercial and multi-family real estate
      loan terms generally are limited to fifteen years or less, although
      payments may be structured on a longer amortization
      basis.  Interest rates may be fixed for three to five years, or
      adjustable. The Bank generally charges an origination fee for its
      services.  We generally require personal guarantees from the
      principal owners of the property supported by a review by the Bank’s
      management of the principal owners’ personal financial
      statements.  We attempt to limit our risk by analyzing the
      borrowers’ cash flow and collateral value on an ongoing basis and by an
      annual review of rent rolls and financial statements.  At
      December 31, 2007, we held $41.7 million in commercial real estate loans
      outstanding, representing 42.7% of gross loans receivable, and no
      undisbursed commercial real estate loan funds. At December 31, 2006, we
      held $18.5 million in commercial real estate loans outstanding,
      representing 53.1%




8


of
      gross loans receivable, and undisbursed commercial real estate loan
      commitments of $1.1 million.




·
            Residential real
      estate - Our residential real estate loans consist of residential
      second mortgage loans. All loans are made in accordance with our appraisal
      policy with the ratio of the loan principal to the value of collateral as
      established by independent appraisal not exceeding 80% when combined with
      any first mortgage, unless private mortgage insurance is obtained for the
      excess amount.  The amortization of second mortgages generally
      does not exceed 15 years and the rates are generally fixed for 12 months
      or longer.  At December 31, 2007, we held $2.7 million in
      residential real estate loans outstanding, representing 2.7% of gross
      loans receivable, and undisbursed commitments of $3.2 million. At December
      31, 2006, we held $2.4 million in residential real estate loans
      outstanding, representing 6.9% of gross loans receivable, and undisbursed
      commitments of $2.6 million.




Commercial loans -
Our target commercial loan market is retail establishments and small-to-
medium-sized businesses.  Our commercial loan portfolio is comprised
of lines of credit for working capital and term loans to finance equipment and
other business assets. The lines of credit typically are limited to a percentage
of the value of the assets securing the line. Lines of credit and term loans
typically are reviewed annually and can be supported by accounts receivable,
inventory, equipment and other assets of the client's businesses. The terms of
these loans vary by purpose and by type of underlying collateral, if
any.  The commercial loans are primarily underwritten on the basis of
the borrower’s ability to service the loan from operating income.  We
typically make equipment loans for a term of five years or less at fixed or
variable rates, with the loan fully amortized over the term.  Loans to
support working capital typically have terms not exceeding one year and are
usually secured by accounts receivable, inventory or personal guarantees of the
principals of the business. For loans secured by accounts receivable or
inventory, principal is typically repaid as the assets securing the loan are
converted into cash, and for loans secured with other types of collateral,
principal is typically due at maturity.  The quality of the commercial
borrower’s management and its ability both to properly evaluate changes in the
supply and demand characteristics affecting its markets for products and
services and to effectively respond to such changes are significant factors in a
commercial borrower’s creditworthiness. At December 31, 2007 we held $21.8
million in commercial loans outstanding, representing 22.4% of gross loans
receivable, and undisbursed commitments of $14.3 million. At December 31, 2006,
we held $9.8 million in commercial loans outstanding, representing 28.2% of
gross loans receivable, and undisbursed commitments of $4.9
million.




SBA loans - SBA loans
continue to support small business owners as they fund purchases of real estate
and business expansion. The Bank’s SBA lending department has the expertise to
offer two types of SBA-guaranteed loans to business clients, depending on the
business needs and underlying collateral.




SBA 504 Loan
Program




Loans
made by the Bank under the SBA 504 program generally are made to small
businesses to provide funding for the purchase of real estate.  Under
this program, the Bank generally provides up to 90% financing of the total
purchase cost, represented by two loans to the borrower.  The first
lien loan is generally a long-term, fully amortizing, fixed rate loan and made
in the amount of 50% of the total purchase cost.  The second lien loan
is a short-term, interest only, adjustable rate loan, based upon the Wall Street
Journal prime lending rate, and made in the amount of 40% of the total purchase
cost.  The Bank’s second lien loan serves as an interim bridge loan to
the borrower until the Certified Development Corporation (“CDC”) obtains bond
funding, pays off the Company’s second lien loan, and provides long-term, fixed
rate financing directly to the borrower.  The CDC pays off the Bank’s
second lien loan generally within three to six months after the loan proceeds
have been fully disbursed by the Bank to the borrower.  The CDC is a
non-profit corporation established to contribute to the economic development
of




9


its
community by working together with the SBA and private sector lenders such as
the Bank, to provide financing to small businesses.  The Company
generally offers SBA 504 loans within a range of $300,000 to $3.0
million.




At
December 31, 2007, we held $1.0 million in commercial real estate second trust
deed SBA 504 loans outstanding, representing 1.1% of gross loans receivable. At
December 31, 2006, we held $1.9 million in commercial real estate second trust
deed SBA 504 loans outstanding, representing 5.3% of gross loans receivable.
There were no undisbursed commitments for SBA 504 loans at December 31, 2007 and
2006.




SBA 7(a) Loan
Program




Loans
made by the Bank under the SBA 7(a) program generally are made to small
businesses to provide working capital or to provide funding for the purchase of
businesses, real estate, or machinery and equipment.  These loans
generally are secured by a combination of assets that may include equipment,
receivables, inventory, business real property, and sometimes a lien on the
personal residence of the borrower.  The terms of these loans vary by
purpose and by type of underlying collateral. The loans are primarily
underwritten on the basis of the borrower’s ability to service the loan from
income. Under the SBA 7(a) loan program the loans carry a Small Business
Administration guaranty up to 75% of the loan. Typical maturities for this type
of loan vary up to ten years. SBA 7(a) loans are all adjustable rate loans based
upon the Wall Street Journal prime lending rate.  Under the SBA 7(a)
program, the Bank can sell in the secondary market the guaranteed portion of its
SBA 7(a) loans and retain the related unguaranteed portion of these loans, as
well as the servicing on such loans, for which it is paid a fee.  The
loan servicing spread is generally a minimum of 1.00% on all
loans.  The Company generally offers SBA 7(a) loans within a range of
$50,000 to $1.0 million.




The Bank
bases its SBA 7(a) loan sales on the level of its SBA 7(a) loan originations,
the premiums available in the secondary market for the sale of such loans, and
general liquidity considerations of the Bank.  During 2007, the Bank
originated $11.3 million in SBA 7(a) loans, of which $7.7 million represented
the guaranteed portion.  During 2007 the Bank elected to sell $7.0
million of the guaranteed portion of its SBA 7(a) loans, for which it recognized
a gain of $392 thousand.




At
December 31, 2007, we held $6.5 million in SBA 7A loans representing 6.6% of
gross loans receivable, including $3.0 million representing the guaranteed
portion retained by the Bank. Of the $6.5 million, $5.0 million was part of the
commercial loan portfolio, $1.4 million was included in the commercial real
estate portfolio, and $95 thousand was included in the consumer loan
portfolio.  At December 31, 2006, we held $2.5 million in SBA 7A loans
representing 7.1% of gross loans receivable, including $1.7 million representing
the guaranteed portion retained by the Bank.  Of this amount, $1.4
million was part of the commercial loan portfolio and $1.1 million was included
in the commercial real estate portfolio.




Consumer and other
lending - Our consumer loan portfolio consists primarily of personal
lines of credit and loans to acquire personal assets such as automobiles and
boats originated on a case-by-case basis as an accommodation for the Bank’s
clients.. The lines of credit generally have terms of one year and the term
loans generally have terms of three to five years. The lines of credit typically
have floating rates. Because many consumer loans are secured by depreciable
assets such as boats, cars and trailers, the loan is amortized over the useful
life of the asset.  At December 31, 2007, we held $328 thousand in
consumer loans outstanding, representing 0.3% of gross loans receivable, and
undisbursed commitments of $96 thousand. At December 31, 2006, we held $238
thousand in consumer loans outstanding, representing 0.7% of gross loans
receivable, and undisbursed commitments of $41 thousand.




10


Composition of
portfolio - The following table sets forth the composition of our loan
portfolio as of December 31 of the years indicated.




2007
              
              
              
              
              
              2006Real estate1-4
      residential
              
              $
              2,654,635
              
              
              
              2.7
              %
              
              $
              2,395,422
              
              
              
              6.9
              %Multi-Family
              
              
              719,959
              
              
              
              0.7
              %
              
              
              297,641
              
              
              
              0.9
              %Non-farm,
      non-residential
              
              
              40,950,795
              
              
              
              41.9
              %
              
              
              18,246,727
              
              
              
              52.3
              %Construction & Land
      Development
              
              
              31,163,576
              
              
              
              31.9
              %
              
              
              3,881,815
              
              
              
              11.1
              %Commercial
              
              
              21,827,512
              
              
              
              22.4
              %
              
              
              9,844,022
              
              
              
              28.2
              %Consumer
              
              
              327,735
              
              
              
              0.3
              %
              
              
              238,064
              
              
              
              0.7
              %97,644,212
              
              
              
              100
              %
              
              
              34,903,691
              
              
              
              100
              %Net deferred loan (fees) costs,
      premiums and discounts
              
              
              229,919
              
              
              
              
              
              
              
              ( 108,286
              )Allowance for loan
      losses
              
              
              ( 1,814,860
              )
              
              
              
              
              
              
              ( 431,640
              )$
              96,059,271
              
              
              
              
              
              
              $
              34,363,765




Average loan size of
portfolio - The following table sets forth the number of loans, and the
average size of each loan, within each class as of December 31 of the years
indicated.




2007
            
            
            2006#of
              Loans
            
            
            Average
              Loan
      Size
            
            
            #
      of
              Loans
            
            
            Average
              Loan
      Size(Dollars
      in Thousands)Real
      estate
            
            
            74
            
            
            $
            599
            
            
            
            53
            
            
            $
            395Construction
            
            
            30
            
            
            
            1,039
            
            
            
            3
            
            
            
            1,294Commercial
            
            
            103
            
            
            
            212
            
            
            
            29
            
            
            
            339Consumer
            
            
            31
            
            
            
            11
            
            
            
            10
            
            
            
            24238
            
            
            
            410
            
            
            
            95
            
            
            
            367







Loan originations -
The following table sets forth our loan originations for 2007 and 2006 including
loan participations that were purchased from and sold to other banks without
recourse.






11






2007
            
            
            2006(In
      Thousands)Real
      estate
            
            $
            36,644
            
            
            $
            25,550Construction
            
            
            44,595
            
            
            
            4,875Commercial
            
            
            35,253
            
            
            
            12,366Consumer
            
            
            170
            
            
            
            222$
            116,662
            
            
            $
            43,013







Contractual maturity of
portfolio - The following table sets forth information at December 31,
2007, regarding the dollar amount of loans maturing in our portfolio based on
the contractual terms to maturity or scheduled amortization. The table does not
give effect to potential prepayments. Loans that have no stated schedule of
repayments or maturity are reported as due in one year or
less.




One
                Year
                or
      Less
              
              
              Over
      1 Year
                through
      5 Years
              
              
              Over
      5 Years
              
              
              Total(In
      Thousands)Fixed
                Rate
              
              
              Floating
      or
                Adjustable
                Rate
              
              
              Fixed
                Rate
              
              
              Floating
      or
                Adjustable
                RateReal
      estate
              
              $
              1,024
              
              
              $
              3,577
              
              
              $
              2,817
              
              
              $
              9,296
              
              
              $
              27,611
              
              
              $
              44,325Construction
              
              
              8,356
              
              
              
              3,600
              
              
              
              16,195
              
              
              
              -
              
              
              
              3,012
              
              
              
              31,163Commercial
              
              
              7,334
              
              
              
              4,871
              
              
              
              3,064
              
              
              
              2,652
              
              
              
              3,907
              
              
              
              21,828Consumer
              
              
              52
              
              
              
              33
              
              
              
              -
              
              
              
              147
              
              
              
              96
              
              
              
              328Total
              
              $
              16,766
              
              
              $
              12,081
              
              
              $
              22,076
              
              
              $
              12,095
              
              
              $
              34,626
              
              
              $
              97,644




Asset
quality




General - The Bank’s
Directors’ Credit Committee, consisting of the Bank’s Chief Executive Officer,
President, Chief Credit Officer, and four outside board members, monitors the
credit quality of the Bank’s assets, reviews classified and other identified
loans and determines the proper level of allowances to allocate against our loan
portfolio, in each case subject to guidelines approved by the Bank’s board of
directors.




12


Loan delinquencies -
When a borrower fails to make a required payment on a loan, we attempt to cure
the deficiency by contacting the borrower and seeking payment. Contact is
generally made following the fifteenth day after a payment is due, at which time
a late payment fee is assessed. In most cases, deficiencies are cured promptly.
If a delinquency extends beyond 15 days, the loan and payment history are
reviewed and efforts are made to collect the loan. While we generally prefer to
work with borrowers to resolve such problems, if a payment becomes 45 days
delinquent, we may institute foreclosure or other proceedings, as necessary, to
minimize any potential loss. As of December 31, 2007, there were four loans with
payments delinquent between 30 and 59 days, including two loans on non-accrual
status. There were no loans delinquent 60 days or more.




Non-performing assets
- Nonperforming assets are defined as non-accrual loans and real estate acquired
by foreclosure or deed-in-lieu thereof. Nonperforming loans are defined as
non-accrual loans and loans 90 days or more past due but still accruing
interest, to the extent applicable. A loan is considered to be impaired if
management determines the recovery of our gross investment in the loan is not
probable.  Troubled debt restructurings (“TDRs”) are defined as loans
which we have agreed to modify by accepting below market terms either by
granting interest rate concessions or by deferring principal and/or interest
payments. Loans are placed on non-accrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When any such loan is placed on
non-accrual status, previously accrued but unpaid interest will be deducted from
interest income. As a matter of policy, we do not accrue interest on loans past
due 90 days or more.  As of December 31, 2007, there were two
construction loan participations on non-accrual, for a total of $2.5
million.  Both lead lenders have initiated foreclosure actions and/or
negotiations to improve the overall collateral position.  We recorded
specific reserves to our provision for loan losses based on recent appraisals of
these projects.




On March 25, 2008, one of the two loans that were
placed on non-accrual during the fourth quarter of 2007 was brought current by
the borrower and $35 thousand in interest was taken into income.  Going
forward, this loan, which has a principal balance of $1.0 million, will be
classified as a restructured debt and begin accruing interest.




Classified assets -
Federal regulations require that each insured financial institution classify its
assets on a regular basis. In addition, in connection with examinations of
insured institutions, federal examiners have authority to identify problem
assets and, if appropriate, classify them. The Bank has established three
classifications for potential problem assets: “substandard,” “doubtful” and
“loss.”   Substandard assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not
corrected.  Doubtful assets have the weakness of substandard assets
with the additional characteristic that the weaknesses make collection or
liquidation in full on the basis of currently existing facts, conditions and
values questionable, and there is a high possibility of loss.  An
asset classified as loss is considered uncollectible, and of such little value
that continuance as an asset of the institution is not warranted. Assets
classified as substandard or doubtful result in the Bank establishing higher
levels of general allowances for loan losses.  If an asset or portion
thereof is classified loss, the Bank must either establish specific allowances
for loan losses in the amount of 100% of the portion of the asset classified as
loss, or charge off such an amount.




The table
below sets forth the amounts and categories of non-performing assets in the
Bank’s loan portfolio.




Nonaccrual,
      Past Due and Restructured Loans(Dollars
      in Thousands)2007
            
            
            2006Nonaccrual
            
            $
            2,467
            
            
            $
            -Past
      Due 90 days or more
            
            
            -
            
            
            
            -Restructured
      Debt
            
            
            -
            
            
            
            -Total
      Non-Performing Loans
            
            $
            2,467
            
            
            $
            -







13


For the year ended December 31, 2007, gross interest income which would have
been recorded had our non-accruing loans been current in accordance with their
original terms amounts to $170 thousand. We received and recorded $126 thousand
for such loans for the year ended December 31, 2007.




Allowance for loan
losses – We maintain an allowance for estimated loan losses based on a
number of quantitative and qualitative factors.  Quantitative factors
used to assess the adequacy of the allowance for loan losses are established
based upon management’s assessment of the credit risk in the portfolio,
historical loan loss experience and our loan underwriting policies as well as
management’s judgment and experience.  Provisions for loan losses may
be provided both on a specific and general basis. Specific and general valuation
allowances are increased by provisions charged to expense and decreased by
charge-offs of loans, net of recoveries.  Specific allowances are
provided for impaired loans for which the expected loss is
measurable.  General valuation allowances are provided based on a
formula that incorporates the factors discussed above.  We
periodically review the assumptions and formula by which additions are made to
the specific and general valuation allowances for losses in an effort to refine
such allowances in light of the current status of the factors described
above.




The
following table sets forth the activity for 2007 and 2006 in our allowance for
loan losses account.  The loan charged off in 2006 was a consumer
loan.




2007
            
            
            2006($
      in thousands)Balance
      at beginning of year
            
            $
            432
            
            
            $
            87Provision
      charged to expense
            
            
            1,383
            
            
            
            350Loans
      charged off
            
            
            -
            
            
            
            ( 5
            )Recoveries
      on loans previously charged off
            
            
            -
            
            
            
            -Balance
      at end of year
            
            $
            1,815
            
            
            $
            432







The
following table sets forth information regarding impaired and non-accrual loans
as of and for the years ended December 31.




2007
              
              
              2006($ in
      thousands)Total impaired loans, all with an
      allowance for loan losses
              
              $
              2,467
              
              
              $
              -Related allowance for loan losses
      on impaired loans
              
              $
              590
              
              
              $
              -Total non-accrual
      loans
              
              $
              2,467
              
              
              $
              -Loans past due 90 days or more and
      still accruing
              
              $
              -
              
              
              $
              -Average balance during the year on
      impaired loans
              
              $
              2,456
              
              
              $
              -Interest income recognized on
      impaired loans
              
              $
              126
              
              
              $
              -




14


The
following tables set forth information concerning the allocation of the
allowance for loan losses, which is maintained on our loan portfolio, by loan
category at December 31 for the years indicated.




2007
              
              Amount
              
              
              Percentage
      of
                loans
      in each
                category
      to
                total
      loans
              
              
              Percentage
      of
                year-end
                allowance
              
              
              Percentage
      of
                reserves
      to
                net
      loans by
                category($
      in thousands)Real
      estate
              
              $
              353
              
              
              
              45.4
              %
              
              
              27.9
              %
              
              
              1.1
              %Construction
              
              
              823
              
              
              
              31.9
              %
              
              
              36.9
              %
              
              
              2.1
              %Commercial
              
              
              197
              
              
              
              22.4
              %
              
              
              10.9
              %
              
              
              0.9
              %Consumer
              
              
              1
              
              
              
              0.3
              %
              
              
              0.1
              %
              
              
              0.5
              %Unallocated
              
              
              441
              
              
              
              -
              
              
              
              24.3
              %
              
              
              -Total
      Allowance for Loan Losses
              
              $
              1,815
              
              
              
              100.0
              %
              
              
              100.0
              %
              
              
              1.9
              %
   2006
              
              Amount
              
              
              Percentage
      of
                loans
      in each
                category
      to
                total
      loans
              
              
              Percentage
      of
                year-end
                allowance
              
              
              Percentage
      of
                reserves
      to
                net
      loans by
                category($
      in thousands)Real
      estate
              
              $
              150
              
              
              
              60.0
              %
              
              
              34.7
              %
              
              
              0.7
              %Construction
              
              
              33
              
              
              
              11.1
              %
              
              
              7.5
              %
              
              
              0.8
              %Commercial
              
              
              72
              
              
              
              28.2
              %
              
              
              16.8
              %
              
              
              0.7
              %Consumer
              
              
              1
              
              
              
              0.7
              %
              
              
              0.3
              %
              
              
              0.5
              %Unallocated
              
              
              176
              
              
              
              -
              
              
              
              40.7
              %
              
              
              -Total
      Allowance for Loan Losses
              
              $
              432
              
              
              
              100.0
              %
              
              
              100.0
              %
              
              
              1.2
              %






The
allowance for loan losses reflects management’s judgment of the level of
allowance adequate to absorb estimated credit losses in our loan portfolio. The
board of directors of the Bank approved a policy formulated by management for a
systematic analysis of the adequacy of the allowance. The major elements of the
policy require: (1) a quarterly analysis of allowance amounts performed by
management; (2) approval by the Bank’s board of directors of the quarterly
analysis; and (3) allocation of the allowance into general and specific
valuation allowance categories. The general valuation allowance includes an
unallocated amount, based upon management’s evaluation of various conditions,
such as general economic and business conditions affecting our key lending
areas, the effects of which may not be directly measured in the determination of
the general valuation allowance formula and specific allowances. The evaluation
of the inherent loss with respect to these conditions is subject to a high
degree of uncertainty because they are not identified with specific problem
credits or portfolio components.




15


Our
external asset review system and loss allowance methodology are designed to
provide for timely identification of problem assets and recognition of losses.
The overall adequacy of the allowance for loan losses is reviewed by the
Directors’ Credit Committee on a monthly basis and submitted to the board of
directors for approval on a quarterly basis. The committee’s responsibilities
consist of risk management, as well as problem loan management, which include
ensuring proper risk grading of all loans and analysis of specific valuation
allowances for all classified loans. The current monitoring process includes a
process of segmenting the loan portfolio into pools of loans that share similar
credit characteristics. The loan portfolio is currently segmented into seven
different risk grades. These specific pools of loans are analyzed for purposes
of calculating the general valuation allowance in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 5.




The
general valuation allowance is derived by analyzing the historical loss
experience and asset quality within each homogeneous loans portfolio segment,
along with assessing qualitative environmental factors, and correlating it with
the delinquency and classification status for each portfolio segment. A grading
system with seven classification categories is used, including assets classified
as Pass, which is divided into three risk grade levels, based upon credit risk
characteristics. Each loan asset is categorized by risk grade allowing for a
more consistent review of similar loan assets. A loss factor is applied to each
risk graded loan segment.




Loss
factors for each risk graded loan segment are based on experience of peer
institutions, national and regional averages published the OCC and
FDIC.  Given that the Bank has extremely limited historical trends,
peer group statistics are used to validate the loss factors applied to the
Bank’s various loan segments. In addition, the following qualitative
environmental elements are considered in determining the loss factors used in
calculating the general valuation allowance: the levels of and trends in past
due, non-accrual and impaired loans; the trend in volume and terms of loans; the
effects of changes in credit concentrations; the effects of changes in risk
selection and underwriting standards, and other changes in lending policies,
procedures and practices; the experience, ability and depth of management and
other relevant staff; national and local economic trends and conditions; and
industry conditions.




The
allowance requirements for any loan segment could be different in the future as
the quantitative and qualitative factors change.  Consequently,
provision levels may also be influenced by changes in the quantitative and
qualitative factors quarter over quarter.




At
December 31, 2007, we had $2.5 million in classified loans.  As loans
move into the classified categories, they are reviewed individually for purposes
of determining specific valuation allowances and impairment as defined in SFAS
No. 114. Loans are also reviewed individually on an annual basis.  In
addition, classified assets are reviewed at the time the loan is classified and
on a regular basis (at least every 90 days) thereafter. This evaluation of
individual loans is documented in the internal asset review report relating to
the specific loan. An impairment analysis is completed with each internal asset
review report, typically on a quarterly basis, for all classified loans secured
by real estate.  Any deficiencies outlined by the impairment analysis
are accounted for in the specific valuation allowance for the loan.  A
loan is determined to be impaired if management determines the recovery of the
Bank’s gross investment is not probable.  A specific valuation
allowance is applied if the amount of loss can be reasonably
determined.  To determine impairment under SFAS No. 114, management
assesses the current operating statement requested from the borrower (although
they may not always be received from the borrower), the property’s current and
past performance, borrower’s ability (defined as capacity, willingness and
rationale) to repay and the overall condition and estimated value of the
collateral.  If a loan is deemed impaired, a specific valuation
allowance is applied equal to the carrying amount of our total investment in the
loan that exceeds the fair value of the collateral.  The fair value of
impaired loans is measured based on present value of expected future cash flows
discounted at the loan’s effective interest rate or, as a




16


practical
expedient, at the loan’s observable market price or the fair value of the
collateral if the loan is collateral dependent.




Management
believes that our allowance for loan losses as of December 31, 2007 was adequate
to absorb the known and inherent risks of loss in the loan portfolio at that
date. While management believes the estimates and assumptions used in its
determination of the adequacy of the allowance are reasonable, there can be no
assurance that such estimates and assumptions will not be proven incorrect in
the future, or that the actual amount of future provisions will not exceed the
amount of past provisions or that any increased provisions that may be required
will not adversely impact our financial condition and results of operations. In
addition, the determination of the amount of the Bank's allowance for loan
losses is subject to review by bank regulators, as part of the routine
examination process, which may result in the establishment of additional
reserves based upon their judgment of information available to them at the time
of their examination.




Investments




In
addition to loans, we make other investments primarily in obligations of the
United States or obligations guaranteed as to principal and interest by the
United States and other taxable securities.  No investment in any of
those instruments exceeds any applicable limitation imposed by law or
regulation.  The asset-liability management committee reviews the
investment portfolio on an ongoing basis in order to ensure that the investments
conform to the Bank’s policy as set by its board of directors.




Investment
securities that management has the positive intent and ability to hold to
maturity are classified as “held-to-maturity” and recorded at amortized
cost.  Securities not classified as held-to-maturity or trading, with
readily determinable fair values, are classified as “available-for-sale” and
recorded at date value, with unrealized gains and losses excluded from earnings
and reported in other comprehensive income, as part of stockholders’
equity.




In the
first quarter of 2007, we sold certain securities that we considered at-risk for
timely interest and principal payments because they were securitized by
mortgages and the deterioration of the sub-prime market had begun. We recognized
a gain on the sale of $4 thousand. Because these investments were sold prior to
maturity, we were required to reclassify all investments as
“available-for-sale”. In the second quarter of 2007 we sold the remaining
investment securities, at a loss of $16 thousand. Currently we own no investment
securities. Any investments we purchase during the 24 months following March
2007 are required to be classified as “available-for-sale”.




Declines
in fair value of held-to-maturity and available-for-sale securities below their
cost that are deemed to be other than temporary are reflected in earnings as
realized losses. Gains and losses on the sale of securities are recorded on the
trade date and are determined using the specific identification method. Purchase
premiums and discounts are recognized in interest income using the interest
method over the estimated lives of the securities.




The table
below sets forth the amounts and distribution of the investment securities and
the weighted average yields at December 31, 2006. There were no investment
securities held at December 31, 2007.







17




Book Value
              
              
              Market
Value
              
              
              Weighted Average
      YieldSecurities held to
      maturityDecember 31,
      2006U.S.
      Government andAgency
      SecuritiesWithin One
    Year
              
              $
              3,999
              
              
              $
              3,986
              
              
              
              4.43
              %One to Five
      Years
              
              
              3,944
              
              
              
              3,958
              
              
              
              4.50
              %Total Securities held to
      maturity
              
              $
              7,943
              
              
              $
              7,944
              
              
              
              4.46
              %




The table
below sets forth the net balance at cost, and fair value of held-to-maturity
investment securities, with gross unrealized gains and losses at December 31,
2006.




Amortized
            
            Unrealized
            
            Unrealized
            
            EstimatedCost
            
            Gains
            
            Losses
            
            Fair
      Value(In
      Thousands)December
      31, 2006U.S.
      Government andAgency
      Securities
            $  7,943
            
            $     13
            
            $   (12)
            
            $  7,944







Management
evaluates investment securities for other-than-temporary impairment taking into
consideration that extent and length of time the fair value has been less than
cost, the financial condition of the issuer and whether or not the Company has
the intent and ability to retain the investment for a period of time sufficient
to allow for any anticipated recovery in fair value. As of December 31, 2006, no
declines were deemed to be other than temporary.




Deposit
services




We offer
a variety of deposit products and services at competitive interest rates. The
Bank utilizes traditional and innovative marketing methods to attract new
clients and deposits, including various forms of advertising and significant
involvement in the local communities. The primary sources of deposits are
residents of, and businesses and their employees located in, our primary service
areas.  We attract these deposits through personal solicitation by our
officers and directors, direct mail solicitations and advertisements published
in the local media.  Due to strong loan demand, we began utilizing
brokered deposits in 2007. As discussed under "Capital Resources and Capital
Adequacy Management", we seek to limit the amount of brokered deposits as their
utilization typically would be expected to increase our overall cost of funds.
As of December 31, 2007, $28.2 million in brokered funds were on deposit. These
deposits are included in other time certificate of deposits.




The
following table sets forth the amount and maturities of the time deposits at
December 31 of the years indicated.






18






Time
      Deposits of
              $100,000
      or more
            
            
            Other
      Time
              Deposits
            
            
            Total
      Time
              Deposits(In
      Thousands)December
      31, 2007Three
      months or less
            
            $
            307
            
            
            $
            15,614
            
            
            $
            15,921Over
      three months through six months
            
            
            549
            
            
            
            9,617
            
            
            
            10,166Over
      six months through 12 months
            
            
            1,006
            
            
            
            10,174
            
            
            
            11,180Over
      12 months
            
            
            1,316
            
            
            
            2,588
            
            
            
            3,904Total
            
            $
            3,178
            
            
            $
            37,993
            
            
            $
            41,171







Competition




Lending - We face
significant competition in Southern California for new loans with other
commercial banks, savings and loan associations, credit unions, credit
companies, Wall Street lending conduits, mortgage bankers, life insurance
companies and pension funds. Some of the largest financial institutions in the
United States operate in California, and have extensive branch systems and
advertising programs, which we do not have.  Large banks and savings
and loan institutions frequently enjoy a lower cost of funds than we do and can
therefore charge less than we do for loans.  In addition these
institutions have higher legal lending limits than we do. We attempt to
compensate for competitive pricing disadvantages that may exist by providing a
higher level of personal service to borrowers and “hands on” involvement of
senior officers to meet the borrowers’ needs and by either brokering or selling
loan participations in loans in excess of our lending limits.




Deposits - We compete
for deposit funds with other financial companies, including banks, savings
associations, credit unions and thrifts.  These companies generally
compete with one another based upon price, convenience and service. Although
many of our competitors offer customers a larger spectrum of products than we
offer, as part of our strategic plan, we continue to enhance the line of
products and services offered to our customers.




We expect
competition to remain intense in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Technological advances, for example, have
lowered barriers to entry, allowed banks to expand their geographic reach by
providing services over the Internet and made it possible for non-depository
institutions to offer products and services that traditionally have been
provided by banks. Changes in federal law permit affiliation among banks,
securities firms and insurance companies, which promotes a competitive
environment in the financial services industry. Competition for deposits and the
origination of loans could limit our growth in the future.




Employees




As of
December 31, 2007, we had 43 employees. Management believes that its relations
with employees are satisfactory. We are not subject to any collective bargaining
agreements.




Supervision
and Regulation




General-The following is a brief
description of certain laws and regulations which are applicable to Pacific
Coast National Bancorp and Pacific Coast National Bank. The description of
these




19


laws and
regulations, as well as descriptions of laws and regulations contained elsewhere
herein, is not complete and is qualified in its entirety by reference to the
applicable laws and regulations.




Regulation
and Supervision of Pacific Coast National Bancorp




General.  Pacific
Coast National Bancorp, as the sole shareholder of Pacific Coast National Bank,
is a bank holding company registered with the Federal Reserve.  Bank
holding companies are subject to comprehensive regulation by the Federal Reserve
under the Bank Holding Company Act of 1956, as amended, and the regulations of
the Federal Reserve.  As a bank holding company, Pacific Coast
National Bancorp is required to file quarterly reports with the Federal Reserve
and any additional information required by the Federal Reserve and is subject to
regular examinations by the Federal Reserve.  The Federal Reserve also
has extensive enforcement authority over bank holding companies, including the
ability to assess civil money penalties, to issue cease and desist or removal
orders and to require that a holding company divest subsidiaries (including its
bank subsidiaries).  In general, enforcement actions may be initiated
for violations of law and regulations and unsafe or unsound
practices.




The Bank Holding Company
Act.Under the Bank
Holding Company Act, Pacific Coast National Bancorp is supervised by the Federal
Reserve.  The Federal Reserve has a policy that a bank holding company
is required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound
manner.  In addition, the Federal Reserve provides that bank holding
companies should serve as a source of strength to its subsidiary banks by being
prepared to use available resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity, and should
maintain the financial flexibility and capital raising capacity to obtain
additional resources for assisting its subsidiary banks.  A bank
holding company's failure to meet its obligation to serve as a source of
strength to its subsidiary banks will generally be considered by the Federal
Reserve to be an unsafe and unsound banking practice or a violation of the
Federal Reserve's regulations or both.




We are
required to file quarterly and periodic reports with the Federal Reserve and
provide additional information as the Federal Reserve may
require.  The Federal Reserve may examine us, and any of our
subsidiaries, and charge us for the cost of the examination.




Pacific
Coast National Bancorp and any subsidiaries that it may control are considered
"affiliates" within the meaning of the Federal Reserve Act, and transactions
between our bank subsidiary and affiliates are subject to numerous
restrictions.  With some exceptions, we, and our subsidiaries, are
prohibited from tying the provision of various services, such as extensions of
credit, to other services offered by us, or our affiliates.




Sarbanes-Oxley Act of
2002.  As a public company, Pacific Coast National Bancorp, is
subject to the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"), which
implements a broad range of corporate governance and accounting measures for
public companies designed to promote honesty and transparency in corporate
America and better protect investors from corporate wrongdoing.  The
Sarbanes-Oxley Act was signed into law on July 30, 2002 in response to public
concerns regarding corporate accountability in connection with various
accounting scandals.  The stated goals of the Sarbanes-Oxley Act are
to increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws.




The
Sarbanes-Oxley Act includes very specific additional disclosure requirements and
new corporate governance rules and required the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules. The Sarbanes-Oxley Act represents significant




20


federal
involvement in matters traditionally left to state regulatory systems, such as
the regulation of the accounting profession, and to state corporate law, such as
the relationship between a board of directors and management and between a board
of directors and its committees.  Our policies and procedures have
been updated to comply with the requirements of the Sarbanes-Oxley
Act.




Acquisitions.  The
Bank Holding Company Act prohibits a bank holding company, with certain
exceptions, from acquiring ownership or control of more than 5% of the voting
shares of any company that is not a bank or bank holding company and from
engaging in activities other than those of banking, managing or controlling
banks, or providing services for its subsidiaries.  Under the Bank
Holding Company Act, the Federal Reserve may approve the ownership of shares by
a bank holding company in any company, the activities of which the Federal
Reserve has determined to be so closely related to the business of banking or
managing or controlling banks as to be a proper incident
thereto.  These activities include: operating a savings institution,
mortgage company, finance company, credit card company or factoring company;
performing certain data processing operations; providing certain investment and
financial advice; underwriting and acting as an insurance agent for certain
types of credit-related insurance; leasing property on a full-payout,
non-operating basis; selling money orders, travelers' checks and U.S. Savings
Bonds; real estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing securities
brokerage services for customers.




Interstate
Banking.  The Federal Reserve must approve an application of a
bank holding company to acquire control of, or acquire all or substantially all
of the assets of, a bank located in a state other than the holding company's
home state, without regard to whether the transaction is prohibited by the laws
of any state.  The Federal Reserve may not approve the acquisition of
a bank that has not been in existence for the minimum time period, not exceeding
five years, specified by the law of the host state.  Nor may the
Federal Reserve approve an application if the applicant controls or would
control more than 10% of the insured deposits in the United States or 30% or
more of the deposits in the target bank's home state or in any state in which
the target bank maintains a branch.  Federal law does not affect the
authority of states to limit the percentage of total insured deposits in the
state that may be held or controlled by a bank holding company to the extent
such limitation does not discriminate against out-of-state banks or bank holding
companies.  Individual states may also waive the 30% state-wide
concentration limit contained in the federal law.




The
federal banking agencies are authorized to approve interstate merger
transactions without regard to whether the transaction is prohibited by the law
of any state, unless the home state of one of the banks adopted a law prior to
June 1, 1997 which applies equally to all out-of-state banks and expressly
prohibits merger transactions involving out-of-state
banks.  Interstate acquisitions of branches will be permitted only if
the law of the state in which the branch is located permits such
acquisitions.  Interstate mergers and branch acquisitions will also be
subject to the nationwide and statewide insured deposit concentration amounts
described above.




Dividends.  The
Federal Reserve has issued a policy statement on the payment of cash dividends
by bank holding companies, which expresses its view that although there are no
specific regulations restricting dividend payments by bank holding companies
other than state corporate laws, a bank holding company must maintain an
adequate capital position and generally should not pay cash dividends unless the
company's net income for the past year is sufficient to fully fund the cash
dividends and that the prospective rate of earnings appears consistent with the
company's capital needs, asset quality, and overall financial
condition.  The Federal Reserve policy statement also indicates that
it would be inappropriate for a company experiencing serious financial problems
to borrow funds to pay dividends.




21


The
California General Corporation Law provides that a corporation may make a
distribution to its shareholders if the corporation’s retained earnings equal at
least the amount of the proposed distribution. The California General
Corporation Law further provides that, in the event sufficient retained earnings
are not available for the proposed distribution, a corporation may nevertheless
make a distribution to its shareholders if, after giving effect to the
distribution, it meets two conditions, which generally stated are as follows:
(i) the corporation’s assets must equal at least 125% of its liabilities; and
(ii) the corporation’s current assets must equal at least its current
liabilities or, if the average of the corporation’s earnings before taxes on
income and before interest expense for the two preceding fiscal years was less
than the average of the corporation’s interest expense for those fiscal years,
then the corporation’s current assets must equal at least 125% of its current
liabilities.




Stock
Repurchases.  Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, are required to give
the Federal Reserve prior written notice of any purchase or redemption of its
outstanding equity securities if the consideration for the purchase or
redemption, when combined with the net consideration paid for all such purchases
or redemptions during the preceding 12 months, is equal to 10% or more of their
consolidated net worth.  The Federal Reserve may disapprove a purchase
or redemption if it determines that the proposal would constitute an unsafe or
unsound practice or would violate any law, regulation, Federal Reserve order, or
any condition imposed by, or written agreement with, the Federal
Reserve.




Capital
Requirements.  The Federal Reserve has established capital
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for banks.  The Federal Reserve
regulations provide that capital standards will be applied on a consolidated
basis in the case of a bank holding company with $150 million or more in total
consolidated assets.  Pacific Coast National Bancorp's total
risk-based capital must equal 8% of risk-weighted assets and one half of the 8%,
or 4%, must consist of Tier 1 (core) capital.  At December 31,
2007, Pacific Coast National Bancorp's capital position was in excess of these
requirements with Tier 1 (core) capital to average assets of 12.7%, Tier 1
(core) capital to risk-weighted assets of 10.8%, and total capital to
risk-weighted assets of 11.9%.




Federal
Securities Laws.Our common stock is
registered with the Securities and Exchange Commission under Section 12(g) of
the Securities Exchange Act of 1934, as amended.  We are subject to
information, proxy solicitation, insider trading restrictions and other
requirements under the Securities Exchange Act of 1934.




Regulation
and Supervision of Pacific Coast National Bank




General.  As
a national bank, Pacific Coast National Bank is subject to extensive regulation
by the OCC and to a lesser extent, the FDIC.  Lending activities and
other investments of the Bank must comply with various statutory and regulatory
requirements.  The Bank is also subject to certain reserve
requirements promulgated by the Federal Reserve.




The OCC,
in conjunction with the FDIC, regularly examines the Bank and prepares reports
for the consideration of the Bank’s board of directors on any deficiencies found
in the operations of the Bank. The relationship between the Bank and the
depositors and borrowers is also regulated by federal and state laws, especially
in such matters as the ownership of deposit accounts and the form and content of
consumer loan documents utilized by the Bank.




The Bank
must file reports with the OCC and the FDIC concerning its activities and
financial condition, in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with or acquisitions of other
financial institutions. This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for




22


the
protection of the FDIC and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss allowance for regulatory purposes. Any change in such regulations, whether
by the OCC, the FDIC, or Congress could have a material adverse impact on the
Company, the Bank, and their operations.




Capital requirements
- The federal banking agencies have adopted risk-based minimum capital
guidelines intended to provide a measure of capital that reflects the degree of
risk associated with a banking organization’s operations for both transactions
reported on the balance sheet as assets and transactions which are recorded as
off balance sheet items. Under these guidelines, nominal dollar amounts of
assets and credit equivalent amounts of off balance sheet items are multiplied
by one of several risk adjustment percentages, which range from 0% for assets
with low credit risk federal banking agencies, to 100% for assets with
relatively high credit risk.




The
risk-based capital ratio is determined by classifying assets and certain
off-balance sheet financial instruments into weighted categories, with higher
levels of capital being required for those categories perceived as representing
greater risk. Under the capital guidelines, a banking organization’s total
capital is divided into tiers. “Tier I capital” consists of 1) common equity, 2)
qualifying noncumulative perpetual preferred stock, 3) a limited amount of
qualifying cumulative perpetual preferred stock, and 4) minority interest in the
equity accounts of consolidated subsidiaries (including trust-preferred
securities), less goodwill and certain other intangible assets.  Not
more than 25% of qualifying Tier I capital may consist of trust-preferred
securities. “Tier II capital” consists of hybrid capital instruments, perpetual
debt, mandatory convertible debt securities, a limited amount of subordinated
debt, preferred stock that does not qualify as Tier I capital, a limited amount
of the allowance for loan and lease losses and a limited amount of unrealized
holding gains on equity securities. “Tier III capital” consists of qualifying
unsecured subordinated debt. The sum of Tier II and Tier III capital may not
exceed the amount of Tier I capital.




The
guidelines require a minimum ratio of qualifying total capital to risk-adjusted
assets of 8% and a minimum ratio of Tier I capital to risk-adjusted assets of
4%. In addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum of Tier I capital to average total
assets, referred to as the leverage ratio.  For a banking organization
rated in the highest of the 5 categories used by the regulators to rate banking
organizations, the minimum leverage ratio of Tier I capital to total assets must
be 3%. In addition to these uniform risk-based capital guidelines and leverage
ratios that apply across the industry, the regulators have the discretion to set
individual minimum capital requirements for specific institutions at rates
significantly above the minimum guidelines and ratios.  During the
first three years of the Bank’s operations, it is required to maintain a
leverage ratio of at least 10%.




In
addition, federal banking regulators may set capital requirements higher than
the minimums described above for financial institutions whose circumstances
warrant it. For example, a financial institution experiencing or anticipating
significant growth may be expected to maintain capital positions substantially
above the minimum supervisory levels without significant reliance on intangible
assets.




The
Federal Reserve considers the leverage ratio and other indicators of capital
strength in evaluating proposals for expansion or new activities.  The
Federal Reserve and the FDIC recently adopted amendments to their risk-based
capital regulations to provide for the consideration of interest rate risk in
the agencies’ determination of a banking institution’s capital
adequacy.




23


Failure
to meet capital guidelines could subject a bank or bank holding company to a
variety of enforcement remedies, including issuance of a capital directive, the
termination of deposit insurance by the FDIC, a prohibition on accepting
brokered deposits, and other restrictions on its business. As described above,
significant additional restrictions can be imposed on FDIC-insured depository
institutions that fail to meet applicable capital requirements.At December 31,
2007, the Bank's capital position was in excess of these requirements with Tier
1 (core) capital to average assets of 12.2%, Tier 1 (core) capital to
risk-weighted assets of 10.3%, and total capital to risk-weighted assets of
11.5%.




Dividends - The Bank is
required by federal law to obtain prior approval of the OCC for payments of
dividends if the total of all dividends declared by its board of directors in
any year would exceed its net profits earned during the current year combined
with its retained net profits of the immediately preceding two years, less any
required transfers to surplus.  In addition, the Bank will be unable
to pay dividends unless and until it has positive retained
earnings.  The Bank commenced operations with an accumulated deficit
as a result of organizational expenses, and the Company expects the Bank to
generate losses during its early periods of operations.  Accordingly,
the Bank will be unable to pay dividends until the accumulated deficit is
eliminated.




In
addition, under “Federal
Deposit Insurance Corporation Improvement Act of 1991”(FDICIA), the Bank may not
pay any dividend if the payment of the dividend would cause the Bank to become
undercapitalized or in the event the Bank is “undercapitalized.”  The
OCC may further restrict the payment of dividends by requiring that a financial
institution maintain a higher level of capital than would otherwise be required
to be “adequately capitalized” for regulatory purposes.  Moreover, if,
in the opinion of the OCC, the Bank is engaged in an unsound practice (which
could include the payment of dividends), the OCC may require, generally after
notice and hearing, that the Bank cease such practice.  The OCC has
indicated that paying dividends that deplete a depository institution’s capital
base to an inadequate level would be an unsafe banking
practice.  Moreover, the OCC has also issued policy statements
providing that insured depository institutions generally should pay dividends
only out of current operating earnings.




Loans-to-one-borrower
limitations - With certain limited exceptions, the maximum amount that a
national bank may lend to any borrower (including certain related entities of
the borrower) at one time may not exceed 15% of the unimpaired capital and
surplus of the institution, plus an additional 10% of unimpaired capital and
surplus for loans fully secured by readily marketable collateral.




At
December 31, 2007, the Bank’s loans-to-one-borrower limit was $2,112,029 based
upon the 15% of unimpaired capital and surplus measurement.  At
December 31, 2007, the Bank had no outstanding balances to a single borrower or
single relationship in excess of our legal lending limit.




Restrictions on transactions
with affiliates and loans to insiders.  The Bank is subject to
the provisions of section 23A of the Federal Reserve Act.  Section 23A
places limits on the amount of:




·
            a
      bank’s loans or extensions of credit to
  affiliates;




·
            a
      bank’s investment in affiliates;




·
            assets
      a bank may purchase from affiliates, except for real and personal property
      exempted by the Federal Reserve;




·
            the
      amount of loans or extensions of credit to third parties collateralized by
      the securities or obligations of affiliates;
and




·
            a
      bank’s guarantee, acceptance or letter of credit issued on behalf of an
      affiliate.




24









The total amount of the above transactions is limited in amount, as to any one
affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates
combined, to 20% of a bank’s capital and surplus.  In addition to the
limitation on the amount of these transactions, each of the above transactions
must also meet specified collateral requirements.  The Bank must also
comply with other provisions designed to avoid the taking of low-quality
assets.




The Bank
is also subject to the provisions of section 23B of the Federal Reserve Act
which, among other things, prohibits it from engaging in the transactions with
affiliates unless the transactions are on terms substantially the same, or at
least as favorable to the institution or its subsidiaries, as those prevailing
at the time for comparable transactions with nonaffiliated
companies.




The Bank
is also subject to restrictions on extensions of credit to its executive
officers, directors, principal shareholders and their related interests. These
extensions of credit (1) must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with third parties and (2) must not involve more than the normal
risk of repayment or present other unfavorable features.




Prompt corrective action and
other enforcement mechanisms - The “Federal Deposit Insurance Corporation
Improvement Act of 1991” (FDICIA) established a system of prompt corrective
action to resolve the problems of undercapitalized financial
institutions.  Under this system, the federal banking regulators have
established five capital categories (“well capitalized,” “adequately
capitalized,” “undercapitalized,” “significantly undercapitalized” and
“critically undercapitalized”), and all institutions are assigned one such
category.  Federal banking regulators are required to take various
mandatory supervisory actions and are authorized to take other discretionary
actions with respect to institutions in the three undercapitalized
categories.  The severity of the action depends upon the capital
category in which the institution is placed.  Generally, subject to a
narrow exception, the banking regulator must appoint a receiver or conservator
for an institution that is “critically undercapitalized.”




The
federal banking agencies have specified by regulation the relevant capital level
for each category.  An institution that is categorized as
“undercapitalized,” “significantly undercapitalized,” or “critically
undercapitalized” is required to submit an acceptable capital restoration plan
to its appropriate federal banking agency.  A bank holding company
must guarantee that a subsidiary depository institution meets its capital
restoration plan, subject to various limitations.  The controlling
holding company’s obligation to fund a capital restoration plan is limited to
the lesser of 5% of an “undercapitalized” subsidiary’s assets at the time it
became “undercapitalized” or the amount required to meet regulatory capital
requirements.  An “undercapitalized” institution is also generally
prohibited from increasing its average total assets, making acquisitions,
establishing any branches or engaging in any new line of business, except under
an accepted capital restoration plan or with FDIC approval.  The
regulations also establish procedures for downgrading an institution to a lower
capital category based on supervisory factors other than capital.




In
addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
of federal regulators for unsafe or unsound practices in conducting their
business or for violations of any law, rule, regulation, or any condition
imposed in writing by the agency or any written agreement with the agency.
Finally, pursuant to an interagency agreement, the FDIC can examine any
institution that has a substandard regulatory examination score or is considered
undercapitalized – without the express permission of the institution’s primary
regulator.




Premiums for deposit
insurance- The Bank’s deposits are insured up to applicable limits by
the Deposit Insurance Fund, or DIF, which is administered by the FDIC. The FDIC
insures deposits up to the




25


applicable
limits and this insurance is backed by the full faith and credit of the United
States government. As insurer, the FDIC imposes deposit insurance premiums and
is authorized to conduct examinations of and to require reporting by
institutions insured by the FDIC. It also may prohibit any institution insured
by the FDIC from engaging in any activity determined by regulation or order to
pose a serious risk to the institution. The FDIC also has the authority to
initiate enforcement actions against insured institutions and may terminate the
deposit insurance if it determines that an institution has engaged in unsafe or
unsound practices or is in an unsafe or unsound condition.




Under
regulations effective January 1, 2007, the FDIC adopted a new risk-based premium
system that provides for quarterly assessments based on an insured institution's
ranking in one of four risk categories based upon supervisory and capital
evaluations. Well-capitalized institutions (generally those with capital
adequacy, asset quality, management, earnings and liquidity, or "CAMELS"
composite ratings of 1 or 2) are grouped in Risk Category I and assessed for
deposit insurance at an annual rate of between five and seven basis points. The
assessment rate for an individual institution is determined according to a
formula based on a weighted average of the institution's individual CAMEL
component ratings plus either five financial ratios or, in the case of an
institution with assets of $10.0 billion or more, the average ratings of its
long-term debt. Institutions in Risk Categories II, III and IV are assessed at
annual rates of 10, 28 and 43 basis points, respectively. This assessment for
the year ended December 31, 2007 was approximately $26 thousand.




Branching - National
banks are required by the National Bank Act to adhere to branching laws
applicable to state banks in the states in which they are
located.  Under current California law, banks are permitted to
establish branch offices throughout California with prior regulatory
approval.  In addition, with prior regulatory approval, banks are
permitted to acquire branches of existing banks located in
California.  Finally, banks generally may branch across state lines by
merging with banks in other states if allowed by the applicable states’
laws.  California law, with limited exceptions, currently permits
branching across state lines through interstate mergers. Under the Federal
Deposit Insurance Act, states may “opt-in” and allow out-of-state banks to
branch into their state by establishing a new start-up branch in the
state.  California law currently permits de novo branching into the
state of California on a reciprocal basis, meaning that an out-of-state bank may
establish a new start-up branch in California only if its home state has also
elected to permit de novo branching into that state.




Expanded financial
activities - Similar to bank holding companies, the “Gramm-Leach-Bliley
Financial Services Modernization Act of 1999” (“GLB Act”), expanded the types of
activities in which a bank may engage.  Generally, a bank may engage
in activities that are financial in nature through a “financial subsidiary” if
the bank and each of its depository institution affiliates are “well
capitalized,” “well managed” and have at least a “satisfactory” rating under the
Community Reinvestment Act.  However, applicable law and regulation
provide that the amount of investment in these activities generally is limited
to 45% of the total assets of the Bank, and these investments are deducted when
determining compliance with capital adequacy guidelines.  Further, the
transactions between the Bank and this type of subsidiary are subject to a
number of limitations.




Expanded
financial activities of national banks generally will be regulated according to
the type of such financial activity: banking activities by banking regulators,
securities activities by securities regulators and insurance activities by
insurance regulators.  The Bank currently has no plans to conduct any
activities through financial subsidiaries.




Community Reinvestment
Act - The Community Reinvestment Act requires that, in connection with
examinations of financial institutions within their respective jurisdictions,
the Federal Reserve, the




26


FDIC, or
the Comptroller, shall evaluate the record of each financial institution in
meeting the credit needs of its local community, including low and
moderate-income neighborhoods. These facts are also considered in evaluating
mergers, acquisitions, and applications to open a branch or facility. Failure to
adequately meet these criteria could impose additional requirements and
limitations on the Bank. Because the Bank’s aggregate assets are currently less
than $250 million, under the Gramm-Leach-Bliley Act, the Bank is subject to a
Community Reinvestment Act examination only once every 60 months if it receives
an outstanding rating, once every 48 months if it receives a satisfactory rating
and as needed if its rating is less than satisfactory. Additionally, the Bank
must publicly disclose the terms of various Community Reinvestment Act-related
agreements. The Bank has not yet been examined by the OCC for compliance with
the Community Reinvestment Act obligations.




Fiscal and Monetary
Policies.Our business and
earnings are affected significantly by the fiscal and monetary policies of the
federal government and its agencies. We are particularly affected by the
policies of the Federal Reserve Board, which regulates the supply of money and
credit in the United States. Among the instruments of monetary policy available
to the Federal Reserve Board are (a) conducting open market operations in United
States government securities; (b) changing the discount rates of borrowings of
depository institutions, (c) imposing or changing reserve requirements against
depository institutions’ deposits, and (d) imposing or changing reserve
requirements against certain borrowings by banks and their affiliates. These
methods are used in varying degrees and combinations to directly affect the
availability of bank loans and deposits, as well as the interest rates charged
on loans and paid on deposits. The policies of the Federal Reserve Board may
have a material effect on our business, results of operations and financial
condition.




Federal
Reserve Board regulations require the Bank to maintain non-interest earning
reserves against the Bank’s transaction deposit accounts.  Currently,
the first $8.5 million of otherwise reservable balances are exempt from the
reserve requirement, a 3% reserve requirement applies to balances over $9.3
million up to $43.9 million and a 10% reserve requirement applies to balances
over $43.9 million.  The Bank was in compliance with these
requirements as of December 31, 2007.




Privacy
Provisions.  Banking regulators, as required under the GLB Act,
have adopted rules limiting the ability of banks and other financial
institutions to disclose nonpublic information about consumers to nonaffiliated
third parties. The rules generally require disclosure of privacy policies to
consumers and, in some circumstances, allow consumers to prevent disclosure of
certain personal information to nonaffiliated third parties. The privacy
provisions of the GLB Act affect how consumer information is transmitted through
diversified financial services companies and conveyed to outside
vendors.




The State
of California has adopted The California Financial Information Privacy Act
(“CFPA”), which took effect in 2004.  The CFPA requires a financial
institution to provide specific information to a consumer related to the sharing
of that consumer’s nonpublic personal information. A consumer may direct the
financial institution not to share his or her nonpublic personal information
with affiliated or nonaffiliated companies with which a financial institution
has contracted to provide financial products and services, and requires that
permission from the consumer be obtained by a financial institution prior to
sharing such information. These provisions are more restrictive than the privacy
provisions of the GLB Act.




In
December 2003, the U.S. Congress adopted, and President Bush signed, the Fair
and Accurate Transactions Act (the “FACT Act”). In 2005, federal courts
determined that the provisions of the CFPA limiting shared information with
affiliates are preempted by provisions of the GLB Act, the FACT Act and the Fair
Credit Reporting Act.




27


Anti-Money Laundering and
Customer Identification.  Congress enacted the Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on October 26, 2001 in
response to the terrorist events of September 11, 2001. The USA Patriot Act
gives the federal government new powers to address terrorist threats through
enhanced domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering requirements. In March
2006, Congress re-enacted certain expiring provisions of the USA Patriot
Act.




Future
Legislation.Legislation is
introduced from time to time in the U.S. Congress and the California State
Legislature that may affect the operations of Pacific Coast National Bancorp and
Pacific Coast National Bank.  This legislation may change banking
statutes and our operating environment in substantial and unpredictable ways. If
enacted, this legislation could increase or decrease the cost of doing business,
limit or expand permissible activities or affect the competitive balance among
banks, savings associations, credit unions, and other financial institutions. In
addition, the regulations governing us may be amended from time to time by the
respective regulators.  We cannot predict whether any such legislation
or regulatory changes will be enacted and, if enacted, the effect that it, or
any implementing regulations, would have on our business, results of operations
or financial condition.




All
of the above laws and regulations add significantly to the cost of
operating  Pacific Coast National Bancorp and the Bank, and thus have
a negative impact on our profitability. We also note that there has been a
tremendous expansion experienced in recent years by certain financial service
providers that are not subject to the same rules and regulations as the
Bank.  These institutions, because they are not so highly regulated,
have a competitive advantage over us and may continue to draw large amounts of
funds away from traditional banking institutions, with a continuing adverse
effect on the banking industry in general.




Risk
Factors




The
reader should carefully consider the following risk factors and all other
information contained in this report in connection with his, her or its
ownership of or investment in our securities.  These risks and
uncertainties are not the only ones faced by us.  Additional risks and
uncertainties not presently known to us or that we currently believe are
immaterial also may impair our business. If any of the events described in the
following risk factors occur, our business, results of operations and financial
condition could be materially adversely affected.  In addition, the
trading price of the Company’s stock could decline due to any of the events
described in these risks.




The
Company has a limited operating history upon which to base an estimate of its
future financial performance.




The
Company commenced active operations when it acquired the Bank on May 16,
2005.  At this time, the Company’s assets consist primarily of cash,
intangible assets related to its organizational efforts, and its ownership of
the Bank, and the Company’s growth is primarily dependent upon the operations of
the Bank.  Consequently, the Company has limited historical operating
or financial information from which to base an estimate of its future financial
performance.




The
liquidity of the Company’s common stock is affected by its limited trading
market.




The
Company’s shares do not at this time qualify for listing on any national
securities exchange, and we cannot assure you that our  shares will
ever be listed on a national securities exchange.  However, the shares
are traded on the OTC Bulletin Board and at least one company makes a market in
the Company’s common stock.  Because the shares are not listed on a
national securities exchange, the




28


Company
cannot assure you that a broadly followed, established trading market for its
common stock will ever develop or be maintained.  Furthermore, the
Company cannot assure you that at least one company will continue to make a
market in its shares for as long as it is quoted on the OTC Bulletin
Board.   Active trading markets generally result in lower price
volatility and more efficient execution of buy and sell orders.  In
addition, active trading markets tend to reduce the bid-ask spreads for sales
transactions.  On the other hand, the absence of an active trading
market would reduce the liquidity, and have an adverse effect on the market
value of the Company’s shares.  In addition, if the Company would
cease to be quoted on the OTC Bulletin Board, shareholders would find it more
difficult to dispose of, or to obtain accurate quotations as to the market value
of, the Company’s common stock, and the market value of the common stock likely
would decline.




The
Company expects to incur losses during its initial years of
operations.




The
Company incurred substantial start-up expenses associated with its organization
and public offering and expects to sustain losses or achieve minimal
profitability during its initial years of operations.  At December 31,
2007, the Company had an accumulated deficit account of approximately $12.8
million, of which $2.8 million resulted from the organizational and pre-opening
expenses that were incurred in connection with the opening of the Bank and $10.0
million resulted from operating losses from its first three years of operations.
Of these expenses, approximately $500 thousand, $1.5 million, and $770 thousand
in 2005, 2006, and 2007 respectively were related to share-based (stock option)
payments which went back into equity as additional paid-in
capital.  In addition, due to the extensive regulatory oversight to
which we are subject, we expect to continue to incur significant administrative
costs.  The Bank’s success will depend, in large part, on its ability
to attract and retain deposits and customers for its services.  In
addition, to gain market share as a de novo bank, the Bank may be required to
pay higher interest rates to attract deposits or extend credit at lower rates to
attract borrowers, which may decrease its profitability or prevent the Bank from
becoming profitable.  Management cannot assure you that the Company
will ever become profitable. If the Company is ultimately unsuccessful, you may
lose part or all of the value of your investment.




Our
emphasis on commercial lending may expose us to increased lending
risks.




Our
current business strategy is focused on the expansion of commercial real estate
and commercial business lending.  These types of lending activities,
while potentially more profitable than single-family residential lending, are
generally more sensitive to regional and local economic conditions, making loss
levels more difficult to predict.  Collateral evaluation and financial
statement analysis in these types of loans requires a more detailed analysis at
the time of loan underwriting and on an ongoing basis.  Recent
economic trends in our service areas have been relatively negative. A decline in
real estate values reduces the value of the real estate collateral securing our
loans and increases the risk that we would incur losses if borrowers defaulted
on their loans.  In addition, these loans generally expose a lender to
greater risk of non-payment and loss than one-to-four family residential
mortgage loans because repayment of the loans often depends on the successful
operation of the property and the income stream of the
borrowers.  Further, such loans typically involve larger loan balances
to single borrowers or groups of related borrowers compared to one- to
four-family residential mortgage loans. Also, many of our commercial borrowers
have more than one loan outstanding with us.  Consequently, an adverse
development with respect to one loan or one credit relationship can expose us to
a significantly greater risk of loss compared to an adverse development with
respect to a one-to-four family residential mortgage loan. Accordingly, when
there are defaults and losses on these types of loans, they are often larger on
a per loan basis than those for permanent single-family or consumer
loans.  A secondary market for most types of commercial real estate
and construction loans is not readily liquid, so we have less opportunity to
mitigate credit risk by selling part or all of our interest in these
loans.




29


A
slowdown in the housing market may have a negative impact on earnings and
liquidity position.




The
overall credit quality of our residential construction loan portfolio is
impacted by trends in residential housing prices. We continually monitor changes
in key economic factors such as unemployment and housing prices because changes
in these factors can impact our residential construction loan portfolio and the
ability of our borrowers to repay their loans.




Across
the United States over the past year, including California, the housing market
has experienced significant adverse trends, including accelerated price
depreciation and rising delinquency and default rates.  These
conditions led to significant increases in loan delinquencies and credit losses
as well as higher provisioning for loan losses which in turn have had a negative
affect on earnings for many banks across the country.  Likewise, we
have also experienced loan delinquencies in our residential construction loan
portfolio.  The current slowdown in the housing market may continue to
cause housing inventories to increase and slow ongoing housing developments,
putting more downward pressure on sales prices. Despite reduced sales prices,
the lack of liquidity in the housing market and tightening of credit standards
within the banking industry may continue to diminish all home sales, further
reducing the borrower builder’s cash flow and weakening their ability to repay
their debt obligations to us.  As a result, we may experience a
further negative material impact on our earnings and liquidity
positions.




Our
business strategy includes significant growth plans, and our financial condition
and results of operations could be negatively affected if we fail to grow or
fail to manage our growth effectively.




We intend
to continue pursuing a significant growth strategy for our
business.  Our growth initiatives are based upon recruiting
experienced personnel to lead such initiatives, and, accordingly, the failure to
identify and retain such personnel would place significant limitations on our
ability to execute our growth strategy.  In addition, achieving our
growth targets requires us to attract customers that currently have banking
relationships with other financial institutions in our service areas, thereby
increasing our share of the market.  To the extent we expand our
lending beyond our current service areas, we could incur additional risk related
to those new service areas.  We cannot assure that we will be able to
expand our market presence in our existing service areas or successfully enter
new markets or that any such expansion will not adversely affect our
profitability.  If we do not manage our growth effectively, we may not
be able to achieve our business plan, and our business, profitability and
prospects could be harmed.  Also, if our growth occurs more slowly
than anticipated or declines, our profitability could be materially adversely
affected.




Our
ability to successfully grow will depend on a variety of factors, including our
ability to attract and retain experienced bankers, the continued availability of
desirable business opportunities, the competitive responses from other financial
institutions in our market area and our ability to manage our
growth.  While we believe we have the executive management resources
and internal systems in place to successfully manage our future growth, there
can be no assurance growth opportunities will be available or that we will
successfully manage our growth.




Our
business is subject to various lending risks which could adversely impact our
results of operations and financial condition.




Our
commercial and multi-family real estate loans involve higher principal amounts
than other loans and repayment of these loans may be dependent on factors
outside our control or the control of our borrowers.




30


We
originate commercial and multi-family real estate loans for individuals and
businesses for various purposes which are secured by commercial
properties.  The credit risk related to commercial and multi-family
real estate loans is considered to be greater than the risk related to
one-to-four family residential or consumer loans because the repayment of
commercial and multi-family real estate loans typically is dependent on the
income stream of the real estate securing the loan as collateral and the
successful operation of the borrower’s business, which can be significantly
affected by conditions in the real estate markets or in the
economy.  For example, if the cash flow from the borrower’s project is
reduced as a result of leases not being obtained or renewed, the borrower’s
ability to repay the loan may be impaired.  In addition, many of our
commercial and multi-family real estate loans are not fully amortizing and
contain large balloon payments upon maturity.  These balloon payments
may require the borrower to either sell or refinance the underlying property in
order to make the balloon payment.




If we
foreclose on a commercial and multi-family real estate loan, our holding period
for the collateral typically is longer than for one-to-four family residential
mortgage loans because there are fewer potential purchasers of the
collateral.  Additionally, commercial and multi-family real estate
loans generally have relatively large balances to single borrowers or related
groups of borrowers.  Accordingly, if we make any errors in judgment
in the collectibility of our commercial and multi-family real estate loans, any
resulting charge-offs may be larger on a per loan basis than those incurred with
our residential or consumer loan portfolios.




Our
construction and development loans are based upon estimates of costs and value
associated with the complete project.




We make
land purchase, lot development and real estate construction loans to individuals
and builders, primarily for the construction of residential properties and, to a
lesser extent, commercial and multi-family real estate projects.  We
will originate these loans whether or not the collateral property underlying the
loan is under contract for sale.  Residential real estate construction
loans include single-family tract construction loans for the construction of
entry level residential homes.  Our construction and land development
loans are based upon estimates of costs and values associated with the completed
project, which may be inaccurate.  Construction and land development
lending involves additional risks when compared with permanent residential
lending because funds are advanced upon the security of the project, which is of
uncertain value prior to its completion.  Because of the uncertainties
inherent in estimating construction costs, as well as the market value of the
completed project and the effects of governmental regulation of real property,
it is relatively difficult to evaluate accurately the total funds required to
complete a project and the related loan-to-value ratio.  This type of
lending also typically involves higher loan principal amounts and is often
concentrated with a small number of builders.  These loans often
involve the disbursement of substantial funds with repayment primarily dependent
on the success of the ultimate project and the ability of the borrower to sell
or lease the property or obtain permanent take-out financing, rather than the
ability of the borrower or guarantor to repay principal and
interest.  If our appraisal of the value of a completed project proves
to be overstated, we may have inadequate security for the repayment of the loan
upon completion of construction of the project and may incur a
loss.




Repayment
of our commercial business loans is often dependent on the cash flows of the
borrower, which may be unpredictable, and the collateral securing these loans
may fluctuate in value.




Our
commercial business loans are primarily made based on the identified cash flow
of the borrower and secondarily on the underlying collateral provided by the
borrower.  Most often, this collateral consists of accounts
receivable, inventory or equipment.  Credit support provided by the
borrower for most of these loans and the probability of repayment is based on
the liquidation of the pledged collateral and enforcement of a personal
guarantee, if any exists.  As a result, in the case of
loans




31


secured
by accounts receivable, the availability of funds for the repayment of these
loans may be substantially dependent on the ability of the borrower to collect
amounts due from it customers.  The collateral securing other loans
may depreciate over time, may be difficult to appraise and may fluctuate in
value based on the success of the business.




If
our allowance for loan losses is not sufficient to cover actual loan losses, our
earnings could be reduced.




We make
various assumptions and judgments about the collectibility of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans.  In determining the amount of the allowance for loan
losses, we review our loans and our loss and delinquency experience, and
evaluate economic conditions.  Management recognizes that significant
new growth in loan portfolios, new loan products and the refinancing of existing
loans can result in portfolios comprised of unseasoned loans that may not
perform in a historical or projected manner.  If our assumptions are
incorrect, our allowance for loan losses may not be sufficient to cover actual
losses, resulting in additions to our allowance.  Material additions
to our allowance could materially decrease our net income.  In
addition, bank regulators periodically review our allowance for loan losses and
may require us to increase our provision for loan losses or recognize additional
loan charge-offs.  Any increase in our allowance for loan losses or
loan charge-offs as required by these regulatory authorities could have a
material adverse effect on our financial condition and
profitability.




Departures
of key personnel or directors may impair our operations.




Our
success depends in large part on the services and efforts of our key personnel
and on our ability to attract, motivate and retain highly qualified
employees.  Competition for employees is intense, and the process of
locating key personnel with the combination of skills and attributes required to
execute our business plan may be lengthy.




In
particular, we believe that retaining Michael Hahn, Stanley Cruse, David Adams,
and Terry Stalk are important to our success.  The loss of services of
any of these persons  for any reason, could materially adversely
affect our operations because other officers may not have the experience and
expertise to readily replace these individuals and attracting suitable
replacements may involve significant time and/or expense.




In order
to continue our expansion, we must attract and retain experienced banking
professionals. The competition to hire experienced banking professionals is
intense. If we are unable to attract qualified banking professionals, our
expansion plans could be delayed or curtailed. If we are unable to retain or
replace if needed our current banking professionals, our business, financial
condition, prospects and profitability may be adversely affected.




We
face intense competition from a variety of competitors.




We face
direct competition from a significant number of financial institutions, many
with a state-wide or regional presence, and in some cases a national presence,
in both originating loans and attracting deposits.  Competition in
originating loans comes primarily from other banks, mortgage companies and
consumer finance institutions that make loans in our primary market
areas.  We also face substantial competition in attracting deposits
from other banking institutions, money market and mutual funds, credit unions
and other investment vehicles.




32


In
addition, banks with larger capitalization and non-bank financial institutions
that are not governed by bank regulatory restrictions have large lending limits
and are better able to serve the needs of larger customers.  Many of
these financial institutions are also significantly larger and have greater
financial resources than us, have been in business for a long period of time and
have established customer bases and name recognition.




We
compete for loans principally on the basis of interest rates and loan fees, the
types of loans we originate and the quality of service we provide to
borrowers.  Our ability to attract and retain deposits requires that
we provide customers with competitive investment opportunities with respect to
rate of return, liquidity, risk and other factors.  To effectively
compete, we may have to pay higher rates of interest to attract deposits,
resulting in reduced profitability.  If we are not able to effectively
compete in our market area, our profitability may be negatively affected,
potentially limiting our ability to pay dividends.  The greater
resources and deposit and loan products offered by some of our competitors may
also limit our ability to increase our interest-earning assets.




We
continually encounter technological change, and we may have fewer resources than
many of our competitors to continue to invest in technological
improvements.




The
financial services industry is undergoing rapid technological changes, with
frequent introductions of new technology-driven products and
services.  The effective use of technology increases efficiency and
enables financial institutions to better serve customers and to reduce
costs.  Our future success will depend, in part, upon our ability to
address the needs of our clients by using technology to provide products and
services that will satisfy client demands for convenience, as well as to create
additional efficiencies in our operations.  Many of our competitors
have substantially greater resources to invest in technological
improvements.  We may not be able to effectively implement new
technology-driven products and services or be successful in marketing these
products and services to our customers.




The
Bank’s legal lending limits may impair its ability to attract
borrowers.




The
Bank’s current legally mandated lending limits are lower than those of many of
its competitors because it has less capital than many of its
competitors.  The lower lending limits may discourage potential
borrowers who have lending needs that exceed these limits, which may restrict
the Bank’s ability to establish relationships with larger businesses in its
market area.




An
economic downturn, especially one affecting our primary service areas, may have
an adverse effect on our financial performance.




Our
success depends on the general economic condition of the region in which we
operate, which management cannot forecast with certainty.  Unlike many
of our larger competitors, substantially all of our borrowers and depositors are
individuals and businesses located or doing business in our service
areas.  As a result, our operations and profitability may be more
adversely affected by a local economic downturn than those of our larger, more
geographically diverse competitors Adverse economic conditions in our service
areas could reduce our growth rate, affect the ability of our customers to repay
their loans, adversely affect the values of our real estate collateral, reduce
our deposit base and the demand for our products and services. Conditions such
as inflation, recession, unemployment, high interest rates, short money supply,
scarce natural resources, international disorders, terrorism and other factors
beyond our control may adversely affect our profitability.  We do not
have the ability of a larger institution to spread the risks of unfavorable
local economic conditions across a large number of diversified
economies.  Any sustained period of increased payment delinquencies,
foreclosures or losses caused by adverse market or economic conditions in the
State of California could adversely affect the value of our assets, revenues,
profitability and financial condition.




33






We
could be negatively affected by changes in interest rates.




Our
profitability, like most financial institutions, depends to a large extent upon
our net interest income, which is the difference between our interest income on
interest-earning assets, such as loans and securities, and our interest expense
on interest-bearing liabilities, such as deposits and borrowed funds.
Accordingly, our results of operations depend largely on movements in market
interest rates and our ability to manage our interest-rate-sensitive assets and
liabilities in response to these movements.




Recently
the U.S. Federal Reserve has decreased its target for the federal funds rate
from 5.25% to 2.25%. Decreases in interest rates can result in increased
prepayments of loans and mortgage-related securities, as borrowers refinance to
reduce their borrowing costs. Under these circumstances, we are subject to
reinvestment risk as we may have to redeploy such loan or securities proceeds
into lower-yielding assets, which might also negatively impact our
income.




We
principally manage interest rate risk by managing our volume and mix of our
earning assets and funding liabilities. In a changing interest rate environment,
we may not be able to manage this risk effectively. If we are unable to manage
interest rate risk effectively, our business, financial condition and results of
operations could be materially harmed. Changes in the general level of interest
rates also affect, among other things, the Bank’s ability to originate loans,
the value of interest-earning assets and its ability to realize gains from the
sale of such assets, the average life of interest-earning assets, and the Bank’s
ability to obtain deposits in competition with other available investment
alternatives.  Interest rates are highly sensitive to many factors,
including government monetary policies, domestic and international economic and
political conditions and other factors beyond the Bank’s
control.  Because fluctuations in interest rates are not predictable
or controllable, management cannot assure you that the Bank will continue to
achieve positive net interest income.




Our
ability to pay dividends is limited.




The
Company currently has no material source of income other than dividends that it
receives from the Bank.  Therefore, the Company’s ability to pay
dividends to its shareholders depends on the Bank’s ability to pay dividends to
the Company.  The board of directors of the Bank intends to retain
earnings to promote growth and build capital and recover any losses incurred in
prior periods.  The Bank is currently prohibited by the regulators
from paying dividends without regulatory approval until our accumulated deficit
has been eliminated.  Accordingly, the Company does not expect to
receive dividends from the Bank in the foreseeable future.  In
addition, banks and bank holding companies are both subject to certain
regulatory restrictions on the payment of cash dividends.




We
are subject to extensive regulatory oversight, which could restrain growth and
profitability.




We are
subject to extensive federal and state regulation and
supervision.  Laws and regulations affecting financial institutions
are undergoing continuous change, and management cannot predict the ultimate
effect of these changes.   Regulatory authorities have extensive
discretion in their supervisory and enforcement activities, including the
imposition of restrictions on our operations, the classification of our assets
and determination of the level of our allowance for loan losses.  Any
change in this regulation and oversight, whether in the form of regulatory
policy, regulations, legislation or supervisory action, may have a material
impact on our operations or otherwise materially and adversely affect our
business, financial condition, prospects or profitability.




34


If
external funds are not available, this could adversely impact our growth and
future prospects.




The Bank
relies on deposits, brokered deposits, and other borrowings to fund its
operations.  Although we have been able to replace maturing deposits
if desired, no assurance can be given that we will be able to replace such funds
in the future if our financial condition or market conditions were to
change.  Although we consider the sources of existing funds adequate
for our current liquidity needs, we may seek additional brokered deposits or
debt in the future to achieve our long-term business
objectives.  There can be no assurance additional funds, if sought,
would be available to us or, if available, would be on favorable
terms.  If additional financing sources are unavailable or are not
available on reasonable terms, our growth and future prospects could be
adversely affected.




In the
future, should the Company need additional capital to support the business of
the Company or the Bank, expand operations or maintain minimum capital
requirements, the Company may not be able to raise additional funds through the
issuance of additional shares of common stock or other
securities.  Our ability to raise additional capital, if needed, will
depend on conditions in the capital markets at that time, which are outside our
control, and on our financial performance. Accordingly, we cannot assure you of
our ability to raise additional capital if needed or on terms acceptable to us.
If we cannot raise additional capital when needed, our ability to further expand
our operations could be materially impaired. Even if the Company is able to
obtain capital through the issuance of additional shares of common stock or
other securities, the sale of these additional shares could significantly dilute
your ownership interest.




The
Company’s directors and executive officers could have the ability to influence
shareholder actions in a manner that may be adverse to your personal investment
objectives.




As of
December 31, 2007, directors and executive officers of the Company owned 120,635
shares of the Company’s common stock, which represents approximately 5.3% of its
issued and outstanding common stock.  Additionally, the Company has
issued warrants to the Company’s directors and has issued stock options to the
Bank’s executive officers. If the outside directors exercised all of their
warrants, they would own shares upon exercise representing as much as 6.7% of
the Company’s then outstanding common stock.  Moreover, although all
of the employee stock options are not immediately exercisable, upon exercise of
the employee stock options issued to the Bank’s executive officers, together
with the exercise of warrants held by the directors, the Company’s directors and
executive officers would own shares representing as much as 16.1% of the
Company’s then outstanding shares of common stock.




Due to
their significant ownership interests, the Company’s directors and executive
officers may be able to exercise significant influence over the management and
affairs of the Company and the Bank.  For example, using their voting
power, the directors and executive officers may be able to influence the outcome
of director elections or block significant transactions, such as a merger or
acquisition, or any other matter that might otherwise be approved by the
shareholders.




The
Company’s articles of incorporation and bylaws and the laws of the State of
California contain provisions that could make a takeover more
difficult.




The
Company’s articles of incorporation and bylaws, and the corporate laws of the
State of California, include provisions designed to provide the board of
directors with time to consider whether a hostile takeover offer is in the
Company’s and shareholders’ best interests, but could be utilized by the board
of directors to deter a transaction that would provide shareholders with a
premium over the market price of the Company’s shares.




These
provisions include the availability of authorized, but unissued shares, for
issuance from time to time at the discretion of the Company’s board of
directors; bylaws provisions enabling the board




35


of
directors to increase the size of the board and to fill the vacancies created by
the increase; bylaw provisions establishing advance notice procedures with
regard to business to be presented at a shareholder meeting or to director
nominations (other than those by or at the direction of the board); and “change
in control” provisions in the employment agreements of each of the Bank’s four
senior executive officers providing for lump sum cash payments of 199% of each
officer’s base compensation.  The California Corporations Code also
contains provisions intended to protect shareholders and prohibit or discourage
various types of hostile takeover activities.




These
provisions may discourage potential acquisition proposals and could delay or
prevent a change in control, including under circumstances where the
shareholders might otherwise receive a premium over the market price of the
Company’s shares.  These provisions may also have the effect of making
it more difficult for third parties to cause the replacement of current
management and may limit the ability of shareholders to approve transactions
that they may deem to be in their best interests.




Item
2.  Description of Property




The Bank
maintains two locations.  Its main branch location, which is also the
principal executive office of the Company, is located at 905 Calle Amanecer,
Suite 100, San Clemente, California 92673.  The Bank occupies 10,130
square feet of the main lobby-accessed ground floor of a 45,000 square foot,
freestanding, three-story office building. The Bank also operates a branch
office located at the intersection of North El Camino Real and Garden View in
Encinitas, California, which is approximately 37 miles south of the main
office.  The branch office occupies 4,284 square feet in a commercial
building in a developed commercial center.  The Bank has entered into
lease agreements with respect to each of the banking locations.  The
aggregate commitments under the leases are set forth in the notes to the audited
financial statements included in this Form 10-KSB.  At this time, the
Bank does not intend to own any of the properties from which it will conduct
banking operations.   Management believes that these facilities
are adequate to meet the present needs of the Company and Bank.




Item
3.  Legal Proceedings




There are
no material pending legal proceedings to which the Company or the Bank is a
party or to which any of its properties are subject; nor are there material
proceedings known to the Company, in which any director, officer or affiliate or
any principal stockholder is a party or has an interest adverse to the Company
or the Bank.




Item
4.  Submission of Matters to a Vote of Security
Holders




No
matters were submitted to a vote of the stockholders during the fourth quarter
of 2006.




PART
II




Item
5.  Market for Common Equity and Related Stockholder
Matters




Market
Price of Common Stock




The
Company’s common stock is traded over the counter on the OTC Bulletin Board
under the symbol “PCST.OB”.  Continental Stock Transfer & Trust
Company is the Company’s transfer agent and registrar, and is able to respond to
inquiries from shareholders on its website: www.continentalstock.com  or
at its mailing address: 17 Battery Place, 8th Floor, New York, New York,
10004.  The following table sets forth the high and low sales prices
for the periods indicated below.






36






Year
      Ended December 31, 2007:
            
            High
            
            
            LowFirst
      Quarter
            
            $
            12.00
            
            
            $
            9.60Second
      Quarter
            
            
            11.00
            
            
            
            9.85Third
      Quarter
            
            
            10.00
            
            
            
            8.75Fourth
      Quarter
            
            
            9.00
            
            
            
            6.50Year
      Ended December 31, 2006:
            
            High
            
            
            LowFirst
      Quarter
            
            $
            14.50
            
            
            $
            11.75Second
      Quarter
            
            
            14.50
            
            
            
            12.25Third
      Quarter
            
            
            13.00
            
            
            
            12.00Fourth
      Quarter
            
            
            13.50
            
            
            
            11.85





Holders




As of
December 31, 2007, there were approximately 496 holders of record.




Dividends




The
Company has never declared or paid dividends on its common stock.  In
addition, the Company expects to retain future earnings, if any, for use in the
operation and expansion of the Bank’s business and does not anticipate paying
any cash dividends in the foreseeable future.  Any determination to
pay dividends in the future will be at the discretion of the board of directors
and will, among other factors, depend upon regulatory requirements and
restrictions, the Company’s results of operations, its financial condition and
capital requirements.  Because, as a holding company, the Company
conducts no material activities at this time other than holding the common stock
of the Bank, its ability to pay dividends depends on the receipt of dividends
from the Bank.  The board of directors of the Bank intends to retain
earnings to promote growth and build capital and to recover any losses incurred
in prior periods.  Accordingly, the Company does not expect to receive
dividends from the Bank in the foreseeable future.  In addition, banks
and bank holding companies are both subject to certain regulatory restrictions
on the payment of cash dividends.  In the case of the Company, for
example, the existence of any cash at the Company in order to be able to pay
dividends to shareholders of the Company is substantially dependent on the
earnings of the Bank and the payment of dividends by the Bank to the Company, as
the Bank’s sole shareholder.  The Bank is currently prohibited by the
regulators from paying dividends without regulatory approval until the
accumulated deficit has been eliminated. For additional discussion of legal and
regulatory restrictions on the payment of dividends, see “Part I – Item
1.  Description of Business – Supervision and
Regulation.”




Securities
Authorized For Issuance Under Equity Compensation Plans




The
shareholders of the Company approved the Pacific Coast National Bancorp 2005
Stock Incentive Plan at the 2006 annual meeting.




37







Equity
Compensation Plan Information


Plan
      Category
            Number
      of Securities to be issued upon exercise of outstanding options, warrants,
      and rights
            Weighted-average
      exercise price of outstanding options, warrants and rights
            Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column
      (a))(a)
            (b)
            (c)Equity
      compensation plans approved by security holders
            1,088,647
            $11.16
            78,454Equity
      compensation plans not approved by security holders
            -
            -
            -Total
            1,088,647
            $11.16
            78,454







Recent
Sales of Unregistered Securities




None




Item
6.  Management’s Discussion and Analysis or Plan of
Operation




The
purpose of the following discussion is to address information relating to our
financial condition and results of operations that may not be readily apparent
from the financial statements and notes included in this Report.  This
discussion should be read in conjunction with the information provided in our
financial statements and the notes thereto. The financial information provided
below has been rounded in order to simplify its
presentation.  However, the ratios and percentages provided below are
calculated using the detailed financial information contained in the
consolidated financial statements, the notes thereto and the other financial
data included elsewhere in this Annual Report.




General




Pacific
Coast National Bancorp is a bank holding company headquartered in San Clemente,
California, offering a broad range of commercial and consumer banking services
through its wholly-owned subsidiary, Pacific Coast National Bank.  As
of December 31, 2007, on a consolidated basis, we had total assets of $112.5
million, net loans of $96.1 million, total deposits of $99.0 million and
shareholders’ equity of $12.8 million.




The
following discussion focuses on our financial condition and results of
operations as of and for the years ended December 31, 2007 and 2006, presented
on a consolidated basis.




Critical
accounting policies




This
discussion and analysis of our financial condition and results of operations is
based upon the Company’s financial statements, which have been prepared in
accordance with United States generally accepted accounting
principles.  The preparation of these consolidated financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets and liabilities, revenues and expenses, and related
disclosures of contingent assets and liabilities at the date of the




38


financial
statements.  Actual results may differ from these estimates under
different assumptions or conditions.  The following is a description
of the Company’s significant accounting policies used in the preparation of the
accompanying consolidated financial statements.




Allowance
for credit losses




Management
considers the policies related to the allowance for loan losses as the most
critical to the financial statement presentation. The total allowance for loan
losses includes activity related to allowances calculated in accordance with
Statement of Financial Accounting Standards (SFAS) No. 114, Accounting
by Creditors for Impairment of a Loan, and SFAS No. 5, Accounting for
Contingencies.




The
allowance for losses on loans represents management’s best estimate of probable
losses inherent in the existing loan portfolio.  The allowance for
losses on loans is increased by the provision for losses on loans charged to
expense and reduced by loans charged-off, net of recoveries.  The
provision for losses on loans is determined based on management’s assessment of
several factors: reviews and evaluations of specific loans, changes in the
nature and volume of the loan portfolio, current and anticipated economic
conditions and the related impact on specific borrowers and industry groups,
historical loan loss experience, the level of classified and nonperforming loans
and the results of regulatory examinations. In addition, because the Bank has no
history on which to base future loan losses, a comparison of peer group
allowance to gross loans ratios is made with the intention of maintaining
similar levels during the Bank’s first few years of operations.




The
allowance for loan losses is comprised of specific reserves assigned to certain
classified loans and general reserves.  Factors contributing to the
determination of specific reserves include the credit-worthiness of the
borrower, and more specifically, changes in the expected future receipt of
principal and interest payments and/or in the value of pledged
collateral.  A reserve is recorded when the carrying amount of the
loan exceeds the discounted estimated cash flows using the loan’s initial
effective interest rate or the fair value of the collateral for certain
collateral dependent loans.  For purposes of determining the general
reserve, the portfolio is segregated by product types in order to recognize
differing risk profiles among categories, and then further segregated by credit
grades.




The loan
loss allowance is based on the most current review of the loan portfolio at that
time. The servicing officer has the primary responsibility for updating
significant changes in a customer’s financial position.  Each officer
prepares status updates on any credit deemed to be experiencing repayment
difficulties which, in the officer’s opinion, would place the collection of
principal or interest in doubt.  The internal loan review department
for the Bank is responsible for an ongoing review of its entire loan portfolio
with specific goals set for the volume of loans to be reviewed on an annual
basis.




At each
review of a credit, a subjective analysis methodology is used to grade the
respective loan. Categories of grading vary in severity to include loans which
do not appear to have a significant probability of loss at the time of review to
grades which indicate a probability that the entire balance of the loan will be
uncollectible.  If full collection of the loan balance appears
unlikely at the time of review, estimates or appraisals of the collateral
securing the debt are used to allocate the necessary allowances. A list of loans
or loan relationships of $150 thousand or more, which are graded as having more
than the normal degree of risk associated with them, is maintained by the
internal loan review officer.  This list is updated on a periodic
basis, but no less than quarterly in order to properly allocate the necessary
allowance and keep management informed on the status of attempts to correct the
deficiencies noted in the credit.




Loans are
considered impaired if, based on current information and events, it is probable
that the Bank will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan
agreement.  The measurement of impaired loans is generally based on
the




39


present
value of expected future cash flows discounted at the historical effective
interest rate stipulated in the loan agreement, except that all
collateral-dependent loans are measured for impairment based on fair value of
the collateral. In measuring the fair value of the collateral, management uses
assumptions (e.g., discount rates) and methodologies (e.g., comparison to the
recent selling price of similar assets) consistent with those that would be
utilized by unrelated third parties.




Changes
in the financial condition of individual borrowers, in economic conditions, in
historical loss experience and in the conditions of the various markets in which
collateral may be sold may all affect the required level of the allowance for
losses on loans and the associated provision for loan losses.




As of
December 31, 2007, a review of the loan portfolio indicated that a loan
loss allowance of $1.8 million was adequate to cover probable losses in the
portfolio.  Refer to Notes to Consolidated Financial Statements,
Note A - Summary of Significant Accounting and Reporting Policies,
Provision and Allowance for Loan Losses for a detailed description of
management’s estimation process and methodology related to the allowance for
loan losses.




Share-based
compensation




The
Company accounts for stock-based employee compensation as prescribed by SFAS No.
123(Revised), Share-Based Payment. This standard revised SFAS No. 123, APB
Opinion No. 25 and related accounting interpretations, and eliminates the use of
the intrinsic value method for employee stock-based compensation. SFAS No.
123(R) requires compensation costs related to share-based payment transactions
to be recognized in the financial statements over the period that an employee
provides service in exchange for the award.




The
Company uses the Black-Scholes option pricing model to estimate the fair values
of the options granted. The estimates that are a part of the calculation for the
compensation costs include the expected life of the stock options, the risk-free
interest rate, expected volatility, dividend yield and the forfeiture rate of
pre-vested options. These estimates have significant influence over the final
expense and the Company does have not a history on which to base these
assumptions. Refer to Notes to Consolidated Financial Statements, Note A -
Summary of Significant Accounting and Reporting Policies, Change In Accounting
Principle for a detailed description of management’s estimation process and
methodology related to stock-based payments.




Deferred
Taxes




Deferred
income taxes are computed using the asset and liability method, which recognizes
a liability or asset representing the tax effects, based on current tax law, of
future deductible or taxable amounts attributable to events that have been
recognized in the financial statements.  A valuation allowance is
established to reduce the deferred tax asset to the level at which it is “more
likely than not” that the tax asset or benefits will be
realized.  Realization of tax benefits of deductible temporary
differences and operating loss carryforwards depends on having sufficient
taxable income of an appropriate character within the carryforward
periods.





In June,
2006, the FASB issued Financial Interpretation (“FIN”) No. 48, “Accounting for
Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in
income taxes recognized in the financials statements in accordance with SFAS No.
109, “Accounting For Income Taxes.” FIN No. 48 provides that a tax benefit from
an uncertain tax position may be recognized when it is more likely than not that
the position will be sustained upon examination, including resolutions of any
related appeals or litigation processes, based on the technical merits. Income
tax positions must meet a more-likely-than




40


not
recognition threshold at the effective date to be recognized upon the adoption
of FIN 48 and in subsequent periods. This interpretation also provides guidance
on measurement, derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.




We
adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes”, on January 1, 2007, with no effect on the
Company’s consolidated financial statements.




We
recognize interest and penalties, if any, related to unrecognized tax
benefits with the income tax expense line in other non-interest expenses.
Accrued interest and penalties, if any, are included in other liabilities in the
consolidated balance sheet.




Recent
Accounting Pronouncements




In
March 2006 the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 156 (“SFAS 156”),
Accounting for Servicing of Financial Assets—an Amendment of FASB Statement
No. 140, which will permit the Bank, beginning in 2007, to choose between
two different methods of measuring ongoing changes in the value of its SBA loan
servicing asset: the amortization method or the fair value measurement method.
The Company has chosen the amortization method for the year ended December 31,
2007.




In June
2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes – an interpretation of FASB Statement 109” (“FIN 48”). FIN 48
establishes a single model to address accounting for uncertain tax positions.
FIN 48 clarifies the accounting for income taxes by prescribing a minimum
recognition threshold a tax position is required to meet before being recognized
in the financial instruments. FIN 48 also provides guidance on derecognition,
measurement classification, interest and penalties, accounting in interim
periods, disclosure and transition. There was no effect on the Company upon
adoption on January 1, 2007.




In
September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS
157”). SFAS 157 clarifies the principal that fair value should be based on the
assumptions market participants would use when pricing an asset or liability and
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. Under the standard, fair value measurements would be
separately disclosed by level within the fair value hierarchy. In February 2008,
the FASB issued FASB Staff Position (FSP) No. 157-2, “Effective Date of FASB
Statement No. 157”, to partially defer FASB Statement No. 157 for nonfinancial
assets and nonfinancial liabilities, except those that are recognized or
disclosed at fair value  in the financial statement on a recurring
basis. SFAS 157 is effective for us on January 1, 2008, except for nonfinancial
assets and nonfinancial liabilities that are not recognized or disclosed at fair
value on a recurring basis for which our effective date is January 1, 2009. We
are in the process of evaluating SFAS No. 157 and do not believe it will have a
significant effect on our financial position, results of operations and cash
flows.




In
February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115”. SFAS 159 permits an entity to choose to measure many financial instruments
and certain other items at fair value. Most of the provisions of SFAS 159 are
elective, however, the amendment to SFAS 115, “Accounting for Certain
Investments in Debt and Equity Securities”, applies to all entities with
available for sale or trading securities. SFAS 159 is elective as of the
beginning of an entity’s first fiscal year that begins after November 15, 2007.
We are currently assessing this statement to determine whether or not we would
elect to measure any financial instruments at their fair value.




41


Executive
Overview




Introduction




Pacific
Coast National Bancorp is a bank holding company headquartered in San Clemente,
California, offering a broad array of banking services through its wholly owned
banking subsidiary, Pacific Coast National Bank. In 2005, the Company completed
an initial public offering of its common stock, issuing 2,280,000 shares at a
price of $10.00 per share. The net proceeds received from the offering were
approximately $20.5 million. The Bank opened for business on May 16,
2005.




Our
principal markets include the coastal regions of Southern Orange County and
Northern San Diego County. As of December 31, 2007, we had, on a consolidated
basis, total assets of $112.5 million, net loans of $96.1 million, total
deposits of $99.0 million, and shareholders' equity of $12.8 million. We
currently operate through our main branch office located at 905 Calle Amanecer
in San Clemente, California and a branch office at 499 North El Camino Real in
Encinitas, California.




We incurred a net loss for 2007 of ($4.0) million or ($1.77) per share,
as compared to a net loss of ($4.2) million, or ($1.84) per share, during 2006.
The improvement in loss per share for the year was primarily attributable to a
73% increase in net interest income, a 383% increase in non-interest income
partially offset by a 13% increase in non-interest expense income and a
reduction in non-cash expense related to our adoption of FAS 123R to $770
thousand in 2007 compared to $1.5 million for 2006. The 2007 loss resulted in a
return on average assets of (5.3%) and a return on average equity of (28.1%).
The 2006 loss resulted in a return on average assets of (9.6%) and a return on
average equity of (24.2%).




The
following discussion focuses on our financial condition as of December 31, 2007
and results of operations for the years ended December 31, 2007 and
2006.




Results
of Operations




Net
Interest Income and Net Interest Margin




Net
interest income is the difference between interest income, principally from loan
and investment securities portfolios, and interest expense, principally on
customer deposits. Net interest income is the Bank's principal source of
earnings. Changes in net interest income result from changes in volume, spread
and margin. Volume refers to the average dollar level of interest-earning assets
and interest-bearing liabilities. Spread refers to the difference between the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities. Margin refers to net interest income divided by
average interest-earning assets, and is influenced by the level and relative mix
of interest-earning assets and interest-bearing liabilities.




Net
interest income for 2007 before the provision for loan losses was $3.5 million
compared to  $2.0 million for 2006. This growth was attributable to
the increase in the volume of earning assets and the greater percentage of loans
as a part of earning assets in 2007.




During
2007, loans accounted for 81% of average earning assets, with a weighted average
yield of 8.08%, compared to 2006 when 50% of the average earning assets were
loans, with a weighted average yield of 8.35%. The increase in loans as a
percentage of average earning assets occurred as a result of significantly
increased loan originations in 2007 and a reduction in investment securities in
2007 in order to provide funding for the loan growth. The decrease in the
average yield resulted from the competitive pricing environment. Total loan
interest income was $4.8 million, including net loan fees of $24




42


thousand,
for 2007 compared to $1.7 million in total loan interest income, including $56
thousand in loan fees, in 2006.




Other
earning assets consist of investments, capital stock of the Federal Reserve
Bank, time deposits with other financial institutions and overnight fed funds.
Fed funds sold averaged $10.7 million in 2007 with an average yield of 5.24%
compared to an average of $11.2 million in 2006 with an average yield of 5.07%.
The increase in the rate in 2007 compared to 2006 was the result of increases in
rates set by the Federal Reserve Bank. Investments, capital stock of the Federal
Reserve Bank, and time deposits with other financial institutions averaged $3.3
million with a yield of 5.06% for 2007 compared to 2006 with an average of $9.5
million with a yield of 4.53%. The increase in the average yield for 2007
occurred as result of higher yields on the investment securities and on time
deposits with other financial institutions.  Total interest earned on
other earning assets was $729 thousand in 2007 compared to $999 thousand in
2006.




Interest-bearing
liabilities, consisting entirely of deposits, averaged $45.4 million with an
average rate of 4.37% during 2007, compared with $18.2 million in
interest-bearing deposits at a rate of 3.67% for 2006.  Total interest
expense was $2.0 million in 2007 compared to $667 thousand in 2006. The increase
in the average rate on deposit products was the result of competitive pressures
within our market areas, a high-yield money market account with the rate tied to
the fed funds rate for large-balance customers, and the utilization of brokered
deposits which in general have higher rates than core deposits. The increases in
deposits in the 2007 periods occurred as a result of our marketing campaigns,
the cross-selling of deposit products to our borrowers, direct sales calls and
utilization of brokered deposits in order to fund increased loan
demand.




Due to
strong loan demand, we began utilizing brokered deposits in 2007. As discussed
under "Capital Resources and Capital Adequacy Management", we seek to limit the
amount of brokered deposits as their utilization typically would be expected to
increase our overall cost of funds. As of December 31, 2007, $28.2 million in
brokered funds were on deposit with an average rate of 4.94%. Total interest
expense for these deposits was $331 thousand in 2007. These deposits are
included in other time certificate of deposits.




The net
interest margin was 4.81% for 2007 compared to 4.94% for 2006. Non-interest
bearing demand account balances averaged $16.9 million for 2007, representing
27.1% of total deposits as compared $8.1 million, representing 30.7% of total
deposits for 2006. While the dollar amount of demand deposits has continually
increased, the percentage of demand deposits to total deposits has decreased.
This was the result of an increase in money market accounts in response to the
new high-yield variable-rate account and the increase in time deposits to
maintain liquidity as the loan portfolio has grown.




We earned
$3.5 million in net interest income on average interest-earning assets of $72.9
million for 2007 compared to $2.0 million in net interest income on $41.1
million in average earning assets for 2006. Net interest income before provision
for loan losses increased by $1.6 million due primarily to the increase in
volume of earning assets, and decreased by $132 thousand due primarily to higher
interest rates.




The
following tables set forth, for the period indicated, information related to the
Company’s average balance sheet and its average yields on assets and average
costs of liabilities.  These yields are derived by dividing income or
expense by the average balance of the corresponding assets or liabilities and
are then annualized.  Average balances have been derived from the
daily balances for the years ended December 31.






43






2007
              
              
              
              
              
              
              
              
              2006Average
                Balance
              
              
              Interest
              
              
              Average
                Yield/
                Cost
              
              
              Average
                Balance
              
              
              Interest
              
              
              Average
                Yield/
                CostAssets:Interest-earning
      Assets:Net
      Loans Receivable (1)
              
              $
              58,873,470
              
              
              $
              4,759,241
              
              
              
              8.08
              %
              
              $
              20,329,370
              
              
              $
              1,697,765
              
              
              
              8.35
              %Investment
      Securities
              
              
              2,647,502
              
              
              
              128,488
              
              
              
              4.85
              %
              
              
              8,221,242
              
              
              
              366,555
              
              
              
              4.46
              %Investment
      in capital stock of Federal Reserve
                Bank and Other Investments
              
              
              655,638
              
              
              
              38,652
              
              
              
              5.90
              %
              
              
              1,311,362
              
              
              
              64,820
              
              
              
              4.94
              %Fed
      funds sold
              
              
              10,725,184
              
              
              
              561,922
              
              
              
              5.24
              %
              
              
              11,206,329
              
              
              
              568,115
              
              
              
              5.07
              %Total
      interest-earning assets
              
              
              72,901,794
              
              
              
              5,488,303
              
              
              
              7.53
              %
              
              
              41,068,303
              
              
              
              2,697,255
              
              
              
              6.57
              %Noninterest-earning
      assets
              
              
              3,763,248
              
              
              
              
              
              
              
              
              
              
              
              2,787,097Total
      Assets
              
              $
              76,665,042
              
              
              
              
              
              
              
              
              
              
              $
              43,855,400Liabilities
      and Stockholders' EquityMoney
      Market and Savings Deposits
              
              $
              29,389,779
              
              
              $
              1,300,882
              
              
              
              4.43
              %
              
              $
              10,187,531
              
              
              
              391,078
              
              
              
              3.84
              %Interest-bearing
      Checking
              
              
              3,161,019
              
              
              
              41,927
              
              
              
              1.33
              %
              
              
              1,998,966
              
              
              
              26,850
              
              
              
              1.34
              %Time
      Deposits of $100,000 or more
              
              
              3,113,659
              
              
              
              163,313
              
              
              
              5.25
              %
              
              
              3,749,227
              
              
              
              171,437
              
              
              
              4.57
              %Other
      Deposits
              
              
              9,752,208
              
              
              
              478,356
              
              
              
              4.91
              %
              
              
              2,248,361
              
              
              
              78,000
              
              
              
              3.47
              %Total
      Interest-bearing liabilities
              
              
              45,416,666
              
              
              
              1,984,478
              
              
              
              4.37
              %
              
              
              18,184,085
              
              
              
              667,365
              
              
              
              3.67
              %Non-interest
      bearing checking accounts
              
              
              16,865,775
              
              
              
              
              
              
              
              
              
              
              
              8,072,933Non-interest
      bearing liabilities
              
              
              448,882
              
              
              
              
              
              
              
              
              
              
              
              237,144Stockholders'
      Equity
              
              
              13,933,719
              
              
              
              
              
              
              
              
              
              
              
              17,361,238Total
      Liabilities andStockholders'
      Equity
              
              $
              76,665,042
              
              
              
              
              
              
              
              
              
              
              $
              43,855,400Net
      Interest Income
              
              
              
              
              
              $
              3,503,825
              
              
              
              
              
              
              
              
              
              
              $
              2,029,890Net
      Interest Spread (2)
              
              
              
              
              
              
              3.16
              %
              
              
              
              
              
              
              
              
              
              
              2.90
              %Net
      Interest Margin (3)
              
              
              
              
              
              
              4.81
              %
              
              
              
              
              
              
              
              
              
              
              4.94
              %




(1)
            Loan fees
      (costs) are included in total interest income as follows: 2007 $24
      thousand; 2006 $56 thousand.(2)
            Net interest
      spread represents the yield earned on average total interest-earning
      assets less the rate paid on average interest-bearing
      liabilities.(3)
            Net interest
      margin is computed by dividing annualized net interest income by average
      total interest-earning assets.






The
following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected interest income and interest expense in 2007 compared
to 2006. Because the Bank grew significantly in 2007, changes due to volume
account for a significant majority of the overall change. Information is
provided in each category with respect to (i) changes attributable to changes in
volume (changes in volume multiplied by prior rate), (ii) changes attributable
to changes in rate (changes in rate multiplied by prior volume), and (iii) the
net change. The changes attributable to the combined impact of volume and rate
have been allocated proportionately to the changes due to volume and the changes
due to rate.






44








Year
      Ended December 31, 2007 Compared to December 31, 2006Increase/(Decrease) in
      Net Interest IncomeDue
      ToRate
            
            
            Volume
            
            
            NetInterest-earning
      Assets:Net
      Loans Receivable
            
            $
            (56,082
            )
            
            $
            3,117,558
            
            
            $
            3,061,476Investment
      Securities
            
            
            29,898
            
            
            
            (267,965
            )
            
            
            (238,067
            )Investment
      in capital stock of
              Federal
      Reserve Bank andOther Investments
            
            
            10,752
            
            
            
            (36,920
            )
            
            
            (26,168
            )Fed
      Funds
            
            
            18,658
            
            
            
            (24,851
            )
            
            
            (6,193
            )Total
            
            
            3,225
            
            
            
            2,787,823
            
            
            
            2,791,048Noninterest-earning
      assetsTotal
      AssetsLiabilities
      and Stockholders' EquityMoney
      Market and Savings Deposits
            
            
            68,326
            
            
            
            841,478
            
            
            
            909,804Interest-bearing
      Checking
            
            
            (340
            )
            
            
            15,417
            
            
            
            15,077Time
      Deposits of $100,000 or more
            
            
            23,226
            
            
            
            (31,350
            )
            
            
            (8,124
            )Other
      Deposits
            
            
            44,173
            
            
            
            356,183
            
            
            
            400,356Total
            
            
            135,385
            
            
            
            1,181,728
            
            
            
            1,317,113Net
      Change in Net Interest Income
            
            $
            (132,159
            )
            
            $
            1,606,094
            
            
            $
            1,473,935







Non-accruing loans increase the volume
of loans and decrease the rate. Loan fees are included as part of interest
earned on loans and therefore increase the rate and have no effect on
volume.




Provision
for credit losses and allowance for credit losses




The
provision for credit losses is the annual cost of providing an allowance or
reserve for estimated probable losses on loans.  The provision for
loan losses was $1.4 million in 2007 and $349 thousand in 2006. The increase in
expense in 2007 was directly related to the $63.1 million increase in our loan
portfolio and the deterioration of two construction loan participations totaling
$2.5 million. The allowance for loan losses reflects management’s judgment of
the level of allowance adequate to absorb estimated credit losses in the Bank’s
loan portfolio.  The allowance for loan losses is determined based on
management's assessment of several factors including, among others, the
following: review and evaluation of individual loans, changes in the nature and
volume of the loan portfolio, current economic conditions and the related impact
on specific borrowers and industry groups, historical loan loss experiences and
the levels of classified and nonperforming loans. Because the Bank has no loss
history on which to build assumptions for future loan losses, a national bank
peer group average is also used to estimate adequate levels of loan loss
reserves. There were no charge-offs of loans during 2007 and one charge-off in
2006 for $5 thousand.




45


Additional
information regarding the calculation of the loan loss provision for 2007, the
factors considered by the Bank’s management in establishing the reserves and the
quality of the Bank’s loan portfolio is included in the section of this Report
titled “Part I – Item 1.
Business – Asset quality.”




Noninterest
Income




For the
year ended December 31, 2007, non-interest income was $618 thousand which
included, in addition to the $392 thousand in gains on the sale of the
guaranteed portion of SBA loans, a net loss on the sale of investments of $12
thousand and loan referral fees of $128 thousand. For the year ended December
31, 2006, non-interest income was $128 thousand including $90 thousand from gain
on sale of SBA loans. To supplement net interest income and diversify the Bank's
income stream, in 2007 the Bank established a Real Estate Industries Group to
generate non-interest fee income by brokering commercial real estate loans in
excess of the Bank’s legal lending limit or that otherwise do not meet the
Bank’s lending criteria due to size, location, or other factors, resulting in
$175 thousand in fee income. The remaining non-interest income of $51 thousand
in 2007 and $38 thousand in 2006 was primarily related to service charges on
deposit accounts.




Noninterest
Expense




Total
noninterest expense was $6.8 million in 2007 as compared to $6.0 million in
2006. The major components of the 2007 expense as compared to 2006 expense are
discussed below. As we grow, management is committed to controlling costs and
expects to moderate noninterest expenses relative to revenue
growth.




Salaries
and employee benefits, the largest component of noninterest expense, totaled
$3.7 million for 2007 and $3.9 million for 2006. Included in salaries and
employee benefits for 2007 was $706 thousand representing a portion of the
expense for the employee stock options granted from May 16, 2005, through
December 31, 2007 as compared to $1.5 million in 2006. SFAS No. 123 (R) requires
compensation cost related to share-based payment transactions to be recognized
in the financial statements over the period that an employee provides service in
exchange for the award. Excluding the expense associated with SFAS No. 123 (R),
salaries and employee benefits increased by $562 thousand in 2007 compared with
2006. The increase in expense was the direct result of hiring additional
personnel to accommodate the growth in our operations. Employee benefit costs,
including employer taxes and group insurance, accounted for approximately 22.1%
of the salary and employee benefits expense in 2007 compared to 19.9% in 2006.
The increase in the ratio in 2007 was due to the lower amortization costs for
the fair value of the stock options. As of December 31, 2007 and 2006, the Bank
had 43 and 31 employees, with a full-time–equivalent of 40 and 29 employees,
respectively. The Bank continues to improve its efficiency as measured by the
ratio of assets per employee. The volume of assets per employee as of the end of
2007 was $2.6 million compared to $1.9 million at the end of 2006.




Occupancy
expense increased to $995 thousand in 2007 from $790 thousand in 2006. The
increase was primarily attributable to the addition of more space in the San
Clemente location beginning in August 2006. Depreciation expense of fixed asset
and tenant improvements for 2007 was $359 thousand as compared to $320 thousand
in 2006.




Professional
fees for 2007 were $609 thousand compared to $185 thousand in 2006. For 2007,
$116 thousand was paid in legal fees, related primarily to corporate matters
including SEC regulations, personnel matters and stock option
grants.  Internal and externalaudit fees totaling $228
thousand and $217 thousand were paid to outside consultants for various
projects. The increase in these costs in 2007 was attributable to more frequent
and in-depth internal audits of the credit and operational areas of the Bank,
costs incurred with the change of accounting firms, and preparation for
compliance with Section




46


404 of
Sarbanes-Oxley. The remaining expenses within this category include
compliance-related training and resources. For 2006, $67 thousand was paid in
legal fees, related primarily to corporate matters including SEC regulations,
$56 thousand related to both internal and external audit fees, $40 thousand
related to outside consultants and various projects, with the remainder related
to compliance issues.




Data
processing expenses for 2007 and 2006 totaled $444 thousand and $407 thousand
respectively. The increase in expenses in 2007 was primarily attributable to
website support related to cash management products including the development of
remote deposit capture products. Most of the other expenses in this category are
routine in nature and are expected to be fairly consistent, however network
administration and security expense can fluctuate as new employees and new
products are added.




For 2007
and 2006, office expenses totaled $439 thousand and $329 thousand, respectively.
The three areas that reflected the largest increases from 2007 to 2006 were auto
expense, postage expense, and armored car expense. Auto expenses increased to
$105 thousand from $79 thousand due to an increase in the number of calling
officers and the cost of fuel. Postage expense increased to $23 thousand from
$10 thousand due to an increase in the number of customers, increased mailings
to shareholders, and direct mail campaigns. Armored car expense increased to $67
thousand from $36 thousand due to an increase in the number of customers using
the service. Other items in this expense category include office supplies,
insurance, including workers compensation insurance, check printing costs,
meetings and travel costs, and ATM surcharge refunds




Marketing
expenses totaled $266 thousand for 2007 and $231 thousand for 2006. This
category includes expenses related to publication of a quarterly newsletter,
periodic shareholder mailings, direct mail campaigns to local businesses, and
sponsorship of key community events. The year over year increase was primarily
due to the implementation of a quarterly shareholders’ newsletter.




The
following table sets forth the breakdown of Other Expenses for periods
shown.




Year
      Ended
              December
      31,
              2007
            
            
            Year
      Ended
              December
      31,
              2006Regulatory
      Assessments
            
            $
            43,370
            
            
            $
            26,344Director
      Training
            
            
            15,082
            
            
            
            15,240Compensation
      Expense related to
              director
      stock options
            
            
            64,488
            
            
            
            22,845Loan-related
      costs(1)
            
            
            66,055
            
            
            
            39,541Recruiting
      Costs
            
            
            87,573
            
            
            
            14,443Costs
      associated with Annual Meeting
            
            
            40,903
            
            
            
            38,801$
            317,421
            
            
            $
            157,216





(1)
            Primarily
      consists of appraisal fees, environmental reports and the provision for
      unfunded loan commitments.




Income
Taxes
  $2
thousand in state taxes were paid during 2007 and 2006. No federal tax expense
or federal or state tax benefit has been recorded for 2007 and 2006 based upon
net operating losses. We will begin to recognize an income tax benefit at the
time we become profitable.





47




Deferred
income taxes are computed using the asset and liability method, which recognizes
a liability or asset representing the tax effects, based on current tax law, of
future deductible or taxable amounts attributable to events that have been
recognized in the financial statements.  A valuation allowance is
established to reduce the deferred tax asset to the level at which it is “more
likely than not” that the tax asset or benefits will be
realized.  Realization of tax benefits of deductible temporary
differences and operating loss carryforwards depends on having sufficient
taxable income of an appropriate character within the carryforward
periods.







Financial
Condition as of December 31, 2007 and 2006




Total
assets as of December 31, 2007, were $112.5 million, consisting primarily of
cash and fed funds sold of $14.5 million and net loans of $96.1 million compared
with total assets as of December 31, 2006 of $56.2 million, consisting primarily
of cash and fed funds sold of $10.9 million, securities held to maturity of $7.9
million and net loans of $34.4 million Total deposits as of December 31, 2007
were $99.0 million compared with $39.9 million as of December 31, 2006, and
shareholder's equity as of December 31, 2007 was $12.8 million compared with
$16.0 million as of December 31, 2006.




Short-Term
Investments and Interest-bearing Deposits in Other Financial
Institutions




At
December 31, 2007, we had $12.8 million in federal funds ("fed funds") sold and
no interest-bearing deposits at other financial institutions. Federal funds sold
allow us to meet Bank liquidity requirements and provide temporary holdings
until the funds can be otherwise deployed or invested. At December 31, 2006, we
had $9.4 million in fed funds and $1.0 million in interest-bearing deposits in
other institutions. The decrease in fed funds and interest-bearing deposits in
other financial institutions was due to the increase in outstanding
loans.




Investment
Securities




The
investment portfolio serves primarily as a source of interest income and,
secondarily, as a source of liquidity and a management tool for the Bank's
interest rate sensitivity. The investment portfolio is managed according to a
written investment policy established by the Bank's Board of Directors and
implemented by the Investment/Asset-Liability Committee.




During
2007, we made the decision to sell specific investments issued by the Federal
National Mortgage Association, or FNMA or Fannie Mae, based on concerns that the
underlying mortgages could be impacted by the events in the sub-prime lending
arena. These securities had been designated as "held to maturity". Because the
securities were sold prior to maturity, we are required to designate the entire
investment portfolio as "available for sale" for 24 months following the sale.
This designation requires that the securities be recorded at market value rather
than book value. The increase and decrease in market value each quarter is made
to accumulated comprehensive income and is not reflected in operating earnings
or losses.




We owned
no investment securities as of December 31, 2007. During 2007 we sold $7.9
million in investment securities held as available for sale, at a net loss of
$12 thousand.




At
December 31, 2007, we had Federal Reserve Bank stock carried at a cost of $405
thousand. At December 31, 2007, this stock was not pledged as collateral for any
purpose. For additional information regarding our securities portfolio see “Item
1. Business – Investments.”




48







Loan
Portfolio




Our
primary source of income is interest on loans. The real estate portion of the
loan portfolio is comprised of the following: mortgage loans secured typically
by commercial and multi-family residential properties, occupied by the borrower,
having terms of three to seven years with both fixed and floating rates;
revolving lines of credit granted to consumers, secured by equity in residential
properties; and construction loans. Construction loans consist primarily of
high-end, single-family residential properties, primarily located in the coastal
communities, and commercial properties for owner-occupied, have a term of less
than one year and have floating rates and commitment fees. Construction loans
are typically made to builders that have an established record of successful
project completion and loan repayment. At December 31, 2007, we held $41.7
million in commercial and multi-family real estate loans outstanding,
representing 42.7% of gross loans receivable, and no undisbursed
commitments.  Of this total, $1.3 million were SBA loans with no
undisbursed commitments. The remaining real estate portfolio was comprised of
$31.2 million in construction loans representing 31.9% of gross loans receivable
with undisbursed commitments of $11.9 million, and $2.6 million in revolving
lines secured by equity in 1-4 family residences, representing 2.7% of gross
loans receivable with undisbursed commitments of $3.2 million.




The
commercial loan portfolio is comprised of lines of credit for working capital
and term loans to finance equipment and other business assets. The lines of
credit typically are limited to a percentage of the value of the assets securing
the line. Lines of credit and term loans typically are reviewed annually and can
be supported by accounts receivable, inventory, equipment and other assets of
the client's businesses. At December 31, 2007, we held $21.8 million in
commercial loans outstanding, representing 22.4% of gross loans receivable, and
undisbursed commitments of $14.3 million. Of this total, $5.0 million were SBA
loans with no undisbursed commitments.




The
consumer loan portfolio consists of personal lines of credit and loans to
acquire personal assets such as automobiles and boats. The lines of credit
generally have terms of one year and the term loans generally have terms of
three to five years. The lines of credit typically have floating rates. At
December 31, 2007, consumer loans totaled $328 thousand, representing less than
one percent of our gross loans receivable and undisbursed commitments of $96
thousand.




Loan
concentrations are considered to exist when there are amounts loaned to a
multiple number of borrowers engaged in similar activities that would cause them
to be similarly impacted by economic or other conditions. We have established
select concentration percentages within the loan portfolio. It also includes
groups of credit considered of either higher risk or worthy of further review as
part of its concentration reporting. As of December 31, 2007 real estate loans
comprise 77.3% of the total loan portfolio, as compared to 71.1% at December 31,
2006. Although significant, a high percentage of these loans are for commercial
purposes with real estate taken as collateral and owner occupied. In addition,
all the SBA loans, which are secured by real estate, are to owner-users.
Although classified as commercial real estate for reporting purposes, the
intended source of the cash flow to repay the obligations is from the commercial
enterprise of the borrower and not directly from the sale or lease of the property. The assessment of the borrower's repayment ability is
therefore based on the financial strength of the business and not the real
estate held as collateral.




There are
no concentrations in our portfolio which are advanced to major companies within
an industry, credits which are advanced to borrowers who handle the same
manufacturer's product, credits to different individuals where the repayment
source is from the same employer, credits secured by real estate within the
confines of a small geographic area, i.e. four block area, etc., or credits
which are advanced to the farming, dairy, or livestock industries.




49






Management
may renew loans at maturity when requested by a customer whose financial
strength appears to support such a renewal or when such a renewal appears to be
in our best interest. We require payment of accrued interest in such instances
and may adjust the rate of interest, require a principal reduction, or modify
other terms of the loan at the time of renewal. For additional information
regarding our loan portfolio as of December 31, 2007 and 2006 see “Item 1.
Business – Lending services.”




Nonperforming
Loans, Leases and Assets




Nonperforming
assets consist of loans and leases on nonaccrual status, loans 90 days or more
past due and still accruing interest, loans that have been restructured
resulting in a reduction or deferral of interest or principal, OREO, and other
repossessed assets. As of December 31, 2007, there were $2.5 million in
nonperforming assets.




A
potential problem loan is defined as a loan where information about possible
credit problems of the borrower is known, causing management to have serious
doubts as to the ability of the borrower to comply with the present loan payment
terms and which may result in the inclusion of such loan in one of the
nonperforming asset categories. An internally classified loan list is maintained
that helps management assess the overall quality of the loan portfolio and the
adequacy of the allowance for loan losses. Loans classified as "special mention"
are those that contain a weakness that, if left unattended, could develop into a
problem affecting the ultimate collectibility of the loan. Loans classified as
"substandard" are those loans with clear and defined weaknesses, such as highly
leveraged positions, unfavorable financial ratios, uncertain repayment resources
or poor financial condition, which may jeopardize recoverability of the loan.
Loans classified as "doubtful" are those loans that have characteristics similar
to substandard loans, but also have an increased risk that loss may occur or at
least a portion of the loan may require a charge-off if liquidated at present.
Although loans classified as substandard do not duplicate loans classified as
doubtful, both substandard and doubtful loans may include some loans that are
past due at least 90 days, are on nonaccrual status or have been restructured.
Loans classified as "loss" are those loans that are in the process of being
charged-off. The $2.5 million in non-accrual loans were classified as
substandard as of December 31, 2007.




On March 25, 2008, one of the two loans that were
placed on non-accrual during the fourth quarter of 2007 was brought current by
the borrower and $35 thousand in interest was taken into income.  Going
forward, this loan, which has a principal balance of $1.0 million, will be
classified as a restructured debt and begin accruing interest as of March 26,
2008.




Allowance
for Loan Losses




Implicit
in our lending activities is the fact that loan losses will be experienced and
that the risk of loss will vary with the type of loan being made and the
creditworthiness of the borrower over the term of the loan. To reflect the
currently perceived risk of loss associated with the loan portfolio, additions
are made to the allowance for loan losses in the form of direct charges against
income to ensure that the allowance is available to absorb possible loan losses.
The factors that influence the amount include, among others, the remaining
collateral and/or financial condition of the borrowers, historical
loan loss, changes in the size and composition of the loan portfolio, and
general economic conditions. Management believes that our allowance for loan
losses as of December 31, 2007 was adequate to absorb the known and inherent
risks of loss in the loan portfolio at that date. While management believes the
estimates and assumptions used in its determination of the adequacy of the
allowance are reasonable, there can be no assurance that such estimates and
assumptions will not be proven incorrect in the future, or that the actual
amount of future provisions will not exceed the amount of past provisions or
that any increased provisions that may be required will not adversely impact our
financial condition and results of operations. In addition, the determination of
the amount of the Bank's allowance for loan losses is subject to review by bank
regulators, as part of the routine examination process, which may result in the
establishment of additional reserves based upon their judgment of information
available to them at the time of their examination.




50






The
amount of the allowance equals the cumulative total of the provisions made from
time to time, reduced by loan charge-offs and increased by recoveries of loans
previously charged-off. Beginning with the second quarter of 2006, the adequacy
of our allowance for loan losses has been determined through a comparison to the
Bank's peer group as defined by the OCC. We will continue to maintain an
equivalent allowance until management has adequate historical data upon which to
base a different level. The peer group currently maintains an average allowance
for loan losses of approximately 1.25% of the outstanding principal. Our
allowance was $1.8 million, or 1.90% of outstanding principal as of December 31,
2007. Management increased the overall allowance from 1.25% to 1.90% as a result
of the weakening in the real estate market in Southern California and our
reserves on impaired loans. We did not incur any charge offs during
2007.




In
addition, a separate allowance for credit losses on off-balance sheet credit
exposures is maintained for the undisbursed portion of approved loans. Although
the loss exposure to the Bank is reduced because the funds have not been
released to the borrower, under certain circumstances the Bank may be required
to continue to disburse funds on a troubled credit. As of December 31, 2007,
this allowance was $62 thousand.




Credit
and loan decisions are made by management and the Board of Directors in
conformity with loan policies established by the Board of Directors. The Bank's
practice is to charge-off any loan or portion of a loan when the loan is
determined by management to be uncollectible due to the borrower's failure to
meet repayment terms, the borrower's deteriorating or deteriorated financial
condition, the depreciation of the underlying collateral, the loan's
classification as a loss by regulatory examiners, or other reasons.




Nonearning
Assets




Premises,
leasehold improvements and equipment totaled $888 thousand at December 31, 2007,
net of accumulated depreciation of $934 thousand compared to $1.1 million at
December 31, 2006, net of accumulated depreciation of $508 thousand. This
decrease occurred due to the ongoing depreciation of fixed assets net of new
purchases of $168 thousand.




Deposits




Deposits
are our primary source of funds. Demand, or non-interest bearing checking,
accounts as a percentage of total deposits were 17.8% at December 31, 2007,
compared to 30.3% at December 31, 2006. We had $28.2 million of brokered
certificates of deposit with the individual balances of under $100,000 at
December 31, 2007. Of this total, $3.5 million consisted of public funds, none
of which required collateralization.  At December 31, 2006, we had no
brokered deposits. We intend to limit non-local and brokered deposits to 35% or
less of total deposits.




Return
on Equity and Assets




The
following table sets forth certain information regarding the Company's return on
equity and assets for the years ended December 31:






51






At Deccember 31, 2007Return
      on average assets
            
            
            -5.27
            %Return
      on average equity
            
            
            -29.01
            %Dividend
      payout ratio
            
            
            0
            %Average
      Equity to Average Assets
            
            
            18.18
            %At Deccember 31, 2006Return
      on average assets
            
            
            -9.59
            %Return
      on average equity
            
            
            -24.23
            %Dividend
      payout ratio
            
            
            0
            %Average
      Equity to Average Assets
            
            
            39.59
            %







Off-Balance
Sheet Arrangements and Loan Commitments




In the
ordinary course of business, we enter into various off-balance sheet commitments
and other arrangements to extend credit that are not reflected in the
consolidated balance sheets of the Company. The business purpose of these
off-balance sheet commitments is the routine extension of credit. As of December
31, 2007, commitments to extend credit included approximately $364 thousand for
letters of credit, $15.7 million for revolving lines of credit arrangements
including $3.8 million in real-estate secured lines, and $13.4 million in unused
commitments for commercial and real estate secured loans. We face the risk of
deteriorating credit quality of borrowers to whom a commitment to extend credit
has been made; however, we currently expect no significant credit losses from
these commitments and arrangements.




Borrowings




The Bank
has access to a variety of borrowing sources including $8 million in federal
funds lines through two correspondent banks. The Bank also has the option of
applying for a line of credit from the Federal Home Loan Bank of San Francisco.
As of December 31, 2007, there were no borrowings outstanding.




Capital
Resources and Capital Adequacy Requirements




There are
two primary measures of capital adequacy for banks and bank holding companies:
(i) risk-based capital guidelines and (ii) the leverage ratio.  The
risk-based capital guidelines measure the amount of a bank’s required capital in
relation to the degree of risk perceived in its assets and its off-balance sheet
items. Under the risk-based capital guidelines, capital is divided into two
“tiers.” Tier 1 capital consists of common shareholders’ equity, noncumulative
and cumulative perpetual preferred stock, and minority interests. Goodwill, if
any, is subtracted from the total. Tier 2 capital consists of the allowance for
loan losses, hybrid capital instruments, term subordinated debt and intermediate
term preferred stock. Banks are required to maintain a minimum risk-based
capital ratio of 8%, with at least 4% consisting of tier 1 capital.




The
second measure of capital adequacy relates to the leverage ratio. The OCC has
established a 3% minimum leverage ratio requirement. The leverage ratio is
computed by dividing tier 1 capital into total assets.  In the case of
the Bank and other banks that are experiencing growth or have not received the
highest regulatory rating from their primary regulator, the minimum leverage
ratio should be 3% plus an additional cushion of at least 1% to 2%, depending
upon risk profiles and other factors.  Moreover, as a newly organized
national bank, the Bank is required to maintain a leverage capital ratio in
excess of 8% for the first three years of operations.




52


The
following table sets forth the Bank’s capital ratios as of December 31, 2007 and
2006.


Actual
              
              
              For
      Capital
                Adequacy
      Purposes
              
              
              To
      Be Well
                Capitalized
      Under
                Prompt
      Corrective
                Action
      ProvisionsAmount
              
              
              
              
              
              Amount
              
              
              
              
              
              Amount(Thousands)
              
              
              Ratio
              
              
              (Thousands)
              
              
              Ratio
              
              
              (Thousands)
              
              
              RatioAs
      of December 31, 2007:Total
      Capital (to Risk-Weighted Assets)
              
              $
              13,672
              
              
              
              11.55
              %
              
              $
              9,470
              
              
              
              8.0
              %
              
              $
              11,837
              
              
              
              10.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              12,193
              
              
              
              10.30
              %
              
              $
              4,735
              
              
              
              4.0
              %
              
              $
              7,102
              
              
              
              6.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              12,193
              
              
              
              12.19
              %
              
              $
              4,002
              
              
              
              4.0
              %
              
              $
              5,002
              
              
              
              5.0
              %As
      of December 31, 2006:Total
      Capital (to Risk-Weighted Assets)
              
              $
              15,529
              
              
              
              50.19
              %
              
              $
              2,470
              
              
              
              8.0
              %
              
              $
              3,088
              
              
              
              10.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              15,133
              
              
              
              49.00
              %
              
              $
              1,235
              
              
              
              4.0
              %
              
              $
              1,853
              
              
              
              6.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              15,133
              
              
              
              27.46
              %
              
              $
              2,204
              
              
              
              4.0
              %
              
              $
              2,755
              
              
              
              5.0
              %







The
following table sets forth the Holding Company's capital ratios as of December
31, 2007 and 2006.
  Actual
                  
                  
                  For
      Capital
                    Adequacy
      PurposesAmount
                  
                  
                  
                  
                  
                  Amount(Thousands)
                  
                  
                  Ratio
                  
                  
                  (Thousands)
                  
                  
                  RatioAs
      of December 31, 2007:Total
      Capital (to Risk-Weighted Assets)
                  
                  $
                  14,230
                  
                  
                  
                  12.03
                  %
                  
                  $
                  9,459
                  
                  
                  
                  8.0
                  %Tier
      1 Capital (to Risk-Weighted Assets)
                  
                  $
                  12,751
                  
                  
                  
                  10.78
                  %
                  
                  $
                  4,730
                  
                  
                  
                  4.0
                  %Tier
      1 Capital (to Average Assets)
                  
                  $
                  12,751
                  
                  
                  
                  12.74
                  %
                  
                  $
                  4,002
                  
                  
                  
                  4.0
                  %As
      of December 31, 2006:Total
      Capital (to Risk-Weighted Assets)
                  
                  $
                  16,416
                  
                  
                  
                  13.88
                  %
                  
                  $
                  2,470
                  
                  
                  
                  8.0
                  %Tier
      1 Capital (to Risk-Weighted Assets)
                  
                  $
                  16,020
                  
                  
                  
                  13.55
                  %
                  
                  $
                  1,235
                  
                  
                  
                  4.0
                  %Tier
      1 Capital (to Average Assets)
                  
                  $
                  16,020
                  
                  
                  
                  16.01
                  %
                  
                  $
                  2,204
                  
                  
                  
                  4.0
                  %
 Liquidity
Management




At
December 31, 2007, the Company (excluding the Bank) had approximately $558
thousand in cash.  These funds can be used for Company operations,
investment and for later infusion into the Bank and other corporate activities.
The primary source of liquidity for the Company will be dividends paid by the
Bank. The Bank is currently restricted from paying dividends without regulatory
approval that will not be granted until the accumulated deficit has been
eliminated. Existing restrictions also require the Bank to maintain its
"well-capitalized" status under regulatory capital guidelines in order to pay
dividends to the Company.




The Bank
had cash and cash equivalents of $14.5 million at December 31,
2007.  The Bank's liquidity is monitored by its staff, the
Investment/Asset-Liability Committee and the Board of Directors, who review
historical funding requirements, current liquidity position, sources and
stability of funding, marketability of assets, options for attracting additional
funds, and anticipated future funding needs, including the level of unfunded
commitments.




The
Bank's primary sources of funds are currently retail and commercial deposits,
loan repayments, other short-term borrowings, and other funds provided by
operations. While scheduled loan repayments and maturing investments are
relatively predictable, deposit flows and early loan prepayments are more
influenced by interest rates, general economic conditions, and competition. The
Bank maintains investments in liquid assets based upon management's assessment
of (1) the need for funds, (2) expected deposit flows, (3) yields available on
short-term liquid assets, and (4) objectives of the asset/liability management
program.




The Bank
also has access to borrowing lines from correspondent banks. These are usually
restricted to short time periods (30 days or less). The Bank also has the option
of applying for a line of credit with the Federal Home Loan Bank
(FHLB).




53






As loan
demand increases, greater pressure is being exerted on the Bank's liquidity.
However, it is management's intention to maintain a loan to deposit ratio in the
range of 90% - 105%. Given this goal, the Bank will not aggressively pursue
lending opportunities if sufficient funding sources (i.e., deposits, Fed Funds,
other borrowing lines) are not available. We intend to limit non-local and
brokered deposits to 35% or less of total deposits. As of December 31, 2007, the
loan to deposit ratio was 98.9% and brokered deposits represented 28.3% of total
deposits.
  Interest
rate sensitivity




Net
interest income, the Bank’s expected primary source of earnings, can fluctuate
with significant interest rate movements.  The Company’s profitability
depends substantially on the Bank’s net interest income, which is the difference
between the interest income earned on its loans and other assets and the
interest expense paid on its deposits and other liabilities. A large change in
interest rates may significantly decrease the Bank’s net interest income and
eliminate the Company’s profitability. Most of the factors that cause changes in
market interest rates, including economic conditions, are beyond the Company’s
control. While the Bank takes measures to minimize the effect that changes in
interest rates has on its net interest income and profitability, these measures
may not be effective.  To lessen the impact of these fluctuations, the
Bank manages the structure of the balance sheet so that repricing opportunities
exist for both assets and liabilities in roughly equal amounts at approximately
the same time intervals.  Imbalances in these repricing opportunities
at any point in time constitute interest rate sensitivity.




Interest
rate risk is the most significant market risk affecting the
Bank.  Other types of market risk, such as foreign currency risk and
commodity price risk, do not arise in the normal course of the Bank’s business
activities.  The ongoing monitoring and management of this risk is an
important component of the asset and liability management process, which is
governed by policies established by the Company’s Board of Directors and carried
out by the Bank’s Investment/Asset-Liability Committee. The
Investment/Asset-Liability Committee’s objectives are to manage the exposure to
interest rate risk over both the one year planning cycle and the longer term
strategic horizon and, at the same time, to provide a stable and steadily
increasing flow of net interest income.




The
primary measurement of interest rate risk is earnings at risk, which is
determined through computerized simulation modeling.  The primary
simulation model assumes a static balance sheet, using the balances, rates,
maturities and repricing characteristics of all of the Bank’s existing assets
and liabilities.  Net interest income is computed by the model
assuming market rates remaining unchanged and comparing those results to other
interest rate scenarios with changes in the magnitude, timing and relationship
between various interest rates. At December 31, 2007, an analysis was performed
using the Risk Monitor model provided through Fidelity Regulatory Solutions and
utilizing the Bank’s quarterly Call Report data. The table below shows the
impact of rising and declining interest rate simulations in 100 basis point
increments over a 12-month period. Changes in net interest income in the rising
and declining rate scenarios are measured against the current net interest
income. The changes in equity capital represent the changes in the present value
of the balance sheet without regards to business continuity, otherwise known as
“liquidation value”. Because the Bank is asset-sensitive, the net interest
margin improves as rates rise and declines as rates decline.




Interest
      Rate Shock(Dollars
      in thousands)Rate
      Shock
              Fed
      Funds Rate
            -2%
              2.25%
            -1%
              3.25%
            Annualized
              4.25%
            +1%
              5.25%
            +2%
              6.25%Net
      Interest Income change
            (349)
            (169)
            -
            44
            80%Change
            -7.7%
            -3.7%
            -
            1.0%
            1.8%Equity
      Capital Change%
            -1.0%
            
            -
            
            -0.1%Net
      Interest margin
            3.8%
            4.0%
            4.1%
            4.1%
            4.2%





54


The
interest rate risk inherent in a bank's assets and liabilities may also be
determined by analyzing the extent to which such assets and liabilities are
"interest rate sensitive" and by measuring the bank's interest rate sensitivity
"gap." An asset or liability is said to be interest rate sensitive within a
defined time period if it matures or reprices within that period. The difference
or mismatch between the




The
following table sets forth, on a stand-alone basis, the Bank's amounts of
interest-earning assets and interest-bearing liabilities outstanding at December
31, 2007, which are anticipated, based upon certain assumptions, to reprice or
mature in each of the future time periods shown. The projected repricing of
assets and liabilities anticipates prepayments and scheduled rate adjustments,
as well as contractual maturities under an interest rate unchanged scenario
within the selected time intervals. While it is believed that such assumptions
are reasonable, there can be no assurance that assumed repricing rates will
approximate actual future deposit activity.




The table indicates a negative cumulative interest rate sensitivity gap
for the time periods up to and including 1-3 years, and a positive interest rate
sensitivity gap for 3 years and greater.




55





As
      of December 31, 2007Volumes
      Subject to Repricing Within(Dollars
      in thousands)0-1
      Day
              
              
              2-90
      Days
              
              
              91-365
      Days
              
              
              1-3
      Years
              
              
              Over
      3 Years
              
              
              Non-Interest
      Sensitive
              
              
              TotalCash,
      fed funds and other
              
              $
              12,785
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              1,689
              
              
              $
              14,474Investments
      and FRB Stock
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              405
              
              
              
              -
              
              
              
              405Loans  (1)
              
              
              203
              
              
              
              30,716
              
              
              
              13,460
              
              
              
              11,215
              
              
              
              39,583
              
              
              
              2,467
              
              
              
              97,644Fixed
      and other assets
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (26
              )
              
              
              (26
              )Total
      Assets
              
              $
              12,988
              
              
              $
              30,716
              
              
              $
              13,460
              
              
              $
              11,215
              
              
              $
              39,988
              
              
              $
              4,130
              
              
              $
              112,497Interest-bearing
      checking, savings
                and
      money market accounts
              
              $
              40,162
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              17,658
              
              
              $
              57,821Certificates
      of deposit
              
              
              -
              
              
              
              15,922
              
              
              
              21,346
              
              
              
              3,823
              
              
              
              81
              
              
              
              -
              
              
              
              41,171Borrowed
      funds
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Other
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              753
              
              
              
              753Shareholders’
      equity
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              12,751
              
              
              
              12,751Total
      liabilities and shareholders’ equity
              
              $
              40,162
              
              
              $
              15,922
              
              
              $
              21,346
              
              
              $
              3,823
              
              
              $
              81
              
              
              $
              31,164
              
              
              $
              112,497Interest
      rate sensitivity gap
              
              $
              (27,174
              )
              
              $
              14,795
              
              
              $
              (7,885
              )
              
              $
              7,392
              
              
              $
              39,907Cumulative  interest
      rate sensitivity gap
              
              $
              (27,174
              )
              
              $
              (12,380
              )
              
              $
              (20,265
              )
              
              $
              (12,873
              )
              
              $
              27,033Cumulative
      gap to total assets
              
              
              -24.2
              %
              
              
              -11.0
              %
              
              
              -18.0
              %
              
              
              -11.4
              %
              
              
              24.0
              %Cumulative
      interest-earning assets to
                cumulative
      interest-bearing liabilities
              
              
              32.3
              %
              
              
              77.9
              %
              
              
              73.8
              %
              
              
              84.2
              %
              
              
              133.2
              %(1)
      Excludes deferred fees and allowance for loan losses


Certain
shortcomings are inherent in the method of analysis presented in the gap table.
For example, although certain assets and liabilities may have similar maturities
or periods of repricing, they may react in different degrees to changes in
market interest rates. Additionally, certain assets, such as adjustable-rate
loans, have features that restrict changes in interest rates, both on a
short-term basis and over the life of the asset. More importantly, changes in
interest rates, prepayments and early withdrawal levels may deviate
significantly from those assumed in the calculations in the table. As a result
of these shortcomings, the Bank will focus more on earnings at risk simulation
modeling than on gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total assets within acceptable limits, the earnings at risk
simulation modeling is considered by management to be more informative in
forecasting future income at risk.




As we
continue to grow, we will continuously structure our rate sensitivity position
in an effort to hedge against rapidly rising or falling interest
rates.  The Bank’s investment/asset and liability committee meets
regularly to develop a strategy for the upcoming period.




56


Item
7.  Financial Statements




Our
consolidated financial statements, including the notes thereto, and the report
of independent certified public accountants are included in this
Report.






INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
   PAGEREPORTS
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS
              58-59FINANCIAL
      STATEMENTSConsolidated
      Balance Sheets
              60Consolidated
      Statements of Operations
              61Consolidated
      Statements of Cash Flows
              62Consolidated
      Statements of Shareholders' Equity
              63Notes
      to Consolidated Financial Statements
              64






57




Report
of Independent Registered Public Accounting Firm
 
 To the
Board of Directors
 Pacific
Coast National Bancorp
 San
Clemente, California
 
 We have
audited the consolidated balance sheet of Pacific Coast National Bancorp and
subsidiary (the Company) as of December 31, 2007, and the related
consolidated statements of operations, shareholders’ equity and cash flows for
the year then ended. These financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these financial statements based on our audit.
 
 We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Pacific Coast National
Bancorp and subsidiary as of December 31, 2007, and the results of their
operations and their cash flows for the year then ended, in conformity with
U.S. generally accepted accounting principles.
 
 We were
not engaged to examine management’s assertion about the effectiveness of Pacific
Coast National Bancorp and subsidiary’s internal control over financial
reporting as of December 31, 2007 included in the accompanying “Management’s
Report on Internal Control over Financial Reporting” and, accordingly, we do not
express an opinion thereon.
 
  /s/ McGladrey &
Pullen, LLP
 Irvine,
California
 March 31,
2008
 58
 
 Report
of Independent Registered Public Accounting Firm
 
 The Board
of Directors and Shareholders
 Pacific
Coast National Bancorp and Subsidiary
 
 We have
audited the accompanying consolidated balance sheets of Pacific Coast National
Bancorp andSubsidiary
as of December 31, 2006, and the related consolidated statements of earnings,
shareholders’ equity and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Pacific Coast National
Bancorp and Subsidiary as of December 31, 2006, and the results of its
operations and cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States of America.
 
 
 
 /s/
Vavrinek, Trine, Day & Co., LLP
 
 Laguna
Hills, California
 March 31,
2007








59






PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





CONSOLIDATED
BALANCE SHEETS


December
31, 2007 and 2006





ASSETS




2007
            
            
            2006Cash
      and due from banks
            
            $
            1,688,892
            
            
            $
            1,556,151Federal
      funds sold
            
            
            12,785,000
            
            
            
            9,360,000TOTAL
      CASH AND CASH EQUIVALENTS
            
            
            14,473,892
            
            
            
            10,916,151Interest-bearing
      deposits in other financial institutions
            
            
            -
            
            
            
            1,000,000Securities
      held to maturity
            
            
            -
            
            
            
            7,943,375Loans
            
            
            97,874,131
            
            
            
            34,795,405Less:
      Allowance for loan losses
            
            
            (1,814,860
            )
            
            
            (431,640
            )Loans:
      net of allowance for loan losses
            
            
            96,059,271
            
            
            
            34,363,765Premises
      and equipment, net
            
            
            887,532
            
            
            
            1,145,105Federal
      Reserve Bank stock, at cost
            
            
            405,150
            
            
            
            493,800Accrued
      interest  receivable and other assets
            
            
            671,339
            
            
            
            332,051TOTAL ASSETS
            
            $
            112,497,184
            
            
            $
            56,194,247





LIABILITIES
AND SHAREHOLDERS’ EQUITY







DepositsNoninterest-bearing
      demand
            
            $
            17,658,241
            
            
            $
            12,071,916Interest-bearing
      demand accounts
            
            
            3,951,566
            
            
            
            3,061,772Money
      market
            
            
            35,961,965
            
            
            
            19,329,525Savings
            
            
            248,780
            
            
            
            170,765Time
      certificates of deposit of $100,000 or more
            
            
            3,177,552
            
            
            
            3,137,238Other
      time certificates of deposit
            
            
            37,993,669
            
            
            
            2,078,856TOTAL
      DEPOSITS
            
            
            98,991,773
            
            
            
            39,850,072Accrued
      interest payable and other liabilities
            
            
            754,146
            
            
            
            324,592TOTAL
      LIABILITIES
            
            
            99,745,919
            
            
            
            40,174,664Shareholders'
      equityCommon
      stock - $0.01 par value; 10,000,000 shares authorized;issued
      and outstanding: 2,281,700 shares at December 31,2007
      and 2,281,500 outstanding at December 31, 2006
            
            
            22,817
            
            
            
            22,815Additional
      paid-in capital
            
            
            25,561,705
            
            
            
            24,788,356Accumulated
      deficit
            
            
            (12,833,257
            )
            
            
            (8,791,588
            )TOTAL
      SHAREHOLDERS' EQUITY
            
            
            12,751,265
            
            
            
            16,019,583TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            112,497,184
            
            
            $
            56,194,247










60


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





CONSOLIDATED
STATEMENTS OF OPERATIONS




Years
Ended December 31, 2007 and 2006





2007
            
            
            2006Interest
      incomeInterest
      and fees on loans
            
            $
            4,759,241
            
            
            $
            1,697,765Federal
      funds sold
            
            
            561,922
            
            
            
            568,115Investment
      securities, taxable
            
            
            128,488
            
            
            
            366,555Other
            
            
            38,652
            
            
            
            64,820Total
      interest income
            
            
            5,488,303
            
            
            
            2,697,255Interest
      expenseTime
      certificates of depositof
      $100,000 or more
            
            
            163,313
            
            
            
            171,437Other
      deposits
            
            
            1,821,165
            
            
            
            495,928Total
      interest expense
            
            
            1,984,478
            
            
            
            667,365Net
      interest income before provision for loan losses
            
            
            3,503,825
            
            
            
            2,029,890Provision
      for loan losses
            
            
            1,383,220
            
            
            
            349,432Net
      interest income afterprovision
      for loan losses
            
            
            2,120,605
            
            
            
            1,680,458Noninterest
      incomeService
      charges and fees
            
            
            237,431
            
            
            
            38,018Gain
      on Sale of SBA loans
            
            
            392,490
            
            
            
            89,858(Loss)
      on sale of investmentsecurities
            
            
            (12,047
            )
            
            
            -617,874
            
            
            
            127,876Noninterest
      expenseSalaries
      and employee benefits
            
            
            3,708,060
            
            
            
            3,914,662Occupancy
            
            
            995,087
            
            
            
            790,163Professional
      services
            
            
            608,871
            
            
            
            184,617Data
      processing
            
            
            443,862
            
            
            
            407,053Office
      expenses
            
            
            438,825
            
            
            
            329,216Marketing
            
            
            266,422
            
            
            
            231,102Other
            
            
            317,421
            
            
            
            157,2166,778,548
            
            
            
            6,014,028(Loss)
      before income taxes
            
            
            (4,040,069
            )
            
            
            (4,205,694
            )Provision
      for income taxes
            
            
            1,600
            
            
            
            1,600Net
      (loss)
            
            $
            (4,041,669
            )
            
            $
            (4,207,294
            )Per
      share dataWeighted-average
      shares outstanding
            
            
            2,281,686
            
            
            
            2,281,041Net
      (loss), basic and diluted
            
            $
            (1.77
            )
            
            $
            (1.84
            )










61


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





CONSOLIDATED
STATEMENTS OF CASH FLOWS


Years
Ended December 31, 2007 and 2006





2007
            
            
            2006Cash
      flows from operating activities:Net
      loss
            
            $
            (4,041,669
            )
            
            $
            (4,207,294
            )Adjustments
      to reconcile net loss to net cashused
      in operating activities:Depreciation
      and amortization
            
            
            423,529
            
            
            
            388,482Provision
      for loan losses
            
            
            1,383,220
            
            
            
            349,432Provision
      for off balance sheet contingencies
            
            
            48,203
            
            
            
            7,925(Accretion)
      of investment securities
            
            
            (6,486
            )
            
            
            (6,712
            )Gain
      on sale of loans
            
            
            (392,490
            )
            
            
            (89,858
            )Loss
      on sale of investment securities
            
            
            12,047
            
            
            
            -Stock-based
      compensation
            
            
            770,851
            
            
            
            1,497,901Increase
      in Other Assets
            
            
            (339,288
            )
            
            
            (87,198
            )Increase
      in Other Liabilities
            
            
            381,351
            
            
            
            170,158Net
      cash  used in operating activities
            
            
            (1,760,732
            )
            
            
            (1,977,164
            )Cash
      flows from investing activities:Proceeds
      from maturity of time deposits in other financial
    institutions
            
            
            1,000,000
            
            
            
            1,750,000Purchases
      of investment securities held to maturity
            
            
            -
            
            
            
            (3,938,720
            )Maturity
      of investment securities held to maturity
            
            
            -
            
            
            
            4,000,000Proceeds
      from sale of investment securities
            
            
            7,937,814
            
            
            
            -Net
      redemption of Federal Reserve Bank stock
            
            
            88,650
            
            
            
            59,900Proceeds
      from sale of loans
            
            
            6,966,193
            
            
            
            1,609,240Net
      (increase) in Loans
            
            
            (69,652,429
            )
            
            
            (26,002,457
            )Purchases
      of premises and equipment
            
            
            (165,956
            )
            
            
            (379,521
            )Net
      cash used in investing activities
            
            
            (53,825,728
            )
            
            
            (22,901,558
            )Cash
      flows from financing activities:Net
      increase in demand deposits and savings accounts
            
            
            23,186,574
            
            
            
            26,160,354Net
      increase in time deposits
            
            
            35,955,127
            
            
            
            1,336,288Proceeds
      from exercise of warrants
            
            
            2,500
            
            
            
            18,750Net
      cash provided by financing activities
            
            
            59,144,201
            
            
            
            27,515,392Net
      increase in cash and cash equivalents
            
            
            3,557,741
            
            
            
            2,636,670Cash
      and cash equivalents at beginning of year
            
            
            10,916,151
            
            
            
            8,279,481Cash
      and cash equivalents at end of year
            
            $
            14,473,892
            
            
            $
            10,916,151Supplemental
      disclosure of cash flow information:Interest
      paid
            
            $
            1,916,374
            
            
            $
            597,238Income
      taxes paid
            
            $
            1,600
            
            
            $
            1,600Supplemental
      schedule of non-cash investing activities:Transfer
      of held to maturity securities to available for sale
            
            $
            7,943,375
            
            
            $
            -







62





PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





CONSOLIDATED
STATEMENT OF SHAREHOLDERS’ EQUITY


Years
Ended December 31, 2007 and 2006







AdditionalShares
            
            
            Common
            
            
            Paid-in
            
            
            AccumulatedOutstanding
            
            
            Stock
            
            
            Capital
            
            
            Deficit
            
            
            TotalBalance
      at December 31, 2005
            
            
            2,280,000
            
            
            $
            22,800
            
            
            $
            23,271,720
            
            
            $
            (4,584,294
            )
            
            $
            18,710,226Warrants
      Exercised
            
            
            1,500
            
            
            
            15
            
            
            
            18,735
            
            
            
            -
            
            
            
            18,750Stock-based
      Compensation
            
            
            -
            
            
            
            -
            
            
            
            1,497,901
            
            
            
            -
            
            
            
            1,497,901Net
      Loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,207,294
            )
            
            
            (4,207,294
            )Balance
      at December 31, 2006
            
            
            2,281,500
            
            
            $
            22,815
            
            
            $
            24,788,356
            
            
            $
            (8,791,588
            )
            
            $
            16,019,583Warrants
      Exercised
            
            
            200
            
            
            
            2
            
            
            
            2,498
            
            
            
            -
            
            
            
            2,500Stock-based
      Compensation
            
            
            -
            
            
            
            -
            
            
            
            770,851
            
            
            
            -
            
            
            
            770,851Net
      Loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,041,669
            )
            
            
            (4,041,669
            )Balance
      at December 31, 2007
            
            
            2,281,700
            
            
            $
            22,817
            
            
            $
            25,561,705
            
            
            $
            (12,833,257
            )
            
            $
            12,751,265

































63


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization




Pacific
Coast National Bancorp, a bank holding company, is a California corporation that
incorporated on July 2, 2003. Pacific Coast National Bank (the “Bank”),
chartered as a national bank by the Office of the Comptroller of the Currency
(the OCC),is a
wholly-owned subsidiary of Pacific Coast National Bancorp. The Bank has been
organized as a single operating segment and maintains two branches in southern
Orange and northern San Diego Counties.  The Bank is primarily in the
business of taking deposits from and making loans to businesses and individuals
throughout Orange and San Diego counties.  The Bank’s primary source
of revenue is interest income from loans to customers. The Bank’s customers are
predominantly small and middle-market businesses and individuals. The Bank
opened for business on May 16, 2005.




Principles of
Consolidation




The
consolidated financial statements include the accounts of Pacific Coast National
Bancorp and the Bank, collectively referred to herein as the
“Company.”  All significant intercompany transactions have been
eliminated.





Basis of
Presentation





The
accounting and reporting policies of the Company are in accordance with
accounting principles generally accepted in the Unites States of America and
prevailing practices within the banking industry.  A summary of the
significant accounting policies consistently applied in preparation of the
accompanying financial statements follows:





Use of Estimates in the
Preparation of Financial Statements





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and at the date of the financial statements and the reported amounts
of certain revenues and expenses during the reporting period.  Actual
results could differ from those estimates.





Material
estimates common to the banking industry that are particularly susceptible to
significant change in the near term include, but are not limited to, the
determination of the allowance for loan losses, the estimation of compensation
expense related to stock options granted to employees and directors, and
valuation allowances associated with deferred tax assets, the recognition of
which are based on future taxable income.




Presentation of Cash
Flows





For the
purposes of reporting cash flows, cash and cash equivalents includes cash,
noninterest-earning deposits and federal funds sold.  Generally,
federal funds are sold for one day periods. Cash flows from loan originations
and principal payments and deposits are reported on a net basis.





64


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued





Cash and Cash
Equivalents





The
Company maintains amounts due from banks which exceed federally insured
limits.  The Company has not experienced nor does it anticipate any
losses in such accounts. The Bank is required to maintain a clearing balance of
$103 thousand with the Federal Reserve Bank of San Francisco.





Investment
Securities





Bonds,
notes, and debentures for which the Company has the positive intent and ability
to hold to maturity are reported at cost, adjusted for premiums and discounts
that are recognized in interest income using the interest method over the period
to maturity.  Investments not classified as trading securities nor as
held-to-maturity securities are classified as available-for-sale securities and
recorded at fair value.  Unrealized gains or losses on
available-for-sale securities are excluded from net income and reported as an
amount net of taxes as a separate component of other comprehensive income
included in shareholders’ equity.  Premiums or discounts on
held-to-maturity and available-for-sale securities are amortized or accreted
into income using the interest method.  Realized gains or losses on
sales of held-to-maturity or available-for-sale securities are recorded using
the specific identification method.





Declines
in the fair value of individual held-to-maturity and available-for-sale
securities below their cost that are other-than-temporary result in write-downs
of the individual securities to their fair value.  The related write-downs
are included in earnings as realized losses.  In estimating
other-than-temporary impairment losses, management considers the length of time
and the extent to which the fair value has been less than cost, the financial
condition and near-term prospects of the issuer, and the intent and ability of
the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value.





Loans





Loans are
reported at their outstanding unpaid principal balances reduced by any
charge-offs or specific valuation accounts and net of any deferred fees or costs
on originated loans, or unamortized premiums or discounts on purchased
loans.





Credit
and loan decisions are made by management and the board of directors in
conformity with loan policies established by the board of directors. The
Company’s practice is to charge-off any loan or portion of a loan when the loan
is determined by management to be uncollectible due to the borrower’s failure to
meet repayment terms, the borrower’s deteriorating or deteriorated financial
condition, the depreciation of the underlying collateral, the loan’s
classification as a loss by regulatory examiners, or other reasons.




The
Company considers a loan to be impaired when it is probable that the Company
will be unable to collect all amounts due (principal and interest) according to
the contractual terms of the loan agreement.  Measurement of
impairment is based on the expected future cash flows of an impaired loan, which
are to be discounted at the loan’s effective interest rate, or measured by
reference to an observable market value, if one exists, or the fair value of the
collateral for a collateral-dependent loan.  The Company selects the
measurement method on a loan- by-loan basis except that collateral-dependent
loans for which foreclosure is probable are measured at the fair value of the
collateral less costs of disposition.  The Company recognizes interest
income on impaired loans based on its existing methods of recognizing interest
income on nonaccrual loans.


65


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued





Provision
and Allowance for Loan Losses




Implicit
in the Company’s lending activities is the fact that loan losses will be
experienced and that the risk of loss will vary with the type of loan being made
and the creditworthiness of the borrower over the term of the
loan.  To reflect the currently perceived risk of loss associated with
the loan portfolio, additions are made to the allowance for loan losses in the
form of direct charges against income to ensure that the allowance is available
to absorb possible loan losses.  The factors that influence the amount
include, among others, the remaining collateral and/or financial condition of
the borrowers, historical and peer bank loan loss experience, changes in the
size and composition of the loan portfolio, and current economic conditions. The
amount of the allowance equals the cumulative total of the provisions made to
date reduced by loan charge-offs and increased by recoveries of loans previously
charged-off.  In addition, a separate allowance for credit losses on
off-balance sheet credit exposures is maintained for the undisbursed portion of
approved loans. Although the loss exposure to the Company is reduced because the
funds have not been released to the borrower, under certain circumstances the
Company may be required to continue to disburse funds on a troubled
credit.




Accrued
Interest and Fees on Loans




Accrued
interest income is recognized daily in accordance with the terms of the note
based on the ending principal balance. Loans on which the accrual of interest
has been discontinued are designated as nonaccrual loans.  The accrual
of interest on loans is discontinued when principal or interest is past due 90
days based on contractual terms of the loan or when, in the opinion of
management, there is reasonable doubt as to collectibility.  When
loans are placed on nonaccrual status, all interest previously accrued but not
collected is reversed against current period interest income.  Income
on nonaccrual loans is subsequently recognized only to the extent that cash is
received and the loan’s principal balance is deemed
collectible.  Interest accruals are resumed on such loans only when
they are brought current with respect to interest and principal and when, in the
judgment of management, the loans are estimated to be fully collectible as to
all principal and interest. During 2007 two loans were designated as nonaccrual
loans. During 2006 no loans were designated as nonaccrual loans.





Loan
origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield of the related loan.





During
the second quarter of 2007 we implemented the accounting for loan fees and costs
as required under SFAS No. 91, “Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases”. Prior to this, loan fees had been deferred as required under FAS No. 91
but the associated loan costs had not been recognized.  In order to bring
the deferred loan costs current to June 30, 2007, $74 thousand in costs was
recognized, bringing net loan fees and costs to a negative, or loss, position.
The charging or waiving of loan fees is often negotiated during initial
discussions with the borrower. It is not unusual for a new bank to have more
costs than fees in the first few years of operations.




In order
to properly record the deferred loan costs as of June 30, 2007, $208 thousand in
costs primarily related to salaries and benefits, net of $74 thousand in
amortization, were deferred, bringing deferred loan fees and costs to a net cost
position.  Of the $208 thousand of net deferred costs recorded during the
quarter ended June 30, 2007, approximately $156 thousand ($0.06 per share at
December 31, 2006) related to the year ended December 31, 2006 and $36 thousand
($0.02 per share at March 31, 2007) related to the quarter ended March 31,
2007.  As the effect of the initial recording of deferred costs was not
material to the overall financial statements, we did not restate earnings for
the year ended December 31, 2006 or the quarter ended March 31,
2007.





66





PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006








NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued





Premises and
Equipment





Premises
and equipment are carried at cost less accumulated depreciation and
amortization.  Depreciation is computed using the straight-line method
over the estimated useful lives, which ranges from three to ten years for
furniture and fixtures. Expenditures for betterments or major repairs are
capitalized and those for ordinary repairs and maintenance are charged to
operations as incurred.





Income Taxes





Deferred
income taxes are computed using the asset and liability method, which recognizes
a liability or asset representing the tax effects, based on current tax law, of
future deductible or taxable amounts attributable to events that have been
recognized in the financial statements.  A valuation allowance is
established to reduce the deferred tax asset to the level at which it is “more
likely than not” that the tax asset or benefits will be
realized.  Realization of tax benefits of deductible temporary
differences and operating loss carryforwards depends on having sufficient
taxable income of an appropriate character within the carryforward
periods.





In June,
2006, the FASB issued Financial Interpretation (“FIN”) No. 48, “Accounting for
Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in
income taxes recognized in the financials statements in accordance with SFAS No.
109, “Accounting For Income Taxes.” FIN No. 48 provides that a tax benefit from
an uncertain tax position may be recognized when it is more likely than not that
the position will be sustained upon examination, including resolutions of any
related appeals or litigation processes, based on the technical merits. Income
tax positions must meet a more-likely-than-not recognition threshold at the
effective date to be recognized upon the adoption of FIN 48 and in subsequent
periods. This interpretation also provides guidance on measurement,
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.




We
adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes”, on January 1, 2007, with no effect on the
Company’s consolidated financial statements.  FIN No. 48 applies to
all open tax years, 2005 through 2007.




Interest
and penalties, if any, related to uncertain tax positions are recorded in other
non-interest expense. Accrued interest and penalties, if any, are included in
other liabilities in the consolidated balance sheet.




Financial
Instruments





In the
ordinary course of business, the Company has entered into off-balance sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit, and standby letters of credit as described in Note
J.  Such financial instruments are recorded in the financial
statements when they are funded or related fees are incurred or
received.




Loss Per
Share





Basic
loss per common share is based on the weighted average number of common shares
outstanding during the period. The effects of potential common shares
outstanding during the period would be included in diluted loss per share;
however, the effect of potential shares is antidilutive during all periods
presented. As a result, the Company only reports basic loss per share.  For
the years ended December 31, 2007 and 2006, the conversion of
approximately 278,000 and 731,000, respectively, common shares issuable
upon exercise of the employee stock options and common stock warrants have not
been included in the 2007 and 2006 loss per share computation because their
inclusion would have been antidilutive on loss per share.




67


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE A - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES - Continued




Stock-Based
Compensation





Effective
January 1, 2006, the Company adopted SFAS 123(R), “Share-Based Payment” (SFAS
123(R)) utilizing the modified prospective approach. Prior to the adoption of
SFAS 123 (R) we accounted for stock option grants in accordance with APB Opinion
No. 25, “Accounting for Stock Issued to Employees” (the intrinsic method), and
accordingly recognized no compensation expense related to
employees.





Under the
modified prospective approach, SFAS 123 (R) applies to new awards and to awards
that were outstanding on January 1, 2006 that are subsequently modified,
repurchased or cancelled. Under the modified prospective approach, compensation
cost recognized in 2006 includes compensation cost for all stock-based payments
granted prior to, but not yet vested as of January 1, 2006, based on the
grant-date fair value estimated in accordance with the original provision of
SFAS 123, and compensation cost for all share-based payments granted subsequent
to January 1, 2006, based on the grant-date fair value estimated in accordance
with the provisions of SFAS 123 (R).  Prior periods were not restated
to reflect the impact of adopting the new standard. During 2007 and 2006 the
Bank recognized pre-tax stock-based compensation expense of $770,851 and
$1,497,901, respectively, as a result of adopting SFAS No. 123(R).





As of
December 31, 2007, there was $231 thousand of unrecognized compensation cost
related to unvested stock options. This cost is expected to be recognized over a
weighted average period of approximately one year.




Disclosure about Fair Value
of Financial Instruments




SFAS No.
107 specifies the disclosure of the estimated fair value of financial
instruments.  The Company’s estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies.




However,
considerable judgment is required to develop the estimates of fair
value.  Accordingly, the estimates are not necessarily indicative of
the amounts the Company could have realized in a current market
exchange.  The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value
amounts.





Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements subsequent to the balance
sheet date and, therefore, current estimates of fair value may differ
significantly from the amounts presented in the accompanying notes.





Recent
Accounting Pronouncements




In
March 2006 the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 156 (“SFAS 156”),
Accounting for Servicing of Financial Assets—an Amendment of FASB Statement
No. 140, which permitted the Bank, beginning in 2007, to choose between two
different methods of measuring ongoing changes in the value of its SBA loan
servicing asset: the amortization method or the fair value measurement method.
Effective January 1, 2007, the Company chose the amortization method for the
year ended December 31, 2007. The adoption of the standard did not have a
material impact on the financial statements.




68


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE A - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES - Continued




Recent Accounting
Pronouncements - Continued




In June
2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes – an interpretation of FASB Statement 109” (“FIN 48”). FIN 48
establishes a single model to address accounting for uncertain tax positions.
FIN 48 clarifies the accounting for income taxes by prescribing a minimum
recognition threshold a tax position is required to meet before being recognized
in the financial instruments. FIN 48 also provides
guidance on derecognition, measurement classification, interest and penalties,
accounting in interim periods, disclosure and transition. There was no effect on
the Company upon adoption on January 1, 2007.




In
September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS
157”). SFAS 157 clarifies the principal that fair value should be based on the
assumptions market participants would use when pricing an asset or liability and
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. Under the standard, fair value measurements would be
separately disclosed by level within the fair value hierarchy. In February 2008,
the FASB issued FASB Staff Position (FSP) No. 157-2, “Effective Date of FASB
Statement No. 157”, to partially defer FASB Statement No. 157 for nonfinancial
assets and nonfinancial liabilities, except those that are recognized or
disclosed at fair value  in the financial statement on a recurring
basis. SFAS 157 is effective for us on January 1, 2008, except for nonfinancial
assets and nonfinancial liabilities that are not recognized or disclosed at fair
value on a recurring basis for which our effective date is January 1, 2009. We
are in the process of evaluating SFAS No. 157 and do not believe it will have a
significant effect on our financial position or results of
operations.




In
February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115”. SFAS 159 permits an entity to choose to measure many financial instruments
and certain other items at fair value. Most of the provisions of SFAS 159 are
elective, however, the amendment to SFAS 115, “Accounting for Certain
Investments in Debt and Equity Securities”, applies to all entities with
available for sale or trading securities. SFAS 159 is elective as of the
beginning of an entity’s first fiscal year that begins after November 15, 2007.
We are currently assessing this statement to determine whether or not we would
elect to measure any financial instruments at their fair value.




Reclassifications




Certain reclassifications have been made in the 2006
consolidated financial statements to conform to the presentation used in
2007.  These classifications are of a normal recurring
nature.






69


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE B - INVESTMENT
SECURITIES




The
Company had no investment securities as of December 31, 2007. The amortized
cost, carrying value and estimated fair values of investment securities as of
December 31, 2006 are as follows:





Amortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            EstimatedCost
            
            
            Gains
            
            
            Losses
            
            
            Fair
      ValueSecurities
      held to maturity:December
      31, 2006U.S.
      Government andAgency
      Securities
            
            $
            7,943,375
            
            
            $
            13,483
            
            
            $
            (12,558
            )
            
            $
            7,944,300







The gross
unrealized loss and related estimated fair value of investment securities that
have been in a continuous loss position for less than twelve months and over
twelve months at December 31, 2006 are as follows:





Less
      than Twelve Months
            
            
            Over
      Twelve Months
            
            
            TotalUnrealized
            
            
            Estimated
            
            
            Unrealized
            
            
            Estimated
            
            
            Unrealized
            
            
            EstimatedLosses
            
            
            Fair
      Value
            
            
            Losses
            
            
            Fair
      Value
            
            
            Losses
            
            
            Fair
      ValueSecurities
      in a loss position at:December
      31, 2006U.S.
      Government andAgency
      Securities
            
            $
            -
            
            
            $
            -
            
            
            $
            (12,558
            )
            
            $
            3,986,180
            
            
            $
            (12,558
            )
            
            $
            3,986,180




Management
evaluates investment securities for other-than-temporary impairment taking into
consideration the extent and length of time the fair value has been less than
cost, the financial condition of the issuer and whether the Company has the
intent and ability to retain the investment for a period of time sufficient to
allow for any anticipated recovery in fair value.





During
the first quarter of 2007, we made the decision to sell specific investments
issued by the Federal National Mortgage Association, or FNMA or Fannie Mae,
based on concerns that the underlying mortgages could be impacted by the events
in the sub-prime lending arena. The investment portfolio was sold in two phases
over the first and second quarters of 2007.  These securities had been
designated as “held to maturity”.




We recorded a gain
of $13 thousand on the sale of $3.9 million in securities in the first quarter
of 2007.  We recorded a loss of $25 thousand on the sale of $4 million in
securities in the second quarter of 2007.




NOTE C - LOANS AND
SUBSEQUENT EVENTS




The
Company’s loan portfolio generally consists of loans to borrowers within
southern Orange and northern San Diego counties in California. However, the
collateral for these loans may sometimes be located outside of
California.  Although the Company seeks to avoid concentrations of
loans to a single industry or based upon a single class of collateral, real
estate and real estate associated businesses are among the principal industries
in the Company’s market areas.  As a result, the Company’s loan and
collateral portfolios are, to some degree, concentrated in those
industries.




70


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


PART
      VIIDecember 31, 2007 and 2006







NOTE C – LOANS AND
SUBSEQUENT EVENTS  - Continued




The
composition of the loan portfolio at December 31 is as follows:





2007
            
            
            
            
            
            2006Real
      estate1-4
      residential
            
            $
            2,654,635
            
            
            
            2.7
            %
            
            $
            2,395,422
            
            
            
            6.9
            %Multi-Family
            
            
            719,959
            
            
            
            0.7
            %
            
            
            297,641
            
            
            
            0.9
            %Non-farm,
      non-residential
            
            
            40,950,795
            
            
            
            41.9
            %
            
            
            18,246,727
            
            
            
            52.3
            %Construction
      & Land Development
            
            
            31,163,576
            
            
            
            31.9
            %
            
            
            3,881,815
            
            
            
            11.1
            %Commercial
            
            
            21,827,512
            
            
            
            22.4
            %
            
            
            9,844,022
            
            
            
            28.2
            %Consumer
            
            
            327,735
            
            
            
            0.3
            %
            
            
            238,064
            
            
            
            0.7
            %97,644,212
            
            
            
            100
            %
            
            
            34,903,691
            
            
            
            100
            %Net
      deferred loan (fees) costs, premiums and discounts
            
            
            229,919
            
            
            
            
            
            
            
            (108,286
            )Allowance
      for loan losses
            
            
            (1,814,860
            )
            
            
            
            
            
            
            (431,640
            )$
            96,059,271
            
            
            
            
            
            
            $
            34,363,765





The Bank
had four loans to directors at December 31, 2007, with outstanding balances of
$2.4 million, compared to two loans with outstanding balances of $1.9 million at
December 31, 2006. During 2007 one of the directors with outstanding loans
resigned. Therefore $1.5 million was reclassified from related party
loans.




A
majority of the Bank’s commercial loan portfolio is with customers located
within California throughout its primary market area of Orange and San Diego
Counties. The Bank grants commercial loans to borrowers in a number of different
industries. The Bank’s real estate and construction loan portfolio, which is
77.3% of the Bank’s total loan portfolio as of December 31, 2007, consists of
loans on real estate located throughout Southern California. Changes in economic
conditions in Southern California may result in losses that cannot be reasonably
predicted at this time.




Changes
in the allowance for loan losses are summarized as follows:






2007
            
            
            2006Balance
      at beginning of year
            
            $
            431,640
            
            
            $
            87,208Provision
      charged to expense
            
            
            1,383,220
            
            
            
            349,432Loans
      charged off
            
            
            -
            
            
            
            (5,000
            )Recoveries
      on loans previously charged off
            
            
            -
            
            
            
            -Balance
      at end of year
            
            $
            1,814,860
            
            
            $
            431,640







71


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2007 and
2006







NOTE C – LOANS AND
SUBSEQUENT EVENTS  - Continued




The Bank
had two loans on which the accrual of interest has been discontinued with an
outstanding balance of $2.5 million as of December 31, 2007. The Bank did not
have any impaired loans as of December 31, 2006.





The table
below sets forth the amounts and categories of non-performing assets in the
Bank’s loan portfolio.





2007
            
            
            2006($
      in thousands)Total
      impaired loans, all with an allowance for loan losses
            
            $
            2,467
            
            
            $
            -Related
      allowance for loan losses on impaired loans
            
            $
            590
            
            
            $
            -Total
      non-accrual loans
            
            $
            2,467
            
            
            $
            -Loans
      past due 90 days or more and still accruing
            
            $
            -
            
            
            $
            -Average
      balance during the year on impaired loans
            
            $
            2,456
            
            
            $
            -Interest
      income recognized on impaired loans
            
            $
            126
            
            
            $
            -





For the
year ended December 31, 2007, gross interest income which would have been
recorded had our non-accruing loans been current in accordance with their
original terms amounts to $170 thousand. We received and recorded $126 thousand
for such loans for the year ended December 31, 2007.




On March 25, 2008, one of the loans placed on
non-accrual in December 2007, with a principal balance of $1.0 million, was
brought current by the borrower.  Interest has been paid through April 1,
2008, and interest reserves have been replenished.  The loan was placed
onto accrual status as of March 26, 2008.




Management
may renew loans at maturity when requested by a customer whose financial
strength appears to support such a renewal or when such a renewal appears to be
in our best interest. We require payment of accrued interest in such instances
and may adjust the rate of interest, require a principal reduction, or modify
other terms of the loan at the time of renewal. Loan terms vary according to
loan type.





72


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2007 and
2006









NOTE
D - COMPANY PREMISES AND EQUIPMENT, NET




The
composition of premises and equipment at December 31 is as follows:






2007
            
            
            2006Bank
      premises
            
            $
            397,791
            
            
            $
            384,991Furniture,
      fixtures and equipment
            
            
            1,423,417
            
            
            
            1,268,2641,821,208
            
            
            
            1,653,255Less
      accumulated depreciation
            
            
            933,676
            
            
            
            508,150$
            887,532
            
            
            $
            1,145,105







NOTE
E - DEPOSITS





At
December 31, the scheduled maturities of time deposits are as
follows:







Time
      Deposits of
              $100,000
      or more
            
            
            Other
      Time
              Deposits
            
            
            Total
      TimeDepositsDecember
      31, 20072008
            
            $
            1,861,459
            
            
            $
            35,405,395
            
            
            $
            37,266,8542009
            
            
            450,293
            
            
            
            2,503,361
            
            
            
            2,953,6542010
            
            
            865,800
            
            
            
            -
            
            
            
            865,8002011
      and later
            
            
            -
            
            
            
            84,913
            
            
            
            84,913Total
            
            $
            3,177,552
            
            
            $
            37,993,669
            
            
            $
            41,171,221







At
December 31, 2007, one customer’s balance, which was our largest depositor,
totaling $28.2 million, comprised approximately 28% of total deposits. These
balances constitute all our brokered deposits at December 31, 2007. The
balances are included in Other Time Deposits, with $28 million maturing in 2008
and the remainder maturing in 2009.




NOTE
F - OTHER BORROWINGS





The
Company may borrow up to $8,000,000 overnight on an unsecured basis from its
correspondent banks.  As of December 31, 2007, no amounts were
outstanding under these arrangements. The Bank did not draw on these lines
during 2007 or 2006. Each line has an annual renewal date and the interest rate
for each line is indexed to the overnight fed funds rate at the time of the
draw.




NOTE G - INCOME
TAXES




Deferred
taxes are a result of differences between income tax accounting and generally
accepted accounting principles with respect to income and expense
recognition.  The following is a summary of the components of the net
deferred tax asset accounts recognized in the accompanying consolidated balance
sheet at December 31:


73


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2007 and
2006







NOTE G - INCOME TAXES -
Continued





2007
            
            
            
            2006Deferred
      tax assets:Pre-Opening
      Expenses
            
            $
            872,000
            
            
            
            $
            1,002,000Net
      loss carryforward
            
            
            2,823,000
            
            
            
            
            1,928,000Allowance
      for loan losses
            
            
            658,000
            
            
            
            
            107,000Other
            
            
            
            46,000
            
            
            
            
            20,000Total
      deferred tax assets
            
            
            4,399,000
            
            
            
            
            3,057,000Deferred
      liabilities:Tax
      over book depreciation
            
            
            (32,000
            )
            
            
            
            (27,000
            )Accrual
      to cash
            
            
            
            (16,000
            )
            
            
            
            (20,000
            )Total
      deferred tax liabilities
            
            
            (48,000
            )
            
            
            
            (47,000
            )Net
      deferred tax assets
            
            
            4,351,000
            
            
            
            
            3,010,000Valuation
      Allowance
            
            
            (4,351,000
            )
            
            
            
            (3,010,000
            )Net
      deferred taxes
            
            $
            -
            
            
            
            $
            -





The
valuation allowance was established because the Company has not reported
earnings sufficient enough to support the recognition of the deferred tax
assets.  The Company has net operating loss carryforwards of
approximately $6.9 million for federal income and California franchise tax
purposes.  Federal net operating loss carry forwards, to the extent
not used, will expire in 2027.  California net operating loss carry
forwards, to the extent not used, will expire in 2017.





The
provision for income tax expense (benefit) differs from the amount of expected
tax expense (benefit) to the amount computed by applying the statutory U. S.
Federal income tax rate of 35% to the income (loss) before income taxes due to
the following:





2007
            
            
            2006Expected
      (benefit) at statutory rate
            -
      Federal
            
            
            (1,374,000
            )
            
            
            (1,430,000- State
            
            
            (238,000
            
            
            
            (195,000
            )Increase 
      in valuation allowance
            
            
            
            1,341,000
            
            
            
            1,122,000Other
      permanent differences,
              stock options
            
            
            
            240,163
            
            
            
            502,000Other
            
            
            
            32,437
            
            
            
            2,600Tax
      (benefit) expense
            
            
            
            1,600
            
            
            
            1,600


74


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE G - INCOME TAXES -
Continued




Because
the Company is in a net loss position for taxes, the tax provision is comprised
of the minimum California Franchise tax. Please refer to Note A – Summary of Significant
Accounting Policies - Recent Accounting Pronouncements for additional
discussion regarding the Company’s tax position.





NOTE H - STOCK
OPTIONS




The
Company’s 2005 Stock Plan was approved by its shareholders in April 2006. Under
the terms of the 2005 Stock Plan, officers and key employees may be granted both
nonqualified and incentive stock options and directors and other consultants,
who are not also an officer or employee, may only be granted nonqualified stock
options.  The Plan provides for options to purchase 478,800 shares of
common stock at a price not less than 100% of the fair market value of the stock
on the date of grant. Stock options expire no later than ten years from the date
of the grant and generally vest over three years.  The Plan provides
for accelerated vesting if there is a change of control, as defined in the
Plan.  The Company recognized stock-based compensation cost of
$770,851 in 2007 and $1,497,901 in 2006. No tax benefit related to stock-based
compensation will be recognized until such time as the Company begins
recognizing its available deferred tax assets.





A summary
of the status of the Company’s stock option plan as of December 31, 2007 and
changes during the year ending thereon is presented below:






As
      of December 31, 2007Prices
      of outstanding options
            $6.90
      - $14.00Weighted
      average remaining contractual life of vested and expected to vest
      options
            7.69
      yearsAggregate
      intrinsic value of options, vested and expected to vest
            noneOptions
      vested and expected to vest
            366,778Weighted
      average exercise price of vested and expected to vest
    options
            $10.32Weighted
      average exercise price of options exercisable
            $10.20Aggregate
      intrinsic value of options exercisable
            noneWeighted
      average remaining contractual life of options exercisable
            7.42
      yearsOptions
      exercisable remaining, end of period
            249,778




The fair
value of each option was estimated using the Black-Scholes option pricing model
with the following assumptions presented below:





2007
            
            2006Dividend
      Yield
            
            0.00%
            
            0.00%Expected
      volatility
            
            17.3%
      - 17.6%
            
            19.70%Risk
      Free Rate
            
            3.78%
      - 4.66%
            
            5.00%Expected
      Forfieture Rate - Employees
            
            10%
      - 51%
            
            2.00%Expected
      Forfieture Rate - Directors and Executive Officers
            
            5%
      - 8%
            
            5.00%Expected
      life of options (in years)
            
            6.5
      Years
            
            6.0
      YearsWeighted-Average
      Grant Date Fair Value
            
            $3.46
            
            $4.83


75


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE H – STOCK OPTIONS -
Continued




Since
the Company has a limited amount of historical stock activity the expected
volatility is based on the historical volatility of a specific bank that has
similar demographics and a longer trading history.  The expected term
represents the estimated average period of time that the options remain
outstanding.  Since the Bank does not have sufficient historical data
on the exercise of stock options, the expected term is based on the “simplified”
method that measures the expected term as the average of the vesting period and
the contractual term.  The risk free rate of return reflects the grant
date interest rate offered for zero coupon U.S. Treasury bonds over the expected
term of the options.




2007
              
              
              
              
              
              2006Weighted-
              
              
              
              
              
              Weighted-Average
              
              
              
              
              
              AverageShares
              
              
              Exercise
    Price
              
              
              Shares
              
              
              Exercise
    PriceOutstanding at beginning of
      year
              
              
              384,965
              
              
              $
              10.34
              
              
              
              353,800
              
              
              $
              10.04Granted
              
              
              55,548
              
              
              $
              10.09
              
              
              
              36,498
              
              
              $
              13.24Exercised
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              $
              -Forfeited
              
              
              (40,167
              )
              
              $
              10.13
              
              
              
              ( 5,333
              )
              
              $
              10.38Outstanding at end of
      year
              
              
              400,346
              
              
              $
              10.32
              
              
              
              384,965
              
              
              $
              10.34Options exercisable at
      year-end
              
              
              249,778
              
              
              $
              10.20
              
              
              
              117,308
              
              
              $
              10.03Weighted-average fair value
      ofoptions granted
      during the year
              
              $
              3.46
              
              
              
              
              
              
              $
              4.82





No
options were exercised during the year ended December 31, 2007 and 2006. As of
December 31, 2007 there was $231,000 of total unrecognized compensation cost
related to the outstanding stock options that will be recognized over a weighted
average period of one year.





NOTE I – RELATED PARTY
TRANSACTIONS




As a
matter of policy, the Company does not make loans to executive officers, but may
make loans to directors and the businesses with which they are associated. In
the Company’s opinion, all loans and loan commitments to such parties are made
on substantially the same terms including interest rates and collateral, as
those prevailing at the time for comparable transactions with other persons. The
balance of these loans outstanding at December 31


was as
follows:




2007
            
            
            2006Beginning
      Balance
            
            $
            1,948,392
            
            
            $Additions
            
            
            1,981,649
            
            
            
            1,948,392Reclassifications
            
            
            (1,500,000
            )Payments
            
            
            (6,914
            )
            
            
            -Ending
      Balance
            
            $
            2,423,127
            
            
            $
            1,948,392Weighted
      Average Interest Rate
            
            
            7.3
            %
            
            
            8.3
            %






76


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE I – RELATED PARTY
TRANSACTIONS - Continued




James W.
Shute, Jr., who resigned as a director of the Company and the Bank on November
28, 2007, is a co-borrower, along with a limited liability company of which he
is the managing member, on a loan from the Bank which is currently in
default.  This loan has been placed on non-accrual status.  The
principal balance outstanding on this loan has been approximately $1.5 million
at all times since January 1, 2007.  Since that date, interest payments of
$83 thousand have been made on the loan and the current interest rate is
7.75%.




Also in
the course of ordinary business, certain officers, directors, shareholders, and
employees of the Company have deposits with the Company. In the Company’s
opinion, all deposit relationships with such parties are made on substantially
the same terms including interest rates and maturities, as those prevailing at
the time of comparable transactions with other persons. The balance of directors
and executive officer deposits at December 31, 2007 and 2006, was approximately
$625,000 and $664,000 respectively.




NOTE J – COMMITMENTS AND
CONTINGENCIES




Financial Instruments with
off-balance sheet risk


The
Company’s exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those
commitments.  Commitments to extend credit (such as the unfunded
portion on lines of credit and commitments to fund new loans) as of December 31,
2007 amounts to approximately $29,450,000, of which approximately $364,000 is
related to irrevocable letters of credit.  The Company uses the same
credit policies in these commitments as is done for all of its lending
activities.  As such, the credit risk involved in these transactions
is essentially the same as that involved in extending loan facilities to
customers.




Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Because many of the
commitments are expected to expire without being drawn upon, the total amounts
do not necessarily represent future cash requirements.  The Company
evaluates each client's credit worthiness on a case-by-case
basis.  The amount of collateral obtained if deemed necessary by the
Company is based on management's credit evaluation of the
customer.  The majority of the Company's commitments to extend credit
and standby letters of credit is secured by real estate.





Lease
Commitments


The
Company entered into a ten-year lease for its main office in San Clemente,
California and a five-year lease for a banking office in Encinitas, California.
The leases began on June 1, 2005 and August 1, 2004, respectively and have
renewal options for two five-year periods and three three-year periods
respectively. In August of 2006, the Company entered into a lease for additional
space in the San Clemente office building, under the same terms , conditions and
expiration date as the original lease . The leases call for fixed annual
increases and the Company is
responsible for its pro rata share of common area expenses and property taxes.
Rent expense amounted to approximately $491,000 and $363,000 for the periods
ending December 31, 2007 and 2006. Such “stepped” rent expense is recorded on
the straight-line basis over the expected life of the lease.




The
approximate future minimum payments for these leases are as
follows:




2008
            
            $
            409,0002009
            
            
            366,2002010
            
            
            265,1002011
            
            
            271,3002012
            
            
            277,600Thereafter
            
            
            696,400$
            2,285,600


77


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE
K - WARRANTS




In
connection with the Company’s initial stock offering, the Company’s organizers
were awarded 234,000 warrants. This included 64,000 warrants awarded to the
Company’s outside Directors in recognition of the expertise imparted, time
expended and the substantial financial risks undertaken by the Directors.
Compensation expense of $494,520 was recognized for the warrants issued to
organizers who were not also directors of the Company.  These warrants
may be exercised any time before their expiration date of May 16,
2015.  The exercise price for these warrants is $10.00 per share. As
of December 31, 2007 and 2006, 234,000 warrants were outstanding.





In
addition to the organizer/director warrants, each of the Company’s initial
shareholders received warrants in recognition of the additional financial risk
of investing in Pacific Coast National Bancorp from inception. Each initial
shareholder received warrants to purchase one share of common stock for every
five shares that he or she purchased in the initial public offering. These
warrants may be exercised any time before their expiration date of May 16, 2008.
The exercise price for these warrants is $12.50 per share. A total of 456,001
warrants were issued in May 2005.  As of December 31, 2007, 454,301
warrants were outstanding.  At December 31, 2006, 454,501 warrants were
outstanding.




Organizer
and initial shareholder warrants to purchase fractional shares were not issued.
Instead, rounding down to the next whole number was used in calculating the
number of warrants issued to any shareholder. Holders of warrants will be able
to profit from any rise in the market price of the Company’s common stock over
the exercise price of the warrants because they will be able to purchase shares
of our common stock at a price that is less than the then current market value.
If the Bank’s capital falls below the minimum level required by the OCC,
management may be directed to require the holders to exercise or forfeit their
warrants.





NOTE
L - FAIR VALUES OF FINANCIAL INSTRUMENTS





In
accordance with FASB Statement No. 107, “Disclosures About Fair Value of
Financial Instruments”, a summary of the estimated fair value of the Bank’s
financial instruments as of December 31, 2007 and 2006 is presented below. The
estimated fair value amounts have been determined by management using available
market information and appropriate valuation methodologies.





However,
considerable judgment is necessary to interpret market data to develop the
estimates of the fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Bank could realize in a current market
exchange. The use of different assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts. Statement No. 107
excludes certain financial instruments and all non-financial assets and
liabilities from its disclosure requirements. Accordingly, the aggregate fair
value





amounts
presented do not represent the underlying value of the Bank. Although management
is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since that date and, therefore, current fair value
estimates may differ significantly from amounts presented herein.





The
following methods and assumptions were used to estimate the fair value of
significant financial instruments:





Financial
Assets




The carrying amounts of cash, short term investments,
due from balances and accrued interest are considered to approximate fair
value.  Short term investments include federal funds sold, securities
purchased under




78


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE
L - FAIR VALUES OF FINANCIAL INSTRUMENTS - Continued





agreements
to resell, and interest bearing deposits with other banks. The fair values of
investment securities, including available for sale, are generally based on
quoted market prices.  The fair value of loans is estimated using a
combination of techniques, including discounting estimated future cash flows and
quoted market prices of similar instruments where available.





Financial
Liabilities





The
carrying amounts of deposit liabilities payable on demand and accrued interest
are considered to approximate fair value.  For fixed maturity
deposits, fair value is estimated by discounting estimated future cash flows
using currently offered rates for deposits of similar remaining
maturities.





Off-Balance Sheet Financial
Instruments





The fair
value of commitments to extend credit and standby letters of credit is estimated
using the fees currently charged to enter into similar
agreements.  The fair values of these financial instruments are not
deemed to be material.





The
estimated fair value of financial instruments is summarized as
follows:





December
      31, 2007
            
            
            December
      31, 2006Carrying
            
            
            Fair
            
            
            Carrying
            
            
            FairValue
            
            
            Value
            
            
            Value
            
            
            ValueFinancial
      Assets:Cash
      and cash equivalents
            
            $
            14,473,892
            
            
            $
            14,473,892
            
            
            $
            10,916,151
            
            
            $
            10,916,151Interest-bearing
      deposits in otherfinancial
      institutions
            
            
            -
            
            
            
            -
            
            
            
            1,000,000
            
            
            
            1,000,000Securities
      held to maturity
            
            
            -
            
            
            
            -
            
            
            
            7,943,375
            
            
            
            7,944,300Loans
      receivable, net
            
            
            96,059,271
            
            
            
            97,855,604
            
            
            
            34,363,765
            
            
            
            34,343,544Federal
      Reserve Bank stock
            
            
            405,150
            
            
            
            405,150
            
            
            
            493,800
            
            
            
            493,800Accrued
      interest receivable
            
            
            396,961
            
            
            
            396,961
            
            
            
            222,136
            
            
            
            222,136Financial
      Liabilities:Time
      deposits
            
            $
            41,171,221
            
            
            $
            41,709,626
            
            
            $
            5,216,094
            
            
            $
            5,229,724Other
      deposits
            
            
            57,820,552
            
            
            
            57,820,552
            
            
            
            34,633,978
            
            
            
            34,633,978Accrued
      interest payable
            
            
            754,146
            
            
            
            754,146
            
            
            
            324,592
            
            
            
            324,592





NOTE
M - REGULATORY MATTERS





The Bank
is subject to various regulatory capital requirements administered by the
federal banking agencies.  Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements.  Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the assets, liabilities, and certain




79


PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE
M - REGULATORY MATTERS - Continued





off-balance-sheet
items as calculated under regulatory accounting practices.  The Bank’s
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors.





Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of total
and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital (as defined) to average assets (as
defined).  Management believes, as of December 31, 2007, that the Bank
meets all capital adequacy requirements to which it is subject.





To
      Be WellCapitalized
      UnderFor
      Capital
            
            
            Prompt
      CorrectiveActual
            
            
            Adequacy
      Purposes
            
            
            Action
      ProvisionsAmount
            
            
            
            
            
            Amount
            
            
            
            
            
            Amount(Thousands)
            
            
            Ratio
            
            
            (Thousands)
            
            
            Ratio
            
            
            (Thousands)
            
            
            RatioAs
      of December 31, 2007:Total
      Capital (to Risk-Weighted Assets)
            
            $
            13,672
            
            
            
            11.55
            %
            
            $
            9,470
            
            
            
            8.0
            %
            
            $
            11,837
            
            
            
            10.0
            %Tier
      1 Capital (to Risk-Weighted Assets)
            
            $
            12,193
            
            
            
            10.31
            %
            
            $
            4,735
            
            
            
            4.0
            %
            
            $
            7,102
            
            
            
            6.0
            %Tier
      1 Capital (to Average Assets)
            
            $
            12,193
            
            
            
            12.19
            %
            
            $
            4,002
            
            
            
            4.0
            %
            
            $
            5,002
            
            
            
            5.0
            %As
      of December 31, 2006:Total
      Capital (to Risk-Weighted Assets)
            
            $
            15,529
            
            
            
            50.19
            %
            
            $
            2,470
            
            
            
            8.0
            %
            
            $
            3,088
            
            
            
            10.0
            %Tier
      1 Capital (to Risk-Weighted Assets)
            
            $
            15,133
            
            
            
            49.00
            %
            
            $
            1,235
            
            
            
            4.0
            %
            
            $
            1,853
            
            
            
            6.0
            %Tier
      1 Capital (to Average Assets)
            
            $
            15,133
            
            
            
            27.46
            %
            
            $
            2,204
            
            
            
            4.0
            %
            
            $
            2,755
            
            
            
            5.0
            %








As of
December 31, 2007, the Bank was categorized as well capitalized under the
regulatory framework for prompt corrective action.  To be categorized
as well capitalized, the Bank must maintain minimum total risk-based, Tier 1
risk-based, Tier 1 leverage ratio as set forth in the table.  There
are no conditions or events since that notification that management believes
have changed the Bank’s category.





The
Company is subject to similar requirements administered by its primary
regulator, the Federal Reserve Board.  For capital adequacy purposes,
the Company must maintain total capital to risk-weighted assets and Tier 1
capital to risk-weighted assets of 8.0% and 4.0%, respectively.  Its
total capital to risk-weighted assets and Tier 1 capital to risk-weighted assets
were not materially different than the ratios shown above.





The Bank
is restricted as to the amount of dividends, which can be
paid.  Dividends declared by national banks that exceed net income (as
defined by OCC regulations) for the current year plus retained net income for
the preceding two years must be approved by the OCC.  Also, the Bank
may not pay dividends that would result in capital levels being reduced below
the minimum requirements shown above.





With
certain exceptions, the Company may not pay a dividend to its shareholders
unless its retained earnings equal at least the amount of the proposed
dividend.




80




PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007 and 2006





NOTE
N - PACIFIC COAST NATIONAL BANCORP




Pacific
Coast National Bancorp (the Bancorp) has no significant business activity other
than its investment in Pacific Coast National Bank.  Accordingly, no
separate financial information on the Bancorp is provided.




NOTE
0 – OTHER EXPENSES





A summary
of other expenses for the years ended December 31 is as follows:





Year
      Ended December 31, 2007
            
            
            Year
      Ended December 31, 2006Regulatory
      Assessments
            
            $
            43,370
            
            
            $
            26,344Director
      Training
            
            
            15,082
            
            
            
            15,240Compensation
      Expense related
              to
      director stock options
            
            
            64,488
            
            
            
            22,845Loan-related
      costs (1)
            
            
            66,005
            
            
            
            39,541Recruiting
      Costs
            
            
            87,573
            
            
            
            14,443Costs
      associated with AnnualMeeting
            
            
            40,903
            
            
            
            38,801$
            317,421
            
            
            $
            157,216(1) Primarily
      consists of appraisal fees, environmental reports andthe
      provision for unfunded loan commitments





81


Item
8.  Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.




The
information required by this item was previously reported by the Company in its
Current Report on Form 8-K filed on April 19, 2007.




ITEM
8A(T). Controls and Procedures




Evaluation
of Disclosure Controls and Procedures




As of
December 31, 2007, the Company's management, with the participation of the
Company's chief executive officer and chief financial officer, evaluated the
effectiveness of the Company's disclosure controls and procedures as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”). Based on this evaluation, the Company's chief
executive officer and chief financial officer concluded that as of December 31,
2007, the Company's disclosure controls and procedures were effective to ensure
that the information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is accumulated and communicated to the
Company's management (including the chief executive officer and chief financial
officer) to allow timely decisions regarding required disclosure, and is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms.




There were no changes in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred
during the quarter ended December 31, 2007, that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting. The annual report of management on the effectiveness of internal
control over financial reporting is set forth below under "Management's Report
on Internal Control Over Financial Reporting."





We do not
expect that our internal control over financial reporting will prevent all
errors and all fraud. A control procedure, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control procedure are met. Because of the inherent limitations
in all control procedures, no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within the
Company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty, and that breakdowns in controls
or procedures can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the control. The
design of any control procedure also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions; over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
procedure, misstatements due to error or fraud may occur and not be
detected.




Management’s
Report on Internal Control Over Financial Reporting
  We are responsible for establishing and
maintaining adequate internal control over financial reporting as defined in
Rule 13a-15 (f) under the Securities Exchange Act of 1934. Our internal control
over financial reporting is designed to provide reasonable assurance to our
management and Board of Directors regarding the preparation and fair
presentation of published financial statements.




82




Because of its inherent limitations,
internal control over financial reporting may not prevent or detect
misstatements. Therefore, even those systems determined to be effective can only
provide reasonable assurance with respect to financial statement preparation and
presentation.




Management, with the participation of
the chief executive and chief financial officers, assessed the effectiveness of
our internal control over financial reporting as of December 31, 2007. In making
this assessment, we used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control – Integrated
Framework. Based on this assessment, management, with the participation of the
chief executive and chief financial officers, believes that, as of December 31,
2007, our internal control over financial reporting is effective based on those
criteria.




This 10-KSB does not include an
attestation report of the Company’s registered public accounting firm regarding
internal control over financial reporting. Management’s report was not subject
to attestation by the Company’s registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit
the Company to provide only management’s report in this
10-KSB.




ITEM
8B. OTHER INFORMATION




None.




PART
III








Item
      9.
            Directors,
      Executive Officers, Promoters, Control Persons and Corporate Governance;
      Compliance With Section 16(a) of the Exchange
  Act




Executive
Officers and Directors of the Registrant




The
executive officers of the Company are identified below. As previously reported
by the Company, the Company has designated President Michael S. Hahn to become
President and Chief Executive Officer of the Company and the Bank upon Mr.
Forkner’s planned retirement on May 16, 2008. Mr. Forkner will continue as Vice
Chairman of the board of directors of the Company and the Bank.




Colin M. Forkner , age
64, is a Director and the current Chief Executive Officer of Pacific Coast
National Bancorp and Pacific Coast National Bank.  Mr. Forkner had retired
as President and Chief Executive Officer of California First National Bank, an
Irvine, California-based bank that he founded in 1999. Before his retirement,
Mr. Forkner had been actively engaged in banking for over forty years, during
which time he held numerous senior executive management positions with Security
Pacific Corporation, The Bank of California, Mitsubishi Bank of California,
Northern Trust Bank of California and California First National Bank.  He
began his banking career in 1965 with Security Pacific Corporation where he
served in numerous management capacities, including Executive Vice
President.  He left Security Pacific Corporation in 1986 to become
Executive Vice President and Director of Strategic Planning, Marketing &
Acquisitions for the Bank of California. Next he was appointed
Chief




83


Executive
Officer of the affiliated institution, Mitsubishi Bank of California where he
remained until heading its merger in 1989 with The Bank of California. Mr.
Forkner then remained with The Bank of California in several executive officer
capacities, including Executive Vice President and Chief Credit Officer, and
Chairman and Chief Executive Officer of the non-traditional investments
affiliate.  Mr. Forkner left The Bank of California in 1991 to join
Community Bank, where he served as Executive Vice President and Chief
Administrative Officer, before joining Northern Trust Bank of California as
Managing Director, where he served for four years.  He left Northern Trust
Bank in 1997 to found California First National Bank and serve as its President
and Chief Executive Officer.  Mr. Forkner is a director and active alumnus
of The Peter F. Drucker Graduate School of Management, Claremont Graduate
University.  He also completed the Graduate School of Financial Management,
Stanford University Graduate School after earning a degree in Economic Theory
from Claremont Men’s College.




Michael S. Hahn, age 49, is a
Director and the President of Pacific Coast National Bancorp and Pacific Coast
National Bank. He also serves as Chief Operating Officer of the Bank. Mr. Hahn
is a San Diego County native and has more than twenty-four years of community
banking experience in the Bank’s service areas. Mr. Hahn began his banking
career with California First Bank which became Union Bank of California, where
he served for nineteen years in various management and officer capacities,
including Coastal Business Banking Center Manager, where he managed the bank’s
business banking in South Orange County and North San Diego County for
twenty-one offices. While at Union Bank of California, Mr. Hahn also served for
eighteen months as Chairman of Vice Chairman, Richard Hartnack’s advisory board.
Mr. Hahn’s banking career with Union Bank of California was briefly interrupted
from 1998 to 2000 when he left to join Temecula Valley Bank, N.A. as Senior Vice
President and Manager to assist them in opening their second de novo office in
Fallbrook, California. Following his time with Temecula Valley Bank, N.A., he
rejoined Union Bank of California to re-open and expand their business banking
office in Oceanside, California where he served until October 31, 2003 when he
left the bank to organize Pacific Coast National Bank. Mr. Hahn holds a Bachelor
of Science degree in Business and Management from the University of Redlands and
Associates in Arts degree in Real Estate from Palomar Community College. Mr.
Hahn is also a graduate of the prestigious leadership program, LEAD San Diego.
He has also been actively involved in numerous leadership positions with local
non-profit organizations, including the San Clemente Sunrise Rotary, the San
Clemente Chamber of Commerce, Fallbrook Village, Encinitas/La Costa and
Shadowridge/Vista Rotary Clubs, the Downtown Encinitas Mainstreet Association,
the Vista Economic Development Association and various local chapters of the
Boys and Girls Club. Mr. Hahn was honored to be named Rotarian Businessman of
the year for 2007 for Rotary District 5320.




Terry A. Stalk, age 53,
serves as Executive Vice President and Chief Financial Officer of Pacific Coast
National Bancorp and Pacific Coast National Bank. Ms. Stalk is a California
native and has been actively involved in banking for over thirty years. Before
joining the organizing team, Ms. Stalk was Senior Vice President and Director of
Strategic Planning for Hawthorne Savings, FSB, a $2.4 billion federal savings
bank where she served from 1999 to 2004. Prior to joining Hawthorne Savings, Ms.
Stalk served as Chief Financial Officer for American International Bank, Pacific
Western National Bank and El Segundo First National Bank. Ms. Stalk attended the
University of California, San Diego.




Stanley M. Cruse, age
58,serves as the
Bank’s Executive Vice President and Chief Credit Officer. Mr. Cruse joined the
Bank on June 1, 2007. Mr. Cruse has over 35 years of commercial banking
experience. Prior to joining the Bank, he served as Executive Vice President and
Chief Credit Officer for Discovery Bank/Discovery Bancorp in San Marcos, CA.
Prior to joining Discovery Bank, he was with Business Bank of California as well
as several other financial institutions. In addition to his banking activities,
Mr. Cruse is actively involved in various community and banking organizations.
Mr. Cruse graduated on September 1, 2006 from the Graduate School of Bank at
Pacific Coast Banking School on the campus of the University of Washington in
Seattle, WA.




84


David L.
Adams, age 54, serves as the Bank's Executive Vice President and manager
of the Real Estate Industries Group.  Mr. Adams joined the Bank in April
2008.  Mr. Adams has over 37 years of experience with financial
institutions.  Prior to joining the Bank, he served as Executive Vice
President at Vineyard Bank in Irvine, California.  Prior to that, his
career included positions with Hawthorne Savings Bank, Downey Savings & Loan
and California First Bank.  Throughout his career his emphasis has been in
real estate lending and development.  Mr. Adams obtained his Bachelor of
Arts degree in economic and business administration from Point Loma Nazarene
University in San Diego, California.




Thomas J. Applegate, age 55,
is a Director of Pacific Coast National Bancorp and Pacific Coast National Bank.
He is a partner with the public accounting firm of CEA, LLP, and has been
actively engaged in the public accounting industry for the past 29 years. He has
been licensed as a certified public accountant by the State of California since
May 1981. A California native, Mr. Applegate is a graduate of San Diego State
University. He has served on the faculty of Palomar College and National
University and currently serves as an advisory director of the boards of two
large private companies. Mr. Applegate is active member of the Chamber of
Commerce, Rotary International, California Society of Certified Public
Accountants, the American Institute of Certified Public Accountants, North
County Estate Planning Group of San Diego and a founding member of ENDOW
CARLSBAD, a community foundation.




Michael V. Cummings, age 66,
is a Director of Pacific Coast National Bancorp and Pacific Coast National Bank.
After serving over 35 years in the banking arena he retired in 2000. He has been
engaged in providing bank consulting services since that time. Prior to that, he
served in various executive management positions with Manufacturers Bank,
Southern California Bank, Bank of California and Security Pacific National Bank.
Mr. Cummings earned his Associates of Arts degree from El Camino College in 1963
and furthered his studies at California State University at Fullerton, majoring
in Business Administration. Mr. Cummings has lived or worked in our primary
service area for more than twenty years.




David E. Davies, age 73, is a
Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
has most recently served as an instructor of Managerial Finance at the
University of Phoenix. Prior to that, he taught Economics and Banking at Keller
Graduate School of Management. Until 1997, Mr. Davies was a career banker,
having functioned primarily as a commercial real estate loan officer for First
Interstate Bank, Sumitomo Bank  of California and the Toyo Trust &
Banking Co. He is a graduate of Miami University, where he earned a Bachelor of
Science degree in Finance, and of Northwestern University, where he earned a
Masters of Business Administration degree in Finance. He has also completed
several real estate certificate programs at the University of California, Los
Angeles and Stanford.




Fred A. deBoom, age 72, is a
Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
has been a director of Acacia Research (NASDAQ) and Combimatrix(NASDAQ) for 10
years and has served as a managing partner in Sonfad Associates, a merger and
acquisition consulting firm for the past eight years. Before joining Sonfad
Associates, he served for five years as the vice president and manager of Tokei
Bank’s Pasadena office and in a similar capacity for Union Bank during the
nine-year period preceding his time with Tokei Bank. For the seventeen years
prior to that, he was a vice president and manager for First Interstate Bank.
Mr. deBoom received a Bachelor of Arts degree from Michigan State University and
a Master of Business Administration degree in finance from the University of
Southern California. Mr. deBoom has been a San Clemente resident since
1995.




85


Dennis C. Lindeman, age
60, is Chairman of the Board of Pacific Coast National Bancorp and Pacific Coast
National Bank.  He is a Certified Financial Planner and has spent the last
twenty years providing comprehensive business and financial planning services to
closely-held business owners, executives and their families throughout Southern
California.  Mr. Lindeman is a veteran of the United States Marine Corps,
where he served for twenty years, primarily in operational planning and command
capacities, before retiring as a Lieutenant Colonel.  Mr. Lindeman has been
actively involved in leadership capacities with numerous community
organizations. Mr. Lindeman received a Bachelor of Arts degree in Economics from
Luther College.  He is also a graduate of the United States International
University, where he received a Master of Business Administration degree in
Finance.  He has lived in Fallbrook for the past twenty-five
years.




Denis H. Morgan, age 55, is a
Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
is a registered civil engineer and a licensed general contractor in the states
of California, Florida and Nevada. He served as the President and Chief
Executive Officer of Pacific 17 until the business was acquired by Alcoa in
November 2001. He has been active in investing in real estate opportunities
since 1989 and is currently investing in and developing multi-family units in
California, Arizona and New York. Mr. Morgan has also been actively involved in
numerous community organizations. His volunteer activities include service as
Finance Chairperson for the United Negro College Fund (San Diego), as corporate
sponsor to the Urban League, Neighborhood House, National Association for the
Advancement of Colored People (NAACP) and several other organizations that
provide educational, housing, and financial support to the community. Mr. Morgan
is a graduate of the University of Guyana, where he earned an HTD in Civil
Engineering and a Bachelor of Engineering degree in Highway Engineering. He also
earned a Master of Science degree in Structural Engineering from the City
University of London.




John Vuona, age 50, is a
director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
is a partner in the accounting firm of Bentson & Vuona, LLP, which he
founded in 1995. Prior to forming the firm, he served as a senior manager with
McGladrey & Pullen, LLP and as a partner in the firm of Gillespie, Lefevie,
Lokietz & Vuona. Over his career, Mr. Vuona has worked extensively with
closely-held companies in the areas of financial, manufacturing, distribution,
service and construction industries. He is a certified public accountant and a
member of the American Institute of Certified Public Accountants and the
California Society of Certified Public Accountants. Mr. Vuona is a graduate of
Babson College, where he earned a Bachelor of Science degree in Accounting. He
also completed a Master of Science degree in Taxation at the University of
Southern California. Mr. Vuona currently resides in Rancho Santa Margarita,
California.




Code
of Ethics




We have
adopted a Code of Business Conduct and Ethics, which, together with the policies
referred to therein, is applicable to all of our directors, officers and
employees and complies with Item 406 of Regulation S-K of the Securities
Exchange Act of 1934 (the “Exchange Act”). The Code of Business Conduct and
Ethics covers all areas of professional conduct, including conflicts of
interest, disclosure obligations, insider trading and confidential information,
as well as compliance with all laws, rules and regulations applicable to our
business. We encourage all employees, officers and directors to promptly report
any violations of any of our policies. Copies of our Code of Business Conduct
and Ethics may be obtained by any person, without charge, upon written request
to Pacific Coast National Bancorp, Attn: Corporate Secretary, 905 Calle
Amanecer, Suite 100, San Clemente, California 92673.




86







Audit
Committee Membership




Section
16(a) Beneficial Ownership Reporting Compliance




Section
16(a) of the Securities Exchange Act of 1934 requires the Company’s directors
and officers, and persons who own more than 10% of a registered class of our
equity securities, to file with the SEC initial reports of ownership and reports
of changes in ownership of common stock and other equity securities of the
Company. Officers, directors and greater than 10% stockholders are required by
SEC regulation to furnish the Company with copies of all Section 16(a) forms
they file.




To our
knowledge, based solely on a review of the copies of such reports furnished to
us and written representations that no other reports were required, during the
fiscal year ended December 31, 2007, all Section 16(a) filing requirements
applicable to its officers, directors and greater than 10% beneficial owners
were complied with except for the failure by Officer David L. Adams to timely
file a Form 3 upon becoming an officer and to timely file a Form 4 to report a
single transaction, the failure by Officer Stanley M. Cruse to timely file a
Form 4 to report a single transaction, the failure by Director Thomas J.
Applegate to timely file a Form 4 to report two transactions and the failure by
former Director James W. Shute, Jr. to timely file a Form 4 to report two
transactions.




Item
10.  Executive Compensation




Compensation
Philosophy




The duty
of the Compensation Committee of the Company’s board of directors is to evaluate
and make recommendations to the board of directors regarding the administration
of the executive compensation program for Pacific Coast National Bancorp and
Pacific Coast National Bank. The Compensation Committee is responsible for
recommending appropriate compensation goals for the executive officers of
Pacific Coast National Bancorp, evaluating the performance of such executive
officers in meeting such goals and making recommendations to the board with
regard to executive compensation. Pacific Coast National Bancorp’s compensation
philosophy is to ensure that executive compensation be directly linked to
continuous improvements in corporate performance, achievement of specific
operation, financial and strategic objectives, and increases in shareholder
value. The Compensation Committee regularly reviews the compensation packages of
Pacific Coast National Bancorp’s executive officers, taking into account factors
that it considers relevant, such as business conditions within and outside the
industry, Pacific Coast National Bancorp’s financial performance, the market
composition for executives of similar background and experience, and the
performance of the executive officer under consideration. The particular
elements of Pacific Coast National Bancorp’s compensation programs for executive
officers are described below.




87






Compensation
Structure
  The base
compensation for the executive officers of Pacific Coast National Bancorp named
in the Summary Compensation Table is intended to be competitive with that paid
in comparable situated industries, taking into account the scope of
responsibilities. The goals of the Compensation Committee in establishing
Pacific Coast National Bancorp’s executive compensation program
are:
  ·
              to
      compensate the executive officers of Pacific Coast National Bancorp fairly
      for their contributions to Pacific Coast National Bancorp’s short, medium
      and long-term performance; and


·
            to
      allow Pacific Coast National Bancorp to attract, motivate and retain the
      management personnel necessary to Pacific Coast National Bancorp’s success
      by providing an executive compensation program comparable to that offered
      by companies with which Pacific Coast National Bancorp competes for
      management personnel.




Upon the
opening of the Bank, the Company entered into employment agreements with Mr.
Forkner, Mr. Hahn, and Ms. Stalk. The Company entered into an employment
agreement with Mr. Cruse in June of 2007, contingent upon his approval as Chief
Credit Officer by the OCC which was received on August 10, 2007. Each employment
agreement provides for a set base salary during the first year of the agreement,
which may be increased upon review by the Board at the end of each year. The
base salary level for each officer is determined by taking into account
individual experience, individual performance, individual potential, cost of
living considerations and specific issues particular to Pacific Coast National
Bancorp. Base salary level for executive officers of selected banks and bank
holding companies of similar size are also taken into consideration in setting
an appropriate base salary for the named executive officers. The base level
established for each executive officer is considered by the Compensation
Committee to be competitive and reasonable.




The
Compensation Committee monitors the base salary levels and the various
incentives of the executive officers of Pacific Coast National Bancorp to ensure
that overall compensation is consistent with Pacific Coast National Bancorp’s
objectives and remains competitive within the area of Pacific Coast National
Bancorp’s operations. In setting the goals and measuring an executive’s
performance against those goals, Pacific Coast National Bancorp considers the
performance of its competitors and general economic and market conditions. None
of the factors included in Pacific Coast National Bancorp’s strategic and
business goals are assigned a specific weight. Instead, the Compensation
Committee recognizes that the relative importance of these factors may change in
order to adapt Pacific Coast National Bancorp’s operations to specific business
challenges and to reflect changing economic and marketplace
conditions.




Annual
Compensation




The
annual compensation of the executive officers of Pacific Coast National Bank
consists of a base salary and an auto allowance or the use of a company-owned
auto. In the future, annual performance bonuses may be paid; however, as is
typically the case with de novo or “start-up” banks, they are prohibited under
an agreement with our primary banking regulators until such time as the bank is
profitable.




Stock
Incentive Plan




The board
of directors and shareholders have approved the Pacific Coast National Bancorp
2005 Stock Incentive Plan. Stock options are currently the primary source of
long-term incentive compensation for the executive officers and directors of
Pacific Coast National Bancorp and Pacific Coast National Bank. Each of the
employees, executive officers, members of senior management and directors of
Pacific Coast National Bancorp and Pacific Coast National Bank is eligible to
participate in the 2005 Stock Incentive Plan. Pursuant to their respective
employment agreements, we issued to Colin M. Forkner, Michael S. Hahn, Stanley
M. Cruse and Terry A. Stalk options to purchase 91,200, 91,200, 12,500 and
57,000 stock options, respectively. In 2006, the Compensation Committee made a
discretionary award to each of the three executive officers of an additional
4,416 stock options based on the successful completion of the first year of
operations at the bank. In 2007, the Compensation Committee made a discretionary
award to Colin M. Forkner and Michael S. Hahn each of 4,926 stock options, and
to Terry A. Stalk of 14,926 stock options, based on the successful completion of
the second year of operations at the Bank.




88


Employment
Agreements




Compensation
of the Chief Executive Officer




We have
entered into an employment agreement with Colin M. Forkner regarding his
employment as Chief Executive Officer of Pacific Coast National Bank. This
agreement will expire upon the effectiveness of Mr. Forkner’s retirement in May
2008. Under the terms of the agreement, Mr. Forkner initially received a
base salary of $160,000 per year. Following the first year of the agreement, the
base salary was reviewed by the board of directors and increased to
$170,000.  Following the second year of the agreement, the base salary
was reviewed by the board of directors and increased to $180,000.
Mr. Forkner is eligible to participate in any incentive compensation plan
and all other benefit programs adopted by the Bank and also receives additional
life insurance plus other customary benefits such as health, dental and life
insurance, membership fees to banking and professional organizations and an
automobile allowance.




Mr. Forkner’s employment agreement also provided
for the issuance of options to purchase 91,200 shares of common stock at an
exercise price of $10.00 per share, exercisable within 10 years from the
date of grant. 30,000 of the options are being treated as incentive stock
options, and 61,200 are being treated as non-statutory stock options, all of
which vest ratably over a period of three years beginning on the date of
grant.




In
reviewing the 2007 compensation of Mr. Forkner, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believes that Mr. Forkner’s total
compensation is reasonable and competitive based on the overall performance of
Pacific Coast National Bancorp.




Compensation
of the Chief Financial Officer




We have
entered into an employment agreement with Terry A. Stalk regarding her
employment as Chief Financial Officer of Pacific Coast National Bank. The term
of the agreement is for five (5) years ending May 2010, and will automatically
renew for successive one year terms following the end of the initial five year
term unless either party provides notice that it will not seek to renew the
agreement.




Under the
terms of the agreement, Ms. Stalk initially received a base salary of $125,000
per year. Following the first year of the agreement, the base salary was
reviewed by the board of directors and increased to $131,250. Following the
second year of the agreement, the base salary was reviewed by the board of
directors and increased to $150,000. Ms. Stalk is eligible to participate in any
incentive compensation plan and all other benefit programs adopted by the Bank
and also receives additional life insurance plus other customary benefits such
as health, dental and life insurance, membership fees to banking and
professional organizations and an automobile allowance.




Ms.
Stalk’s employment agreement also provided for the issuance of options to
purchase 57,000 shares of common stock at an exercise price of $10.00 per share,
exercisable within 10 years from the date of grant. 30,000 of the options
are being treated as incentive stock options, and 27,000 are being treated as
non-statutory stock options, all of which vest ratably over a period of three
years beginning on the date of grant.




In
reviewing the 2007 compensation of Ms. Stalk, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believes that Ms. Stalk’s total
compensation is reasonable and competitive based on the overall performance of
Pacific Coast National Bancorp.




89


Compensation
of the President




We have
entered into an employment agreement with Michael S. Hahn regarding his
employment as President of Pacific Coast National Bank. The term of the
agreement is for five (5) years ending May 2010 and will automatically renew for
successive one year terms following the end of the initial five year term unless
either party provides notice that it will not seek to renew the
agreement.




Under the
terms of the agreement, Mr. Hahn initially received a base salary of
$135,000 per year. Following the first year of the agreement, the base salary
was reviewed by the board of directors and increased to $141,750. Following the
second year of the agreement, the base salary was reviewed by the board of
directors and increased to $160,000. Mr. Hahn is eligible to participate in
any incentive compensation plan and all other benefit programs adopted by the
Bank and also receives additional life insurance plus other customary benefits
such as health, dental and life insurance, membership fees to banking and
professional organizations and an automobile allowance or use of a company-owned
vehicle.




Mr. Hahn’s
employment agreement also provided for the issuance of options to purchase
91,200 shares of common stock at an exercise price of $10.00 per share,
exercisable within 10 years from the date of grant. 30,000 of the options
are being treated as incentive stock options, and 61,200 are being treated as
non-statutory stock options, all of which vest ratably over a period of three
years beginning on the date of grant.




In
reviewing the 2007 compensation of Mr. Hahn, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believes that Mr. Hahn’s total
compensation is reasonable and competitive based on the overall performance of
Pacific Coast National Bancorp.




Compensation
of the Chief Credit Officer




In June
of 2007 we entered into an employment agreement with Stanley M. Cruse regarding
his employment as Executive Vice President and Chief Credit Officer of Pacific
Coast National Bank. Under the terms of the agreement, Mr. Cruse received a
base salary of $140,000 per year. Mr. Cruse is eligible to participate in
any incentive compensation plan and all other benefit programs adopted by the
Bank and also receives customary benefits such as health, dental and life
insurance, membership fees to banking and professional organizations and an
automobile allowance or use of a company-owned vehicle.




Mr. Cruse’s
employment agreement also provided for the issuance of options to purchase
12,500 shares of common stock at an exercise price of $8.75 per share,
exercisable within 10 years from the date of grant. All of the options are
being treated as incentive stock options, which vest ratably over a period of
three years beginning on the date of grant.




In
reviewing the 2007 compensation of Mr. Cruse, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believed that Mr. Cruse’s total
compensation was reasonable and competitive based on the overall performance of
Pacific Coast National Bancorp.




90


Executive
Compensation Deductibility




Section
162(m) of the Internal Revenue Code generally disallows a tax deduction to
public companies for compensation in excess of $1,000,000 paid to a company’s
chief executive officer or any of the three other most highly compensated
officers. Section 162(m) specifically exempts certain performance-based
compensation from the deduction limit. The board of directors and Compensation
Committee generally intends to limit non-performance based compensation and
grant awards under the 2005 Stock Incentive Plan, consistent with terms of
Section 162(m) so that the awards will not be subject to the $1,000,000
deductibility limit.




Executive
Compensation Tables




Summary
of cash and certain other compensation




The
following table sets forth for each of our named executive officers for the
years ended December 31, 2007 and 2006: (i) the dollar value of base salary and
bonus earned; (ii) for options granted to each named executive officer, the
dollar amount recognized by the Company for such options in accordance with FAS
123 (R); (iii) the dollar value of earnings for services pursuant to awards
granted under non-equity incentive plans; (iv) the change in pension value and
non-qualified deferred compensation earnings; (v) all other compensation; and,
finally, (vi) the dollar value of total compensation.




Name
      and Principal
              Position
            
            Year
            
            Salary
            
            Bonus
              ($)
            
            Stock
              Awards
              ($)
            
            Option
              Awards(1)
              ($)
            
            Non-Equity
              Incentive
      Plan
              Compensation
              ($)
            
            Change
      in
              Pension
      Value
              and
      Non-
              qualified
              Deferred
              Compensation
              Earnings
              ($)
            
            All
      Other
              Compensation
              ($)
            
            Total
      ($)Colin
      M. Forkner
              Chief
      Executive
              Officer
            
            2007
              
              2006
            
            175,769
              
              165,769
            
            -
              
              -
            
            -
              
              -
            
            206,301
              
              384,394
            
            -
              
              -
            
            -
              
              -
            (2)
            32,954
              
              27,011
            
            415,025
              
              577,174Terry
      A. Stalk
              Chief
      Financial
              Officer
            
            2007
              
              2006
            
            142,067
              
              128,606
            
            -
              
              -
            
            -
              
              -
            
            146,879
              
              243,404
            
            -
              
              -
            
            -
              
              -
            (3)
            38,900
              
              29,668
            
            327,847
              
              401,678Michael S. Hahn
              President
              Chief
      Operating
              Officer
            
            2007
              
              2006
            
            152,279
              
              138,894
            
            -
              
              -
            
            -
              
              -
            
            198,767
              
              384,394
            
            -
              
              -
            
            -
              
              -
            (4)
            24,484
              
              11,068
            
            375,530
              
              534,356Stanley
      M. Cruse
              Executive
      Vice
              President
              Chief
      Credit Officer(6)
            
            2007
              
              2006
            
            78,616
              
              N/A
            
            -
              
              N/A
            
            -
              
              N/A
            
            9,669
              
              N/A
            
            -
              
              N/A
            
            -
              
              N/A
            (5)
            15,606
              
              N/A
            
            103,891
              
              N/A






(1)
            Reflects
      the dollar amounts
      recognized for financial statement reporting purposes for the years ended
      December 31, 2007 and 2006 in accordance with SFAS No. 123(R), of stock
      options awarded to the named executive officers.  The
      assumptions used in the calculation of these amounts are included in Note
      H of the Notes to Consolidated Financial Statements contained in Item 7 of
      this report.(2)
            Includes
      an auto allowance of $750 per month, gasoline, auto insurance, and toll
      road charges reimbursements, and annual life insurance
      premiums.(3)
            Includes
      an auto allowance of $500 per month, gasoline, auto insurance, and toll
      road charges reimbursements, annual life insurance premiums, and the cost
      of lodging several nights per week because Mrs. Stalk lives out of the
      area.(4)
            Includes
      use of a company-owned car, auto maintenance, gasoline, auto insurance,
      and toll road charges reimbursements, and annual life insurance
      premiums.(5)
            Includes
      an auto allowance of $500 per month, gasoline, auto insurance, and toll
      road charges reimbursements, annual life insurance premiums from June 1,
      2007 through December 31, 2007.(6)
            As
      previously reported by the Company, Mr. Cruse was hired as Executive Vice
      President and Chief Credit Officer effective June 1,
  2007.







91




Outstanding
Equity Awards at Fiscal Year End




The
following table sets forth information on outstanding option awards held by the
named executive officers at December 31, 2007, including the number of shares
underlying both exercisable and unexercisable portions of each stock option as
well as the exercise price and the expiration date of each outstanding option.
There were no stock awards outstanding as of December 31, 2007.




Outstanding
Equity Awards at December 31, 2007 Year-End Table




(Executive
Officers)




Option
      AwardsNumber
      of
              Securities
              Underlying
              Unexercised
              Options
      (#)
            
            Number
      of
              Securities
              Underlying
              Unexercised
              Options
      (#)
            
            Equity
              Incentive
              Plan
              Awards:
            
            Option
              Exercise
              Price
              ($)
            
            Option
              Expiration
              DateName
            
            Exercisable
            
            Unexercisable
            Number
      of
              Securities
              Underlying
              Unexercised
              UnearnedColin
      M. Forkner
            
            60,800
            
            
            
            -
            
            $10.00
            
            5/14/201530,400
            
            -
            
            $10.00
            
            5/14/20152,208
            
            
            
            -
            
            $13.25
            
            5/14/20162,208
            
            -
            
            $13.25
            
            5/14/2016$10.50
            
            5/13/2017Terry
      A. Stalk
            
            38,000
            
            
            
            -
            
            $10.00
            
            5/14/201519,000
            
            -
            
            $10.00
            
            5/14/20151,472
            
            
            
            -
            
            $13.25
            
            5/14/20172,944
            
            -
            
            $13.25
            
            5/14/201714,926
            
            
            
            $10.50
            
            5/13/2017Michael
      S. Hahn
            
            60,800
            
            
            
            -
            
            $10.00
            
            5/14/201530,400
            
            -
            
            $10.00
            
            5/14/20151,472
            
            
            
            -
            
            $13.25
            
            5/14/20162,944
            
            -
            
            $13.25
            
            5/14/20164,926
            
            
            
            $10.50
            
            5/13/2017Stanley
      M. Cruse
            
            -
            
            12,500
            
            -
            
            $8.75
            
            8/10/2017





Health
and insurance benefits




Our
full-time officers and employees are provided hospitalization and major medical
insurance. We pay a substantial part of the premiums for these coverages. All
insurance coverage under these plans is provided under group plans on generally
the same basis to all full-time employees. In addition, we maintain term life
insurance, which provides benefits to all employees who have completed one month
of full-time employment with us.








92






DIRECTOR
COMPENSATION




Meetings
of our board of directors are held regularly each month. We do not currently
make cash payments to directors for any service provided as a director. Under
the 2005 Stock Incentive Plan, directors may be compensated for their service to
the Company with non-statutory stock options. We intend to begin compensating
our directors with cash payments for their service once Pacific Coast National
Bancorp and Pacific Coast National Bank become profitable.  The table
below sets for the compensation for 2007 for our outside
directors.  Inside directors (Messrs. Forkner and Hahn) are not
compensated for their service as directors.  For information regarding
the compensation paid to the inside directors, see “Executive Compensation
Tables-Summary Compensation Table.”






Name
            
            Fees
              Earned
      or
              Paid
      in
              Cash
            
            Stock
              Awards
            
            Option
              Awards
            
            Non-Equity
              Incentive
              Plan
              Compensa-
              tion
            
            Change
      in
              Pension
      Value
              and
      Non-
              qualified
              Deferred
              Compensation
              Earnings
            
            All
              Other
              Compen-
              sation
            
            Total($)
            ($)
            ($)
      (1)
            ($)
            ($)
            ($)
            ($)Thomas
      J. Applegate
            
            -
            
            -
            
            8,914
            
            -
            
            -
            
            -
            
            8,914Michael
      V. Cummings (2)
            
            -
            
            -
            
            7,605
            
            -
            
            -
            
            78,406
            
            86,011David
      E. Davies
            
            -
            
            -
            
            7,605
            
            -
            
            -
            
            -
            
            7,605Fred
      A. deBoom
            
            -
            
            -
            
            6,339
            
            -
            
            -
            
            -
            
            6,339David
      Johnson
            
            -
            
            -
            
            7,605
            
            -
            
            -
            
            -
            
            7,605Dennis
      C. Lindeman
            
            -
            
            -
            
            8,239
            
            -
            
            -
            
            -
            
            8,239Denis
      H. Morgan
            
            -
            
            -
            
            7,605
            
            -
            
            -
            
            -
            
            7,605John
      Vuona
            
            -
            
            -
            
            5,964
            
            -
            
            -
            
            -
            
            5,964




(1)
            Reflects
      the dollar amounts recognized for financial statement reporting purposes
      for the year ended December 31, 2007 in accordance with SFAS No. 123(R),
      of stock options awarded to the outside directors. The assumptions used in
      the calculation of these amounts are included in Note H of the Notes to
      Consolidated Financial Statements contained in Item  7 of this
      report.  As of December 31, 2007, total shares underlying stock
      options held by the outside directors were as follows: Mr. Applegate -
      3,611 shares; Mr. Cummings - 2,666 shares; Mr. Davies - 2,666 shares; Mr.
      deBoom - 2,222 shares; Mr. Johnson - 2,666 shares; Mr. Lindeman - 2,888
      shares; Mr. Morgan - 2,666 shares; Mr. Vuona - 2,222
    shares.(2)
            Mr.
      Cummings provided consulting services to the Bank in regards to specific
      credit matters during the first and second quarters of 2007. These
      services included an analysis of the credit process, the Bank's credit
      reporting, and marketing structure. He assisted management in the search
      for and transition of the Chief Credit Officer's position. During this
      stage he relinquished his position as chairman of the Directors' Credit
      Committee to the Vice Chairman to avoid any conflicts of
      interest.





93


Item
11.  Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters







This
following table sets forth information regarding the beneficial ownership of the
common stock of the Company as of March 19, 2008, for:




·
            each
      person known by us to own beneficially more than 5% of our common
      stock;




·
            each
      officer named in the summary compensation
table;




·
            each
      of our directors and director nominees;
and




·
            all
      of our directors and executive officers as a
  group.




Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission and includes voting and investment power with respect to the
securities. Subject to applicable community property laws, the persons named in
the table have sole voting and investment power with respect to all shares of
common stock shown as beneficially owned by them. In addition, shares of common
stock issuable upon exercise of options and warrants beneficially owned that are
exercisable within sixty days of March 25, 2008, are deemed outstanding for the
purpose of computing the percentage ownership of the person holding those
options and other rights, and the group as a whole, but are not deemed
outstanding for computing the percentage ownership of any other
person.




Name
      of Beneficial Owner
            
            Amount
      and Nature of Beneficial
              Ownership
            
            
            Percent
      of
              Class
      (12)Greater
      Than 5% Shareholders:NoneDirectors
      and Named Executive Officers:Thomas
      J. Applegate
            
            24,612
            (1)
            
            
            
            
            
            
            
            *Michael
      V. Cummings
            
            8,421
            (2)
            
            
            
            
            
            
            
            *David
      E. Davies
            
            6,521
            (3)
            
            
            
            
            
            
            
            *Fred
      A. deBoom
            
            13,651
            (4)
            
            
            
            
            
            
            
            *Colin
      M. Forkner
            
            107,824
            (5)
            
            
            
            
            
            
            
            4.13%Michael
      S. Hahn
            
            117,786
            (6)
            
            
            
            
            
            
            
            4.51%David
      Johnson
            
            18,721
            (7)
            
            
            
            
            
            
            
            *Dennis
      C. Lindeman
            
            45,616
            (8)
            
            
            
            
            
            
            
            1.75%Denis
      H. Morgan
            
            43,221
            (9)
            
            
            
            
            
            
            
            1.66%John
      Vuona
            
            8,251
            (10)
            
            
            
            
            
            
            
            *Stanley
      M. Cruse
            
            900
            
            
            
            
            
            
            
            
            *Terry
      A. Stalk
            
            51,919
            (11)
            
            
            
            
            
            
            
            1.99%All
      directors and executive officers as a group
            
            447,443
            
            
            
            
            
            
            
            
            17.14%









94






* The
address of each of our directors and named executives is c/o Pacific Coast
National Bancorp, 905 Calle Amanecer, Suite 100, San Clemente, California
92673.






Notes
      to beneficial ownership table(1)
            Includes
      options to acquire 2,777 shares of common stock and warrants to acquire
      1,000 shares of common stock.(2)
            Includes
      options to acquire 2,221 shares of common stock and warrants to acquire
      4,200 shares of common stock.(3)
            Includes
      options to acquire 2,221 shares of common stock and warrants to acquire
      4,050 shares of common stock.(4)
            Includes
      options to acquire 1,851 shares of common stock and warrants to acquire
      5,000 shares of common stock.(5)
            Includes
      options to acquire 97,824 shares of common stock and warrants to acquire
      1,000 shares of common stock.(6)
            Includes
      options to acquire 95,786 shares of common stock and warrants to acquire
      15,000 shares of common stock.(7)
            Includes
      options to acquire 2,221 shares of common stock and warrants to acquire
      6,000 shares of common stock.(8)
            Includes
      options to acquire 2,406 shares of common stock and warrants to acquire
      17,660 shares of common stock.(9)
            Includes
      options to acquire 2,221 shares of common stock and warrants to acquire
      15,000 shares of common stock.(10)
            Includes
      options to acquire 1,851 shares of common stock and warrants to acquire
      4,400 shares of common stock.(11)
            Includes
      options to acquire 45,919 shares of common stock and warrants to acquire
      1,000 shares of common stock.(12)
            Calculated
      based on 2,610,308 shares of common stock outstanding as of March 19, 2008
      including options and warrants exercisable within sixty days of March 19,
      2008.






Item
12.  Certain Relationships and Related Transactions, Director
Independence
  Certain Relationships and Related Transactions




Under
Section 402 of the Sarbanes-Oxley Act of 2002, it is unlawful for any issuer to
extend, renew or arrange for the extension of credit in the form of a personal
loan to or for any director or executive officer of that issuer. This
prohibition does not apply to loans that were made on or prior to July 30, 2002,
or certain types of loans described in Section 402 that are (i) made available
by the issuer in the ordinary course of the issuer’s consumer credit business;
(ii) of a type generally made available by such issuer to the public; and (iii)
made by the issuer on market terms, or terms that are no more favorable than
those offered by the issuer to the general public.




Section
402 also does not apply to loans by an insured depository institution, such as
Pacific Coast National Bank, if the loan is subject to the insider lending
restrictions of Section 22(h) of the Federal Reserve Act or the Federal
Reserve’s Regulation O. We believe that all related transactions comply with
Section 402 of the Sarbanes-Oxley Act or have been made pursuant to a valid
exception from Section 402 of the Sarbanes-Oxley Act.




Certain
of our officers, directors and principal shareholders and their affiliates have
had transactions with Pacific Coast National Bank, including borrowings and
investments in certificates of deposit. Except as noted below, our management
believes that all such loans and investments have been and will continue to be
made in the ordinary course of business of Pacific Coast National Bank on
substantially the same terms, including interest rates paid and collateral
required, as those prevailing at the time for comparable transactions with
unaffiliated persons, and do not involve more than the normal risk of
collectibles or present other unfavorable features.




James W. Shute, Jr., who resigned as a director of
the Company and the Bank on November 28, 2007, is a co-borrower, along with a
limited liability company of which he is the managing member, on a loan from the
Bank which is currently in default.  This loan has been placed on
non-accrual status.  The principal balance outstanding on this loan has
been approximately $1.5 million at all times since Januray 1, 2007.  Since
that date, interest payments of $83 thousand have been made on the loan and the
current interest rate is 7.75%.






95




Director
Independence




Our Board
of Directors has determined that each of our current directors, except Messrs.
Forkner and Hahn, is independent under the applicable NASDAQ rules. Mr. Forkner
currently serves as the Company’s and the Bank’s Chief Executive Officer. Mr.
Hahn currently serves as the Company’s and the Bank’s President as well as the
Chief Operating Officer of the Bank.




Item
13.  Exhibits




(a)           Exhibits




Number
            Description3.1
            Articles
      of incorporation*3.2
            Bylaws*4.1
            Specimen
      common stock certificate*4.2
            See
      Exhibits 3.1 and 3.2 for provisions of the articles of incorporation and
      bylaws defining rights of holders of the common stock10.1
            Office
      Lease dated as of July 5, 2004**10.2
            Lease
      dated as of December 6, 2003**10.3
            [reserved]10.4
            Form
      of Pacific Coast National Bancorp Organizers’ Warrant
      Agreement*10.5
            Form
      of Pacific Coast National Bancorp Shareholders’ Warrant
      Agreement*10.6
            Form
      of Pacific Coast National Bancorp, Inc. 2005 Stock Incentive
      Plan+*10.7
            Form
      of Employment Agreement by and between Pacific Coast National Bancorp and
      Michael Hahn+*10.8
            Form
      of Employment Agreement by and between Pacific Coast National Bancorp and
      Stanley M. Cruse+****10.9
            Form
      of Employment Agreement by and between Pacific Coast National Bancorp and
      Colin Forkner+*10.10
            Form
      of Employment Agreement by and between Pacific Coast National Bancorp and
      Terry Stalk+*10.11
            Form
      of Employment Agreement by and between Pacific Coast National Bancorp and
      David L. Adams****10.12
            Form
      of Incentive Stock Option Agreement+*****10.13
            Form
      of Nonqualified Stock Option Agreement+*****10.14
            Amendment
      To Lease Date Change to Office Lease dated as of February 23,
      2005******10.15
            Second
      Amendment to Office Lease dated as of March 1,
  2006******14
            Code
      of Ethics***21
            Subsidiaries
      of Registrant******31.1
            Certification
      of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities
      Exchange Act31.2
            Certification
      of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities
      Exchange Act32
            Certification
      Pursuant to Rule 13a-14(b) of the Securities Exchange Act and 18 U.S.C.
      §1350.*
            Previously
      filed as an exhibit to the registration statement on Form SB-2 filed by
      the registrant with the Securities and Exchange Commission on September 8,
      2004.**
            Previously
      filed as an exhibit to the registrant’s quarterly report on Form 10-QSB
      for the quarter ended March 31, 2005.***
            Previously
      filed as an exhibit to the registrant’s annual report on Form 10-KSB for
      the year ended December 31, 2005.****
            Previously
      filed as an exhibit to the registrant's quarterly report on Form 10-QSB
      for the quarter ended June 30, 2007.*****
            Previously
      filed as an exhibit to the registrant's annual report on Form 10-KSB for
      the year ended December 31, 2005.******
            Previously
      filed as an exhibit to the registrant's annual report on Form 10-KSB for
      the year ended December 31, 2006.+
            Indicates
      a compensatory plan or contract.




96


(b)           None




Item
14.  Principal Accounting Fees and Services.




The
following table shows the fees paid by us for the audit and other services
provided by our auditor, McGladrey & Pullen for 2007 and Vavrinek, Trine
& Day, LLP, for 2006.




2007
            
            2006Audit
      Fees
            
            $
            170,200
            
            $
            29,000Audit-related
      Fees
            
            
            8,300Tax
      Fees
            
            
            -
            
            
            4,000All
      Other Fees
            
            
            11,634Total
            
            $
            190,134
            
            $
            33,000





As
defined by the Securities and Exchange Commission, (i) “Audit Fees” are fees for
professional services rendered by the Company’s principal accountant for the
audit of the company’s annual financial statements and review of financial
statements included in the Company’s Form 10-QSB and Form 10-KSB, or for
services that are normally provided by the accountant in connection with
statutory and regulatory filings or engagements for those fiscal years; (ii)
“audit-related fees” are fees for assurance and related services by the
Company’s principal accountant that are reasonably related to the performance of
the audit or review of the company’s financial statements and are not reported
under “audit fees;” (iii) “tax fees” are fees for professional services rendered
by the Company’s principal accountant for tax compliance, tax advice, and tax
planning; and (iv) “all other fees” are fees for products and services provided
by the Company’s principal accountant, other than the services reported under
“audit fees,” “audit-related fees,” and “tax fees” primarily, discussions with
management relating to internal control assessment.




Under
applicable Securities and Exchange Commission rules, the Audit Committee is
required to pre-approve the audit and non-audit services performed by the
independent auditors in order to ensure that they do not impair the auditors’
independence. The Commission’s rules specify the types of non-audit services
that an independent auditor may not provide to its audit client and establish
the Audit Committee’s responsibility for administration of the engagement of the
independent auditors.




Consistent
with the Commission’s rules, the Audit Committee Charter requires that the Audit
Committee review and pre-approve all audit services and permitted non-audit
services provided by the independent auditors to us or any of our subsidiaries.
The Audit Committee may delegate pre-approval authority to a member of the Audit
Committee and if it does, the decisions of that member must be presented to the
full Audit Committee at its next scheduled meeting.









97


SIGNATURES





In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.




PACIFIC COAST NATIONAL BANCORP,
      INC.Date:  March 31, 2008
              By:
              /s/ Colin
      M. ForknerColin
      M. ForknerChief
      Executive Officer






In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.




SIGNATURE
            TITLE
            DATE/s/ Colin
      Forkner
            Chief
      Executive Officer and Director
            March
      31, 2008Colin
      Forkner
            (Principal
      Executive Officer)/s/ Thomas J.
      Applegate
            Director
            March
      31, 2008Thomas
      J. Applegate/s/ Michael
      Cummings
            Director
            March
      31, 2008Michael
      Cummings/s/ David E.
      Davies
            Director
            March
      31, 2008David
      E. Davies/s/ Fred A. de
      Boom
            Director
            March
      31, 2008Fred
      A. de Boom/s/ Michael
      Hahn
            Director
            March
      31, 2008Michael
      Hahn/s/ David
      Johnson
            Director
            March
      31, 2008David
      Johnson/s/ Dennis
      Lindeman
            Director
      and Chairman of the Board
            March
      31, 2008Dennis
      Lindeman/s/ Denis H.
      Morgan
            Director
            March
      31, 2008Denis
      H. Morgan/s/ Jack
      Vuona
            Director
            March
      31, 2008Jack
      Vuona/s/ Terry
      Stalk
            Executive
      Vice President and Chief Financial Officer
            March
      31, 2008Terry
      Stalk
            (Principal
      Financial and Accounting Officer)





98