**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, 2006**




**OR**




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




Commission
      File Number **333-118859**




**PACIFIC
      COAST NATIONAL BANCORP**


(Exact
      name of registrant as specified 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, including zip code)**(949)
                361-4300**(Registrant’s
                telephone number, including area code)Securities
                registered pursuant to Section 12(b) of the Act: NoneSecurities
                registered pursuant to Section 12(g) of the Act: NoneCommon
                Stock, par value$.01
                per share


Indicate
      by check mark whether the registrant: (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days.


Yes
      [X]
      No [ ]




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of the Form 10-K or any amendment of
      this
      Form 10-K. [ ]




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


Yes
      [ ]
      No [X]




Registrant’s
      revenues for the fiscal year ended December 31, 2006, were
      $2,825,131.




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 09,
      2007: $23,686,000. 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 Registrant
      outstanding as of March 1, 2007, was 2,281,500.




DOCUMENTS
      INCORPORATE BY REFERENCE: Portions of the Company’s definitive proxy statement
      for the 2007 Annual Meeting of Shareholders, expected to be held in June 2007,
      are incorporated by reference into Part III of this Form 10-KSB.




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
            37ITEM
                3. LEGAL PROCEEDINGS
            37ITEM
                4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
            37PART
                IIITEM
                5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
                MATTERS
            37ITEM
                6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
                OF OPERATION
            39ITEM
                7. FINANCIAL STATEMENTS
            52ITEM
                8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
                FINANCIAL DISCLOSURE.
            52ITEM
                8A. CONTROLS AND PROCEDURES
            52ITEM
                8B. CONTROLS AND PROCEDURES
            54PART
                IIIITEM
                9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
            54ITEM
                10. EXECUTIVE COMPENSATION
            54ITEM
                11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                MANAGEMENT
            54ITEM
                12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
            54ITEM
                13. EXHIBITS
            54ITEM
                14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
            55




-i-




**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 the Company’s
      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
      the Company believes 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 the control of the Company and its subsidiary, Pacific Coast National
      Bank (“Bank”). The following factors, among others, could cause the Company’s
      results or financial performance to differ materially from its 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;




·
            adverse
                changes in general economic conditions and economic conditions in
                Southern
                California and industries in which the Bank operates;




·
            adverse
                changes in the local real estate market and the value of real estate
                collateral securing a substantial portion of the Bank’s 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;




·
            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;  -
            2 -




·
            changes
                in the interest rate environment, which may reduce interest margins
                and
                impact funding sources;




·
            increased
                asset levels and changes in the composition of assets and the resulting
                impact on the capital levels and regulatory capital ratios of the
                Company
                or the Bank;




·
            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 the Bank’s 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 a more detailed
      and additional discussion of certain factors that could cause the Company’s
      results or financial performance to differ materially from its goals, plans,
      objectives, intentions, expectations and other forward-looking statements New
      factors emerge from time to time, and it is not possible for the Company to
      predict which factor, if any, will materialize. In addition, the Company cannot
      assess the potential impact of each factor on the Company’s business or the
      extent to which any factor, or combination of factors, may cause actual results
      to differ materially from those contained in any forward-looking
      statements.




**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 a 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 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.




The
      Company chose a holding company structure because it believed it would provide
      flexibility in accommodating the Company’s and Bank’s business objectives. For
      example, with a holding company structure, the Company may assist the Bank
      in
      maintaining its required capital ratios by borrowing money and contributing
      the
      proceeds of that debt to the Bank as primary capital. Additionally, under
      provisions of the Gramm-Leach-Bliley Act, if the Company elected to be a
      financial holding company, it could engage in activities that are financial
      in
      nature or incidental or complementary to a financial activity, including
      merchant banking activities, in which the Bank would be prohibited from
      engaging. Although the Company does not presently intend to engage in these
      financial activities, it would be able to do so without notice to or a filing
      with the Federal Reserve if it believes that there is a need for these services
      in its market area, that it can be successful in these activities, and that
      these activities would be profitable.


-
          3 -


At
      this
      time, the Company engages in no material business operations other than owning
      and managing the Bank.




Pacific
      Coast National Bank - On May
      16, 2005, the Bank began banking operations as a federally-chartered national
      bank, having received all necessary regulatory approvals. 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 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.




The
      Bank
      is headquartered in San Clemente, California, and currently operates full
      service retail banking offices in San Clemente and Encinitas, California. 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, and consumers. Lending services include consumer loans and
      commercial loans to small- to medium-sized
      businesses and professional concerns. 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, travelers’ checks, 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. The Bank’s website iswww.pacificcoastnationalbank.com.




**Philosophy
      and strategy**




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




To
      carry
      out its philosophy, the Bank’s 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 - The
      Bank’s primary service areas are the coastal regions of south Orange County and
      north San Diego County, which it serves from two locations. The main office
      is
      located at


-
          4 -


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. The
      Bank
      draws most of its customer deposits and conducts most of its lending
      transactions from and within its 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 the Bank cannot be certain,
      it expects this trend to continue.




Local
      economy - The
      Bank believes that its banking market represents a unique market with a
      diversified and growing customer base. It also believes that the primary service
      areas present an environment that will support its growth. As a community bank,
      the Bank is designed to serve the needs of the residents and small- to
      medium-sized businesses within this growing economy. Because the Southern
      California market is a critical part of the national economy, many groups
      research, analyze and project how the market will fare in the coming months.
      A
      few of these forecasts are cited below.




In
      a Los
      Angeles Times article on February 21, 2007 the recently released economic
      forecasts by the Los Angeles County Economic Development Corporation and the
      Center for Continuing Study of the California Economy was referenced as stating
      that the economic growth for Southern California is expected to be “slightly
      slower but still solid.” Quality of life issues are expected to hamper the
      region including traffic congestion, poor performing schools, and a shortage
      of
      affordable housing. On the positive side, trade, professional services and
      tourism are all expected to show growth.




The
      article went on to say that international trade faces risks due to a federal
      law
      that is expected to take effect this year requiring that all transportation
      workers have certain credentials. It is estimated that 20% to 30% of the area’s
      truck drivers may be undocumented. This could create a bottleneck at the ports,
      as truck drivers are already in short supply.




Grubb
      & Ellis has released their 2007 Real Estate Forecast. For the Southern
      California area their report states “Office vacancies all around the region were
      below 10% at year end 2006, with varying amounts of new construction underway.
      There will be continuing demand for office space in the region during 2007,
      especially from the professional, scientific & technical services sector
      (which includes accounting, law and engineering).”
http://www.grubb-ellis.com/research/forecast2007/




Lending- The
      Bank faces 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 the Bank does not have. Large banks and savings
      and
      loan institutions frequently enjoy a lower cost of funds than the Bank and
      can
      therefore charge less than the Bank for loans. The Bank attempts 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.




Deposits - The
      Bank competes 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 the Bank’s competitors offer customers a larger spectrum of products
      than the Bank, the Bank, as part of its strategic plan, continues to enhance
      the
      line of products and services offered to its customers.


-
          5 -




**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. The
      Bank
      offers 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 the Bank
      from its larger financial-institution competitors. The Bank endeavors to hire
      the most qualified and experienced people in the market who share its commitment
      to customer service and believes that this 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, the Bank has implemented the following operating
      and growth strategies.




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




·
            *Experienced
                senior management*.
                The Bank’s senior management possesses extensive experience in the banking
                industry, as well as substantial business and banking contacts in
                its
                primary service areas.




·
            *Quality
                employees*.
                The Bank has hired, and will continue to hire, highly trained and
                seasoned
                staff. Ongoing training provides the staff with extensive knowledge
                of the
                Bank’s products and services allowing the first employee a customer
                encounters to resolve most questions the customer may have.




·
            *Community-oriented
                board of directors*.
                The Bank’s directors are either experienced bankers or local business and
                community leaders. Many of its directors are residents of the Bank’s
                primary service areas, and most have significant business ties to
                the
                primary service 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*.
                The Bank’s main office is highly visible and located in close proximity to
                major traffic arteries. The main office 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 banking 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 the Bank a presence
                in a
                market that is dominated by branch offices of banks headquartered
                out of
                the area.




·
            *Individual
                customer focus*.
                The Bank focuses on providing individual service and attention to
                its
                target customers, which include individuals and small- to medium-sized
                businesses. Due to personal relationships of the Bank’s employees,
                officers and directors with many of the Bank’s customers, the Company
                believes the Bank generally is 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*.
                The Bank uses 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  -
            6 -




professionals
      are utilized to ensure that the look of the Bank’s marketing material has a
      consistent, professional message that is appropriate to its target market.




Growth
      strategies -
      Because the Bank believes that the growth and expansion of its operations will
      be significant factors in its success, the Bank has implemented, or plans to
      implement, the following growth strategies:




·
            *Capitalize
                on its community orientation*.
                The Bank actively markets itself to capitalize on its 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 its market area.




·
            *Employ
                experienced lending officers*.
                The Bank has 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, the Bank has been
                able to
                attract local businesses who appreciate dealing with bankers who
                know
                their business.




·
            *Offer
                fee-generating products and services*.
                The Bank’s range of services, pricing strategies, interest rates paid and
                charged, and hours of operation are structured to attract the Bank’s
                target customers and increase its market share. The Bank strives
                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**




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




Lending
      policy - The
      Bank’s 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 the Bank. The Bank’s strategic focus
      includes an effective, efficient and responsive transaction execution, which
      is
      consistent with the Bank’s relatively flat organizational structure and its
      reliance upon relatively few, highly-skilled lending professionals. This results
      in a rapid response to credit requests provided through local decision making
      and provides the Bank with a competitive advantage.




The
      Bank’s 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. The Bank does not
      make
      loans to any of its directors unless the loan receives prior approval by the
      Bank’s 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.
      The Bank’s current policy is not to lend to its executive officers.




Lending
      limits - The
      Bank’s 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, the Bank is 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


-
            7 -




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. 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 the Bank’s primary service areas make
      proportionately more loans to medium- to large-sized businesses than the Bank
      makes. Many of the Bank’s 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
      Bank makes commercial real estate loans, construction and development loans,
      small business loans and residential real estate loans. These may include
      commercial loans where the Bank takes a security interest in real estate out
      of
      an “abundance of caution” and not as the principal collateral for the loan. At
      December 31, 2006, the Bank held $24.8 million in loans secured by real estate,
      representing 71.1% of gross loans receivable, and undisbursed commitments of
      $4.7 million. At December 31, 2005, the Bank held $7.8 million is loans secured
      by real estate, representing 75.3% of gross loans receivable, and undisbursed
      commitments of $1.2 million. The classes of real estate loans are described
      below.




·
            Construction
                and development loans-
                The Bank offers owner-occupied and developer construction loans.
                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. Construction
                and
                development loans are generally made with a term of six to twelve
                months
                and interest is paid monthly. The ratio of the loan principal to
                the value
                of the collateral as established by independent appraisal typically
                will
                not exceed industry standards. Speculative loans are based on the
                borrower’s financial strength and cash flow position. 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. Risks associated with construction loans include fluctuations
                in
                the value of real estate and new job creation trends. At December
                31,
                2006, the Bank had $3.9 million in construction loans outstanding,
                representing 11.1% of gross loans receivable, and $993 thousand in
                undisbursed construction loan commitments. The Bank had no construction
                loans at December 31, 2005.




·
            Commercial
                real estate-
                Commercial 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. The
                Bank
                generally requires 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. Risks associated with commercial
                real estate loans include fluctuations in the value of real estate,
                new
                job creation trends, tenant vacancy rates and the quality of the
                borrower’s management. The Bank limits its risk by analyzing borrowers’
                cash flow and collateral value on an ongoing basis. At December 31,
                2006,
                the Bank held $18.5 million in commercial real estate loans outstanding,
                representing 53.1% of gross loans receivable, and undisbursed commercial
                real estate loan commitments of $1.1 million. At December 31, 2005,
                the
                Bank held $6.6 million in commercial real estate
                loans  -
            8 -




outstanding,
      representing 64.3% of gross loans receivable, and undisbursed commercial real
      estate loan commitments of $27 thousand.




·
            Residential
                real estate-
                The Bank’s residential real estate loans consist of residential second
                mortgage loans. All loans are made in accordance with the Bank’s appraisal
                policy with the ratio of the loan principal to the value of collateral
                as
                established by independent appraisal not exceeding 80%, unless the
                borrower has private mortgage insurance. Management expects that
                these
                loan-to-value ratios will be sufficient to compensate for fluctuations
                in
                real estate market value and to minimize losses that could result
                from a
                downturn in the residential real estate market. At December 31, 2006,
                the
                Bank held $2.4 million in residential real estate loans outstanding,
                representing 6.9% of gross loans receivable, and undisbursed commitments
                of $2.6 million. At December 31, 2005, the Bank held $541 thousand
                in
                residential real estate loans outstanding, representing 5.2% of gross
                loans receivable, and undisbursed commitments of $1.2 million.




Commercial
      loans - The
      target commercial loan market is retail establishments and small- to
      medium-sized 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 income. The Bank
      typically makes 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, 2006, the Bank held $9.8 million in
      commercial loans outstanding, representing 28.2% of gross loans receivable,
      and
      undisbursed commitments of $4.9 million. At December 31, 2005, the Bank held
      $2.5 million in commercial loans outstanding, representing 24.0% of gross loans
      receivable, and undisbursed commitments of $3.9 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-
                SBA 504 second trust deed loan terms are generally limited to six
                months
                or less, and interest rates are adjustable. The Bank generally charges
                an
                origination fee for its services. The Bank generally requires 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. Risks associated with commercial real estate loans include
                fluctuations in the value of real estate, new job creation trends,
                tenant
                vacancy rates and the quality of the borrower’s management. The Bank
                limits its risk by analyzing borrowers’ cash flow and collateral value on
                an ongoing basis. At December 31, 2006, the Bank held $1.9 million
                in
                commercial real estate SBA 504 loans outstanding, representing 5.3%
                of
                gross loans receivable. At December 31, 2005, the Bank held $602
                thousand
                in commercial real estate SBA 504 loans outstanding, representing
                5.8% of
                gross loans receivable. There were no undisbursed commitments for
                SBA 504
                loans at December 31, 2006 and
                2005.




·
            SBA
                7A-**The
                Bank expects that SBA 7A loans for commercial purposes in various
                lines of
                businesses will be an important part its commercial loan portfolio.
                The
                target market for  -
            9 -




SBA
      7A
      loans is retail establishments and small- to medium-sized businesses. 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 7A 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. 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 an SBA 7A
      borrower’s creditworthiness. At December 31, 2006, the Bank held $2.5 million in
      SBA 7A loans representing 7.1% of gross loans receivable. 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. At December 31, 2005, the Bank had
      no
      SBA 7A loans.




Consumer
      and other lending - The
      Bank makes a variety of loans to individuals for personal, family and household
      purposes, including secured and unsecured installment and term loans, second
      mortgages, home equity loans, and overdrafts, which are done on a case-by-case
      basis as an accommodation for the Bank’s clients. The amortization of second
      mortgages generally does not exceed 15 years and the rates are generally fixed
      for 12 months or longer. Repayment of consumer loans depends upon the borrower’s
      financial stability and is more likely to be adversely affected by divorce,
      job
      loss, illness and personal hardships than repayment of other loans. 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. The 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. The
      principal competitors for consumer loans are the established banks and finance
      companies in the Bank’s market areas. At December 31, 2006, the Bank held $238
      thousand in consumer loans outstanding, representing 0.7% of gross loans
      receivable, and undisbursed commitments of $41 thousand. At December 31, 2005,
      the Bank held $72 thousand in consumer loans outstanding, representing 0.7%
      of
      gross loans receivable, and undisbursed commitments of $25
      thousand.




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


2006
              
              2005Real
                  estate
              
              $
              20,939,790
              
              $
              7,791,112Construction
              
              
              3,881,815
              
              
              -Commercial
              
              
              9,844,022
              
              
              2,483,127Consumer
              
              
              238,064
              
              
              72,25934,903,691
              
              
              10,346,498Deferred
                  loan fees
              
              
              (
                  108,286
              )
              
              (
                  29,168
              )Allowance
                  for loan losses
              
              
              (
                  431,640
              )
              
              (
                  87,208
              )$
              34,363,765
              
              $
              10,230,122






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.


-
          10 -


2006
              
              2005#
                  of Loans
              
              Average
                  Loan Size
              
              #
                  of Loans
              
              Average
                  Loan SizeReal
                  estate
              
              
              53
              
              $
              395,090
              
              
              20
              
              $
              389,556Construction
              
              
              3
              
              
              1,293,938
              
              
              -
              
              
              -Commercial
              
              
              29
              
              
              339,449
              
              
              9
              
              
              275,903Consumer
              
              
              10
              
              
              23,806
              
              
              11
              
              
              6,56995
              
              
              367,407
              
              
              40
              
              
              258,662




Loan
      originations - The
      following table sets forth the Bank’s loan originations for 2006 and 2005,
      including loan participations that were purchased from and sold to other banks
      without recourse.


2006
              
              2005Real
                  estate
              
              $
              25,550,123
              
              $
              12,329,250Construction
              
              
              4,875,000
              
              
              -Commercial
              
              
              12,366,094
              
              
              6,463,911Consumer
              
              
              222,095
              
              
              98,160$
              43,013,312
              
              $
              18,891,321




Repricing
      of portfolio - The
      following table summarizes the maturities for fixed rate loans and the repricing
      intervals for adjustable rate loans as of December 31, 2006.


Principal
                  BalanceInterval
              
              Fixed
                  Rate
              
              Adjustable
                  Rate
              
              Total<
                  3 months
              
              $
              8,818
              
              $
              12,732,339
              
              $
              12,741,157>
                  3 to 12 months
              
              
              95,260
              
              
              2,293,078
              
              
              2,388,338>
                  1 to 3 Years
              
              
              478,871
              
              
              4,897,667
              
              
              5,376,538>
                  3 to 5 years
              
              
              3,311,703
              
              
              5,977,959
              
              
              9,289,662>
                  5 to 15 years
              
              
              1,514,746
              
              
              3,593,250
              
              
              5,107,996Gross
                  Loans Receivable
              
              $
              5,409,398
              
              $
              29,494,293
              
              $
              34,903,691




Contractual
      maturity of portfolio - The
      following table sets forth information at December 31, 2006, regarding the
      dollar amount of loans maturing in the Bank’s 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.




-
          11 -


<1
                  Year
              
              1
                  -
                  5 years
              
              5
                  -
                  15 years
              
              Over
                  15 years
              
              Total
                  loansReal
                  estate
              
              $
              3,243,016
              
              $
              3,151,684
              
              $
              14,109,890
              
              $
              435,200
              
              $
              20,939,790Construction
              
              
              3,881,815
              
              
              -
              
              
              -
              
              
              -
              
              
              3,881,815Commercial
              
              
              2,924,440
              
              
              4,685,758
              
              
              2,233,824
              
              
              -
              
              
              9,844,022Consumer
              
              
              166,818
              
              
              65,925
              
              
              -
              
              
              5,321
              
              
              238,064Gross
                  Loans Receivable
              
              $
              10,216,089
              
              $
              7,903,367
              
              $
              16,343,714
              
              $
              440,521
              
              $
              34,903,691




**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 the Bank’s loan portfolio, in each case subject to guidelines approved
      by the Bank’s board of directors.




Loan
      delinquencies - When a
      borrower fails to make a required payment on a loan, the Bank attempts 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 the Bank generally
      prefers to work with borrowers to resolve such problems, if a payment becomes
      45
      days delinquent, the Bank may institute foreclosure or other proceedings, as
      necessary, to minimize any potential loss. As of December 31, 2006, there were
      no delinquent loan payments.




Non-performing
      assets - At
      December 31, 2006, the Bank had no nonperforming 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 the Bank’s gross investment in the loan is not probable. Troubled
      debt restructurings (“TDRs”) are defined as loans which the Bank has 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,
      the Bank does not accrue interest on loans past due 90 days or more. There
      were
      no loans placed on non-accrual during 2006.




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  -
            12 -


the
      amount of 100% of the portion of the asset classified as loss, or charge off
      such an amount. At December 31, 2006 and 2005, the Bank had no classified
      assets.




Allowance
      for loan losses - The
      Bank maintains 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 the Bank’s 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.
      The
      Bank periodically reviews 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 2006 in the Bank’s allowance for
      loan losses account.


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




The
      following table sets forth information concerning the allocation of the
      allowance for loan losses, which is maintained on the Bank’s loan portfolio, by
      loan category at December 31, 2006.


Amount
              
              Percentage
                  of loans in each category to total loans
              
              Percentage
                  of year-end allowance
              
              Percentage
                  of reserves to net loans by categoryReal
                  estate
              
              $
              150,036
              
              
              60.0
              %
              
              34.7
              %
              
              0.7
              %Construction
              
              
              32,688
              
              
              11.1
              %
              
              7.5
              %
              
              0.8
              %Commercial
              
              
              72,303
              
              
              28.2
              %
              
              16.8
              %
              
              0.7
              %Consumer
              
              
              1,150
              
              
              0.7
              %
              
              0.3
              %
              
              0.5
              %Unallocated
              
              
              175,463
              
              
              
              
              
              40.7
              %Total
                  Allowance for Loan Losses
              
              $
              431,640
              
              
              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 the Bank’s loan
      portfolio. The board of directors of the Bank  -
            13 -


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 the Bank’s 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.
      Management currently intends to maintain an unallocated allowance, in the range
      of 5% to 7.5% of the total general valuation allowance, for the inherent risk
      associated with imprecision in estimating the allowance, and an additional
      25%
      to 35% of the total general valuation allowance to account for the lack of
      historical trends within the Bank’s target market segment and the loan
      portfolio.




The
      Bank’s 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.




At
      December 31, 2006, the Bank had no classified credits, and insufficient data
      for
      historical trends. In the future, as loans move into the classified categories,
      they will be reviewed individually for purposes of determining specific
      valuation allowances and impairment as defined in SFAS No. 114. Loans are
      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


-
          14 -


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 amount the
      Bank’s total investment in the varying value of 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 practical expedient, at the loan’s observable market
      price or the fair value of the collateral if the loan is collateral
      dependent.




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. In addition, various regulatory agencies, as an integral
      part of their examination process, periodically review the Bank’s valuation
      allowance. These agencies may require increases to the allowance based on their
      judgments of the information available to them at the time of their
      examination.




Management
      believes that the Bank’s overall asset quality is sound, as supported by the
      Bank’s internal risk rating process.




**Investments**




In
      addition to loans, the Bank makes 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. Currently, all
      investment securities of the Bank are classified as
      held-to-maturity.




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 of the years indicated.  -
            15 -




Book
                  Value
              
              Market
                  Value
              
              Weighted
                  Average Yield**Securities
                  held to maturity****December
                  31, 2006**U.S.
                  Government andAgency
                  SecuritiesWithin
                  One Year
              
              $
              3,998,738
              
              $
              3,986,180
              
              
              4.43
              %One
                  to Five Years
              
              
              3,944,637
              
              
              3,958,120
              
              
              4.50
              %**Total
                  Securities held to maturity**
              
              $
              7,943,375
              
              $
              7,944,300
              
              
              4.46
              %




**December
                  31, 2005**U.S.
                  Government andAgency
                  SecuritiesWithin
                  One Year
              
              $
              5,997,943
              
              $
              5,968,140
              
              
              4.18
              %One
                  to Five Years
              
              
              2,000,000
              
              
              1,999,740
              
              
              4.32
              %**Total
                  Securities held to maturity**
              
              $
              7,997,943
              
              $
              7,967,880
              
              
              4.22
              %




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
      of
      the years indicated.


Amortized
              
              Unrealized
              
              Unrealized
              
              EstimatedCost
              
              Gains
              
              Losses
              
              Fair
                  Value**Securities
                  held to maturity:****December
                  31, 2006**U.S.
                  Government andAgency
                  Securities
              
              $
              7,943,375
              
              $
              13,483
              
              $
              (
                  12,558
              )
              $
              7,944,300**December
                  31, 2005**U.S.
                  Government andAgency
                  Securities
              
              $
              7,997,943
              
              $
              -
              
              $
              (
                  30,063
              )
              $
              7,967,880




**Deposit
      services**




The
      Bank
      offers 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, the Bank’s primary
      service areas. The Bank attracts these deposits through personal solicitation
      by
      its officers and directors, direct mail solicitations and advertisements
      published in the local media. The Bank does not operate a money desk or
      otherwise solicit brokered deposits.




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


-
          16 -




**Time
                  Deposits of $100,000 or more**
              
              **Other
                  Time Deposits**
              
              **Total
                  Time Deposits****December
                  31, 2006**Three
                  months or less
              
              $
              801,211
              
              $
              619,788
              
              $
              1,420,999Over
                  three months through six months
              
              
              1,727,605
              
              
              566,445
              
              
              2,294,050Over
                  six months through 12 months
              
              
              608,422
              
              
              771,734
              
              
              1,380,156Over
                  12 months
              
              
              -
              
              
              120,889
              
              
              120,889Total
              
              $
              3,137,238
              
              $
              2,078,856
              
              $
              5,216,094


**Time
                  Deposits of $100,000 or more**
              
              **Other
                  Time Deposits**
              
              **Total
                  Time Deposits****December
                  31, 2005**Three
                  months or less
              
              $
              -
              
              $
              10,000
              
              $
              10,000Over
                  three months through six months
              
              
              601,509
              
              
              251,430
              
              
              852,939Over
                  six months through 12 months
              
              
              1,810,956
              
              
              1,205,911
              
              
              3,016,867Over
                  12 months
              
              
              -
              
              
              -
              
              
              -Total
              
              $
              2,412,465
              
              $
              1,467,341
              
              $
              3,879,806




**Supervision
      and Regulation**




**General** **-** Banking
      is a complex, highly regulated industry. Consequently, the growth and earnings
      performance of the Company and the Bank can be affected, not only by management
      decisions and general and local economic conditions, but also by the statutes
      administered by, and the regulations and policies of, various governmental
      regulatory authorities. These authorities include, but are not limited to, the
      Federal Reserve, the FDIC, the OCC, the Internal Revenue Service and state
      taxing authorities. The effect of these statutes, regulations and policies
      and
      any changes to any of them can be significant and cannot be
      predicted.




The
      primary goals of the Bank regulators are to maintain a safe and sound banking
      system and to facilitate the conduct of sound monetary policy. In furtherance
      of
      these goals, Congress has created several largely autonomous regulatory agencies
      and enacted numerous laws that govern banks, bank holding companies and the
      banking industry. The system of supervision and regulation applicable to the
      Company and the Bank establishes a comprehensive framework for their respective
      operations and is intended primarily for the protection of the FDIC’s deposit
      insurance funds, the Bank’s depositors and the public, rather than the
      shareholders and creditors. The following is an attempt to summarize some of
      the
      relevant laws, rules and regulations governing banks and bank holding companies,
      but does not purport to be a complete summary of all applicable laws, rules
      and
      regulations governing banks and bank holding companies. The descriptions are
      qualified in their entirety by reference to the specific statutes and
      regulations discussed.




**Pacific
      Coast National Bancorp** - The
      Company is a bank holding company subject to regulatory oversight by the Federal
      Reserve. As such, the Company is required to register and file reports with
      the
      Federal Reserve and is subject to regulation and examination by the Federal
      Reserve. In  -
            17 -


addition,
      the Federal Reserve has enforcement authority over the Company and its
      subsidiaries, which also permits the Federal Reserve to restrict or prohibit
      activities that are determined to be a serious risk to the subsidiary bank.




In
      accordance with Federal Reserve policy, the Company is expected to act as a
      source of financial strength to the Bank and commit resources to support the
      Bank. This support may be required under circumstances when the Company might
      not be inclined to do so absent this Federal Reserve policy. As discussed below,
      the Company could be required to guarantee the capital plan of the Bank if
      it
      becomes undercapitalized for purposes of banking regulations.




Certain
      acquisitions - The
      Bank Holding Company Act requires every bank holding company to obtain the
      prior
      approval of the Federal Reserve before (i) acquiring more than five
      percent of the voting stock of any bank or other bank holding company, (ii)
      acquiring all or substantially all of the assets of any bank or bank holding
      company, or (iii) merging or consolidating with any other bank holding
      company.




Additionally,
      the Bank Holding Company Act provides that the Federal Reserve may not approve
      any of these transactions if it would result in or tend to create a monopoly
      or
      substantially lessen competition or otherwise function as a restraint of trade,
      unless the anti-competitive effects of the proposed transaction are clearly
      outweighed by the public interest in meeting the convenience and needs of the
      community to be served. The Federal Reserve is also required to consider the
      financial and managerial resources and future prospects of the bank holding
      companies and banks concerned and the convenience and needs of the community
      to
      be served. The Federal Reserve’s consideration of financial resources generally
      focuses on capital adequacy, which is discussed below. As a result of the
      Patriot Act, which is discussed below, the Federal Reserve is also required
      to
      consider the record of a bank holding company and its subsidiary bank(s) in
      combating money laundering activities in its evaluation of bank holding company
      merger or acquisition transactions.




Under
      the
      Bank Holding Company Act, if adequately capitalized and adequately managed,
      any
      bank holding company located in California may purchase a bank located outside
      of California. Conversely, an adequately capitalized and adequately managed
      bank
      holding company located outside of California may purchase a bank located inside
      California. In each case, however, restrictions currently exist on the
      acquisition of a bank that has only been in existence for a limited amount
      of
      time or will result in specified concentrations of deposits.




Change
      in bank control -
      Subject to various exceptions, the Bank Holding Company Act and the “Change in
      Bank Control Act of 1978,” together with related regulations, require Federal
      Reserve approval prior to any person or company acquiring “control” of a bank
      holding company. Control is conclusively presumed to exist if an individual
      or
      company acquires 25% or more of any class of voting securities of the bank
      holding company. With respect to the Company, control is rebuttably presumed
      to
      exist if a person or company acquires 10% or more, but less than 25%, of any
      class of voting securities.




Permitted
      activities -
      Generally, bank holding companies are prohibited under the Bank Holding Company
      Act, from engaging in or acquiring direct or indirect control of more than
      5% of
      the voting shares of any company engaged in any activity other than (i) banking
      or managing or controlling banks or (ii) an activity that the Federal Reserve
      determines to be so closely related to banking as to be a proper incident to
      the
      business of banking.




Activities
      that the Federal Reserve has found to be so closely related to banking as to
      be
      a proper incident to the business of banking include:




·
            factoring
                accounts receivable;  -
            18 -




·
            making,
                acquiring, brokering or servicing loans and usual related activities;




·
            leasing
                personal or real property;




·
            operating
                a non-bank depository institution, such as a savings association;




·
            trust
                company functions;




·
            financial
                and investment advisory activities;




·
            conducting
                discount securities brokerage activities;




·
            underwriting
                and dealing in government obligations and money market instruments;




·
            providing
                specified management consulting and counseling activities;




·
            performing
                selected data processing services and support services;




·
            acting
                as agent or broker in selling credit life insurance and other types
                of
                insurance in connection with credit transactions;
                and




·
            performing
                selected insurance underwriting
                activities.




Despite
      prior approval, the Federal Reserve has the authority to require a bank holding
      company to terminate an activity or terminate control of or liquidate or divest
      certain subsidiaries or affiliates when the Federal Reserve believes the
      activity or the control of the subsidiary or affiliate constitutes a significant
      risk to the financial safety, soundness or stability of any of its banking
      subsidiaries. A bank holding company that qualifies and elects to become a
      financial holding company is permitted to engage in additional activities that
      are financial in nature or incidental or complementary to financial activity.
      The Bank Holding Company Act expressly lists the following activities as
      financial in nature:




·
            lending,
                exchanging, transferring, investing for others, or safeguarding money
                or
                securities;




·
            insuring,
                guaranteeing or indemnifying against loss or harm, or providing and
                issuing annuities, and acting as principal, agent or broker for these
                purposes, in any state;




·
            providing
                financial, investment or advisory
                services;




·
            issuing
                or selling instruments representing interests in pools of assets
                permissible for a bank to hold directly;




·
            underwriting,
                dealing in or making a market in securities;




·
            other
                activities that the Federal Reserve may determine to be so closely
                related
                to banking or managing or controlling banks as to be a proper incident
                to
                managing or controlling banks;




·
            foreign
                activities permitted outside of the United States if the Federal
                Reserve
                has determined them to be usual in connection with banking operations
                abroad;




·
            merchant
                banking through securities or insurance affiliates; and  -
            19 -




·
            insurance
                company portfolio investments.




To
      qualify to become a financial holding company, the Bank and any other depository
      institution subsidiary that the Company may own at the time must be well
      capitalized and well managed and must have a Community Reinvestment Act rating
      of at least satisfactory. Additionally, the Company would be required to file
      an
      election with the Federal Reserve to become a financial holding company and
      to
      provide the Federal Reserve with 30 days’ written notice prior to engaging in a
      permitted financial activity. A bank holding company that falls out of
      compliance with these requirements may be required to cease engaging in some
      of
      its activities. The Federal Reserve serves as the primary “umbrella” regulator
      of financial holding companies, with supervisory authority over each parent
      company and limited authority over its subsidiaries. Expanded financial
      activities of financial holding companies 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 Company currently has no plans to make
      a
      financial holding company election.




Sound
      banking practice - Bank
      holding companies are not permitted to engage in unsound banking practices.
      For
      example, the Federal Reserve’s Regulation Y requires a holding company to give
      the Federal Reserve prior notice of any redemption or repurchase of its own
      equity securities, if the consideration to be paid, together with the
      consideration paid for any repurchases in the preceding year, is equal to 10%
      or
      more of the company’s consolidated net worth. The Federal Reserve may oppose the
      transaction if it believes that the transaction would constitute an unsafe
      or
      unsound practice or would violate any law or regulation. As another example,
      a
      holding company could not impair its subsidiary bank’s soundness by causing it
      to make funds available to non-banking subsidiaries or their customers if the
      Federal Reserve believed it not prudent to do so.




The
      “Financial Institutions Reform, Recovery and Enforcement Act of 1989” (FIRREA)
      expanded the Federal Reserve’s authority to prohibit activities of bank holding
      companies and their non-banking subsidiaries which represent unsafe and unsound
      banking practices or which constitute violations of laws or regulations. FIRREA
      increased the amount of civil money penalties which the Federal Reserve can
      assess for activities conducted on a knowing and reckless basis, if those
      activities caused a substantial loss to a depository institution. The penalties
      can be as high as $1,000,000 for each day the activity continues. FIRREA also
      expanded the scope of individuals and entities against which such penalties
      may
      be assessed.




Anti-tying
      restrictions - Bank
      holding companies and affiliates are prohibited from tying the provision of
      services, such as extensions of credit, to other services offered by a holding
      company or its affiliates.




Dividends -
      Consistent with its policy that bank holding companies should serve as a source
      of financial strength for their subsidiary banks, the Federal Reserve has stated
      that, as a matter of prudence, the Company, as a bank holding company, generally
      should not maintain a rate of distributions to shareholders unless its available
      net income has been sufficient to fully fund the distributions, and the
      prospective rate of earnings retention appears consistent with the bank holding
      company’s capital needs, asset quality and overall financial condition. In
      addition, the Company is subject to certain restrictions on the making of
      distributions as a result of the requirement that the Bank maintain an adequate
      level of capital as described below. As a California corporation, the Company
      is
      restricted under the “California Business Corporation Act of 1957” from paying
      dividends under certain conditions.




**Pacific
      Coast National Bank** **** -
      As a
      national bank, the Bank is subject to extensive regulation by the OCC and the
      FDIC. Lending activities and other investments of the Bank must comply with
      various  -
            20 -


statutory
      and regulatory requirements. The Bank is also subject to certain reserve
      requirements promulgated by the FRB.




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 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.




Federal
      Financial Institutions Examination Council (FFIEC): *Authentication
      in an Internet Banking Environment* - On
      October 12, 2005, the Federal Financial Institutions Examination Council (FFIEC)
      issued guidance, “Authentication in an Internet Banking Environment.” This
      updated interagency guidance, which replaces the FFIEC’s *Authentication
      in an Electronic Banking Environment,* issued
      in
      2001, specifically addresses the need for risk-based assessment, customer
      awareness, and security measures to authenticate customers using a financial
      institution’s Internet-based services.




This
      guidance applies to both retail and commercial customers and does not endorse
      any particular technology. National banks should use this guidance when
      evaluating and implementing authentication systems and practices whether they
      are provided internally or by a technology service provider. Although this
      guidance is focused on the risks and risk management techniques associated
      with
      the Internet delivery channel, the principles are applicable to all forms of
      electronic banking activities.




Consistent
      with the *FFIEC
      Information Technology Examination Handbook* financial institutions should periodically:




●
            Ensure
                that their information security
                program:




-
            Identifies
                and assesses the risks associated with Internet-based products and
                services;


-
            Identifies
                risk mitigation actions, including appropriate authentication strength;
                and


-
            Measures
                and evaluates customer awareness
                efforts;





●
            Adjust,
                as appropriate, their information security program in light of any
                relevant changes in technology, the sensitivity of their customer
                information, and internal or external threats to information;
                and




●
            Implement
                appropriate risk mitigation
                strategies.




After
      having conducted a thorough assessment of the risks associated with its online
      banking products, Pacific Coast National Bank has implemented a mandatory
      enhanced Multi Factor Authentication practice for both its business and personal
      customers. The last phase of this conversion was initiated on December 19,
      2006
      and is now complete.


-
          21 -


Fair
      and Accurate Credit Transactions Act - The
      Fair and Accurate Credit Transactions Act (FACT Act) establishes new obligations
      for financial firms to help deter identity theft and give consumers more control
      of their credit data. It also reauthorizes a federal ban on state laws that
      interfere with corporate credit granting and marketing practices. The provisions
      of this law include:




·
            Marketing
                solicitations based on information from
                affiliates;




·
            Preventing
                the re-pollution of consumer
                reports;




·
            Identity
                theft provisions; and




·
            Other
                miscellaneous provisions including most recently the use of medical
                information for credit eligibility and requirements for data
                disposal.




These
      provisions are provided to ensure the protection of a consumer’s rights and
      information and to standardize procedures in processing and handling certain
      customer information.




Privacy and
      The Gramm Leach Bliley Act of 1999 -
      Federal banking rules limit the ability of banks and other financial
      institutions to disclose non-public information about consumers to nonaffiliated
      third parties **** and
      requires the Bank to safeguard its customers’ non public personal
      information. **** Under
      these rules, financial institutions must provide:




·
            Initial
                notices to customers about their privacy policies, describing the
                conditions under which they may disclose nonpublic personal information
                to
                nonaffiliated third parties and
                affiliates;




·
            Annual
                notices of their privacy policies to current customers;
                and




·
            A
                reasonable method for customers to “opt out” of disclosures to
                nonaffiliated third parties.




·
            A
                comprehensive written information security program that includes
                administrative, technical and physical safeguards of customer information
                that is appropriate to the size and complexity of the financial
                institution and thee nature and scope of its
                activities.




In
      recent
      years, a number of states have implemented their own versions of privacy laws.
      In 2003, California adopted standards in the *California
      Data Protection Act* that are
      tougher than federal law, allowing bank’s customers the opportunity to bar
      financial institutions from sharing information with their affiliates and which
      defines a detailed response protocol for any breech of the security of customer
      non public personal information.





These
      privacy provisions affect how consumer information is transmitted through
      diversified financial companies and conveyed to outside vendors. The Bank has
      implemented privacy policies and information security practices designed to
      comply with these laws.





There
      were no breeches of security in 2006. The Bank utilizes multiple programs and
      processes to insure that the vulnerabilities are minimized. These
      include:





Ø
            24/7
                firewall monitoring and intrusion detection
                services


Ø
            Weekly
                software updates and patches


Ø
            E
                mail filtering for SPAM, viruses etc.


Ø
            The
                use of a virus protection system (which is updated
                daily)


Ø
            Regular
                reviews of the password integrity of employees network access
                passwords


-
          22 -




These
      practices help minimize the risk from what are considered some of the biggest
      threats to security in the financial industry which include hacking, viruses,
      software vulnerabilities and end user violations of security
      procedures.




USA
      Patriot Act of 2001  **-** In
      the
      wake of the tragic events of September 11 th ,
      on
      October 26, 2001, the President signed into law the Uniting and Strengthening
      America by Providing Appropriate Tools Required to Intercept and Obstruct
      Terrorism Act of 2001. Also known as the “Patriot Act,” the law enhances the
      powers of the federal government and law enforcement organizations to combat
      terrorism, organized crime and money laundering. The Patriot Act significantly
      amends and expands the application of the Bank Secrecy Act, including enhanced
      measures regarding customer identity, new suspicious activity reporting rules
      and enhanced anti-money laundering programs.




Under
      the
      Patriot Act, financial institutions are subject to prohibitions against
      specified financial transactions and account relationships as well as enhanced
      due diligence and “know your customer” standards in their dealings with foreign
      financial institutions and foreign customers. For example, the enhanced due
      diligence policies, procedures and controls generally require financial
      institutions to take reasonable steps:




·
            to
                conduct enhanced scrutiny of account relationships to guard against
                money
                laundering and report any suspicious transaction;




·
            to
                ascertain the identity of the nominal and beneficial owners of, and
                the
                source of funds deposited into, each account as needed to guard against
                money laundering and report any suspicious
                transactions;




·
            to
                ascertain for any foreign bank, the shares of which are not publicly
                traded, the identity of the owners of the foreign bank and the nature
                and
                extent of the ownership interest of each such owner; and




·
            to
                ascertain whether any foreign bank provides correspondent accounts
                to
                other foreign banks and, if so, the identity of those foreign banks
                and
                related due diligence information.




Under
      the
      Patriot Act, financial institutions must also establish anti-money laundering
      programs. The Patriot Act sets forth minimum standards for these programs,
      including: (i) the development of internal policies, procedures and controls;
      (ii) the designation of a compliance officer; (iii) an ongoing employee training
      program; and (iv) an independent audit function to test the programs.




In
      addition, the Patriot Act requires the bank regulatory agencies to consider
      the
      record of a bank or bank holding company in combating money laundering
      activities in their evaluation of bank and bank holding company merger or
      acquisition transactions. Under the authority of the Patriot Act, the Secretary
      of the Treasury has also adopted rules increasing the cooperation and
      information sharing among financial institutions, regulators and law enforcement
      authorities regarding individuals, entities and organizations engaged in, or
      reasonably suspected based on credible evidence of engaging in, terrorist acts
      or money laundering activities. Under these rules, a financial institution
      is
      required to:




·
            expeditiously
                search its records to determine whether it maintains or has maintained
                accounts, or engaged in transactions with individuals or entities,
                listed
                in a request submitted by the Financial Crimes Enforcement Network
                (“FinCEN”);




·
            notify
                FinCEN if an account or transaction is identified;  -
            23 -




·
            designate
                a contact person to receive information requests;




·
            limit
                use of information provided by FinCEN to: (1) reporting to FinCEN,
                (2)
                determining whether to establish or maintain an account or engage
                in a
                transaction and (3) assisting the financial institution in complying
                with
                the Bank Secrecy Act; and




·
            maintain
                adequate procedures to protect the security and confidentiality of
                FinCEN
                requests.




Under
      the
      rules, a financial institution may also share information regarding individuals,
      entities, organizations and countries for purposes of identifying and, where
      appropriate, reporting activities that it suspects may involve possible
      terrorist activity or money laundering. Such information-sharing is protected
      under a safe harbor if the financial institution: (i) notifies FinCEN of its
      intention to share information, even when sharing with an affiliated financial
      institution; (ii) takes reasonable steps to verify that, prior to sharing,
      the
      financial institution or association of financial institutions with which it
      intends to share information has submitted a notice to FinCEN; (iii) limits
      the
      use of shared information to identifying and reporting on money laundering
      or
      terrorist activities, determining whether to establish or maintain an account
      or
      engage in a transaction, or assisting it in complying with the Bank Security
      Act; and (iv) maintains adequate procedures to protect the security and
      confidentiality of the information. Any financial institution complying with
      these rules will not be deemed to have violated the privacy requirements
      discussed above.




The
      Secretary of the Treasury has also adopted a rule intended to prevent money
      laundering and terrorist financing through correspondent accounts maintained
      by
      U.S. financial institutions on behalf of foreign banks. Under the rule,
      financial institutions: (i) are prohibited from providing correspondent accounts
      to foreign shell banks; (ii) are required to obtain a certification from foreign
      banks for which they maintain a correspondent account stating the foreign bank
      is not a shell bank and that it will not permit a foreign shell bank to have
      access to the U.S. account; (iii) must maintain records identifying the owner
      of
      the foreign bank for which they may maintain a correspondent account and its
      agent in the United States designated to accept services of legal process;
      (iv)
      must terminate correspondent accounts of foreign banks that fail to comply
      with
      or fail to contest a lawful request of the Secretary of the Treasury or the
      Attorney General of the United States, after being notified by the Secretary
      or
      Attorney General.




In
      2006,
      Pacific Coast National Bank’s Anti Money Laundering and Bank Secrecy Act
      programs were deemed satisfactory to comply with Federal
      Regulations.




Di vidends - 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 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  -
            24 -


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, 2006, the Bank’s loans-to-one-borrower limit was $2,329,000 based
      upon the 15% of unimpaired capital and surplus measurement. At December 31,
      2006, the Bank’s two largest lending relationships had outstanding balances of
      $2,465,000, which consisted of eight loans secured by commercial real estate,
      and $2,647,000, which consisted of four loans, secured by commercial real estate
      and SBA guarantees. These loans were performing in accordance with their terms
      and did not exceed the Bank’s loan-to-one-borrower limits at the time of
      funding.




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.




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.




Capital standards - 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


-
          25 -


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 8%.




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.




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.




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


-
          26 -


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.




Safety
      and soundness standards - The
      federal banking agencies have adopted guidelines designed to assist the federal
      banking agencies in identifying and addressing potential safety and soundness
      concerns before capital becomes impaired. The guidelines set forth operational
      and managerial standards relating to: (i) internal controls, information systems
      and internal audit systems, (ii) loan documentation, (iii) credit underwriting,
      (iv) asset growth, (v) earnings, and (vi) compensation, fees, and benefits.
      In
      addition, the federal banking agencies have also adopted safety and soundness
      guidelines with respect to asset quality and earnings standards. These
      guidelines provide 6 standards for establishing and maintaining a system to
      identify problem assets and prevent those assets from deteriorating. Under
      these
      standards, an insured depository institution should: (i) conduct periodic asset
      quality reviews to identify problem assets, (ii) estimate the inherent losses
      in
      problem assets and establish reserves that are sufficient to absorb estimated
      losses, (iii) compare problem asset totals to capital, (iv) take appropriate
      action to resolve problem assets, (v) consider the size and potential risks
      of
      material asset concentrations, and (vi) provide periodic asset quality reports
      with adequate information for management and the board of directors to assess
      the level of asset risk. These guidelines also set forth standards for
      evaluating and monitoring earnings and for ensuring that earnings are sufficient
      for the maintenance of adequate capital and reserves.




Premiums
      for deposit insurance -
      On
      February 8, 2006, the President signed The
      Federal Deposit Insurance Reform Act of 2005 into
      law. The Federal Deposits Insurance Reform Conforming Amendments Act of 2005,
      which the President signed into law on February 15, 2006, contains necessary
      technical and conforming changes to implement deposit insurance reform, as
      well
      as a number of study and survey requirements (together with the February 8,
      2006
      law above, the “Reform Act”). The Reform Act provides for the following
      changes:  -
            27 -




·
            Merging
                the Bank Insurance Fund (BIF) and the Savings Association Insurance
                Fund
                (SAIF) into a new fund, the Deposit Insurance Fund (DIF). This change
                was
                made effective March 31, 2006.




·
            Increasing
                the coverage limit for retirement accounts to $250,000 and indexing
                the
                coverage limit for retirement accounts to inflation as with the general
                deposit insurance coverage limit. This change was made effective
                April 1,
                2006.




·
            Establishing
                a range of 1.15 percent to 1.50 percent within which the FDIC Board
                of
                Directors may set the Designated Reserve Ratio (DRR).




·
            Allowing
                the FDIC to manage the pace at which the reserve ratio varies within
                this
                range.




·
            Eliminating
                the restrictions on premium rates based on the DRR and granting the
                FDIC
                Board the discretion to price deposit insurance according to risk
                for all
                insured institutions regardless of the level of the reserve ratio.




·
            Granting
                a one-time initial assessment credit (of approximately $4.7 billion)
                to
                recognize institutions' past contributions to the fund.




·
            The
                Reform Act requires the FDIC to conduct studies of three issues:
                (1)
                further potential changes to the deposit insurance system, (2) the
                appropriate deposit base in designating the reserve ratio, and (3)
                the
                Corporation’s contingent loss reserving methodology and accounting for
                losses.




·
            The
                Reform Act also requires the Comptroller General to conduct studies
                of (1)
                federal bank regulators’ administration of the prompt corrective action
                program and recent changes to the FDIC deposit insurance system,
                and (2)
                the organizational structure of the FDIC.




Through
      the Deposit Insurance Fund (“DIF”), the FDIC insures deposits of the Bank’s
      customers up to prescribed limits for each depositor. The amount of FDIC
      assessments paid by each DIF member is based on its relative risk of default
      as
      measured by regulatory capital ratios and other factors. Specifically, the
      assessment rate is based on the institution’s capitalization risk category and
      supervisory subgroup category. An institution’s capitalization risk category is
      based on the FDIC’s determination of whether the institution is well
      capitalized, adequately capitalized or less than adequately capitalized. An
      institution’s supervisory subgroup category is based on the FDIC’s assessment of
      the financial condition of the institution and the probability that FDIC
      intervention or other corrective action will be required.




The
      assessment rate currently ranges from zero to 27 cents per $100 of domestic
      deposits. The FDIC may increase or decrease the assessment rate schedule on
      a
      semi-annual basis. The DIF has a minimum ratio of 1.15% of insured deposits
      mandated by law. If the ratio drops below 1.15%, it is likely that the FDIC
      will
      be required to assess premiums on all banks. Any increase in assessments or
      the
      assessment rate could have a material adverse effect on the company’s earnings,
      depending on the amount of the increase. Furthermore, the FDIC is authorized
      to
      raise insurance premiums under certain circumstances.




The
      FDIC
      is authorized to terminate a depository institution’s deposit insurance upon a
      finding by the FDIC that the institution’s financial institution’s condition is
      unsafe or unsound or that the institution has engaged in unsafe or unsound
      practices or has violated any applicable rule, regulation, order or condition
      enacted or imposed by the institution’s regulatory agency. The termination of
      deposit insurance for the Bank could have a material adverse effect on the
      company’s earnings.  -
            28 -


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” 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 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.




Other
      regulations -
      Interest and other charges collected or contracted for by the Bank will be
      subject to state usury laws and federal laws concerning interest rates. The
      Bank’s loan operations are also subject to federal laws applicable to credit
      transactions, such as:




·
            the
                federal “Truth-In-Lending Act,” governing disclosures of credit terms to
                consumer borrowers;




·
            the
                “Home Mortgage Disclosure Act of 1975,” requiring financial institutions
                to provide information to enable the public and public officials
                to
                determine whether a financial institution is fulfilling its obligation
                to
                help meet the housing needs of the community it serves;  -
            29 -




·
            the
                “Equal Credit Opportunity Act,” prohibiting discrimination on the basis of
                race, creed or other prohibited factors in extending credit;




·
            the
                “Fair Credit Reporting Act of 1978,” governing the use and provision of
                information to credit reporting agencies;




·
            the
                “Fair Debt Collection Act,” governing the manner in which consumer debts
                may be collected by collection agencies; and




·
            the
                rules and regulations of the various federal agencies charged with
                the
                responsibility of implementing these federal laws.




The
      deposit operations of the Bank are also subject to:




·
            the
                “Right to Financial Privacy Act,” which imposes a duty to maintain
                confidentiality of consumer financial records and prescribes procedures
                for complying with administrative subpoenas of financial records;
                and




·
            the
                “Electronic Funds Transfer Act” and Regulation E issued by the Federal
                Reserve to implement that act, which govern automatic deposits to
                and
                withdrawals from deposit accounts and customers’ rights and liabilities
                arising from the use of automated teller machines and other electronic
                banking services.




Federal
      Reserve System - The
      FRB requires all depository institutions to maintain non-interest bearing
      reserves at specified levels against their transaction accounts (primarily
      interest bearing and non-interest bearing checking accounts) and non-personal
      time deposits. At December 31, 2005, the Bank was in compliance with these
      requirements.




Proposed
      legislation and regulatory action .
      New
      regulations and statutes are regularly proposed that contain wide-ranging
      proposals for altering the structures, regulations and competitive relationships
      of the nation’s financial institutions. The Company cannot predict whether or in
      what form any proposed regulation or statute will be adopted or the extent
      to
      which the business of the Company or the Bank may be affected by any new
      regulation or statute.




Effect
      of governmental monetary policies .
      The
      commercial banking business is affected not only by general economic conditions
      but also by the fiscal and monetary policies of the Federal Reserve. Some of
      the
      instruments of fiscal and monetary policy available to the Federal Reserve
      include changes in the discount rate on member bank borrowings, the fluctuating
      availability of borrowings at the “discount window,” open market operations, the
      imposition of and changes in reserve requirements against member banks’ deposits
      and assets of foreign branches, the imposition of and changes in reserve
      requirements against certain borrowings by banks and their affiliates, and
      the
      placing of limits on interest rates that member banks may pay on time and
      savings deposits. Such policies influence to a significant extent the overall
      growth of bank loans, investments, and deposits and the interest rates charged
      on loans or paid on time and savings deposits. Management cannot predict the
      nature of future fiscal and monetary policies and the effect of such policies
      on
      the future business and the Company’s earnings.




**All
      of the above laws and regulations add significantly to the cost of operating
      the
      Company and the Bank, and thus have a negative impact on the Company’s
      profitability. The Company would 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 Company and the
      Bank. These institutions, because they are not so highly regulated, have a
      competitive**


-
          30 -


**advantage
      over the Company and Bank 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 Company securities. These risks and uncertainties
      are not the only ones faced by the Company or the Bank. Additional risks and
      uncertainties not presently known to the Company or that the Company currently
      believes are immaterial also may impair the business of the Company or the
      Bank.
      If any of the events described in the following risk factors occur, the
      Company’s and Bank’s 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 little 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 it cannot assure you that the shares will ever be
      listed on a national securities exchange. However, the shares are traded on
      the
      OTC Bulletin Board or “pink sheets,” 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 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, 2006,
      the
      Company had an accumulated deficit account of approximately $8.8 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 $6.0 million
      resulted from operating losses from its first two years of operations. Of these
      expenses, approximately $500 thousand and $1.5 million respectively were related
      to share-based (stock option) payments which went back into equity as  -
            31 -


additional
      paid-in capital. In addition, due to the extensive regulatory oversight to
      which
      will be subject, the Bank expects 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.




*Failure
      to implement* *the
      Bank’s business strategies may adversely affect its financial
      performance.*




The
      Bank
      has developed a business plan that details the strategies it is working to
      implement in its efforts to achieve profitable operations. If these business
      strategies cannot be implemented, the Bank will be hampered in its ability
      to
      develop business and serve its customers, which, in turn, could have an adverse
      effect on the Company’s financial performance. Even if the business strategies
      are successfully implemented, the Company cannot assure you that the strategies
      will have the favorable impact that it anticipates. Furthermore, while
      management believes that the Bank’s business plan is reasonable and that the
      strategies will enable the Bank to execute the business plan, the Bank has
      no
      control over the future occurrence of certain events upon which the business
      plan and strategies are based, particularly
      general and local economic conditions that may affect the Bank’s loan-to-deposit
      ratio, total deposits, the rate of deposit growth, cost of funding, the level
      of
      earning assets and interest-related revenues and expenses.




*The
      Bank’s emphasis on commercial business and commercial real estate lending may
      result in greater credit risk.*




Management
      expects that commercial business and commercial real estate lending will
      ultimately comprise more than 60% of the Bank’s loan portfolio, which may result
      in greater credit risk to the Bank. Generally, commercial loans are considered
      to be riskier than residential mortgage or construction loans or consumer loans
      because they have larger balances to a single borrower or group of related
      borrowers. In addition, the borrower’s ability to repay a commercial loan
      depends, in many cases, on the successful operation of the business or the
      property securing the loan. Because these types of loans are considered to
      be
      riskier than residential mortgage or construction loans or consumer loans,
      the
      Bank will be required to reserve greater amounts in its loan loss allowance
      in
      anticipation of the higher credit losses. If management underestimates the
      credit risk associated with these lending activities, the Bank’s actual loan
      losses may exceed the amounts reserved against the loans, in which case its
      profits and financial condition would be adversely affected.




*The
      Company’s profitability will be affected by the ability of Bank management to
      measure and limit credit risk associated with the Bank’s loan portfolio.*




As
      a
      material part of its business plan, the Bank makes commercial, consumer,
      commercial and residential real estate and construction loans. The principal
      economic risk associated with each class of loans is the creditworthiness of
      the
      borrower, which is affected by the strength of the relevant business market
      segment, local market conditions and general economic conditions.




Additional
      factors related to the credit quality of commercial loans include the quality
      of
      the management of the business and the borrower’s ability both to properly
      evaluate changes in the supply and demand characteristics affecting its market
      for products and services and to effectively respond to those changes.
      Additional factors related to the credit quality of commercial real estate
      loans
      include tenant vacancy rates and the quality of management of the property.
      Additional factors related to the


-
          32 -


credit
      quality of construction loans include fluctuations in the value of real estate
      and new job creation trends.




Many
      of
      the Bank’s loans are made to small and medium sized businesses that are less
      able to withstand competitive, economic and financial pressures that larger
      borrowers. If the Bank is unable to effectively measure and limit the risk
      of
      default associated with its loan portfolio, the Company’s profitability will be
      adversely impacted.




*Departures
      of key personnel or directors may impair* *the
      Bank’s operations.*




The
      Bank’s success depends in large part on the services and efforts of its key
      personnel and on its 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
      the
      Bank’s business plan may be lengthy.




In
      particular, the Company believes that retaining Colin Forkner, Michael Hahn,
      Richard Grinyer and Terry Stalk are important to the Bank’s success. If any of
      these persons leaves the Bank for any reason, its financial condition and
      results of operations may suffer.




Effective
      April 16 th ,
      2007,
      Richard Grinyer will resign as Chief Credit Officer. He resigned as a member
      of
      the Board of Directors of the Company and the Bank in March, 2007. However,
      he
      will continue to be employed by the Bank as a relationship officer. The Company
      does not expect that this change will have a material effect on its operations.




If
      the
      services of any of the Bank’s key personnel should become unavailable for any
      reason or if the regulatory agencies should require the employment of additional
      persons to fill positions at the Bank, it would be required to employ other
      persons to manage and operate the Bank, and the Company cannot assure you that
      the Bank would be able to employ qualified persons on terms acceptable to the
      Bank.




Additionally,
      the directors’ involvement, diverse backgrounds and extensive local business
      relationships are important to the Bank’s success. If the composition of the
      Bank’s board of directors changes materially, its banking business may
      suffer.




*The
      Bank* *faces
      intense competition from a variety of competitors.*




The
      banking business in the Bank’s target banking market and the surrounding areas
      has become increasingly competitive over the past several years, and management
      expects the level of competition to continue to increase. If this competition
      forces the Bank to offer aggressive loan and deposit rates or otherwise incur
      higher funding costs, its profitability will be diminished.




Many
      of
      the Bank’s competitors are larger than it is and have greater financial and
      personnel resources. Many of its competitors have established customer bases
      and
      offer services, such as extensive and established branch networks and trust
      services, that the Bank does not currently provide. Also, some competitors
      are
      not subject to the same degree of regulation as the Bank is and thus may have
      a
      competitive advantage over the Bank.




The
      Company believes that the Bank will be a successful competitor in the area’s
      financial services market. However, the Company cannot assure you that the
      Bank
      will be able to compete successfully with other financial institutions serving
      its target banking market. An inability to compete effectively could be expected
      to have a material adverse effect on the Bank’s growth and
      profitability.


-
          33 -


The
      Bank
      competes in an industry that continually experiences technological change,
      and
      it may not be able to compete effectively with other banking institution, with
      greater resources.




In
      order
      to compete effectively with competitors that have significantly more resources,
      the Bank will need to maintain an infrastructure capable of implementing its
      business objectives as a community bank to provide a superior level and quality
      of services. The Bank’s infrastructure needs to be flexible and adapt to
      technological changes; however, the Bank does not have the same level of
      resources as some of its competitors. The Bank has a limited number of software
      and hardware suppliers. Furthermore, because the Bank has been in operation
      for
      a short time, it has very little experience with local software and hardware
      suppliers or other vendors that might provide it with technology infrastructure
      support. In addition, the Bank will need to update its infrastructure
      continually and hire additional personnel to accommodate increases in the number
      of customers. Any inability to develop and maintain the appropriate
      infrastructure may cause unanticipated service disruptions, slower response
      times, reduced levels of customer service, impaired quality, or delays in
      reporting accurate financial information. The Company cannot assure you that
      the
      Bank will be able to project accurately the rate or timing of increases, if
      any,
      in the subscriptions to services or upgrade and expand its systems in a timely
      manner or to integrate any newly developed systems smoothly. The Bank’s
      inability to do so could have a material adverse effect on its ability to
      compete effectively in its market and also on its business, financial condition,
      and results of operations.




*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* *the
      Bank’s primary service area, may have an adverse effect on its financial
      performance.*




The
      Bank’s success depends on the general economic condition of the region in which
      it operates, which management cannot forecast with certainty. Unlike many of
      the
      Bank’s larger competitors, the majority of the Bank’s borrowers and depositors
      are individuals and businesses located or doing business in its local banking
      market. As a result, the Bank’s operations and profitability may be more
      adversely affected by a local economic downturn than those of its larger, more
      geographically diverse competitors. Factors that adversely affect the economy
      in
      the Bank’s local banking market could reduce its deposit base and the demand for
      its products and services, which may decrease the Bank’s (and, thus, the
      Company’s) earnings. For example, an adverse change in the local economy could
      make it more difficult for borrowers to repay their loans, which could lead
      to
      loan losses for the Bank.




*Monetary
      policy and other economic factors could adversely affect* *the
      Bank’s profitability.*




Changes
      in governmental economic and monetary policies, the Internal Revenue Code and
      banking and credit regulations, as well as such other factors as national,
      state
      and local economic growth rates, employment rates and population trends, will
      affect the demand for loans and the ability of the Bank and other banks to
      attract deposits. The foregoing monetary and economic factors, and the need
      to
      pay rates sufficient to attract deposits, may adversely affect the ability
      of
      the Bank to maintain an interest margin sufficient to result in operating
      profits.


-
          34 -


*The
      Bank could be negatively affected by changes in interest rates.*




The
      Bank’s profitability (and, therefore, the Company’s profitability) depends,
      among other things, on its net interest income, which is the difference between
      the income that the Bank earns on its interest-earning assets, such as loans,
      and the expenses that the Bank incurs in connection with its interest-bearing
      liabilities, such as checking or savings deposits or certificates of deposit.
      Changes in the general level of interest rates and other economic factors can
      affect the Bank’s net interest income by affecting the spread between
      interest-earning assets and interest-bearing liabilities.




Over
      the
      past year, as the Federal Reserve Board has increased interest rates, the yield
      curve has flattened, in that long-term interest rates have not moved in tandem
      with short-term rates. Under ordinary conditions the yield curve has a positive
      slope, indicating that long-term instruments pay higher yields than do
      short-term instruments, and that borrowers are willing to pay a premium for
      long-term funds. A flat yield curve, on the other hand, generally indicates
      uncertainty about the direction in which interest rates are moving. If this
      trend continues, the Bank’s future net interest income, and therefore its
      profitability, may decline.




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.




*The
      Company’s* *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. 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.




*The
      Company and the Bank* *are
      subject to extensive regulatory oversight, which could restrain growth and
      profitability.*




Banking
      organizations such as the Company and the Bank 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. The Company cannot assure you that any change
      in the regulatory structure or the applicable statutes and regulations will
      not
      materially and adversely affect the business, condition or operations of the
      Company or the Bank or benefit competing entities that are not subject to the
      same regulations and supervision.




*The
      Company* *may
      not be able to raise additional capital on favorable terms.*




In
      the
      future, should the Company need additional capital to support 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.  -
            35 -


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, 2006, directors and executive officers of the Company owned 128,200
      shares of the Company’s common stock, which represents approximately 5.6% 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 pursuant to certain employment agreements. If the directors
      exercised all of their warrants, they would own shares upon exercise
      representing as much as 9.3% 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 25.8% of the Company’s then outstanding 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 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.  -
            36 -


**Item
      2. Description of Property**




The
      Bank
      maintains two locations. Its main office, 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, 8 th Floor,
      New York, New York, 10004. The following table sets forth the high and low
      sales
      prices for the periods indicated below.


**Year
                  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**Year
                  Ended December 31, 2005:**
              
              High
              
              LowFirst
                  Quarter
              
              $
              -
              
              $
              -Second
                  Quarter
              
              
              10.50
              
              
              10.50Third
                  Quarter
              
              
              13.00
              
              
              10.50Fourth
                  Quarter
              
              
              12.25
              
              
              10.75




-
            37 -




**Holders**




As
      of
      December 31, 2006, there were approximately 542 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.  -
            38 -


Equity
        Compensation Plan Information
 Plan
                  Category
              Number
                  of Securities to be issued upon exercise of outstanding options,
                  warrants,
                  and rights
                
                
                
                *(a)*
              Weighted-average
                  exercise price of outstanding options, warrants and rights
                
                
                
                
                *(b)*
              Number
                  of securities remaining available for future issuance under equity
                  compensation plans (excluding securities reflected in column
                  (a))
                
                *(
                    c)*Equity
                  compensation plans approved by security holders
              1,073,466
              $
                  11.18
              93,835Equity
                  compensation plans not approved by security holders
              -
              -
              -Total
              1,073,466
              $
                  11.18
              93,835




**Recent
      Sales of Unregistered Securities**




None




**Item
      6. Management** **’s
      Discussion and Analysis of Financial Condition and Results of
      Operation**




The
      purpose of the following discussion is to address information relating to the
      financial condition and results of operations of the Company 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 the Company’s 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 financial statements,
      the notes thereto and the other financial data included elsewhere in this Annual
      Report.




**General**




The
      Company is a bank holding company headquartered in San Clemente, California,
      offering a board range of commercial and consumer banking services through
      its
      wholly-owned subsidiary, Pacific Coast National Bank. As of December 31, 2006,
      on a consolidated basis, the Company had total assets of $56.2 million, net
      loans of $34.4 million, total deposits of $39.9 million and shareholders’ equity
      of $16.0 million.




The
      following discussion focuses on the Company’s financial condition and results of
      operations during the years ended December 31, 2006 and 2005, presented on
      a
      consolidated basis. Since the Company did not commence active banking operations
      until May 16, 2005, most comparisons of 2006 to 2005 are not for like 12-month
      periods.  -
            39 -


**Critical
      accounting policies**




This
      discussion and analysis of the Company’s 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 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. Until management has adequate historical data upon which
      to
      base the estimate of the allowance for credit losses, a balance of approximately
      1.2% of the outstanding principal is used unless additional information
      regarding the ability of the borrower to repay the loan, current economic
      conditions or other pertinent factors indicate a different allowance is needed.




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  -
            40 -


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 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, 2006, a review of the loan portfolio indicated that a loan
      loss allowance of $432 thousand was adequate to cover probable losses in the
      portfolio.  Refer
      to **Notes
      to 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
      estimates that are a part of the calculation for the compensation costs include
      the average life of the stock options, the future price of the Company’s stock
      when the options are exercised, and the average forfeiture 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 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.




*Estimation
      of fair value*




The
      estimation of fair value is significant to a number of the Company’s assets,
      including available for sale investment securities and other real estate owned.
      These are all recorded at either fair value or at the lower of cost or fair
      value. Furthermore, accounting principles generally accepted in the United
      States require disclosure of the fair value of financial instruments as a part
      of the notes to the


-
          41 -


consolidated
      financial statements. Fair values are volatile and may be influenced by a number
      of factors, including market interest rates, prepayment speeds, discount rates
      and the shape of yield curves.




*New
      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 not
      yet determined which method the Company will adopt, so the impact of
      SFAS 156 on the 2007 financial statements has not been
      determined.




In
      July
      2006, the FASB issued Financial Accounting Standards Interpretation No. 48,
      (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of
      FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in
      income taxes recognized in an enterprise’s financial statements in accordance
      with SFAS No. 109, Accounting for Income Taxes.  FIN 48 prescribes a
      recognition threshold and measurement attribute for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. FIN 48 also provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosures and
      transition. FIN 48 is effective for fiscal years beginning after December 15,
      2006. The Company is currently analyzing the potential effects of FIN 48 on
      its
      financial statements.





In
      September 2006, the FASB issued SFAS 157, “ *Fair
      Value Measurements* ”
(“SFAS
      157”). SFAS 157 defines fair value, establishes a framework for measuring fair
      value, and expands disclosures about fair value measurements. This statement
      clarifies that the exchange price is the price in an orderly transaction between
      market participants to sell the asset or transfer the liability in the market
      in
      which the reporting entity would transact for the asset or liability. It also
      emphasizes that fair value is a market-based measurement not an entity specific
      measurement. SFAS 157 expands disclosures about the use of fair value to measure
      assets and liabilities in interim and annual periods subsequent to initial
      recognition. The disclosures focus on the inputs used to measure fair value
      and
      for recurring fair value measurements using significant unobservable inputs, the
      effect of the measurements on earnings for the period. The Company does not
      expect the adoption of SFAS 157 to have a material effect on the Company’s
      consolidated financial statements.





In
      February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial
      Assets and Financial Liabilities, which also establishes presentation and
      disclosure requirements designed to facilitate comparisons between companies
      that choose different measurement attributes for similar types of assets and
      liabilities. The standard requires companies to provide additional information
      that will help investors and other users of financial statements to more easily
      understand the effect of the company’s choice to use fair value on its earnings.
      It also requires entities to display the fair value of those assets and
      liabilities for which the company has chosen to use fair value on the face
      of
      the balance sheet.  The new Statement does not eliminate disclosure
      requirements included in other accounting standards, including requirements
      for
      disclosures about fair value measurements included in FASB Statements No. 157, *Fair
      Value Measurements,* and No.
      107, *Disclosures
      about Fair Value of Financial Instruments.* The
      Company is currently analyzing the potential effects of adopting SFAS 159 on
      its
      financial statements.





**Results
      of operations for the year** **s
      ended December 31, 2006 and 2005**




The
      Company’s net loss for the year ended December 31, 2006 was $4.2 million
      compared to the loss in 2005 of $3.0 million. In 2006 the loss was entirely
      related to banking operations while in 2005  -
            42 -


$1.8
      million of the loss was related to banking operations, with the remainder of
      $1.2 million related to pre-opening expenses. The operating loss during both
      2006 and 2005 was due primarily to level of overhead costs, compared to the
      Company’s asset size. For 2006 and 2005, the Company’s overhead costs, or
      noninterest expense, which totaled approximately $6.0 million and $3.6 million
      respectively, were only partially offset by its net interest income of
      approximately $2.0 million and $695 thousand respectively. Noninterest income
      earned during 2006 was $128 thousand compared to $8 thousand in 2005. The
      provision for loan losses grew to $349 thousand in 2006 from $87 thousand in
      2005, as a direct result of the growth in the loan portfolio.




The
      2006
      loss resulted in a return on average assets of (9.6%) and a return on average
      equity of (24.2%). The 2005 loss resulted in a return on average assets of
      (17.9%) and a return on average equity of (25.7%). For 2005 these ratios were
      distorted by the impact of the pre-opening period on earnings as well as the
      average outstanding assets and equity.




**Net** **interest
      income**




Net
      interest income is the difference between the income earned on assets and
      interest paid on deposits and borrowings used to support such assets. Net
      interest income is determined by the yields earned on the Company’s
      interest-earning assets and the rates paid on its interest-bearing liabilities,
      the relative amounts of interest-earning assets and interest-bearing
      liabilities, and the degree of mismatch and the maturity and repricing
      characteristics of its interest-earning assets and interest-bearing liabilities.
      Net interest income divided by average interest-earning assets represents the
      Company’s net interest margin.




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
      year ended December 31.  -
            43 -




2006
              
              2005Average
                  Balance
              
              Interest
              
              Average
                  Yield / Cost
              
              Average
                  Balance
              
              Interest
              
              Average
                  Yield / CostAssets:Interest-earning
                  Assets:Net
                  Loans Receivable
              
              $
              20,329,370
              
              $
              1,697,765
              
              
              8.35
              %
              $
              2,894,090
              
              $
              230,166
              
              
              7.95
              %Investment
                  Securities
              
              
              8,221,242
              
              
              366,555
              
              
              4.46
              %
              
              2,558,130
              
              
              106,536
              
              
              4.16
              %Investment
                  in capital stock of Federal Reserve Bank
              
              
              519,581
              
              
              31,131
              
              
              5.99
              %
              
              361,797
              
              
              21,670
              
              
              5.99
              %Time
                  Deposits in other financial institutions
              
              
              791,781
              
              
              33,689
              
              
              4.25
              %
              
              734,318
              
              
              20,985
              
              
              2.86
              %Cash,
                  fed funds and other
              
              
              11,206,329
              
              
              568,115
              
              
              5.07
              %
              
              8,457,655
              
              
              422,284
              
              
              4.99
              %Total
                  interest-earning assets
              
              
              41,068,303
              
              
              2,697,255
              
              
              6.57
              %
              
              15,005,990
              
              
              801,641
              
              
              5.34
              %Noninterest-earning
                  assets
              
              
              2,787,097
              
              
              
              
              
              
              
              
              1,643,067Total
                  Assets
              
              $
              43,855,400
              
              
              
              
              
              
              
              $
              16,649,057Liabilities
                  and Stockholders' EquityMoney
                  Market and Savings Deposits
              
              $
              10,187,531
              
              $
              391,078
              
              
              3.84
              %
              $
              1,449,209
              
              
              30,616
              
              
              2.11
              %Interest-bearing
                  Checking
              
              
              1,998,966
              
              
              26,850
              
              
              1.34
              %
              
              353,748
              
              
              3,060
              
              
              0.87
              %Time
                  Deposits of $100,000 or more
              
              
              3,749,227
              
              
              171,437
              
              
              4.57
              %
              
              698,962
              
              
              25,748
              
              
              3.68
              %Other
                  Deposits
              
              
              2,248,361
              
              
              78,000
              
              
              3.47
              %
              
              487,697
              
              
              17,408
              
              
              3.57
              %Other
              
              
              -
              
              
              -
              
              
              
              
              
              709,583
              
              
              30,022
              
              
              4.23
              %Total
                  Interest-bearing liabilities
              
              
              18,184,085
              
              
              667,365
              
              
              3.67
              %
              
              3,699,199
              
              
              106,854
              
              
              2.89
              %Non-interest
                  bearing checking accounts
              
              
              8,072,933
              
              
              
              
              
              
              
              
              1,179,917Non-interest
                  bearing liabilities
              
              
              237,144
              
              
              
              
              
              
              
              
              147,901Stockholders'
                  Equity
              
              
              17,361,238
              
              
              
              
              
              
              
              
              11,622,040Total
                  Liabilities andStockholders'
                  Equity
              
              $
              43,855,400
              
              
              
              
              
              
              
              $
              16,649,057Net
                  Interest Income
              
              
              
              
              $
              2,029,890
              
              
              
              
              
              
              
              $
              694,787Net
                  Interest Spread
              
              
              
              
              
              2.90
              %
              
              
              
              
              
              
              
              2.45
              %Net
                  Interest Margin
              
              
              
              
              
              4.94
              %
              
              
              
              
              
              
              
              4.63
              %




Net
      interest income for the year ended December 31, 2006 was $2.0 million compared
      to 2005 at $695 thousand. This increase was due primarily to an increase in
      average earning assets and secondarily to the mix of earning assets. The
      increase in interest income to $2.7 million in 2006 from $802 thousand in 2005
      was due to growth in earning assets of $26.1 million, with $17.4 million in
      loan
      growth. Primarily because loans had the highest yield of the earning assets,
      the
      overall yield on earning assets increased by 123 basis points to 6.57% from
      5.34%. Interest expense also increased, to $667 thousand in 2006 from  -
            44 -


$107
      thousand in 2005. Average deposits grew in 2006 by $21.4 million to $26.3
      million and the cost of interest-bearing deposits increased by 78 basis points
      to 3.67% in 2006 from 2.89% in 2005. The cost of funds increased due to
      competitive pressures in the market place and the Bank’s willingness to pay
      higher interest rates in order to attract deposits because of increased loan
      demand. The most significant growth was in the money market and savings
      category, followed closely by the growth in non-interest bearing checking
      accounts. The growth in average non-interest bearing deposits of $6.9 million
      to
      $8.1 million contributed to the increase in the net interest margin of 4.94%
      for
      2006, an increase of 31 basis points over the net interest margin of 4.63%
      in
      2005.




Other
      interest expense in 2005 included interest paid on a line of credit used during
      the organizational stage of the Company. There were no borrowings by the Company
      during 2006 and therefore no such expense for the year.




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 2006 compared
      to 2005. Because the Bank began operations in 2005, changes due to volume in
      2006 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.  -
            45 -


Year
        Ended December 31, 2006 Compared to December 31, 2005


Increase/(Decrease)
      in Net Interest Income


Due
                  ToRate
              
              Volume
              
              NetInterest-earning
                  Assets:Net
                  Loans Receivable
              
              $
              11,528
              
              $
              1,456,071
              
              $
              1,467,599Investment
                  Securities
              
              
              7,522
              
              
              252,497
              
              
              260,019Investment
                  in capital stock of Federal Reserve Bank
              
              
              7
              
              
              9,454
              
              
              9,461Time
                  Deposits in other financial institutions
              
              
              10,259
              
              
              2,445
              
              
              12,704Cash,
                  fed funds and other
              
              
              6,484
              
              
              139,347
              
              
              145,831Total
              
              
              35,800
              
              
              1,859,814
              
              
              1,895,614Noninterest-earning
                  assetsTotal
                  AssetsLiabilities
                  and Stockholders' EquityMoney
                  Market and Savings Deposits
              
              
              25,016
              
              
              335,446
              
              
              360,462Interest-bearing
                  Checking
              
              
              1,692
              
              
              22,098
              
              
              23,790Time
                  Deposits of $100,000 or more
              
              
              6,213
              
              
              139,476
              
              
              145,689Other
                  Deposits
              
              
              (492
              )
              
              61,084
              
              
              60,592Other
              
              
              -
              
              
              (30,022
              )
              
              (30,022
              )Total
              
              
              32,429
              
              
              528,083
              
              
              560,511Net
                  Change in Net Interest Income
              
              $
              3,372
              
              $
              1,331,731
              
              $
              1,335,103




**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 $349 thousand in 2006 and $87 thousand in 2005. The increase in expense
      in
      2006 was directly related to the increase in gross outstanding loans of $24.6
      million from December 31, 2005 to December 31, 2006. 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.




Information
      regarding the calculation of the loan loss provision for 2006, the factors
      considered by the Company 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**




Noninterest
      income for the year ended December 31, 2006 was $128 thousand compared to 2005
      at $8 thousand. In 2006 the Company sold the guaranteed portion of certain
      SBA
      loans resulting in a gain on sale of $90 thousand. There were no SBA loan sales
      in 2005. The remaining non-interest income of $38 thousand in 2006 was primarily
      related to charges on deposit accounts for merchant credit card processing
      of
      $13 thousand and for presentation of non-sufficient funds (NSF) items of $11
      thousand, and  -
            46 -


referral
      fees from other banks for loan referrals in loan products that the Bank does
      not
      offer, of $8 thousand. In 2005, in order to attract depositors, the Bank took
      a
      competitive posture in regards to service charges and waived most normal service
      charges for activity on business accounts for the first 90 days of business.
      This held noninterest income to a minimum.




**Noninterest
      expense**




Noninterest
      expenses for 2006 totaled $6.0 million compared to $3.6 million for 2005. In
      2006, non-interest expense included $1.5 million in expense related to the
      accounting for stock options and $4.5 million attributable to a full year of
      banking operations. In 2005, $1.3 million was attributable to pre-opening
      expenses and $2.3 million was attributable to approximately seven months of
      banking operations.




Salaries
      and employee benefits, the largest component of noninterest expense, totaled
      $3.9 million for 2006 and $1.3 million for 2005. In 2006, $1.5 million was
      related to the accounting for stock options. There was no expense in 2005
      because the shareholders did not approve the stock option plan until the annual
      meeting in 2006. Benefits as a percentage of salary expense was 19.9% for 2006
      compared to 26% for 2005. The primary cause of the decrease in benefits as
      a
      percentage of salary was the result of a full year of operations in 2006
      compared to seven months in 2005. In 2006 more employees had the opportunity
      to
      reach the maximum wage limit for certain state and federal taxes. This reduced
      the Bank’s employer-tax burden. Group insurance as a percentage of gross
      salaries also decreased in 2006 as the demographics of the staff changed. The
      staff expanded in the entry-level positions, with lower insurance costs. As
      of
      December 31, 2006 and 2005, the Bank had 31 and 24 employees, with a
      full-time-equivalent of 29 and 23 employees, respectively.




Occupancy
      expense increased to $790 thousand in 2006 from $448 thousand in 2005. This
      increase was primarily the result of more months of operations in 2006, and
      secondarily due to additional space leased in the San Clemente location. The
      additional space increased monthly rent expense by approximately $23 thousand
      in
      2006, and is occupied by the Credit Administration group. Overall, for 2006,
      $363 thousand was paid in rent and common area maintenance, $320 thousand was
      depreciation of equipment and amortization of leasehold improvements, $59
      thousand was related to telephone and utilities expense, and the remainder
      was
      related to maintenance and repairs. For 2005, $255 thousand was paid in rent
      and
      common area maintenance, $99 thousand was depreciation of equipment and
      amortization of leasehold improvements, $53 thousand was related to telephone
      and utilities expense, and the remainder was related to maintenance and
      repairs.




For
      2006,
      professional services totaled $185 thousand while in 2005 professional services
      totaled $624 thousand, with $70 thousand related to banking operations and
      $554
      thousand related to pre-opening expenses. 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, and $22 thousand was
      compliance-related. For 2005, the $70 thousand consisted of $23 thousand in
      legal fees, $16 thousand related to auditor expense, $12 thousand in
      compliance-related expenses, with the remainder related to internal audits
      and
      reviews.




Data
      processing expenses for 2006 and 2005 totaled $407 thousand and $224 thousand
      respectively, including expenses related to the design and maintenance of the
      website of $58 thousand and $17 thousand.




For
      2006
      and 2005, office expenses totaled $370 thousand and $265 thousand. These
      expenses include $79 thousand and $51 thousand for 2006 and 2005 in auto-related
      expenses respectively. The increase in 2006 is due to more months of operations,
      an increase in staff positions that receive mileage reimbursement, and an
      increase in fuel costs. The cost of office supplies decreased to $65 thousand
      in  -
            47 -


2006
      from
      $82 thousand in 2005. 2005 included the initial ordering of forms, supplies,
      and
      brochures for the Bank opening. Insurance costs including workers’ compensation,
      property, and liability insurance rose to $83 thousand in 2006 from $48 thousand
      in 2005. This increase was due to an increase in staff and more months of
      operations. Armored car and courier costs rose as the number of deposit
      customers increased, to $36 thousand in 2006 from $20 thousand in 2005. FDIC
      and
      OCC assessments increased to $26 thousand in 2006 from $9 thousand in 2005.
      As
      deposits increase, the FDIC assessment increases, so annual increases in expense
      are anticipated. Check printing costs rose to $32 thousand in 2006 from $12
      thousand in 2005. Often the Bank will absorb the cost of printing checks for
      customers as a way of expediting the opening of new accounts. In 2006 this
      expense increased as the number of accounts at the Bank increased. Other
      expenses in this category include recruiting expense, postage, and travel and
      seminar expenses.




Marketing
      expenses totaled $231 thousand for 2006 and $164 thousand for 2005. These
      expenses included the design and placement of newspaper advertising, targeted
      direct mail pieces, support of community and service club events and individual
      officer direct call efforts.




The
      expense related to the stock warrants granted to organizers of $495 thousand
      was
      incurred during the pre-opening phase.




Other
      operating expenses totaled $116 thousand for 2006 and $42 thousand for 2005.
      In
      2006 $32 thousand consisted of loan production costs such as appraisals and
      credit reports, some of which may be reimbursed at the time the loans are
      funded. In 2005 this expense was $30 thousand. Expenses related to the annual
      shareholders’ meeting including the printing and mailing of the 10-KSB and proxy
      material were $39 thousand in 2006. There was no expense in 2005 as that was
      the
      first year of operations. Expenses related to director training were $15
      thousand and $12 thousand in 2006 and 2005, respectively. The directors
      regularly attend classes presented by banking organizations, regulators, and
      banking compliance experts, in order to increase their awareness of the issues
      affecting banking. In 2006 $22 thousand was related to the accounting for stock
      options awarded to the directors. There was no expense in 2005 because the
      shareholders did not approve the stock option plan until the annual meeting
      in
      2006. Expense related to reserves for off-balance sheet contingencies was $8
      thousand in 2006 and $16 thousand for 2005.




**Financial
      condition as of December 31,** **2006
      and 2005**




**Loans**




The
      Bank’s loan portfolio represents the highest yielding component of the Company’s
      earning asset base. Information regarding the Company’s loan portfolio as of
      December 31, 2006 and 2005 is included in the section of this Report titled *“Part
      I - Item 1. Business - Lending services”* and *“Part
      I - Item 1. Business - Asset quality.”*




**Securities
      and other earning assets**




The
      securities portfolio is used to make various term investments, to provide a
      source of liquidity and to serve as collateral for certain types of deposits
      and
      borrowings. Information regarding the Company’s securities portfolio as of
      December 31, 2006 and 2005 is included in the section of this Report titled *“Part
      I - Item 1. Business - Investments.”*


-
          48 -




**Nonearning
      assets**




Premises,
      leasehold improvements and equipment totaled $1.15 million at December 31,
      2006,
      net of accumulated depreciation of $508 thousand, and $1.15 million at December
      31, 2005, net of accumulated depreciation of $120 thousand. There are no
      definitive agreements regarding acquisition or disposition of owned or leased
      facilities and, for the near-term future, there are no significant changes
      anticipated in the total occupancy expense.




**Deposits**




Deposits
      are the Company’s primary source of funds to support its earning assets. The
      Company has been able to effectively compete for deposits in its primary market
      areas. Information regarding the Company’s deposit mix as of December 31, 2006
      and 2005 is included in the section above titled *“Net
      interest income.”*




**Liquidity**




On
      May
      16, 2005, the Company completed its initial public offering of common stock
      and
      issued 2,280,000 shares of its common stock at $10 per share for a total of
      $22,800,000. As of December 31, 2006 and 2005, the Company maintained cash
      and
      cash equivalents of $887 thousand and $967 thousand respectively. The Company
      is
      a holding company with no significant business operations outside of the Bank.
      Accordingly, 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 until the accumulated deficit has been
      eliminated.




For
      the
      Bank, liquidity represents the ability to provide steady sources of funds for
      loan commitments and investment activities, as well as to maintain sufficient
      funds to cover deposit withdrawals and payment of debt and operating
      obligations. The Bank’s primary funding sources are deposits, principal payments
      on loans, and cash flows from operations. Other possible sources of liquidity
      available to the Bank include the sale of loans and investment securities,
      commercial bank lines of credit, and direct access, under certain conditions,
      to
      borrowings from the Federal Reserve System. The Company currently may borrow
      up
      to $4 million overnight on an unsecured basis from a correspondent bank. The
      cash needs of the Bank are principally for the payment of interest on, and
      withdrawals of deposit accounts, the funding of loans, investments and operating
      costs and expenses. At December 31, 2006, the Bank’s liquidity ratio (Cash, Due
      from banks, and investments as a percentage of total assets) was 35.3%. The
      Bank
      considers this more than adequate to meet the funding needs of the loan
      portfolio. A target ratio for liquidity as the Bank matures is expected to
      be in
      the range of 12% to 18%.




**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.  -
            49 -


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, 2006, 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
              
              -2%
              
              -1%
              
              Annualized*
              
              +1%
              
              +2%Fed
                  Funds Rate
              
              3.25%
              
              4.25%
              
              5.25%
              
              6.25%
              
              7.25%Net
                  Interest Income Change
              
              
              (297
              )
              
              (147
              )
              
              -
              
              
              42
              
              
              81%
                  Change
              
              
              -11.3
              %
              
              -5.7
              %
              
              -
              
              
              1.6
              %
              
              3.1
              %Equity
                  Capital Change %
              
              
              -3.0
              %
              
              
              
              
              -
              
              
              
              
              
              1.4
              %Net
                  Interest Margin
              
              
              4.4
              %
              
              4.6
              %
              
              5.0
              %
              
              5.1
              %
              
              5.1
              %




Interest
      rate sensitivity refers to the responsiveness of interest-bearing assets and
      liabilities to change in market interest rates. The rate sensitive position,
      or
“gap,” is the difference in the volume of rate sensitive assets and liabilities
      at a given time interval. The general objective of gap management is to actively
      manage rate sensitive assets and liabilities in order to reduce the impact
      of
      interest rate fluctuations on the net interest margin. The Bank attempts to
      maintain a balance between rate sensitive assets and liabilities as the exposure
      period is lengthened to minimize the Bank’s overall interest rate risk. The Bank
      regularly evaluates the balance sheet’s asset mix in terms of several variables:
      yield, credit quality, appropriate funding sources and liquidity.




The
      following table sets forth information concerning the sensitivity of the
      Company’s interest-earning assets and interest-bearing liabilities as of
      December 31, 2006. The amount of assets and liabilities shown within a
      particular period were determined in accordance with their contractual
      maturities, except that the adjustable rate products are reflected in the
      earlier period of when they are first scheduled to adjust or
      mature.


-
            50 -




**As
                  of December 31, 2006****Volumes
                  Subject to Repricing Within****(Dollars
                  in thousands)****0-1
                  Days**
              
              **2-90
                  Days**
              
              **91-365
                  Days**
              
              **1-3
                  Years**
              
              **Over
                  3 Years**
              
              **Non-Interest
                  Sensitive**
              
              **Total****Assets:**Cash,
                  fed funds and other
              
              $
              10,360
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              1,556
              
              $
              11,916Investments
                  and FRB Stock (1)
              
              
              -
              
              
              -
              
              
              3,999
              
              
              3,945
              
              
              494
              
              
              -
              
              
              8,438Loans
                  (2)
              
              
              -
              
              
              12,741
              
              
              2,388
              
              
              5,377
              
              
              14,398
              
              
              -
              
              
              34,904Fixed
                  and other assets
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              936
              
              
              936Total
                  Assets
              
              $
              10,360
              
              $
              12,741
              
              $
              6,387
              
              $
              9,322
              
              $
              14,892
              
              $
              2,492
              
              $
              56,194**Liabilities
                  and Stockholders’ Equity:**Interest-bearing
                  checking, savings and money market accounts
              
              $
              22,562
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              12,072
              
              $
              34,634Certificates
                  of deposit
              
              
              -
              
              
              1,421
              
              
              3,674
              
              
              40
              
              
              81
              
              
              -
              
              
              5,216Borrowed
                  funds
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Other
                  liabilities
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              324
              
              
              324Stockholders’
                  equity
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              16,020
              
              
              16,020Total
                  liabilities and stockholders’ equity
              
              $
              22,562
              
              $
              1,421
              
              $
              3,674
              
              $
              40
              
              $
              81
              
              $
              28,416
              
              $
              56,194Interest
                  rate sensitivity gap
              
              $
              (12,202
              )
              $
              11,320
              
              $
              2,713
              
              $
              9,282
              
              $
              14,811Cumulative
                  interest rate sensitivity gap
              
              $
              (12,202
              )
              $
              (882
              )
              $
              1,831
              
              $
              11,113
              
              $
              25,924Cumulative
                  gap to total assets
              
              
              -21.7
              %
              
              -1.6
              %
              
              3.3
              %
              
              19.8
              %
              
              46.1
              %Cumulative
                  interest-earning assets to cumulative interest-bearing liabilities
              
              
              45.9
              %
              
              96.3
              %
              
              106.6
              %
              
              140.1
              %
              
              193.3
              %







(1)
            Excludes
                investments’ mark-to-market
                adjustments


(2)
            Excludes
                deferred fees and allowance for loan
                losses.




As
      the
      Bank continues to grow, it will continuously structure its 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.




**Off-balance
      sheet arrangements**




In
      the
      ordinary course of business, the Company enters 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, 2006, commitments to extend credit included approximately $10 thousand
      for
      letters of credit, approximately $2.6 million for revolving line of credit
      arrangements and $7.0 million in unused commitments for commercial and real
      estate secured loans. As of December 31, 2005, commitments to extend credit
      included approximately $1.8 million for letters of credit, approximately $1.0
      million for revolving line of credit arrangements and $3.9 million in unused
      commitments for commercial and real estate secured loans. The Company faces
      the
      risk of deteriorating credit quality of borrowers to whom a commitment to extend
      credit has been made; however, no significant credit losses are expected from
      these commitments and arrangements.  -
            51 -


**Capital
      adequacy**




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.




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


To
                  Be WellCapitalized
                  UnderFor
                  Capital
              
              Prompt
                  CorrectiveActual
              
              Adequacy
                  Purposes
              
              Action
                  ProvisionsAmount
              
              
              
              Amount
              
              
              
              Amount(Thousands)
              
              Ratio
              
              (Thousands)
              
              Ratio
              
              (Thousands)
              
              Ratio**As
                  of December 31, 2006:**Total
                  Capital (to Risk-Weighted Assets)
              
              $
              15,529
              
              
              50.2
              %
              $
              2,470
              
              
              8.0
              %
              $
              3,088
              
              
              10.0
              %Tier
                  1 Capital (to Risk-Weighted Assets)
              
              $
              15,133
              
              
              49.0
              %
              $
              1,235
              
              
              4.0
              %
              $
              1,853
              
              
              6.0
              %Tier
                  1 Capital (to Average Assets)
              
              $
              15,133
              
              
              27.5
              %
              $
              2,204
              
              
              4.0
              %
              $
              2,755
              
              
              5.0
              %**As
                  of December 31, 2005:**Total
                  Capital (to Risk-Weighted Assets)
              
              $
              17,841
              
              
              101.7
              %
              $
              1,403
              
              
              8.0
              %
              $
              1,754
              
              
              10.0
              %Tier
                  1 Capital (to Risk-Weighted Assets)
              
              $
              17,738
              
              
              101.2
              %
              $
              701
              
              
              4.0
              %
              $
              1,052
              
              
              6.0
              %Tier
                  1 Capital (to Average Assets)
              
              $
              17,738
              
              
              64.1
              %
              $
              1,108
              
              
              4.0
              %
              $
              1,385
              
              
              5.0
              %




**Item
      7. Financial Statements**




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




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




Not
      applicable.




**ITEM
      8A. Controls and Procedures**




As
      of the
      end of the period covered by this Annual Report on Form 10-KSB for the year
      ended December 31, 2006, the Company carried out an evaluation, under the
      supervision and with the  -
            52 -


participation
      of its management, including its chief executive officer and chief financial
      officer, of the effectiveness of the design and operation of its “disclosure
      controls and procedures,” as such term is defined under Exchange Act Rule
      13a-15(e).




Based
      on
      this evaluation, the Company’s chief executive officer and chief financial
      officer concluded that, as of the end of the fiscal year covered by this report,
      such disclosure controls and procedures were reasonably designed to ensure
      that
      information required to be disclosed by the Company in the reports it files
      or
      submits under the Exchange Act is: (a) recorded, processed, summarized and
      reported within the time periods specified in the rules and forms of the
      Securities and Exchange Commission, and (b) accumulated and communicated to
      management, including its chief executive officer and chief financial officer,
      as appropriate to allow timely decisions regarding required
      disclosure.




In
      designing and evaluating the disclosure controls and procedures, management
      recognized that any controls and procedures, no matter how well designed and
      operated, can provide only reasonable assurance of achieving the desired control
      objectives and in reaching a reasonable level of assurance management of the
      Company necessarily was required to apply its judgment in evaluating the
      cost-benefit relationship of possible controls and procedures.




On
      October 31, 2006, the Company filed an amended Quarterly Report on Form 10-QSB
      for the quarter ended June 30, 2006 to restate its previously issued unaudited
      financial statements at and for the quarter and six months ended June 30, 2006
      to correct errors related to accounting for stock-based compensation expenses.
      The error did not affect the financial statements for any prior
      periods.




In
      connection with the Company's investigation of the circumstances giving rise
      to
      the restatement, the Company determined that the error resulted from an
      incorrect interpretation of Statement of Financial Accounting Standards No.
      123
      (revised), *“Share-Based
      Payments”* .
      This
      error did not relate to the company's overall valuation of the stock options
      granted in the second quarter of 2006 under the Black-Scholes-Merton option
      pricing model, but rather related to the portion of such value that the company
      determined was required to be expensed in the second quarter of 2006 under
      FAS
      123R, as shown in the financial statements included in the company's June 30,
      2006 Quarterly Report on Form 10-QSB.




In
      light
      of the restatement of the Company's consolidated financial statements, the
      Company concluded that as of June 30, 2006 effective disclosure controls and
      procedures were not maintained over the amounts to be expensed attributable
      to
      employee stock options in its consolidated statements of operations.
      Accordingly, management determined that this control deficiency constituted
      a
      material weakness. A material weakness is a control deficiency, or a combination
      of control deficiencies, that result in more than a remote likelihood that
      a
      material misstatement of the annual or interim financial statements will not
      be
      prevented or detected.




The
      Company has now fully remediated this material weakness. The company will
      monitor all new accounting pronouncements and make a determination whether
      sufficient expertise exists within the company to evaluate and apply the
      standards set forth in such new accounting pronouncements. In the event that
      management determines that additional resources are necessary to evaluate the
      impact of the new accounting pronouncements on the company's financial
      statements, management will engage a qualified accounting firm to assist
      management in the implementation of the new accounting
      pronouncements.




There
      were no other changes in the Company’s internal controls over financial
      reporting during the year ended December 31, 2006 that materially affected,
      or
      were reasonably likely to materially affect, its internal controls over
      financial reporting.  -
            53 -


**ITEM
      8B. Controls and Procedures**




Not
      applicable.




**PART
      III**




**Item
      9. Directors and Executive Officers of the Registrant**




The
      information required by this Item is incorporated by reference from the
      Company’s definitive proxy statement for its 2007 Annual Meeting of
      Shareholders, expected to be held in June 2007





**Item
      10.** **Executive
      Compensation**




The
      information required by this Item is incorporated by reference from the
      Company’s definitive proxy statement for its 2007 Annual Meeting of
      Shareholders, expected to be held in June 2007





**Item
      11. Security Ownership of Certain Beneficial Owners and
      Management**




The
      information required by this Item is incorporated by reference from the
      Company’s definitive proxy statement for its 2007 Annual Meeting of
      Shareholders, expected to be held in June 2007





**Item
      12. Certain Relationships and Related Transactions**




The
      information required by this Item is incorporated by reference from the
      Company’s definitive proxy statement for its 2007 Annual Meeting of
      Shareholders, expected to be held in June 2007





**Item
      13. Exhibits**




**(a)**
            **Exhibits**




**Number**
            **Description**  3.1
            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 incorporationand
                bylaws defining rights of holders of the common stock


10.1
            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 NationalBancorp
                and Michael Hahn+*


10.8
            Form
                of Employment Agreement by and between Pacific Coast NationalBancorp
                and Richard Grinyer+*


10.9
            Form
                of Employment Agreement by and between Pacific Coast NationalBancorp
                and Colin Forkner+*


10.10
            Form
                of Employment Agreement by and between Pacific Coast NationalBancorp
                and Terry Stalk+*


-
          54 -


10.11
            Form
                of Incentive Stock Option
                Agreement+


10.12
            Form
                of Nonqualified Stock Option
                Agreement+


10.13
            Amendment
                To Lease Date Change to Office Lease dated as of February 23,2005


10.14
            Second
                Amendment to Office Lease dated as of March 1,
                2006


14
            Code
                of Ethics***


21
            Subsidiaries
                of Registrant


23
            Consent
                of Independent Accountants


31.1
            Certification
                of Chief Executive Officer Pursuant to Rule 13a-14(a) of theSecurities
                Exchange Act


31.2
            Certification
                of Chief Financial Officer Pursuant to Rule 13a-14(a) of theSecurities
                Exchange Act


32
            Certification
                Pursuant to Rule 13a-14(b) of the Securities Exchange Act and 18U.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.


+
            Indicates
                a compensatory plan or contract.




**(b)**
            None




**Item
      14. Principal Accounting Fees and Services.**




The
      information required by this Item is incorporated by reference from the
      Company’s definitive proxy statement for its 2007 Annual Meeting of
      Shareholders, expected to be held in June 2007.


-
          55 -




**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Exchange Act, the Registrant
      has caused this report to be signed on its behalf by the undersigned, thereunto
      duly authorized.




**PACIFIC COAST NATIONAL BANCORP,
              INC.**By:
            /s/
              Colin M. ForknerColin
              M. ForknerChief
              Executive Officer


Pursuant
      to the requirements of the Securities Exchange Act of 1934, 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
                  29, 2007Colin
                Forkner
              
              (Principal
                  Executive Officer)/s/
                  Thomas J. Applegate
              
              Director
              
              March
                  29, 2007Thomas
                  J. Applegate/s/
                  Michael Cummings
              
              Director
              
              March
                  29, 2007Michael
                  Cummings/s/
                  David E. Davies
              
              Director
              
              March
                  29, 2007David
                  E. Davie/s/
                  Fred A. de Boom
              
              Director
              
              March
                  29, 2007Fred
                  A. de Boo/s/
                  Michael Hahn
              
              Director
              
              March
                  29, 2007Michael
                  Hah/s/
                  David Johnson
              
              Director
              
              March
                  29, 2007David
                  Johnso/s/
                  Dennis Lindeman
              
              Director
              
              March
                  29, 2007Dennis
                  Lindema/s/
                  Denis H. Morgan
              
              Director
              
              March
                  29, 2007Denis
                  H. Morga/s/
                  James W. Shute
              
              Director
              
              March
                  29, 2007James
                  W. Shut/s/
                  Jack Vuona
              
              Director
              
              March
                  29, 2007Jack
                  Vuon/s/
                  Terry Stalk
              
              Executive
                  Vice President and Chief Financial OfficerTerry
                  Stalk
              
              (Principal
                  Financial and Accounting Officer)
              
              March
                  29, 2007




-
          56 -




**CONTENTS**






**REPORT
                OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
            **F-1****FINANCIAL
                STATEMENTS****Consolidated
                Balance Sheets**
            **F-2****Consolidated
                Statements of Earnings**
            **F-3****Consolidated
                Statements of Cash Flows**
            **F-4****Consolidated
                Statement of Shareholders’ Equity**
            **F-5****Notes
                to Consolidated Financial Statements**
            **F-6
                through F-23**











**Vavrinek, Trine, Day & Co.,
              LLP**Certified
              Public Accountants & Consultants
            
            VALUE
                THE DIFFERENCE








**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 and Subsidiary as of December 31, 2006 and 2005, and the related
      consolidated statements of earnings, shareholders’ equity and cash flows for the
      years 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 2005, and the results of
      its
      operations and cash flows for the years then ended, in conformity with
      accounting principles generally accepted in the United States of
      America.





As
      discussed in Note A to the Consolidated Financial Statements, the Company
      adopted new accounting guidance which impacts the accounting for stock
      options.








Laguna
      Hills, California


March
      21,
      2007






25231
        Paseo De Alicia, Suite 100     Laguna Hills, CA
        92653     Tel:
        949.768.0833     Fax:
        949.768.8408     www.vtdcpa.com
  **FRESNO****·****LAGUNA HILLS****·****PALO ALTO****·****PLEASANTON****·****RANCHO CUCAMONGA**
 F-1




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**CONSOLDIATED
      BALANCE SHEETS**


**December
      31, 2006 and 2005**




**ASSETS**


2006
              
              2005Cash
                  and due from banks
              
              $
              1,556,151
              
              $
              1,699,481Federal
                  funds sold
              
              
              9,360,000
              
              
              6,580,000**TOTAL
                  CASH AND CASH EQUIVALENTS**
              
              
              10,916,151
              
              
              8,279,481Interest-bearing
                  deposits in other financial institutions
              
              
              1,000,000
              
              
              2,750,000Securities
                  held to maturity
              
              
              7,943,375
              
              
              7,997,943Loans,
                  net
              
              
              34,363,765
              
              
              10,230,122Premises
                  and equipment, net
              
              
              1,145,105
              
              
              1,154,066Federal
                  Reserve Bank stock, at cost
              
              
              493,800
              
              
              553,700Accrued
                  interest and other assets
              
              
              332,051
              
              
              244,853$
              56,194,247
              
              $
              31,210,165





**LIABILITIES
      AND SHAREHOLDERS’ EQUITY**


DepositsNoninterest-bearing
                  demand
              
              $
              12,071,916
              
              $
              4,266,093Interest-bearing
                  demand accounts
              
              
              3,061,772
              
              
              788,633Money
                  market
              
              
              19,329,525
              
              
              3,332,615Savings
              
              
              170,765
              
              
              86,283Time
                  certificates of deposit of $100,000 or more
              
              
              3,137,238
              
              
              2,412,465Other
                  time certificates of deposit
              
              
              2,078,856
              
              
              1,467,341**TOTAL
                  DEPOSITS**
              
              
              39,850,072
              
              
              12,353,430Accrued
                  interest and other liabilities
              
              
              324,592
              
              
              146,509**TOTAL
                  LIABILITIES**
              
              
              40,174,664
              
              
              12,499,939Commitments
                  and contingenciesShareholders'
                  equityCommon
                  stock - $0.01 par value; 10,000,000 shares authorized;issued
                  and outstanding: 2,281,500 shares at December 31,2006
                  and 2,280,000 outstanding at December 31, 2005
              
              
              22,815
              
              
              22,800Additional
                  paid-in capital
              
              
              24,788,356
              
              
              23,271,720Accumulated
                  deficit
              
              
              (
                  8,791,588
              )
              
              (
                  4,584,294
              )**TOTAL
                  SHAREHOLDERS' EQUITY**
              
              
              16,019,583
              
              
              18,710,226$
              56,194,247
              
              $
              31,210,165




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


F-2




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**CONSOLIDATED
      STATEMENTS OF EARNINGS**


**Years
      Ended December 31, 2006 and 2005**


2006
              
              2005Interest
                  incomeInterest
                  and fees on loans
              
              $
              1,697,765
              
              $
              230,166Federal
                  funds sold
              
              
              568,115
              
              
              307,687Investment
                  securities
              
              
              366,555
              
              
              128,206Other
              
              
              64,820
              
              
              135,5822,697,255
              
              
              801,641Interest
                  expenseTime
                  certificates of deposit of $100,000 or more
              
              
              171,437
              
              
              25,748Other
                  deposits
              
              
              495,928
              
              
              51,084Other
              
              
              -
              
              
              30,022667,365
              
              
              106,854Net
                  interest income
              
              
              2,029,890
              
              
              694,787Provision
                  for loan losses
              
              
              349,432
              
              
              87,208Net
                  interest income afterprovision
                  for loan losses
              
              
              1,680,458
              
              
              607,579Noninterest
                  incomeService
                  charges and fees
              
              
              12,450
              
              
              3,416Other
                  income
              
              
              115,426
              
              
              4,379127,876
              
              
              7,795Noninterest
                  expenseSalaries
                  and employee benefits
              
              
              3,914,662
              
              
              1,340,480Occupancy
              
              
              790,163
              
              
              448,183Professional
                  services
              
              
              184,617
              
              
              623,972Data
                  processing
              
              
              407,053
              
              
              223,624Office
                  expenses
              
              
              370,003
              
              
              265,078Marketing
              
              
              231,102
              
              
              164,221Stock
                  warrants granted to organizers
              
              
              -
              
              
              494,520Other
              
              
              116,428
              
              
              42,1096,014,028
              
              
              3,602,187Loss
                  before income taxes
              
              
              (4,205,694
              )
              
              (2,986,813
              )Provision
                  for income taxes
              
              
              1,600
              
              
              1,600Net
                  loss
              
              $
              (4,207,294
              )
              $
              (2,988,413
              )Per
                  share dataWeighted-average
                  shares outstanding
              
              
              2,281,041
              
              
              2,280,000Net
                  loss, basic
              
              $
              (
                  1.84
              )
              $
              (
                  1.31
              )




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


F-3




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**Years
      Ended December 31, 2006 and 2005**


2006
              
              2005Cash
                  flows from operating activities:Net
                  loss
              
              $
              (
                  4,207,294
              )
              $
              (
                  2,988,413
              )Adjustments
                  to reconcile net loss to net cashused
                  by operating activities:Depreciation
                  and amortization
              
              
              388,482
              
              
              119,668Provision
                  for loan losses
              
              
              349,432
              
              
              87,208Provision
                  for off balance sheet contingencies
              
              
              7,925
              
              
              15,847Amortization
                  (accretion) of investment securities
              
              
              (
                  6,712
              )
              
              133Gain
                  on sale of loans
              
              
              (
                  89,858
              )
              
              -Stock-based
                  compensation
              
              
              1,497,901
              
              
              -Noncash
                  compensation expense for organizer warrants
              
              
              -
              
              
              494,520Other
                  items, net
              
              
              82,960
              
              
              (
                  287,703
              )Net
                  cash used by operating activities
              
              
              (
                  1,977,164
              )
              
              (
                  2,558,740
              )Cash
                  flows from investing activities:Purchase
                  or maturity of time deposits in other financial
                  institutions
              
              
              1,750,000
              
              
              (
                  2,750,000
              )Purchases
                  of investment securities held to maturity
              
              
              (
                  3,938,720
              )
              
              (
                  7,998,075
              )Maturity
                  of investment securities held to maturity
              
              
              4,000,000
              
              
              -Purchase
                  or redemption of Federal Reserve Bank stock
              
              
              59,900
              
              
              (
                  553,700
              )Proceeds
                  from sale of loans
              
              
              1,609,240
              
              
              -Loan
                  originations
              
              
              (
                  26,002,457
              )
              
              (10,317,330
              )Purchases
                  of bank premises and equipment
              
              
              (
                  379,521
              )
              
              (
                  1,193,374
              )Net
                  cash used in investing activities
              
              
              (
                  22,901,558
              )
              
              (22,812,479
              )Cash
                  flows from financing activities:Net
                  increase in demand deposits and savings accounts
              
              
              26,160,354
              
              
              8,473,624Net
                  increase in time deposits
              
              
              1,336,288
              
              
              3,879,806Advances
                  from (repayments to) organizers
              
              
              -
              
              
              (
                  735,000
              )Net
                  change in borrowings
              
              
              -
              
              
              (
                  825,000
              )Proceeds
                  from sale of common stock
              
              
              18,750
              
              
              22,800,000Net
                  cash provided by financing activities
              
              
              27,515,392
              
              
              33,593,430Net
                  increase in cash and cash equivalents
              
              
              2,636,670
              
              
              8,222,211Cash
                  and cash equivalents at beginning of year
              
              
              8,279,481
              
              
              57,270Cash
                  and cash equivalents at end of year
              
              $
              10,916,151
              
              $
              8,279,481Supplemental
                  disclosure of cash flow information:Interest
                  paid
              
              $
              597,238
              
              $
              73,302Income
                  taxes paid
              
              $
              1,600
              
              $
              1,600




The
        accompanying notes are an integral part of these financial
        statements.
 F-4




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**CONSOLIDATED
      STATEMENT OF SHAREHOLDERS’ EQUITY**


**Years
      Ended December 31, 2006 and 2005**


AdditionalShares
              
              Common
              
              Paid-in
              
              AccumulatedOutstanding
              
              Stock
              
              Capital
              
              Deficit
              
              Total**Balance
                  at December 31, 2004**
              
              
              -
              
              $
              -
              
              $
              -
              
              $
              (1,595,881
              )
              $
              (1,595,881
              )Initial
                  Capitalization
              
              
              2,280,000
              
              
              22,800
              
              
              22,777,200
              
              
              -
              
              
              22,800,000Warrant
                  Grants
              
              
              -
              
              
              -
              
              
              494,520
              
              
              -
              
              
              494,520Net
                  Loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (
                  2,988,413
              )
              
              (
                  2,988,413
              )**Balance
                  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
              )
              $
              16,019,583




The
        accompanying notes are an integral part of these financial
        statements.
 F-5




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**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, **** 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
      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.





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
      and Due from Banks





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.





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





F-7





**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**NOTE
      A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued**





Investment
      Securities - Continued





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
      Receivable





Loans
      receivable that management has the intent and ability to hold for the
      foreseeable future or until maturity or payoff 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. The Company
      recognizes interest income on impaired loans based on its existing methods
      of
      recognizing interest income on nonaccrual loans.





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


F-8




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**NOTE
      A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued**





Provision
      and Allowance for Loan Losses - Continued





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 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.




Interest
      and Fees on Loans





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 2006 and 2005, 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.





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.





Other
      Real Estate Owned





Other
      real estate owned represents real estate acquired through foreclosure and is
      carried at the lower of the recorded investment in the property or its fair
      value. Prior to foreclosure, the value of the underlying loan is written down
      to
      the fair market value of the real estate to be acquired by a charge to the
      allowance for credit losses, if necessary. Any subsequent write-downs are
      charged against operating expenses. Operating expenses of such
      properties, net of related income, are included in other expenses. During 2006
      and 2005 the Company did not foreclose on any real estate.


F-9




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**NOTE
      A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued**





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.





Advertising
      Costs





The
      Company expenses the costs of advertising in the period incurred.





Comprehensive
      Income





Statement
      of Financial Accounting Standard (“SFAS”) No. 130, *"Reporting
      Comprehensive Income"* (SFAS
      No. 130) requires the disclosure of comprehensive income and its components.
      For
      the years ended December 31, 2006 and 2005, the Company had no components of
      comprehensive income other than net losses from operations.





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.





Share-Based
      Compensation





The
      Company has adopted SFAS No. 123(R) “ *Share-Based
      Payment.”* This
      Statement generally requires entities to recognize the cost of employee services
      received in exchange for awards of stock options, or other equity instruments,
      based on the grant-date fair value of those awards. This cost is recognized
      over
      the period which an employee is required to provide services in exchange for
      the
      award, generally the vesting period.


F-10




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**NOTE
      A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued**





Change
      in Accounting Principle





The
      Company adopted SFAS No. 123(R) on January 1, 2006 using the “modified
      prospective method.” Under this method compensation expense is recognized using
      the fair-value method for all new stock option awards as well as any existing
      awards that are modified, repurchased or cancelled after January 1, 2006 and
      prior periods are not restated. In addition, the unvested portion of previously
      awarded options outstanding as of January 1, 2006 will also be recognized as
      expense over the requisite service period based on the fair value of those
      options as previously calculated at the grant date under the pro-forma
      disclosures of SFAS No. 123. The fair value of each grant is estimated using
      the
      Black-Scholes option pricing model. During 2006 the Bank recognized pre-tax
      stock-based compensation expense of $1,497,901 as a result of adopting SFAS
      No.
      123(R).





Prior
      to
      the adoption of SFAS No. 123(R), the Company accounted for stock-based awards
      using the intrinsic value method prescribed in Accounting Principles Board
      (“APB”) Opinion No. 25, “ *Accounting
      for Stock Issued to Employees,”* and
      related interpretations. Accordingly, compensation cost for stock options was
      measured as the excess, if any, of the quoted market price of the Company’s
      stock at the date of the grant over the amount an employee must pay to acquire
      the stock. All of the Company’s stock option grants included exercise prices
      equal to the Company’s current market price per share; accordingly, no
      compensation expense was reported using the intrinsic value method of APB
      Opinion No. 25.





The
      Company accounts for stock options and warrants issued to non-employees in
      accordance with Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting
      for Equity Instruments That Are Issued to Other Than Employees for Acquiring
      or
      in Conjunction with Selling, Goods and Services.” Accordingly, the Company
      recorded compensation costs for stock-based compensation issued to non-employees
      in the amount of $494,520 in 2005.





The
      Company has not presented pro forma information related to employee option
      grants in 2005 because its stock incentive plan was approved by the shareholders
      in 2006.





In
      connection with the Company’s initial stock offering, the Company’s outside
      Directors were awarded a total of 64,000 warrants in recognition of the
      expertise imparted, time expended and the substantial financial risks undertaken
      by the Directors. Since these warrants were not subject to shareholder approval,
      pro forma disclosure is presented below.





The
      fair
      value of each warrant grant was estimated at the grant date using the
      Black-Scholes option-pricing model. The Black-Scholes option-pricing valuation
      model was developed for use in estimating the fair value of traded options
      and
      warrants that have no vesting restrictions and are fully transferable. In
      addition, option valuation models require the input of highly subjective
      assumptions, including the expected stock price volatility. Because the
      Company’s stock options and warrants have characteristics significantly
      different from those of traded
      options, and because changes in the subjective input assumptions can materially
      affect the fair value estimate, in management’s opinion, the existing models do
      not necessarily provide a reliable single measure of the fair value of its
      stock
      options and warrants.





The
      following table illustrates the effect on net loss and loss per share if the
      fair value based method had been applied to all outstanding and unvested
      director warrants:


F-11




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**NOTE
      A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued**





Change
      in Accounting Principle - Continued


2005Net
                  Income:As
                  Reported
              
              $
              (
                  2,988,413
              )Stock-Based
                  Compensation using Intrinsic Value Method
              
              
              -Stock-Based
                  Compensation that would have been reportedusing
                  the Fair Value Method of SFAS 123(R)
              
              
              (
                  210,994
              )Pro
                  Forma
              
              $
              (
                  3,199,407
              )Per
                  Share:Net
                  Income - BasicAs
                  Reported
              
              $
              (
                  1.31
              )Pro
                  Forma
              
              $
              (
                  1.40
              )





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.




Reclassifications




Certain
      reclassifications have been made in the 2005 consolidated financial statements
      to conform to the presentation used in 2006.  These classifications are of
      a normal recurring nature.





**NOTE
      B - INVESTMENT SECURITIES**





The
      amortized cost, carrying value and estimated fair values of investment
      securities as of December 31 are as follows:


F-12








**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 200** **6
      and 2005**





**NOTE
      B - INVESTMENT SECURITIES - Continued**


Amortized
              
              Unrealized
              
              Unrealized
              
              EstimatedCost
              
              Gains
              
              Losses
              
              Fair
                  Value**Securities
                  held to maturity:****December
                  31, 2006**U.S.
                  Government andAgency
                  Securities
              
              $
              7,943,375
              
              $
              13,483
              
              $
              (
                  12,558
              )
              $
              7,944,300**December
                  31, 2005**U.S.
                  Government andAgency
                  Securities
              
              $
              7,997,943
              
              $
              -
              
              $
              (
                  30,063
              )
              $
              7,967,880




The
      amortized cost and estimated fair value of debt securities at December 31 by
      contractual maturity, are shown below. Mortgage-backed securities are classified
      in accordance with their estimated lives. Expected maturities may differ from
      contractual maturities because borrowers may have the right to prepay
      obligations.


Book
                  Value
              
              Market
                  Value
              
              Weighted
                  Average Yield**Securities
                  held to maturity****December
                  31, 2006**U.S.
                  Government andAgency
                  SecuritiesWithin
                  One Year
              
              $
              3,998,738
              
              $
              3,986,180
              
              
              4.43
              %One
                  to Five Years
              
              
              3,944,637
              
              
              3,958,120
              
              
              4.50
              %**Total
                  Securities held to maturity**
              
              $
              7,943,375
              
              $
              7,944,300
              
              
              4.46
              %**December
                  31, 2005**U.S.
                  Government andAgency
                  SecuritiesWithin
                  One Year
              
              $
              5,997,943
              
              $
              5,968,140
              
              
              4.18
              %One
                  to Five Years
              
              
              2,000,000
              
              
              1,999,740
              
              
              4.32
              %**Total
                  Securities held to maturity**
              
              $
              7,997,943
              
              $
              7,967,880
              
              
              4.22
              %




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 are as follows:




F-13




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 200** **6
      and 2005**





**NOTE
      B - INVESTMENT SECURITIES - Continued**


Less
                  than Twelve Months
              
              Over
                  Twelve Months
              
              TotalUnrealized
              
              Estimated
              
              Unrealized
              
              Estimated
              
              Unrealized
              
              EstimatedLosses
              
              Fair
                  Value
              
              Losses
              
              Fair
                  Value
              
              Losses
              
              Fair
                  Value**Securities
                  in a loss position at:****December
                  31, 2006**U.S.
                  Government andAgency
                  Securities
              
              $
              -
              
              $
              -
              
              $
              (
                  12,558
              )
              $
              3,986,180
              
              $
              (
                  12,558
              )
              $
              3,986,180**December
                  31, 2005**U.S.
                  Government andAgency
                  Securities
              
              $
              (
                  30,063
              )
              $
              7,967,880
              
              $
              -
              
              $
              -
              
              $
              (
                  30,063
              )
              $
              7,967,880




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. As of December
      31, 2006, no declines are deemed to be other than temporary.





**NOTE
      C - LOANS**





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.





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


2006
              
              2005Real
                  estate
              
              $
              20,939,790
              
              $
              7,791,112Construction
              
              
              3,881,815
              
              
              -Commercial
              
              
              9,844,022
              
              
              2,483,127Consumer
              
              
              238,064
              
              
              72,25934,903,691
              
              
              10,346,498Deferred
                  loan fees
              
              
              (
                  108,286
              )
              
              (
                  29,168
              )Allowance
                  for loan losses
              
              
              (
                  431,640
              )
              
              (
                  87,208
              )$
              34,363,765
              
              $
              10,230,122




F-14




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 200** **6
      and 2005**





**NOTE
      C - LOANS - Continued**




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




2006
              
              2005Balance
                  at beginning of year
              
              $
              87,208
              
              $
              -Provision
                  charged to expense
              
              
              349,432
              
              
              87,208Loans
                  charged off
              
              
              (
                  5,000
              )
              
              -Recoveries
                  on loans previously charged off
              
              
              -
              
              
              -Balance
                  at end of year
              
              $
              431,640
              
              $
              87,208





During
      2006 and 2005 the Company had no significant nonaccrual or past due loans.




**NOTE
      D - COMPANY PREMISES AND EQUIPMENT**





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


2006
              
              2005Bank
                  premises
              
              $
              384,991
              
              $
              311,262Furniture,
                  fixtures and equipment
              
              
              1,268,264
              
              
              962,4721,653,255
              
              
              1,273,734Less
                  accumulated depreciation
              
              
              508,150
              
              
              119,668$
              1,145,105
              
              $
              1,154,066




F-15




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**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
                  Time Deposits****December
                  31, 2006**Three
                  months or less
              
              $
              801,211
              
              $
              619,788
              
              $
              1,420,999Over
                  three months through six months
              
              
              1,727,605
              
              
              566,445
              
              
              2,294,050Over
                  six months through 12 months
              
              
              608,422
              
              
              771,734
              
              
              1,380,156Over
                  12 months
              
              
              -
              
              
              120,889
              
              
              120,889Total
              
              $
              3,137,238
              
              $
              2,078,856
              
              $
              5,216,094




**Time
                  Deposits of $100,000 or more**
              
              **Other
                  Time Deposits**
              
              **Total
                  Time Deposits****December
                  31, 2005**Three
                  months or less
              
              $
              -
              
              $
              10,000
              
              $
              10,000Over
                  three months through six months
              
              
              601,509
              
              
              251,430
              
              
              852,939Over
                  six months through 12 months
              
              
              1,810,956
              
              
              1,205,911
              
              
              3,016,867Over
                  12 months
              
              
              -
              
              
              -
              
              
              -Total
              
              $
              2,412,465
              
              $
              1,467,341
              
              $
              3,879,806




**NOTE
      F - OTHER BORROWINGS**





The
      Company may borrow up to $4,000,000 overnight on an unsecured basis from its
      correspondent banks. As of December 31, 2006, no amounts were outstanding under
      these arrangements.




F-16




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**








**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 statements of financial condition at
      December 31:


2006
              
              2005Deferred
                  tax assets:Pre-Opening
                  Expenses
              
              $
              1,002,000
              
              $
              1,130,000Net
                  loss carryforward
              
              
              1,928,000
              
              
              822,000Allowance
                  for loan losses
              
              
              107,000
              
              
              -Other
              
              
              20,000
              
              
              7,000Total
                  deferred tax assets
              
              
              3,057,000
              
              
              1,959,000Deferred
                  liabilities:Tax
                  over book depreciation
              
              
              (
                  27,000
              )
              
              (
                  29,000
              )Allowance
                  for loan losses
              
              
              -
              
              
              (
                  8,000
              )Accrual
                  to cash
              
              
              (
                  20,000
              )
              
              (
                  36,000
              )Total
                  deferred tax liabilities
              
              
              (
                  47,000
              )
              
              (
                  73,000
              )Net
                  deferred tax assets
              
              
              3,010,000
              
              
              1,886,000Valuation
                  Allowance
              
              
              (
                  3,010,000
              )
              
              (
                  1,886,000
              )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 $2.7
      million for federal income and California franchise tax purposes. Federal net
      operating loss carry forwards, to the extent not used, will expire in 2026.
      California net operating loss carry forwards, to the extent not used, will
      expire in 2016.





**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 $1,497,901 in 2006. No tax benefit
      related to stock-based compensation will be recognized until the Company is profitable.


F-17




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**





**NOTE
      H - STOCK OPTIONS - Continued**





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


2006Expected
                  Volatility
              
              
              19.70
              %Expected
                  Term
              
              
              6
                  YearsExpected
                  Dividends
              
              
              NoneRisk
                  Free Rate
              
              
              5.00
              %Weighted-Average
                  Grant Date Fair Value
              
              $
              4.83





Since
      the
      Bank has a limited amount of historical stock activity the expected volatility
      is based on the historical volatility of similar banks that have 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.





A
      summary
      of the status of the Bank’s stock option plan as of December 31, 2006 and
      changes during the year ending thereon is presented below:


Weighted-Weighted-
              
              AverageAverage
              
              Remaining
              
              AggregateExercise
              
              Contractual
              
              IntrinsicShares
              
              Price
              
              Term
              
              ValueOutstanding
                  at Beginning of Year
              
              
              353,800
              
              $
              10.04
              
              
              8.4
                  yearsGranted
              
              
              36,498
              
              $
              13.24
              
              
              9.4
                  yearsExercised
              
              
              -
              
              $
              -
              
              
              -Forfeited
                  or Expired
              
              
              (
                  5,333
              )
              $
              10.38
              
              
              8.9
                  yearsOutstanding
                  at End of Year
              
              
              384,965
              
              $
              10.34
              
              
              8.4
                  years
              
              $
              640,000Options
                  Exercisable
              
              
              117,308
              
              $
              10.03
              
              
              7.8
                  Years
              
              $
              231,000




No
      options were exercised during the year ended December 31, 2006. As of December
      31, 2006, there was $975,000 of total unrecognized compensation cost related
      to
      the outstanding stock options that will be recognized over a weighted average
      period of 1.2 years.


F-18




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**





**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:


**2006**
              
              **2005**Beginning
                  Balance
              
              $
              -
              
              $
              -Additions
              
              
              1,948,392
              
              
              -Payments
              
              
              -
              
              
              -Ending
                  Balance
              
              $
              1,948,392
              
              $
              -Weighted
                  Average Interest Rate
              
              
              8
              %
              
              -





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 officer deposits at December 31, 2006 and 2005, was approximately $664,000
      and $367,000 respectively.




**NOTE
      J - COMMITMENTS AND CONTINGENCIES**




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, 2006 amounts to
      approximately $9,622,000, of which approximately $10,000 is related to
      irrevocable letters of credit. At December 31, 2005, commitments to extend
      credit were approximately $6,792,000 of which approximately $1,816,000 was
      related to irrevocable letter 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. For December 31, 2006,
      the balance represented one standby letter of credit which expired on January
      7,
      2007 without being exercised. No balances were pledged by the Company to support
      this commitment. For December 31, 2005, the entire balance of standby letters
      of
      credit referred to above supported international letters of credit issued by
      other financial institutions for which the Company had guaranteed and pledged
      $2
      million of its time deposits in other financial institutions that are presented
      on the Consolidated Balance Sheet as of December 31, 2005.




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.


F-19




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**





**NOTE
      J - COMMITMENTS AND CONTINGENCIES - Continued**





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 $363,000 and $244,000 for the periods
      ending December 31, 2006 and 2005.





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


2007
              
              $
              398,3002008
              
              
              409,0002009
              
              
              366,2002010
              
              
              265,1002011
              
              
              271,300Thereafter
              
              
              974,000$
              2,683,900




**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,
      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. As of 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 Comptroller,
      management may be directed to require the holders to exercise or forfeit their
      warrants.





**NOTE
      L - FAIR VALUES OF FINANCIAL INSTRUMENTS**





The
      fair
      value of a financial instrument is the amount at which the asset or obligation
      could be exchanged in a current transaction between willing parties, other
      than
      in a forced or liquidation sale. Fair value estimates are


F-20
 
  **PACIFIC
        COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**





**NOTE
      L - FAIR VALUES OF FINANCIAL INSTRUMENTS - Continued**





made
      at a
      specific point in time based on relevant market information and information
      about the financial instrument. These estimates do not reflect any premium
      or
      discount that could result from offering for sale at one time the entire
      holdings of a particular financial instrument. Because no market value exists
      for a significant portion of the financial instruments, fair value estimates
      are
      based on judgments regarding future expected loss experience, current economic
      conditions, risk characteristics of various financial instruments, and other
      factors. These estimates are subjective in nature, involve uncertainties and
      matters of judgment, and therefore cannot be


determined
      with precision. Changes in assumptions could significantly affect the
      estimates.





Fair
      value estimates are based on financial instruments both on and off the balance
      sheet without attempting to estimate the value of anticipated future business
      and the value of assets and liabilities that are not considered financial
      instruments. Additionally, tax consequences related to the realization of the
      unrealized gains and losses can have a potential effect on fair value estimates
      and have not been considered in many of the estimates.





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, and due from balances are
      considered to approximate fair value. Short term investments include federal
      funds sold, securities purchased under 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 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:




F-21




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**





**NOTE
      L - FAIR VALUES OF FINANCIAL INSTRUMENTS - Continued**


December
                  31, 2006
              
              December
                  31, 2005Carrying
              
              Market
              
              Carrying
              
              MarketValue
              
              Value
              
              Value
              
              ValueFinancial
                  Assets:Cash
                  and cash equivalents
              
              $
              10,916,151
              
              $
              10,916,151
              
              $
              8,279,481
              
              $
              8,279,481Time
                  deposits in other financial institutions
              
              
              1,000,000
              
              
              1,000,000
              
              
              2,750,000
              
              
              2,750,000Investment
                  securities
              
              
              7,943,375
              
              
              7,944,300
              
              
              7,997,943
              
              
              7,967,880Loans
                  receivable, net
              
              
              34,363,765
              
              
              34,343,544
              
              
              10,230,122
              
              
              10,248,084Federal
                  Reserve Bank stock
              
              
              493,800
              
              
              493,800
              
              
              553,700
              
              
              553,700Accrued
                  interest receivable
              
              
              222,136
              
              
              222,136
              
              
              244,853
              
              
              244,853Financial
                  Liabilities:Time
                  deposits
              
              $
              5,216,094
              
              $
              5,229,724
              
              $
              3,879,806
              
              $
              3,877,386Other
                  deposits
              
              
              34,633,978
              
              
              34,633,978
              
              
              8,473,624
              
              
              8,473,624Other
                  borrowings
              
              
              -
              
              
              -
              
              
              -
              
              
              -Accrued
                  interest and other liabilities
              
              
              324,592
              
              
              324,592
              
              
              146,509
              
              
              146,509




**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 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, 2006, that the Bank meets all capital adequacy requirements
      to which it is subject.


F-22




**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2006 and 2005**





**NOTE
      M - REGULATORY MATTERS - Continued**


To
                  Be WellCapitalized
                  UnderFor
                  Capital
              
              Prompt
                  CorrectiveActual
              
              Adequacy
                  Purposes
              
              Action
                  ProvisionsAmount
              
              
              
              Amount
              
              
              
              Amount(Thousands)
              
              Ratio
              
              (Thousands)
              
              Ratio
              
              (Thousands)
              
              Ratio**As
                  of December 31, 2006:**Total
                  Capital (to Risk-Weighted Assets)
              
              $
              15,529
              
              
              50.2
              %
              $
              2,470
              
              
              8.0
              %
              $
              3,088
              
              
              10.0
              %Tier
                  1 Capital (to Risk-Weighted Assets)
              
              $
              15,133
              
              
              49.0
              %
              $
              1,235
              
              
              4.0
              %
              $
              1,853
              
              
              6.0
              %Tier
                  1 Capital (to Average Assets)
              
              $
              15,133
              
              
              27.5
              %
              $
              2,204
              
              
              4.0
              %
              $
              2,755
              
              
              5.0
              %**As
                  of December 31, 2005:**Total
                  Capital (to Risk-Weighted Assets)
              
              $
              17,841
              
              
              101.7
              %
              $
              1,403
              
              
              8.0
              %
              $
              1,754
              
              
              10.0
              %Tier
                  1 Capital (to Risk-Weighted Assets)
              
              $
              17,738
              
              
              101.2
              %
              $
              701
              
              
              4.0
              %
              $
              1,052
              
              
              6.0
              %Tier
                  1 Capital (to Average Assets)
              
              $
              17,738
              
              
              64.1
              %
              $
              1,108
              
              
              4.0
              %
              $
              1,385
              
              
              5.0
              %





As
      of
      December 31, 2006, 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.





**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.


F-23






















**PACIFIC
      COAST NATIONAL BANCORP AND SUBSIDIARY**





**FINANCIAL
      STATEMENTS**


**WITH**


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**


**December
      31, 2006 and 2005**