UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10–K




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





For
the fiscal year ended December 31, 2008




OR




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




For
the transition period from _______ to _______




Commission
File Number 000-51960




PACIFIC COAST NATIONAL
BANCORP


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





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. [  ] Yes [X] No





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. [  ] Yes [X] No





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
past 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days.


Yes [] No
[X ]
















Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes  ̈ 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 this Form 10-K or any amendment to this
Form 10-K. [ ]




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





Large
Accelerated Filer [
]                                                                                              Accelerated
Filer [ ]


Non-Accelerated
Filer [ ] (Do not check if a smaller reporting company)  Smaller reporting
company [X]








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


Yes [ ]
No [X]




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 June 30,
2008: $11,538,048. 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 31, 2009, was 2,554,850.




DOCUMENTS
INCORPORATED BY REFERENCE: None.












PACIFIC
COAST NATIONAL BANCORP




ANNUAL
REPORT ON FORM 10-K




INDEX


PAGE


PART
      IITEM
      1. BUSINESS
                  4ITEM
      1A. RISK FACTORS
                  35ITEM
      IB. UNRESOLVED STAFF COMMENTS
                  51ITEM
      2. PROPERTIES
                  51ITEM
      3. LEGAL PROCEEDINGS
                  51ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
                  51PART
      IIITEM
      5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
      ISSUER PURCHASES OF EQUITY SECURITIES
                  51ITEM
      6 SELECTED FINANCIAL DATA
                  54ITEM
      7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF OPERATIONS
                  54ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
    RISK
                  74ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
                  76ITEM
      9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
      FINANCIAL DISCLOSURE.
                  107ITEM
      9A(T). CONTROLS AND PROCEDURES
                  107ITEM
      9B. OTHER INFORMATION
                  109PART
      IIIITEM
      10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
                  109ITEM
      11. EXECUTIVE COMPENSATION
                  113ITEM
      12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
      RELATED STOCKHOLDER MATTERS
                  124ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
                  125ITEM
      14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
                  126PART
      IVITEM
      15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
                  127













PART
I




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




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




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




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




·
            the
      loss of key personnel;




·
            the
      failure of assumptions;




·
            changes
      in various monetary and fiscal policies and
  regulations;




·
            changes
      in policies by regulatory agencies;




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




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




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




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






2








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




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




·
            changes
      in the quality or composition of our loan
  portfolio;




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




·
            our
      ability to manage loan delinquency rates, which may be impacted by
      deterioration in the housing and commercial real estate markets that may
      lead to increased losses and non-performing assets in our loan portfolios,
      and may result in our allowance for loan losses not being adequate to
      cover actual losses and may require us to materially increase our
      reserves;




·
            results
      of examinations by the Office of the Comptroller of the Currency and other
      regulatory authorities, including the possibility that any such regulatory
      authority may, among other things, require us to increase our reserve for
      loan losses, write-down assets, change our regulatory capital position or
      affect our ability to borrow funds or maintain or increase deposits, which
      could adversely affect our liquidity and results of
      operations;




·
            the
      possibility that a definitive agreement for a substantial equity
      investment in the Company or a sale of the Company will not be
      reached;




·
            our
      ability to comply with the additional regulatory restrictions that have
      recently been imposed on us as well as the agreement or agreements we
      anticipate we will be required to enter into with our
      regulators;




·
            competition
      from bank and non-bank competitors;




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




·
            the
      ability to grow our core
businesses;




·
            decisions
      to change or adopt new business
strategies;




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




·
            technological
      changes;




·
            changes
      in consumer spending and savings habits;
and




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




In
addition to the factors described above, the reader’s attention is directed to
“Item 1A Risk Factors“ set forth elsewhere in this Form 10-K and from time to
time in other filings with the Securities and Exchange Commission for a more
detailed and additional discussion of certain factors that could cause our
results or financial performance to differ materially from our goals, plans,
objectives,






3






intentions,
expectations and other forward-looking statements. New factors emerge from time
to time, and it is not possible for us to predict which factor, if any, will
materialize. In addition, we cannot assess the potential impact of each factor
on our business or the extent to which any factor, or combination of factors,
may cause actual results for 2009 and beyond to differ materially from those
contained in any forward-looking statements.




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




Item
1.  Business




Overview




Pacific Coast National
Bancorp – The Company, headquartered in San Clemente, California, was
organized as a California corporation on July 2, 2003 to serve as the bank
holding company for Pacific Coast National Bank. The Company became a bank
holding company on May 16, 2005, following its initial public offering, upon the
acquisition of all of the issued and outstanding shares of stock of the 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. As a
bank holding company, the Company is subject to regulation by the Board of
Governors of the Federal Reserve System (the “Federal Reserve Board“). At this
time, the Company engages in no material business operations other than owning
the Bank.




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




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




We
maintain a website with the address www.pacificcoastnationalbank.com.
The information contained on our website is not included as a part of, or
incorporated by reference into, this Annual Report on Form 10-K. Other than an
investor’s own Internet access charges, we make available free of charge through
our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q and
current






4






reports
on Form 8-K, and amendments to these reports, as soon as reasonably practicable
after we have electronically filed such material with, or furnished such
material to, the Securities and Exchange Commission.




Regulatory
Restrictions





Subsequent to December 31, 2008, we
were notified by the OCC that it has imposed a number of requirements and
restrictions on the Bank’s operations, primarily due to our reduced capital
levels, deteriorating asset quality and net losses. These requirements and
restrictions: (i) require us to notify the OCC in advance prior to adding or
replacing a director or senior executive officer; (ii) generally prohibit us
from making severance or indemnification payments without complying with certain
restrictions, including obtaining prior regulatory approval for such payments;
(iii) prohibit us from increasing our loans above the amount we had on our
balance sheet as of December 31, 2008 until we have adopted and implemented
satisfactory credit and concentration risk management processes; (iv) prohibit
us from accepting, renewing or rolling over brokered deposits and restrict the
effective yield we can offer on deposits; (v) require us to submit a capital
restoration plan to the OCC; (vi) prohibit us from allowing our average total
assets during any calendar quarter to exceed our average total assets during the
preceding calendar quarter unless (A) the OCC has accepted our capital
restoration plan, (B) any increase in our assets is consistent with the plan,
and (C) the Bank’s ratio of tangible equity to assets increases during the
calendar quarter at a rate sufficient to enable the Bank to become adequately
capitalized within a reasonable time; (vii) prohibit the Bank from acquiring or
establishing a financial subsidiary and preclude us from expedited treatment on
certain regulatory applications and require us to file regulatory applications
in advance for certain activities instead of after-the-fact notices; and (viii)
will increase our semi-annual assessment payable to the OCC. The Bank may also
be subject to higher deposit insurance premiums. The OCC also has proposed that
the Bank achieve and maintain regulatory capital ratios in excess of the
regulatory minimums. Specifically, we must develop a plan, subject to the OCC’s
review and nonobjection, to achieve ratios of Tier 1 capital to adjusted total
assets of 9.0% and total risk-based capital to risk-weighted assets of 11.0% by
June 30, 2009, and ratios of Tier 1 capital to adjusted total assets of 9.0% and
total risk-based capital to risk-weighted assets of 12.0% by September 30, 2009.
The Company was also notified by the Federal Reserve Bank of San Francisco that
the Company may not declare or pay any dividends or make any extraordinary
payments to any entity or related party without prior approval of the Federal
Reserve Bank of San Francisco. In addition to the regulatory actions already
taken, it is anticipated that the Bank and/or the Company will be required to
enter into some form of written agreement with their primary regulators which
could impose further requirements and restrictions on their
operations.





The Bank’s ratio of total capital to
risk-weighted assets was 5.03% at December 31, 2008 and 6.84% as of March 31, 2009,
which caused the Bank to be deemed “significantly undercapitalized“ as of
December 31, 2008, and “undercapitalized“ as of March 31, 2009, under regulatory
capital guidelines. The Bank’s ratios of Tier 1 capital to risk-weighted assets
and Tier 1 capital to average assets were 3.74% and 3.59%, respectively, as of
December 31, 2008 and 5.55% and 5.23%, respectively as of March 31, 2009. In
order to be “adequately capitalized“ under regulatory capital guidelines, an
institution’s ratios of total capital to risk-weighted assets, Tier 1 capital to
risk-weighted assets and Tier 1 capital to average assets must be at least 8.0%,
4.0% and 4.0%, respectively. See “Supervision and Regulation—Regulation and
Supervision of Pacific Coast National Bank-Capital Requirements.“ The
improvement in the Bank’s regulatory capital ratios was attributable to the
downstreaming by the Company to the Bank of the proceeds the Company received in
January 2009 of a $4.1 million investment from the United States Department of
the Treasury pursuant to the Treasury’s TARP Capital Purchase
Program.







5







Business Strategy





In
response to the challenging economic environment and increased regulatory
supervision, we plan to take a number of tactical actions aimed at preserving
existing capital, reducing our lending exposures and associated capital
requirements and increasing liquidity. The tactical actions include, but are
not limited to the following: slowing loan originations, growing retail
deposits, reducing brokered deposits, seeking commercial loan participation and
sales arrangements with other lenders or private equity sources and reducing
operating costs. Our goal is to achieve profitability by controlling our growth,
stabilizing our losses, managing our problematic assets and reducing overall
expenses. We are working on the following four primary objectives as a
basis for the long-term success of our franchise:





·
            Improve
      Asset Quality.We have taken proactive steps to resolve our
      non-performing loans, including negotiating repayment plans, forbearances,
      loan modifications and loan extensions with our borrowers when
      appropriate. We also have established a separate department to monitor and
      attempt to reduce our exposure to a further deterioration in asset
      quality. We plan to apply more conservative underwriting practices to our
      new loans, including, among other things, requiring more detailed credit
      information in certain circumstances, increasing the amount of required
      collateral or equity requirements and reducing loan-to-value
      ratios.




·
            Control
      Asset Growth and Improve Regulatory Capital Ratios.We plan to
      control our asset growth which should help reduce our risk profile and
      improve capital ratios through reductions in the amount of outstanding
      loans through a slowing of loan originations and through normal principal
      amortization, and a corresponding reduction of liabilities. We may also
      seek commercial loan participation and sales arrangements with other
      lenders or private equity sources. As noted under “Regulatory
      Restrictions,“ we are currently prohibited from increasing our loans above
      the level as of December 31, 2008 until we have adopted and implemented
      satisfactory credit and concentration risk management
      processes




·
            Continued
      Expense Control.We will make it a priority to identify cost
      savings opportunities throughout all phases of
  operations.




·
            Increase
      Core Deposits and Other Retail Deposit Products.We will seek to
      increase core deposits and other retail deposit products. As noted under
      “Regulatory Restrictions,“ we are currently prohibited from accepting,
      renewing or rolling over brokered
deposits.




We are
also evaluating various
strategic options, including capital raising alternatives, the sale of our
Encinitas branch office and a sale or merger of our company. In this regard, we
have been in extensive discussions with several parties regarding the
possibility of a substantial equity investment in the Company, which could also
entail a rights offering to existing shareholders, or a possible sale of the
Company. While we plan to focus on the tactical actions described above and
pursue strategic alternatives, as
has been widely publicized, access to capital markets is extremely limited in
the current economic environment, and we can give no assurances thatour
efforts will be successful and will result in sufficient capital preservation or
infusion.Our ability to decrease
our levels of non-performing assets is also vulnerable to market conditions as
our construction loan borrowers rely on an active real estate market as a source
of repayment, and the sale of loans in this market is difficult. If the real
estate market does not improve, our level of non-performing assets may continue
to increase.






6







While we
believe that we are taking
appropriate steps to respond to these economic risks and regulatory actions,
further deterioration in the economic environment or additional regulatory
actions could adversely affect our operations.







Operating
Philosophy




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




Consistent
with this philosophy, we seek to:




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




·
            Hire
      and retain experienced and qualified banking
  personnel;




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




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




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




·
            Implement
      a strong marketing program.




Market
opportunities




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




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




Local economy - We
believe that our banking market represents a unique market with a diversified
and growing customer base. As a community bank, the Bank seeks to serve the
needs of the residents and small-to-medium-sized businesses within this market.
The local economy is comprised of a diverse mix of high-technology commercial
endeavors as well as defense and military expenditures. Most of the job growth,
particularly in San Diego County, has been in the high-technology area with
emerging growth in the areas of telecommunications, electronics, computers,
software and biotechnology. Median household income and per capita income for
San Diego and Orange County are above national averages, reflecting the urban
nature of the market and availability of high paying white collar and technical
jobs. Local unemployment levels, however, have recently been above the national
average. For February 2009,






7






San Diego
and Orange Counties reported preliminary unemployment rates of 8.8% and 7.8%,
respectively, as compared to the national average of 8.1% for the same period.
By comparison, for January 2008 San Diego and Orange Counties reported
preliminary unemployment rates of 5.1% and 4.4%, respectively, as compared to
the national average of 4.9% for the same period. For a discussion regarding the
competition in our primary service areas, see “Competition.“




Lending
services




We offer
a full range of lending products, including commercial loans to
small-to-medium-sized businesses, professionals, and consumer loans to
individuals, though, as discussed under “Regulatory Restrictions,“ we are
currently prohibited from increasing our loans above the level on our balance
sheet as of December 31, 2008 until we have adopted and implemented satisfactory
credit and concentration risk management processes. Management understands that
we are competing for these loans with competitors who are well established in
our primary market area and have greater resources and legal lending limits and
are not subject to the types of regulatory restrictions under which we are
currently operating.




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




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




Lending limits - Our
lending activities are subject to a variety of lending limits. Differing limits
apply based on the type of loan or the nature of the borrower, including the
borrower’s relationship to the Bank. In general, however, we are able to loan to
any one borrower a maximum amount equal to 15% of the Bank’s capital and surplus
and allowance for loan losses. The legal limit will increase or decrease as the
Bank’s capital increases or decreases as a result of its earnings or losses,
among other reasons. As discussed under “Regulatory Restrictions,“ however, we
are currently prohibited from increasing our loans above the level on our
balance sheet as of December 31, 2008 until we have adopted and implemented
satisfactory credit and concentration risk management processes.




Credit risks - The
principal economic risk associated with each category of loans that the Bank
makes is the creditworthiness of the borrower. Borrower creditworthiness is
affected by general economic conditions and the strength of the relevant
business market segment. Our loan officers review the borrower’s past credit
history, past income level, debt history and, when applicable, cash flow and
determine the impact of all these factors on the ability of the borrower to make
future payments as agreed. General economic factors affecting a borrower’s
ability to repay include interest, inflation and employment rates, as well as
other factors affecting a borrower’s customers, suppliers and employees. The
well-established financial institutions in our primary service areas make
proportionately more loans to medium-to-large-sized businesses than we
originate. Many of our commercial loans are and/or will






8






likely be
made to small-to-medium-sized businesses that may be less able to withstand
competitive, economic and financial pressures than larger
borrowers.




Real estate loans -
The real estate portion of our loan portfolio is comprised of the following:
mortgage loans secured typically by commercial and multi-family residential
properties, revolving lines of credit granted to consumers secured by equity in
residential properties; and construction and development loans. At December 31,
2008, we held $97.7 million in loans secured by real estate, representing 72.6%
of gross loans receivable, and undisbursed commitments of $8.7 million. At
December 31, 2007, we held $75.5 million is loans secured by real estate,
representing 77.3% of gross loans receivable, and undisbursed commitments of
$15.0 million. The classes of real estate loans are described
below.




·
            Construction and
      development loans - Construction loans consist primarily of
      high-end, single-family residential properties, primarily located in the
      coastal communities, and commercial properties for owner-occupied, have a
      term of less than one year, have floating interest rates and commitment
      fees. Construction loans are typically made to builders that have an
      established record of successful project completion and loan repayment.
      Loan repayment for owner occupied transactions is generally from permanent
      financing with either the Bank or qualified mortgage lender. Repayment of
      developer loans is principally derived from the sale of the individual
      units with the purchaser obtaining permanent financing from a qualified
      mortgage lender. Repayment of developer loans is subject to current market
      conditions, mortgage rates and the economic environment. The ratio of the
      loan principal to the value of the collateral as established by
      independent appraisal typically will not exceed 75%. Loans for projects
      that are not pre-sold are based on the borrower’s financial strength and
      cash flow position. At December 31, 2008, $27.4 million of our
      construction portfolio represented projects that were not pre-sold,
      compared to $28.7 million at December 31, 2007. Loan proceeds are
      disbursed based on the percentage of completion and only after an
      experienced construction lender or third-party inspector has inspected the
      project. At December 31, 2008, we had $34.5 million in construction loans
      outstanding, representing 25.6% of gross loans receivable, and $3.8
      million in undisbursed construction loan commitments, of which $27.4
      million and $2.5 million represented loans and undisbursed construction
      loan commitments to developers. At December 31, 2007, we had $31.2 million
      in construction loans outstanding, representing 31.9% of gross loans
      receivable, and $11.9 million in undisbursed construction loan
      commitments, of which $28.7 million and $9.2 million represented loans and
      undisbursed construction loan commitments to
  developers.




·
            Commercial and
      multi-family real estate - Commercial and multi-family real estate
      loan terms generally are limited to fifteen years or less, although
      payments may be structured on a longer amortization basis. Interest rates
      may be fixed for three to five years, or adjustable. The Bank generally
      charges an origination fee for its services. We generally require personal
      guarantees from the principal owners of the property supported by a review
      by the Bank’s management of the principal owners’ personal financial
      statements. We attempt to limit our risk by analyzing the borrowers’ cash
      flow and collateral value on an ongoing basis and by an annual review of
      rent rolls and financial statements. At December 31, 2008, we held $57.6
      million in commercial and multi-family real estate loans outstanding,
      representing 42.9% of gross loans receivable, with $154 thousand in
      undisbursed commercial and multi-family real estate loan funds. At
      December 31, 2007, we held $41.7 million in commercial and multi-family
      real estate loans outstanding, representing 42.7% of gross loans
      receivable, and no undisbursed commercial and multi-family real estate
      loan funds.






9








·
            Residential real
      estate - Our residential real estate loans consist of residential
      second mortgage loans. All loans are made in accordance with our appraisal
      policy with the ratio of the loan principal to the value of collateral as
      established by independent appraisal typically not exceeding 80% when
      combined with any first mortgage, unless private mortgage insurance is
      obtained for the excess amount. The amortization of second mortgages
      generally does not exceed 15 years and the rates are generally fixed for
      12 months or longer. At December 31, 2008, we held $5.6 million in
      residential real estate loans outstanding, representing 4.2% of gross
      loans receivable, and undisbursed commitments of $4.8 million. At December
      31, 2007, we held $2.7 million in residential real estate loans
      outstanding, representing 2.7% of gross loans receivable, and undisbursed
      commitments of $3.2 million.




·
            Commercial
      loans - Our target commercial loan market is retail establishments
      and small-to- medium-sized businesses. Our commercial loan portfolio is
      comprised of lines of credit for working capital and term loans to finance
      equipment and other business assets. The lines of credit typically are
      limited to a percentage of the value of the assets securing the line.
      Lines of credit and term loans typically are reviewed annually and can be
      supported by accounts receivable, inventory, equipment and other assets of
      the client‘s businesses. The terms of these loans vary by purpose and by
      type of underlying collateral, if any. The commercial loans are primarily
      underwritten on the basis of the borrower’s ability to service the loan
      from operating income. We typically make equipment loans for a term of
      five years or less at fixed or variable rates, with the loan fully
      amortized over the term. Loans to support working capital typically have
      terms not exceeding one year and are usually secured by accounts
      receivable, inventory or personal guarantees of the principals of the
      business. For loans secured by accounts receivable or inventory, principal
      is typically repaid as the assets securing the loan are converted into
      cash, and for loans secured with other types of collateral, principal is
      typically due at maturity. The quality of the commercial borrower’s
      management and its ability both to properly evaluate changes in the supply
      and demand characteristics affecting its markets for products and services
      and to effectively respond to such changes are significant factors in a
      commercial borrower’s creditworthiness. At December 31, 2008 we held $36.6
      million in commercial loans outstanding, representing 27.2% of gross loans
      receivable, and undisbursed commitments of $22.4 million. At December 31,
      2007 we held $21.8 million in commercial loans outstanding, representing
      22.4% of gross loans receivable, and undisbursed commitments of $14.3
      million.




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




SBA 504 Loan
Program




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






10






after the
loan proceeds have been fully disbursed by the Bank to the borrower. The CDC is
a non-profit corporation established to contribute to the economic development
of its community by working together with the SBA and private sector lenders
such as the Bank, to provide financing to small businesses. The Company
generally offers SBA 504 loans within a range of $300,000 to $3.0
million.




Under the
SBA 504 program, at December 31, 2008, we held $8.9 million in commercial real
estate first trust deed and $166 thousand in commercial real estate second trust
deed loans outstanding, representing 6.6% and 0.1% of gross loans receivable,
respectively. Under the SBA 504 program, at December 31, 2007, we held $4.5
million in commercial real estate first trust deed and $1.0 million in
commercial real estate second trust deed loans outstanding, representing 4.6%
and 1.1% of gross loans receivable, respectively. There was $134 thousand in
undisbursed commitments for SBA 504 loans at December 31, 2008 and no
undisbursed commitments for SBA 504 loans at December 31, 2007.




SBA 7(a) Loan
Program




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




The Bank
bases its SBA 7(a) loan sales on the level of its SBA 7(a) loan originations,
the premiums available in the secondary market for the sale of such loans, and
general liquidity considerations of the Bank. During 2008, the Bank originated
$15.0 million in SBA 7(a) loans, of which $11.3 million represented the
guaranteed portion. During 2008 the Bank elected to sell $12.3 million of the
guaranteed portion of its SBA 7(a) loans, for which it recognized a gain of $685
thousand. During 2007, the Bank originated $11.3 million in SBA 7(a) loans, of
which $7.7 million represented the guaranteed portion. During 2007, the Bank
elected to sell $7.0 million of the guaranteed portion of its SBA 7(a) loans,
for which it recognized a gain of $392 thousand.




At
December 31, 2008, we held $7.4 million in SBA 7A loans representing 5.5% of
gross loans receivable, including $1.3 million representing the guaranteed
portion retained by the Bank. Of the $7.4 million, $6.6 million was part of the
commercial loan portfolio and $750 thousand was included in the commercial real
estate portfolio. At December 31, 2007, we held $4.9 million in SBA 7A loans
representing 5.0% of gross loans receivable, including $1.8 million representing
the guaranteed portion retained by the Bank. Of the $4.9 million, $4.5 million
was part of the commercial loan portfolio, $280 thousand was included in the
commercial real estate portfolio, and $95 thousand was included in the consumer
loan portfolio.






11







SBA Express
Program




The SBA
Express program is a very streamlined program designed to provide access to
financing for small business, with reduced documentation requirements and quick
approval process. Loans made by the Bank under the SBA Express program generally
are made to provide working capital, carry accounts receivable or purchase
inventory. These loans generally are secured by a combination of assets and
require a personal guarantee of 20% or more of each owner of the business. The
terms of these loans vary by purpose and by type of underlying collateral and
carry a Small Business Administration guaranty up to 50% of the loan. Typical
maturities for this type of loan vary up to ten years. SBA Express loans are all
adjustable rate loans based upon the Wall Street Journal prime lending rate. The
Company generally offers SBA Express loans within a range of $50,000 to
$350,000.




At
December 31, 2008, we held $1.0 million in SBA Express loans representing 0.7%
of gross loans receivable, including $519 thousand representing the guaranteed
portion retained by the Bank, and $463 thousand in undisbursed funds. These
loans were included in the commercial loan portfolio. At December 31, 2007, we
held $471 thousand in SBA Express loans representing 0.5% of gross loans
receivable, including $236 thousand representing the guaranteed portion retained
by the Bank, and $529 thousand in undisbursed funds. These loans are included in
the commercial loan portfolio.




Consumer and other
lending - Our consumer loan portfolio consists primarily of personal
lines of credit and loans to acquire personal assets such as automobiles and
boats originated on a case-by-case basis as an accommodation for the Bank’s
clients.. The lines of credit generally have terms of one year and the term
loans generally have terms of three to five years. The lines of credit typically
have floating rates. Because many consumer loans are secured by depreciable
assets such as boats, cars and trailers, the loan is amortized over the useful
life of the asset. At December 31, 2008, we held $231 thousand in consumer loans
outstanding, representing 0.2% of gross loans receivable, and undisbursed
commitments of $126 thousand. At December 31, 2007, we held $328 thousand in
consumer loans outstanding, representing 0.3% of gross loans receivable, and
undisbursed commitments of $96 thousand.




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








12








2008
                        
                        
                        
                        
                        
                        2007Real estate1-4
      residential
                        
                        $
                        5,629,466
                        
                        
                        
                        4.2
                        %
                        
                        $
                        2,654,635
                        
                        
                        
                        2.7
                        %Multi-Family
                        
                        
                        2,110,061
                        
                        
                        
                        1.6
                        %
                        
                        
                        719,959
                        
                        
                        
                        0.7
                        %Non-farm,
      non-residential
                        
                        
                        55,507,910
                        
                        
                        
                        41.3
                        %
                        
                        
                        40,950,795
                        
                        
                        
                        41.9
                        %Construction & Land
      Development
                        
                        
                        34,466,448
                        
                        
                        
                        25.6
                        %
                        
                        
                        31,163,576
                        
                        
                        
                        31.9
                        %Commercial
                        
                        
                        36,565,534
                        
                        
                        
                        27.2
                        %
                        
                        
                        21,827,512
                        
                        
                        
                        22.4
                        %Consumer
                        
                        
                        231,289
                        
                        
                        
                        0.2
                        %
                        
                        
                        327,735
                        
                        
                        
                        0.3
                        %134,510,708
                        
                        
                        
                        100
                        %
                        
                        
                        97,644,212
                        
                        
                        
                        100
                        %Net deferred loan costs, premiums
      and discounts
                        
                        
                        369,581
                        
                        
                        
                        
                        
                        
                        
                        229,919Allowance for loan
      losses
                        
                        
                        ( 6,550,000
                        )
                        
                        
                        
                        
                        
                        
                        ( 1,814,860
                        )$
                        128,330,289
                        
                        
                        
                        
                        
                        
                        $
                        96,059,271






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.


2008
                  
                  
                  
                  
                  
                  2007# of Loans
                  
                  
                  Average Loan
      Size
                  
                  
                  # of Loans
                  
                  
                  Average Loan
      SizeReal estate1-4
      residential
                  
                  
                  23
                  
                  
                  $
                  244,759
                  
                  
                  
                  13
                  
                  
                  $
                  204,203Multi-Family
                  
                  
                  4
                  
                  
                  
                  527,515
                  
                  
                  
                  2
                  
                  
                  
                  359,980Non-farm,
      non-residential
                  
                  
                  76
                  
                  
                  
                  730,367
                  
                  
                  
                  59
                  
                  
                  
                  694,081Construction & Land
      Development
                  
                  
                  33
                  
                  
                  
                  1,044,438
                  
                  
                  
                  30
                  
                  
                  
                  1,038,786Commercial
                  
                  
                  166
                  
                  
                  
                  220,274
                  
                  
                  
                  103
                  
                  
                  
                  211,918Consumer
                  
                  
                  18
                  
                  
                  
                  12,849
                  
                  
                  
                  31
                  
                  
                  
                  10,572320
                  
                  
                  $
                  420,346
                  
                  
                  
                  238
                  
                  
                  $
                  410,270






Loan originations -
The following table sets forth our loan originations for 2008 and 2007 including
loan participations that were purchased from and sold to other banks without
recourse.








13







2008
                                
                                
                                
                                
                                
                                2007(Dollars in
      thousands)Real estate1-4
      residential
                                
                                $
                                4,697
                                
                                
                                
                                6.2
                                %
                                
                                $
                                2,889
                                
                                
                                
                                2.5
                                %Multi-Family
                                
                                
                                1,415
                                
                                
                                
                                1.9
                                %
                                
                                
                                440
                                
                                
                                
                                0.4
                                %Non-farm,
      non-residential
                                
                                
                                21,496
                                
                                
                                
                                28.5
                                %
                                
                                
                                33,177
                                
                                
                                
                                28.4
                                %Construction
                                
                                
                                7,709
                                
                                
                                
                                10.2
                                %
                                
                                
                                43,434
                                
                                
                                
                                37.2
                                %Commercial
                                
                                
                                40,069
                                
                                
                                
                                53.1
                                %
                                
                                
                                36,601
                                
                                
                                
                                31.4
                                %Consumer
                                
                                
                                120
                                
                                
                                
                                0.2
                                %
                                
                                
                                121
                                
                                
                                
                                0.1
                                %$
                                75,507
                                
                                
                                
                                100
                                %
                                
                                $
                                116,662
                                
                                
                                
                                100
                                %







Contractual maturity of
portfolio - The following table sets forth information at December 31,
2008, regarding the dollar amount of loans maturing in our portfolio based on
the contractual terms to maturity or scheduled amortization. The table does not
give effect to potential prepayments. Loans that have no stated schedule of
repayments or maturity are reported as due in one year or less. Loans that are
on non-accrual are not included in this table.




As
      of December 31, 2008(Dollars
      in thousands)One
      Year
                  
                  
                  Over
      1 Year
                  
                  
                  Over
      5 Yearsor
      Less
                  
                  
                  through
      5 Years
                  
                  
                  TotalFixed
      Rate
                  
                  
                  Floating
      or Adjustable Rate
                  
                  
                  Fixed
      Rate
                  
                  
                  Floating
      or Adjustable RateReal
      estate
                  
                  $
                  2,076
                  
                  
                  $
                  7,996
                  
                  
                  $
                  2,787
                  
                  
                  $
                  15,845
                  
                  
                  $
                  34,543
                  
                  
                  $
                  63,247Construction
                  
                  
                  34,011
                  
                  
                  
                  -
                  
                  
                  
                  456
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  34,467Commercial
                  
                  
                  16,695
                  
                  
                  
                  7,640
                  
                  
                  
                  1,743
                  
                  
                  
                  2,473
                  
                  
                  
                  8,016
                  
                  
                  
                  36,566Consumer
                  
                  
                  2
                  
                  
                  
                  106
                  
                  
                  
                  -
                  
                  
                  
                  91
                  
                  
                  
                  32
                  
                  
                  
                  231Total
                  
                  $
                  52,783
                  
                  
                  $
                  15,742
                  
                  
                  $
                  4,986
                  
                  
                  $
                  18,409
                  
                  
                  $
                  42,591
                  
                  
                  $
                  134,511


Asset
quality




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




Loan delinquencies -
When a borrower fails to make a required payment on a loan, we attempt to cure
the deficiency by contacting the borrower and seeking payment. Contact is
generally made following the fifteenth day after a payment is due, at which time
a late payment fee is assessed. In most cases, deficiencies are cured promptly.
If a delinquency extends beyond 15 days, the loan and payment history






14






are
reviewed and efforts are made to collect the loan. While we generally prefer to
work with borrowers to resolve such problems, if a payment becomes 45 days
delinquent, we may institute foreclosure or other proceedings, as necessary, to
minimize any potential loss. As of December 31, 2008, there were two loans with
payments delinquent between 30 and 89 days. As of December 31, 2007, there were
four loans with payments delinquent between 30 and 59 days, including two loans
on non-accrual status.




Non-performing assets
- Nonperforming assets are defined as non-performing loans and real estate
acquired by foreclosure or deed-in-lieu thereof (commonly referred to as other
real estate owned or OREO) and other repossessed assets. Nonperforming loans are
defined as non-accrual loans,  loans 90 days or more past due but
still accruing interest and troubled debt restructurings (“TDRs”). TDRs are
defined as loans which we have agreed to modify by accepting below market terms
either by granting interest rate concessions or by deferring principal and/or
interest payments. Loans are placed on non-accrual status when, in the judgment
of management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When any such loan is placed on
non-accrual status, previously accrued but unpaid interest will be deducted from
interest income. As a matter of policy, we generally do not accrue interest on
loans past due 90 days or more.




As of
December 31, 2008, there were 10 loans on non-accrual, for a total of $7.8
million.   A majority of these non-accrual loans are construction
and land development loans we originated or are participations purchased from
other financial institutions, and the lead lenders have initiated foreclosure
actions and/or have been negotiating with the borrowers to improve the overall
collateral position. The remaining non-accrual loans are commercial loans,
including one SBA 7A, where our expected source of repayment was from the cash
flow of the business. We have liens on the equipment on each commercial loan but
the resale value is not adequate to cover the balance of the
loans.  The TDR at December 31, 2008 is also on nonaccrual and
involves a participation purchased land loanthat was restructured
during 2008. We recorded
specific reserves in our allowance for loan losses based on recent appraisals
and/or valuations of the collateral for $1.6 million of these non-performing
loans. As of December 31, 2007, there were two construction loan participations
on non-accrual, for a total of $2.5 million, with reserves to our provision for
loan losses based on then- recent appraisals of these projects.




Other
loans not included in the non-performing categories as of December 31, 2008 but
where known information about the borrowers and/or the collateral securing the
loans caused management to have serious doubts as to the ability of such
borrowers to comply with present loan repayment terms totaled $13.2 million at
December 31, 2008. Subsequent to December 31, 2008, the Bank
placed  $9.9 million of these loans on nonaccrual.  Of
the loans placed on nonaccrual subsequent to December 31, 2008, $6.0 million are
construction and land development loans and loan participations and $3.9 million
are commercial loans.  Subsequent to December 31, 2008, we recorded
specific reserves in our allowance for loan losses based on recent appraisals
and/or valuations of the collateral for $1.5 million of these non-performing
loans.




Impaired
LoansManagement evaluates loan impairment according to
the provisions of SFAS No. 114, Accounting by Creditors for Impairment of a
Loan. Under SFAS No. 114, loans are considered impaired when it is probable that
we will be unable to collect all amounts due as scheduled according to the
contractual terms of the loan agreement, including contractual interest and
principal payments. Impaired loans are measured for impairment based on the
present value of expected future cash flows discounted at the loan’s effective
interest rate, or, alternatively, at the loan’s observable market price or the
fair value of the collateral of the loan, less estimated costs to sell if the
loan is collateral dependent. If a loan is collateral-dependent and considered
impaired, the outstanding principal is reduced through a charge off to the
bulk-sale value less costs to sell. Once the loss has been recognized, no
additional reserves for losses are taken for these loans; however additional
charge-offs could be required if there is a






15






continued
deterioration in collateral value. Therefore, the related allowance for loan
losses on impaired loans represents only the allowance for non-collateral
dependent loans.




By
definition, impaired loans as of a particular date may include loans that do not
fall within any of the “non-performing” categories described
above.  As of December 31, 2008, we had $21.0 million of loans
classified as impaired, including the $7.8 million of non-performing loans as of
that date.  The $21.0 million of impaired loans are primarily
construction and land development loans and have been classified as impaired
based on various factors, including current appraisals which reflect the general
deterioration in the real estate market, especially in the Inland Empire region
of Southern California. The impaired commercial loans are secured through UCC
filings on equipment used in each business.   For additional
information regarding impaired loans, see “—Allowance for Loan
Losses.”









16


The table
below sets forth the amounts and categories of non-performing assets and
impaired loans as of the dates indicated.  Non-performing assets as of
those dates were comprised entirely of non-performing loans.






December 31,
      2008
                                
                                
                                December 31,
      2007(Dollars in
      thousands)Impaired loans with a valuation
      allowance
                                
                                $
                                8,834
                                
                                
                                $
                                1,877Impaired loans without a valuation
      allowance
                                
                                
                                12,198
                                
                                
                                
                                -Total impaired
      loans
                                
                                $
                                21,032
                                
                                
                                $
                                1,877Valuation allowance related to
      impaired loans
                                
                                $
                                2,790
                                
                                
                                $
                                590Average balance during the year on
      impaired loans
                                
                                $
                                21,673
                                
                                
                                $
                                2,456Cash collections applied to reduce
      principal balances
                                
                                $
                                275
                                
                                
                                $
                                -Interest income recognized on cash
      collections
                                
                                $
                                153
                                
                                
                                $
                                126Nonaccrual
      LoansReal estate
                                
                                $
                                -
                                
                                
                                $
                                -Construction & Land
      Development
                                
                                
                                5,906
                                
                                
                                
                                2,467Commercial
                                
                                
                                1,028
                                
                                
                                
                                -Consumer
                                
                                
                                -
                                
                                
                                
                                -Accruing loans past due 90 days or
      more
                                
                                
                                -
                                
                                
                                
                                -Troubled debt
      restructuring
                                
                                
                                882
                                
                                
                                
                                -Total Nonaccrual and restructured
      debt
                                
                                $
                                7,816
                                
                                
                                $
                                2,467Impaired loans as a percent of
      total gross loans
                                
                                
                                15.64
                                %
                                
                                
                                2.53
                                %Allowance for loan losses to
      impaired loans
                                
                                
                                31
                                %
                                
                                
                                74
                                %Allowance for loan losses to
      classified loans net of
                                  related allowance for impaired
      loans
                                
                                
                                16
                                %
                                
                                
                                65
                                %







For the
year ended December 31, 2008, gross interest income which would have been
recorded had our non-accruing loans been current in accordance with their
original terms amounts to $343 thousand. We received and recorded $153 thousand
for such loans for the year ended December 31, 2008. For the year ended December
31, 2007, gross interest income which would have been recorded had our
non-accruing loans been current in accordance with their original terms amounts
to $170 thousand. We received and recorded $126 thousand for such loans for the
year ended December 31, 2007.




Classified assets –
In addition to evaluating loans for impairment under SFAS No. 114, Federal
regulations require that each insured financial institution classify its assets
on a regular basis. In connection with examinations of insured institutions,
federal examiners also 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






17






some loss
if the deficiencies are not corrected. Doubtful assets have the weakness of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified as loss is considered uncollectible, and of such little value
that continuance as an asset of the institution is not warranted. Assets
classified as substandard or doubtful result in the Bank establishing higher
levels of general allowances for loan losses. If an asset or portion thereof is
classified loss, the Bank must either establish specific allowances for loan
losses in the amount of 100% of the portion of the asset classified as loss, or
charge off such an amount. At December 31, 2008, we had $20.8 million in assets
classified as substandard, $348 thousand in assets classified as doubtful
and $2.1 million in assets classified as loss, compared with $3.2 million
in assets classified as substandard, and no assets classified as doubtful
or loss at December 31, 2007.




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




The
following table sets forth the activity for 2008 and 2007 in our allowance for
loan losses account.




2008
                              
                              
                              2007($ in
      thousands)Balance at beginning of
      year
                              
                              $
                              1,815
                              
                              
                              $
                              432Provision charged to
      expense
                              
                              
                              7,937
                              
                              
                              
                              1,383Loans charged
      off:Real
      Estate
                              
                              
                              -
                              
                              
                              
                              -Construction
                              
                              
                              ( 2,162
                              )
                              
                              
                              -Commercial
                              
                              
                              ( 1,308
                              )
                              
                              
                              -Loans charged
      off
                              
                              
                              ( 3,470
                              )
                              
                              
                              -Recoveries on loans previously
      charged off
                              
                              
                              268
                              
                              
                              
                              -Balance at end of
      year
                              
                              $
                              6,550
                              
                              
                              $
                              1,815Net charge offs to average loans
      outstanding
                              
                              
                              2.69
                              %
                              
                              
                              0
                              %







18


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





2008
                                                                                                      
                                                                                                      Amount
                                                                                                      
                                                                                                      
                                                                                                      Percentage
      of
                                                                                                        loans
      in each
                                                                                                        category
      to
                                                                                                        total
      loans
                                                                                                      
                                                                                                      
                                                                                                      Percentage
      of
                                                                                                        year-end
                                                                                                        allowance
                                                                                                      
                                                                                                      
                                                                                                      Percentage
      of
                                                                                                        reserves
      to
                                                                                                        net
      loans by
                                                                                                        category($
      in thousands)Real
      estate
                                                                                                      
                                                                                                      $
                                                                                                      1,462
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      47.0%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      22.3%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      2.3%Construction
                                                                                                      
                                                                                                      
                                                                                                      1,925
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      25.6%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      29.4%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      5.6%Commercial
                                                                                                      
                                                                                                      
                                                                                                      2,862
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      27.2%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      43.7%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      7.8%Consumer
                                                                                                      
                                                                                                      
                                                                                                      1
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      0.2%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      0.0%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      0.4%Unallocated
                                                                                                      
                                                                                                      
                                                                                                      300
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      4.6%Total
      Allowance for Loan Losses
                                                                                                      
                                                                                                      $
                                                                                                      6,550
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      100.0%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      100.0%
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      4.9%
  2007
                                        
                                        Amount
                                        
                                        
                                        Percentage
      of
                                          loans
      in
                                          each
      category
                                          to
      total loans
                                        
                                        
                                        Percentage
      of
                                          year-end
                                          allowance
                                        
                                        
                                        Percentage
      of
                                          reserves
      to
                                          net
      loansbycategory($
      in thousands)Real
      estate
                                        
                                        $
                                        353
                                        
                                        
                                        
                                        45.4%
                                        
                                        
                                        
                                        27.9%
                                        
                                        
                                        
                                        1.1%Construction
                                        
                                        
                                        823
                                        
                                        
                                        
                                        31.9%
                                        
                                        
                                        
                                        36.9%
                                        
                                        
                                        
                                        2.1%Commercial
                                        
                                        
                                        197
                                        
                                        
                                        
                                        22.4%
                                        
                                        
                                        
                                        10.9%
                                        
                                        
                                        
                                        0.9%Consumer
                                        
                                        
                                        1
                                        
                                        
                                        
                                        0.3%
                                        
                                        
                                        
                                        0.1%
                                        
                                        
                                        
                                        0.5%Unallocated
                                        
                                        
                                        441
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        24.3%
                                        
                                        
                                        
                                        -Total
      Allowance for Loan Losses
                                        
                                        $
                                        1,815
                                        
                                        
                                        
                                        100.0%
                                        
                                        
                                        
                                        100.0%
                                        
                                        
                                        
                                        1.9%


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




Our
external asset review system and loss allowance methodology are designed to
provide for timely identification of problem assets and recognition of losses.
The overall adequacy of the allowance for loan losses is reviewed by the
Directors’ Credit Committee on a monthly basis and submitted to the






19








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. In our management’s report on
internal control over financial reporting included in this 10-K filing, we
concluded that our internal control over financial reporting was not effective
as of December 31, 2008 due to a material weakness identified in our policies
relating to the determination of the allowance for loan losses. See Item 9A(T).
Controls and Procedures – Management’s Report on Internal Control Over Financial
Reporting.




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




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




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




As loans
move into the classified category, they are reviewed individually for purposes
of determining specific valuation allowances and impairment as defined in SFAS
No. 114. Loans are also reviewed individually on an annual basis. In addition,
classified assets are reviewed at the time the loan is classified and on a
regular basis (at least every 90 days) thereafter. This evaluation of individual
loans is documented in the internal asset review report relating to the specific
loan. An impairment analysis is completed with each internal asset review
report, typically on a quarterly basis, for all classified loans secured by real
estate. Any deficiencies outlined by the impairment analysis are accounted for
in the specific valuation allowance for the loan. As indicated above, under
“Impaired Loans,” a loan is determined to be impaired if management determines
it is probable that the Company will be unable to collect all amounts (principal
and interest) according to the contractual terms of the loan agreement. 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, and borrower’s ability (defined as capacity, willingness and
rationale) to repay and the overall condition and estimated value of the
collateral. If a loan is deemed impaired, a specific valuation allowance is
applied equal to the carrying amount of our total investment in the loan that
exceeds the fair






20






value of
the collateral. Impaired loans are measured based on the present value of
expected future cash flows discounted at the loan’s effective interest rate or,
as a practical expedient, at the  estimated value of the collateral
less costs to sell.




As
indicated above under “—Impaired Loans,” at December 31, 2008, we had $21.0
million in loans classified as impaired before valuation
allowances.  Of the $21.0 million of loans classified as impaired at
December 31, 2008, $8.8 million had valuation allowances. The largest loan, for
$2.0 million, had a valuation allowance of $163 thousand and subsequent to
yearend the collateral for this loan became an OREO. There are seven additional
loans with balances exceeding $1.0 million at December 31, 2008, only one of
which had a valuation allowance, totaling $31 thousand. One impaired loan
totaling $1.5 million was paid off by the borrower subsequent to yearend, with
no loss to the Bank. Three of the impaired loans at December 31, 2008 are not
classified as nonaccrual loans, since they are performing in accordance with
their contractual terms.




Also classified as impaired with a
valuation allowances are five SBA loans totaling $1.1 million with total
valuation allowances of $950 thousand at December 31, 2008. Four of the loans
were substantially charged-off subsequent to year end. The only SBA loan with a
valuation allowance at December 31, 2008 that was not subsequently charged-off
has a balance at December 31, 2008 of $130 thousand, with a general allowance of
losses of $19 thousand.




Of the
two loans that were classified as impaired at December 31, 2007, one loan for
$967 thousand was charged-off during the first quarter of 2009. The second loan,
with an outstanding balance of $1.5 million at December 31, 2007, was reduced
through a charge-off to $1.0 million which management believed represented the
bulk-sale value of the property less costs to sell. During 2008, we received a
payoff of $1 million and recoveries of $174 thousand on this loan.




The
present downturn in real estate including construction has had an adverse effect
on borrowers’ ability to repay loans and has affected our results of operations
and financial condition. As of December 31, 2008, substantially all of our real
estate secured loan portfolio consisted of loans located in Southern California.
If real estate values continue to decline in this area, the collateral for our
loans will provide less security. As a result, our ability to recover on
defaulted loans by selling the underlying real estate will be diminished, and we
would be more likely to suffer losses on defaulted loans. These changes were
taken into account when we evaluated our allowance for loan losses during the
fourth quarter of 2008 which resulted in a substantial increase in our provision
for loan losses.




Management
believes that our allowance for loan losses as of December 31, 2008 was adequate
to absorb the known and inherent risks of loss in the loan portfolio at that
date. While management believes the estimates and assumptions used in its
determination of the adequacy of the allowance are reasonable, there can be no
assurance that such estimates and assumptions will not be proven incorrect in
the future, or that the actual amount of future provisions will not exceed the
amount of past provisions or that any increased provisions that may be required
will not adversely impact our financial condition and results of operations. In
addition, the determination of the amount of the Bank‘s allowance for loan
losses is subject to review by bank regulators, as part of the routine
examination process, which may result in the establishment of additional
reserves based upon their judgment of information available to them at the time
of their examination.




Investments




In
addition to loans, we make other investments primarily in obligations of the
United States or obligations guaranteed as to principal and interest by the
United States and other taxable securities. No investment in any of those
instruments exceeds any applicable limitation imposed by law or regulation.






21






The
asset-liability management committee reviews the investment portfolio on an
ongoing basis in order to ensure that the investments conform to the Bank’s
policy as set by its board of directors.




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




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




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




Management
evaluates investment securities for other-than-temporary impairment taking into
consideration that extent and length of time the fair value has been less than
cost, the financial condition of the issuer and whether or not the Company has
the intent and ability to retain the investment for a period of time sufficient
to allow for any anticipated recovery in fair value.




Deposit
services




We offer
a variety of deposit products and services at competitive interest rates. The
Bank utilizes traditional and innovative marketing methods to attract new
clients and deposits, including various forms of advertising and significant
involvement in the local communities. The primary sources of deposits are
residents of, and businesses and their employees located in, our primary service
areas. We attract these deposits through personal solicitation by our officers
and directors, direct mail solicitations and advertisements published in the
local media. Due to strong loan demand, we began utilizing brokered deposits in
2007. As discussed under “Regulatory Restrictions“, we are currently prohibited
from accepting, renewing or rolling over brokered deposits. As of December 31,
2008, $35.6 million in brokered funds were on deposit. Of this total, $400
thousand are shown in other time certificates of deposit with the remaining
balance included in other time deposits of $100,000 or more. $34.9 million in
brokered deposits mature in 2009 and the remaining $718 thousand mature in 2010.
As of December 31, 2007, $28.2 million in brokered funds were on deposit. These
deposits are included in other time certificate of deposits.




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








22









Time Deposits of $100,000 or
      more
                          
                          
                          Other Time
                            Deposits
                          
                          
                          Total Time
                            DepositsDecember 31,
      2008
                          
                          ($ in
      thousands)Three months or
      less
                          
                          $
                          3,450
                          
                          
                          $
                          18,074
                          
                          
                          $
                          21,524Over three months through six
      months
                          
                          
                          1,341
                          
                          
                          
                          16,752
                          
                          
                          
                          18,093Over six months through 12
      months
                          
                          
                          805
                          
                          
                          
                          15,146
                          
                          
                          
                          15,951Over 12
    months
                          
                          
                          -
                          
                          
                          
                          841
                          
                          
                          
                          841Total
                          
                          $
                          5,596
                          
                          
                          $
                          50,813
                          
                          
                          $
                          56,409


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




Competition




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




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




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






23






competitive
environment in the financial services industry. Competition for deposits and the
origination of loans could limit our growth in the future.




Employees




As of
December 31, 2008, we had 37 employees. Management believes that its relations
with employees are satisfactory. We are not subject to any collective bargaining
agreements.




Supervision
and Regulation




General-The following is a brief
description of certain laws and regulations which are applicable to Pacific
Coast National Bancorp and Pacific Coast National Bank. The description of these
laws and regulations, as well as descriptions of laws and regulations contained
elsewhere herein, are not complete and are qualified in their entirety by
reference to the applicable laws and regulations.




Regulation
and Supervision of Pacific Coast National Bancorp




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




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




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




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






24








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




The
Sarbanes-Oxley Act includes very specific additional disclosure requirements and
new corporate governance rules and required the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules. The Sarbanes-Oxley Act represents significant federal involvement in
matters traditionally left to state regulatory systems, such as the regulation
of the accounting profession, and to state corporate law, such as the
relationship between a board of directors and management and between a board of
directors and its committees. Our policies and procedures have been updated to
comply with the requirements of the Sarbanes-Oxley Act.




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




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




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






25






mergers
and branch acquisitions will also be subject to the nationwide and statewide
insured deposit concentration amounts described above.




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




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




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




Capital Requirements.
The Federal Reserve has established capital adequacy guidelines for bank holding
companies that generally parallel the capital requirements of the FDIC for
banks. The Federal Reserve regulations provide that capital standards will be
applied on a consolidated basis in the case of a bank holding company with $500
million or more in total consolidated assets. Under these guidelines, a bank
holding company’s total risk-based capital must equal at least 8% of
risk-weighted assets and at least one half of the 8%, or 4%, must consist of
Tier 1 (core) capital. At December 31, 2008, Pacific Coast National
Bancorp‘s capital position was Tier 1 (core) capital to average assets of 3.60%,
Tier 1 (core) capital to risk-weighted assets of 3.75%, and total capital to
risk-weighted assets of 5.04%. Total capital to risk-weighted assets at 5.04%
did not meet the capital requirements. On January 16, 2009, the Company received
$4.1 million from the U.S. Department of the Treasury through the TARP Capital
Purchase Program (CPP) from the U. S. Treasury. As a result, Pacific Coast
National Bancorp’s Tier 1 (core) capital to average assets, Tier 1 (core) to
risk-weighted assets and total capital to risk-weighted assets improved to
5.35%, 5.68% and 6.97%, respectively, as of March 31, 2009.




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






26






Regulation
and Supervision of Pacific Coast National Bank




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




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




The Bank
must file reports with the OCC and the FDIC concerning its activities and
financial condition, in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with or acquisitions of other
financial institutions. This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the FDIC and depositors. The regulatory
structure also gives the regulatory authorities extensive discretion in
connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss allowance for regulatory purposes. Any
change in such regulations, whether by the OCC, the FDIC, or Congress could have
a material adverse impact on the Company, the Bank, and their
operations.




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




The
risk-based capital ratio is determined by classifying assets and certain
off-balance sheet financial instruments into weighted categories, with higher
levels of capital being required for those categories perceived as representing
greater risk. Under the capital guidelines, a banking organization’s total
capital is divided into tiers. “Tier 1 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 1 capital may consist of trust-preferred securities.
“Tier 2 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 1 capital, a limited amount of the
allowance for loan and lease losses and a limited amount of unrealized holding
gains on equity securities. “Tier 3 capital“ consists of qualifying unsecured
subordinated debt. For a bank subject to the market risk adjustment because it
has certain trading activities equal to at least 10% of assets or $1 billion,
the sum of Tier 2 and Tier 3 capital may not exceed the amount of Tier 1
capital.




The
guidelines require a minimum ratio of qualifying total capital to risk-adjusted
assets of 8% and a minimum ratio of Tier 1 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 1 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






27






ratio of
Tier 1 capital to total assets must be 3%. For all other institutions, the
minimum leverage ratio is 4%. 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.




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.At December 31,
2008, the Bank‘s capital position was below these requirements with Tier 1
(core) capital to average assets of 3.59%, Tier 1 (core) capital to
risk-weighted assets of 3.74%, and total capital to risk-weighted assets of
5.03%. A ratio of total capital to risk-weighted assets at 5.03% caused the Bank
to be deemed “significantly undercapitalized“ at December 31, 2008. As a result
of the downstreaming by the Company to the Bank of the proceeds the Company
received from the TARP Capital Purchase Program in January 2009, the Bank’s Tier
1 (core) capital to average assets, Tier 1 (core) capital to risk-weighted
assets and total capital to risk-weighted assets improved to 5.23%, 5.55% and
6.84%, respectively, as of March 31, 2009, and the bank was deemed
“undercapitalized“ as of that date. As discussed under “Regulatory
Restrictions,“ the Bank is currently subject to a number of requirements and
restrictions on its operations recently imposed on it by the OCC, including a
requirement that it maintain certain capital ratios in excess of the general
regulatory minimums. Specifically, the Bank must develop a plan, subject to the
OCC’s review and nonobjection, to achieve ratios of Tier 1 capital to adjusted
total assets of 9.0% and total risk-based capital to risk-weighted assets of
11.0% by June 30, 2009, and ratios of Tier 1 capital to adjusted total assets of
9.0% and total risk-based capital to risk-weighted assets of 12.0% by September
30, 2009.




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




In
addition, under the Federal Deposit Insurance Corporation Improvement Act of
1991(FDICIA), the
Bank may not pay any dividend if the payment of the dividend would cause the
Bank to become undercapitalized or in the event the Bank is “undercapitalized.“
As noted under “Regulatory Restrictions“ the Bank was undercapitalized as of
March 31, 2009, and is accordingly subject to this additional restriction. 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. As noted under “Capital
Requirements,“ the OCC has required the






28






Bank to
maintain certain capital rations in excess of the regulatory minimums. 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, 2008, the Bank’s loans-to-one-borrower limit was $1,771,246 based
upon the 15% of unimpaired capital and surplus measurement. At December 31,
2008, the Bank had no outstanding balances to a single borrower or single
relationship in excess of its legal lending limit.




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




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




·
            a
      bank’s investment in affiliates;




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




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




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




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




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




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




Prompt corrective action and
other enforcement mechanisms - The Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA) established a system of prompt corrective
action to resolve the problems of undercapitalized financial institutions. Under
this system, the federal banking regulators have established five capital
categories (“well capitalized,“ “adequately capitalized,“ “undercapitalized,“
“significantly undercapitalized“ and “critically undercapitalized“), and all
institutions are assigned one such category. Federal banking regulators are
required to take various mandatory






29






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. As noted under “Regulatory Restrictions,“ the Bank was
“undercapitalized“ at December 31, 2008 and is subject to numerous requirements
and restrictions on its operations, as described in that section.




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




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




The FDIC
assesses deposit insurance premiums on all FDIC-insured institutions quarterly
based on annualized rates for four risk categories. Each institution is assigned
to one of four risk categories based on its capital, supervisory ratings and
other factors. Well capitalized institutions that are financially sound with
only a few minor weaknesses are assigned to Risk Category I. Risk Categories II,
III and IV present progressively greater risks to the DIF. The Bank’s assessment
for the year ended December 31, 2008 was approximately $135,888. The assessment
for 2009 is expected to be significantly higher. Under FDIC’s risk-based
assessment rules, effective April 1, 2009, the initial base assessment rates
prior to adjustments range from 12 to 16 basis points for Risk Category I, and
are 22 basis points for Risk Category II, 32 basis points for Risk Category III,
and 45 basis points for Risk Category IV. Initial base assessment rates are
subject to adjustments based on an institution’s unsecured debt, secured
liabilities and brokered deposits, such that the total base assessment rates
after adjustments range from 7 to 24 basis points for Risk Category I, 17 to 43
basis points for Risk Category II, 27 to 58 basis points for Risk Category III,
and 40 to 77.5 basis points for Risk Category IV.






30






The rule
also includes authority for the FDIC to increase or decrease total base
assessment rates in the future by as much as three basis points without a formal
rulemaking proceeding.




In
addition to the regular quarterly assessments, due to losses and projected
losses attributed to failed institutions, the FDIC has adopted a rule, effective
April 1, 2009, imposing on every insured institution a special assessment equal
to 20 basis points of its assessment base as of June 30, 2009, to be collected
on September 30, 2009. There are proposals under discussion, under which the
FDIC would reduce the special assessment to 10 basis points. There can be no
assurance whether any such proposal will become effective. The special
assessment rule also authorizes the FDIC to impose additional special
assessments if the reserve ratio of the DIF is estimated to fall to a level that
the FDIC’s board believes would adversely affect public confidence or that is
close to zero or negative. Any additional special assessment would be in amount
up to 10 basis points on the assessment base for the quarter in which it is
imposed and would be collected at the end of the following quarter.




The FDIC
may terminate the deposit insurance of any insured depository institution,
including the Bank, if it determines after a hearing that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the institution
at the time of the termination, less subsequent withdrawals, will continue to be
insured for a period of six months to two years, as determined by the
FDIC.





On
October 3, 2008, pursuant to the EESA (discussed below), the FDIC increased
its insurance coverage limits on all deposits from $100,000 to $250,000 per
account until December 31, 2009. Effective November 21, 2008 and until
December 31, 2009, the FDIC expanded deposit insurance limits for certain
accounts under the FDIC‘s Temporary Liquidity Guarantee Program or TLGP.
Provided an institution has not opted out, the FDIC may (i) guarantee,
under the Debt Guarantee Program or DGP, certain newly issued senior unsecured
debt for certain periods and, (ii) under the Transaction Account Guarantee
Program or TAGP, will provide full FDIC deposit insurance coverage for
noninterest bearing transaction deposit accounts, Negotiable Order of Withdrawal
(“NOW“) accounts paying less than 0.5% interest per annum and Interest on
Lawyers Trust Accounts (“IOLTA“) accounts held at participating FDIC-insured
institutions through December 31, 2009. Coverage under the TLGP was
available for the first 30 days without charge. Various fees are assessed
under the DGP. The fee assessment for TAGP coverage is 10 basis points per
quarter on amounts in covered accounts exceeding $250,000. We are monitoring the
many programs which continue to emerge as part of the Federal government‘s
efforts to stabilize and strengthen the nation‘s economy. All programs are
evaluated based on their applicability to us, and whether they will provide
benefit to us and our shareholders. As neither the Company nor the Bank
anticipates issuing qualifying debt, they will not participate in the
DGP.




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 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.






31








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




Expanded
financial activities of national banks generally will be regulated according to
the type of such financial activity: banking activities by banking regulators,
securities activities by securities regulators and insurance activities by
insurance regulators. The Bank currently has no plans to conduct any activities
through financial subsidiaries and is currently prohibited from doing so. See
“Regulatory Restrictions.“




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. The Bank received a “Satisfactory“ rating
from the OCC during 2008 for compliance with the Community Reinvestment Act
obligations.




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




Federal
Reserve Board regulations require the Bank to maintain reserves against the
Bank’s transaction deposit accounts. For 2009, the first $10.3 million of
otherwise reservable balances are exempt from the reserve requirement, a 3%
reserve requirement applies to balances over $10.3 million up to $44.4 million
and a 10% reserve requirement applies to balances over $44.4 million. The Bank
was in compliance with applicable requirements as of December 31,
2008.






32






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




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




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




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




Recent Regulatory
Developments.In light of current conditions in the global financial
markets and the global economy, regulators have increased their focus on the
regulation of the financial services industry. Proposals for legislation that
could substantially intensify the regulation of the financial services industry
are expected to be introduced in the U.S. Congress and in state legislatures.
The agencies regulating the financial services industry also frequently adopt
changes to their regulations. Substantial regulatory and legislative
initiatives, including a comprehensive overhaul of the regulatory system in the
U.S., are possible in the months or years ahead. Any such action could have a
materially adverse effect on our business, financial condition and results of
operations.





Recent
months have seen an unprecedented number of government initiatives designed to
respond to the stresses experienced in financial markets.





In
response to the financial crises affecting the banking system and financial
markets and going concern threats to investment banks and other financial
institutions, the Emergency Economic Stabilization Act of 2008 (“EESA“) was
signed into law on October 3, 2008. Pursuant to EESA, the U.S. Department
of the Treasury was given the authority to, among other things, purchase up to
$700 billion of mortgages, mortgage-backed securities and certain other
financial instruments from financial institutions for the purpose of stabilizing
and providing liquidity to the U.S. financial markets. Pursuant to EESA, the
U.S. Treasury established the Troubled Asset Relief Program (“TARP“) and has
since injected capital into many financial institutions under the TARP Capital
Purchase Program. The Company participated in the TARP Capital Purchase Program
by issuing $4.12 million of preferred stock to the U.S. Treasury on January 16,
2009.






33







On
February 10, 2009, the U.S. Treasury announced the Financial Stability Plan
(“FSP“), which, among other things, proposes to establish a new Capital
Assistance Program (“CAP“) through which eligible banking institutions will have
access to U.S. Treasury capital as a bridge to private capital until market
conditions normalize, and extends the TLGP to October 31, 2009. As a
complement to CAP, a new Public-Private Investment Fund on an initial scale of
up to $500 billion, with the potential to expand up to $1 trillion, was
announced to catalyze the removal of legacy assets from the balance sheets of
financial institutions. This proposed fund will combine public and private
capital with government financing to help free up capital to support new
lending. In addition, the existing Term Asset-Backed Securities Lending Facility
(“TALF“) would be expanded (up to $1 trillion) in order to reduce credit spreads
and restart the securitized credit markets that in recent years supported a
substantial portion of lending to households, students, small businesses, and
others. Furthermore, the FSP proposes a new framework of governance and
oversight to help ensure that banks receiving funds are held responsible for
appropriate use of those funds through stronger conditions on lending, dividends
and executive compensation along with enhanced reporting to the public. As of
the date of this report, we have not determined to seek to participate. However,
we will continue to monitor emerging government programs to evaluate whether
such programs would be applicable to, and beneficial to, us.





On
February 17, 2009, the American Recovery and Reinvestment Act of 2009
(“ARRA“) was signed into law. AARA is intended to provide tax breaks for
individuals and businesses, direct aid to distressed states and individuals, and
infrastructure spending. In addition, ARRA imposes new executive compensation
and expenditure limits on all previous and future TARP Capital Purchase Program
recipients and expands the class of employees to whom the limits and
restrictions apply. ARRA also provides the opportunity for additional repayment
flexibility for existing TARP Capital Purchase Program recipients. Among other
things, ARRA prohibits the payment of bonuses, other incentive compensation and
severance to certain highly paid employees (except in the form of restricted
stock subject to specified limitations and conditions), and requires each TARP
Capital Purchase Program recipient to comply with certain other executive
compensation related requirements. These provisions modify the executive
compensation provisions that were included in EESA, and in most instances apply
retroactively for so long as any obligation arising from financial assistance
provided to the recipient under TARP remains outstanding. To the extent that the
executive compensation provisions in ARRA are more restrictive than the
restrictions described in the Treasury‘sexecutive compensation
guidelines already issued under EESA, the new ARRA guidelines appear to
supersede those restrictions. However, both ARRA and the existing Treasury
guidelines contemplate that the Secretary of the Treasury will adopt standards
to provide additional guidance regarding how the executive compensation
restrictions under ARRA and EESA will be applied. We are currently evaluating
our compensation program in view of the restrictions in the ARRA, pending the
issuance of the Treasury’s new guidelines.





In
addition, ARRA directs the Secretary of the Treasury to review previously-paid
bonuses, retention awards and other compensation paid to the senior executive
officers and certain other highly-compensated employees of each TARP Capital
Purchase Program recipient to determine whether any such payments were
excessive, inconsistent with the purposes of ARRA or the TARP, or otherwise
contrary to the public interest. If the Secretary determines that any such
payments have been made by a TARP Capital Purchase Program recipient, the
Secretary will seek to negotiate with the TARP Capital Purchase Program
recipient and the subject employee for appropriate reimbursements to the U.S.
government (not the TARP Capital Purchase Program recipient) with respect to any
such compensation or bonuses. ARRA also permits the Secretary, subject to
consultation with the appropriate federal banking agency, to allow a TARP
Capital Purchase Program recipient to repay any assistance previously provided
to such TARP






34






Capital
Purchase Program recipient under the TARP, without regard to whether the TARP
Capital Purchase Program recipient has replaced such funds from any source, and
without regard to any waiting period. Any TARP Capital Purchase Program
recipient that repays its TARP assistance pursuant to this provision would no
longer be subject to the executive compensation provisions under ARRA. Because,
as of the date of this report, the Company is not a TARP Capital Purchase
Program recipient, such provisions are not currently applicable to
us.





On
February 18, 2009, the U.S. Treasury announced the Homeowner Affordability
and Stability Plan (“HASP“), which proposes to provide refinancing for certain
homeowners, to support low mortgage rates by strengthening confidence in Fannie
Mae and Freddie Mac, and to establish a Homeowner Stability Initiative to reach
at-risk homeowners. Among other things, the Homeowner Stability Initiative would
offer monetary incentive to mortgage servicers and mortgage holders for certain
modifications of at-risk loans, and would establish an insurance fund designed
to reduce foreclosures.





It is not
clear at this time what impact EESA, the TARP Capital Purchase Program, the
TLGP, the FSP, AARA, HASP, or other liquidity and funding initiatives will have
on the financial markets and the other difficulties described above, including
the high levels of volatility and limited credit availability currently being
experienced, or on the U.S. banking and financial industries and the broader
U.S. and global economies. Failure of these programs to address the issues noted
above could have an adverse effect on the Company and its business.





Future
Legislation.Additional legislation,
including proposals to change substantially the financial institution regulatory
system, is from time to time introduced in the U.S. Congress. This legislation
may change banking statutes and our operating environment in substantial and
unpredictable ways. If enacted, this legislation could increase or decrease the
cost of doing business, limit or expand permissible activities or affect the
competitive balance among banks, savings associations, credit unions, and other
financial institutions. We cannot predict whether any of this potential
legislation will be enacted and, if enacted, the effect that it, or any
implementing regulations, would have on our business, results of operations or
financial condition.




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




Item
1A. Risk Factors




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






35






Risks
Relating to Our Industry




Recent
negative developments in the financial institutions industry and credit markets,
as well as the economy in general, may continue to adversely affect our
financial condition and results of operations.





The
recent negative events in the housing market, including significant and
continuing home price reductions coupled with the upward trends in delinquencies
and foreclosures, have resulted and will likely continue to result in poor
performance of mortgage and construction loans and in significant asset
write-downs by many financial institutions. This has caused and will likely
continue to cause many financial institutions to seek additional capital, to
merge with larger and stronger institutions and, in some cases, to seek
government assistance or bankruptcy protection. Bank failures and liquidations
or sales by the FDIC as receiver have also increased.





Reduced
availability of commercial credit and increasing unemployment have further
contributed to deteriorating credit performance of commercial and consumer
loans, resulting in additional write-downs. Financial market and economic
instability has caused many lenders and institutional investors to severely
restrict their lending to customers and to each other. This market turmoil and
credit tightening has exacerbated commercial and consumer deficiencies, the lack
of consumer confidence, market volatility and widespread reduction in general
business activity. Financial institutions also have experienced decreased access
to deposits and borrowings.





It is
difficult to predict how long these economic conditions will exist, which of our
markets and loan products will ultimately be most affected, and whether our
actions will effectively mitigate these external factors. The current economic
pressure on consumers and businesses and the lack of confidence in the financial
markets has adversely affected and may continue to adversely affect our
business, financial condition, results of operations and stock price. We do not
believe these conditions are likely to improve in the near future. As a result
of the challenges presented by these conditions, we face the following
risks:





•
            The
      number of our borrowers unable to make timely repayments of their loans,
      and/or decreases in the value of real estate collateral securing the
      payment of such loans could continue to rise, resulting in additional
      credit losses, which could have a material adverse effect on our operating
      results.




•
            Potentially
      increased regulation of our industry, including heightened legal standards
      and regulatory requirements, as well as expectations imposed in connection
      with recent and proposed legislation. Compliance with such additional
      regulation will likely increase our operating costs and may limit our
      ability to pursue business
opportunities.




•
            The
      process we use to estimate losses inherent in our credit exposure requires
      difficult, subjective and complex judgments, including forecasts of
      economic conditions and how these economic conditions might impair the
      ability of our borrowers to repay their loans. The level of uncertainty
      concerning economic conditions may adversely affect the accuracy of our
      estimates which may, in turn, impact the reliability of the
      process.




•
            Further
      disruptions in the capital markets or other events, which may result in an
      inability to borrow on favorable terms or at all from other financial
      institutions.




•
            Further
      increases in FDIC insurance premiums, due to the increasing number of
      failed institutions, which have significantly depleted the Deposit
      Insurance Fund of the FDIC and reduced the ratio of reserves to insured
      deposits. Our current risk profile will also cause us to pay higher
      deposit insurance premiums.







36








Recent
legislative and regulatory initiatives to address difficult market and economic
conditions may not stabilize the U.S. banking system.




The
recently enacted Emergency Economic Stabilization Act of 2008 (the “EESA“)
authorizes the United States Department of the Treasury (the “Treasury“) to
purchase from financial institutions and their holding companies up to $700
billion in mortgage loans, mortgage-related securities and certain other
financial instruments, including debt and equity securities issued by financial
institutions and their holding companies, under a troubled asset relief program,
or “TARP.“ The purpose of TARP is to restore confidence and stability to the
U.S. banking system and to encourage financial institutions to increase their
lending to customers and to each other. The Treasury has allocated $250 billion
towards the TARP Capital Purchase Program. Under the TARP Capital Purchase
Program, the Treasury purchased preferred equity securities from participating
institutions, including $4.12 million of our preferred stock. The EESA also
increased federal deposit insurance on most deposit accounts from $100,000 to
$250,000. This increase is in place until the end of 2009.





The EESA
followed, and has been followed by, numerous actions by the Federal Reserve
Board, the U.S. Congress, the Treasury, the FDIC and others to address the
current liquidity and credit crisis that has followed the sub-prime meltdown
that commenced in 2007. These measures include homeowner relief that encourage
loan restructuring and modification; the establishment of significant liquidity
and credit facilities for financial institutions and investment banks; the
lowering of the federal funds rate; a temporary guaranty program for money
market funds; the establishment of a commercial paper funding facility to
provide back-stop liquidity to commercial paper issuers; and coordinated
international efforts to address illiquidity and other weaknesses in the banking
sector. Treasury also recently announced its Financial Stability Plan, to attack
the current credit crisis, and its Homeowner Affordability and Stability Plan,
which seeks to help up to nine million families restructure or refinance their
mortgages to avoid foreclosure. In addition, on February 17, 2009, President
Obama signed into law the American Recovery and Reinvestment Act. The purpose of
these legislative and regulatory actions is to stabilize the U.S. banking
system, improve the flow of credit and foster an economic recovery. The
regulatory and legislative initiatives described above may not have their
desired effects, however. If the volatility in the markets continues and
economic conditions fail to improve or worsen, our business, financial condition
and results of operations could be materially and adversely
affected.





Current
levels of market volatility are unprecedented.




The
capital and credit markets have been experiencing volatility and disruption for
more than a year. In recent months, the volatility and disruption has reached
unprecedented levels. In some cases, the markets have produced downward pressure
on financial institution stock prices and credit availability for certain
issuers without regard to those issuers‘ underlying financial strength. If
current levels of market disruption and volatility continue or worsen, there can
be no assurance that we will not experience an adverse effect, which may be
material, on our ability to access capital in the future and on our business,
financial condition and results of operations.





The
actions and commercial soundness of other financial institutions could affect
our ability to engage in routine funding transactions.





Financial
service institutions are interrelated as a result of trading, clearing,
counterparty or other relationships. We have exposure to different industries
and counterparties because we execute transactions with various counterparties
in the financial industry, including brokers and dealers,






37






commercial
banks, investment banks, mutual and hedge funds, and other institutional
clients. Recent defaults by financial services institutions, and even rumors or
questions about one or more financial services institutions or the financial
services industry in general, have led to market wide liquidity problems and
could lead to losses or defaults by us or by other institutions. Many of these
transactions expose us to credit risk in the event of default of counterparty.
Any such losses could materially and adversely affect our results of
operations.







Risks
Relating to the Company and the Bank




Our
independent registered public accounting firm has expressed substantial doubt
about our ability to continue as a going concern.




Our
independent registered public accounting firm in their audit report for fiscal
year 2008 has expressed substantial doubt about our ability to continue as a
going concern, noting in their report that we have suffered significant losses
from operations since inception, had an accumulated deficit of $21.6 million as
of December 31, 2008 and have regulatory capital deficiencies that must be
addressed. Continued operations may depend on our ability to comply with the
requirements our regulators have imposed on us (discussed below) and the
financing or other capital required to do so may not be available or may not be
available on acceptable terms. Our audited financial statements were prepared
under the assumption that we will continue our operations on a going concern
basis, which contemplates the realization of assets and the discharge of
liabilities in the normal course of business. Our financial statements do not
include any adjustments that might be necessary if we are unable to continue as
a going concern. If we cannot continue as a going concern, our shareholders will
lose some or all of their investment in the Company.





We
are subject to increased regulatory scrutiny and are subject to certain business
limitations. Further, we may be subject to more severe future regulatory
enforcement actions if our financial condition or performance
weakens.





Subsequent
to December 31, 2008, we were notified by the OCC that it has imposed a number
of requirements and restrictions on the Bank’s operations, primarily due to our
reduced capital levels, deteriorating asset quality and net losses. Among other
things, these requirements and restrictions require that we notify the
regulators prior to making any additions or changes to our directors and senior
executive officers, preclude us from paying certain kinds of severance and other
compensation without prior regulatory approval, prohibit us from increasing our
loans until we adopt and implement satisfactory credit and concentration risk
management processes, prohibit us from accepting, renewing or rolling over
brokered deposits and restrict the effective yield we can offer on deposits. We
are also required to develop a plan to achieve ratios of Tier 1 capital to
adjusted total assets of 9.0% and total risk-based capital to risk-weighted
assets of 11.0% by June 30, 2009, and ratios of Tier 1 capital to adjusted total
assets of 9.0% and total risk-based capital to risk-weighted assets of 12.0% by
September 30, 2009. These requirements and restrictions are described in greater
detail under “Item 1. Business—Regulatory Restrictions.“ In addition, the Bank
is expected to be subject to higher regulatory assessments from the OCC and FDIC
deposit premiums than those prevailing in prior periods.





We are
working to address the issues raised by our regulators, but any current or past
actions, violations or deficiencies could be the subject of future regulatory
enforcement actions. Such enforcement actions could involve penalties or further
limitations on our business at the Bank or Pacific Coast National Bancorp and
negatively affect our ability to implement our business plans and the value of
our common stock. In this regard, we anticipate that the Bank and/or the Company
will be required to enter into some form of written agreement with their primary
regulators which could impose further requirements and restrictions on their
operations.







38







We
may be required to raise additional capital, but that capital may not be
available and without additional capital other courses such as selling assets
and looking for merger partners may need to be pursued.





As noted
above, the Bank is required to develop and adopt a plan to address how it will
increase its capital ratios to levels that are significantly greater than the
regulatory minimums. Our ability to achieve these ratios is contingent on
current and future economic conditions and on our financial performance which
may ultimately require us to seek additional capital. Capital market conditions
are currently unfavorable, and we do not anticipate any material improvement in
these markets in the near term. Accordingly, we cannot be certain of our ability
to raise additional capital on any terms. If we cannot raise additional capital
and/or continue to down-size operations or complete a strategic merger or sale,
we may not be able to sustain further deterioration in our financial condition
and other regulatory actions may be taken against us.





Liquidity
risk could impair our ability to fund operations and jeopardize our financial
condition.




Liquidity
is essential to our business, as we must maintain sufficient funds to respond to
the needs of depositors and borrowers. An inability to raise funds through
deposits, borrowings, the sale of loans and other sources could have a
substantial negative effect on our liquidity. Our access to funding sources in
amounts adequate to finance our activities could be impaired by factors that
affect the financial services industry in general or us specifically, such as a
decline in the level of our business activity due to a market downturn or
adverse action taken against us by our regulators or our lenders. In this
regard, as noted above, we are currently precluded from accepting, renewing or
rolling over brokered deposits. These developments may require us to seek more
expensive funding sources to support our operations, which would adversely
affect our results of operations.





Concerns
of customers over deposit insurance may cause a decrease in
deposits.




With
recent increased concerns about bank failures, customers increasingly are
concerned about the extent to which their deposits are insured by the FDIC.
Customers may withdraw deposits in an effort to ensure that the amount they have
on deposit with their bank is fully insured. Decreases in deposits may adversely
our liquidity, funding costs, financial condition and results of
operations.




If our allowance for
loan losses is not sufficient to cover actual loan losses or if we are required
to increase our provision for loan losses, our results of operations and
financial condition could be materially adversely affected.




We make
various assumptions and judgments about the collectability of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans. In determining the amount of the allowance for loan losses, we review
our loans and the loss and delinquency experience, and evaluate economic
conditions. If our assumptions are incorrect, the allowance for loan losses may
not be sufficient to cover losses inherent in our loan portfolio, resulting in
the need for additions to our allowance through an increase in the provision for
loan losses. Material additions to the allowance or increases in our provision
for loan losses could have a material adverse effect on our financial condition
and results of operations.






39






In
addition, bank regulators periodically review our allowance for loan losses and
may require us to increase our provision for loan losses or recognize further
loan charge-offs. Any increase in our allowance for loan losses or loan
charge-offs as required by these regulatory authorities may have a material
adverse effect on our financial condition and results of
operations.




We
may suffer losses in our loan portfolio despite our underwriting
practices.




We seek
to mitigate the risks inherent in our loan portfolio by adhering to specific
underwriting practices. Although we believe that our underwriting criteria are
appropriate for the various kinds of loans we make, we may incur losses on loans
that meet our underwriting criteria, and these losses may exceed the amounts set
aside as reserves in our allowance for loan losses.




We may be required to
make further increases in our provisions for loan losses and to charge off
additional loans in the future, which could adversely affect our results of
operations.




For the
year ended December 31, 2008, we recorded a provision for loan losses of $7.9
million compared to $1.4 million for the year ended December 31, 2007, which
adversely affected our results of operations for 2008. We also recorded net loan
charge-offs of $3.5 million for the year ended December 31, 2008 compared to
none for the year ended December 31, 2007. Generally, our non-performing loans
and assets reflect operating difficulties of individual borrowers resulting from
weakness in the economy of Southern California. In particular, slowing sales in
certain housing markets have been a contributing factor to the increase in
non-performing loans as well as the increase in delinquencies, particularly in
our residential construction loan portfolio. The current slowdown in the housing
market may continue to cause housing inventories to increase and slow ongoing
housing developments, putting more downward pressure on sales prices. Despite
reduced sales prices, the lack of liquidity in the housing market and tightening
of credit standards within the banking industry may continue to diminish all
home sales, further reducing the borrower builder’s cash flow and weakening
their ability to repay their debt obligations to us. At December 31, 2008 our
impaired loans totaled $21.0 million compared to $2.5 million at December 31,
2007. While construction and land development loans represented 25.6% of our
total loan portfolio at December 31, 2008 they represented 75.4% of our impaired
loans at that date. If current trends in the housing and real estate markets
continue, we expect that we will continue to experience increased delinquencies
and credit losses. Moreover, to the extent the current economic recession
continues or worsens, we could experience significantly higher delinquencies and
loan losses. An increase in our loan losses or our provision for loan losses
would adversely affect our financial condition and results of operations,
perhaps materially.




A
further economic slowdown in Southern California could hurt our
business.




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






40






Downturns
in the Southern California real estate markets could hurt our
business.




Our
business activities and credit exposure are primarily concentrated in Southern
California. While we do not have any sub-prime loans, our construction and land
loan portfolios, our commercial and multifamily loan portfolios and certain of
our other loans have been affected by the downturn in the residential real
estate market that has continued into 2009. We anticipate that further declines
in the Southern California real estate markets will hurt our
business.  Substantially all of our real estate secured loan portfolio
currently consists of loans located in Southern California. If real estate
values continue to decline in this area, the collateral for our loans will
provide less security. As a result, our ability to recover on defaulted loans by
selling the underlying real estate will be diminished, and we would be more
likely to suffer losses on defaulted loans. The events and conditions described
in this risk factor could therefore have a material adverse effect on our
business, results of operations and financial condition.




Our loan portfolio is
concentrated in loans with a higher risk of loss.




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




We make
land purchase, lot development and real estate construction loans to individuals
and builders, primarily for the construction of residential properties and, to a
lesser extent, commercial and multi-family real estate projects. We originate
these loans whether or not the collateral property underlying the loan is under
contract for sale. Residential real estate construction loans include
single-family tract construction loans for the construction of entry level
residential homes.




This type
of lending contains the inherent difficulty in estimating both a property’s
value at completion of the project and the estimated cost (including interest)
of the project. If the estimate of construction cost proves to be inaccurate, we
may be required to advance funds beyond the amount originally committed to
permit completion of the project. If the estimate of value upon completion
proves to be inaccurate, we may be confronted at, or prior to, the maturity of
the loan with a project the value of which is insufficient to assure full
repayment. In addition, speculative construction loans to a builder are often
associated with homes that are not pre-sold, and thus pose a greater potential
risk to us than construction loans to individuals on their personal residences.
Speculative construction lending also typically involves higher loan principal
amounts and is often concentrated with a small number of builders. Loans on land
under development or held for future construction also poses additional risk
because of the lack of income being produced by the property and the potential
illiquid nature of the collateral. These risks can be significantly impacted by
supply and demand conditions. As a result, this type of lending often involves
the disbursement of substantial funds with repayment dependent on the success of
the ultimate project and the ability of the borrower to sell or lease the
property, or obtain permanent take-out financing, rather than the ability of the
borrower or guarantor themselves to repay principal and interest. At December
31, 2008, we had $34.5 million or 25.6% of total loans in construction and land
loans.




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




We
originate commercial and multi-family real estate loans for individuals and
businesses for various purposes which are secured by commercial properties.
These loans typically involve higher principal amounts than other types of
loans, and repayment is dependent upon income generated, or expected to be
generated, by the property securing the loan in amounts sufficient to cover
operating expenses and debt service, which may be adversely affected by changes
in the economy or local market






41






conditions.
For example, if the cash flow from the borrower’s project is reduced as a result
of leases not being obtained or renewed, the borrower’s ability to repay the
loan may be impaired. Commercial and multifamily mortgage loans also expose a
lender to greater credit risk than loans secured by residential real estate
because the collateral securing these loans typically cannot be sold as easily
as residential real estate. In addition, many of our commercial and multifamily
real estate loans are not fully amortizing and contain large balloon payments
upon maturity. Such balloon payments may require the borrower to either sell or
refinance the underlying property in order to make the payment, which may
increase the risk of default or non-payment.




If we
foreclose on a commercial and multi-family real estate loan, our holding period
for the collateral typically is longer than for one-to-four family residential
mortgage loans because there are fewer potential purchasers of the collateral.
Additionally, commercial and multi-family real estate loans generally have
relatively large balances to single borrowers or related groups of borrowers.
Accordingly, if we make any errors in judgment in the collectability of our
commercial and multi-family real estate loans, any resulting charge-offs may be
larger on a per loan basis than those incurred with our residential or consumer
loan portfolios. At December 31, 2008, we had $57.6 million or 42.9% of total
loans in commercial and multi-family mortgage loans.




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




Our
commercial loans are primarily made based on the identified cash flow of the
borrower and secondarily on the underlying collateral provided by the borrower.
The borrowers’ cash flow may be unpredictable, and collateral securing these
loans may fluctuate in value. Most often, this collateral is accounts
receivable, inventory, equipment or real estate. Credit support provided by the
borrower for most of these loans and the probability of repayment is based on
the liquidation of the pledged collateral and enforcement of a personal
guarantee, if any exists. As a result, in the case of loans secured by accounts
receivable, the availability of funds for the repayment of these loans may be
substantially dependent on the ability of the borrower to collect amounts due
from its customers. Other collateral securing loans may depreciate over time,
may be difficult to appraise and may fluctuate in value based on the success of
the business. At December 31, 2008, we had $36.6 million or 27.2% of total loans
in commercial business loans.




The maturity and
repricing characteristics of our assets and liabilities are mismatched and
subject us to interest rate risk which could adversely affect our results of
operations and financial condition.




Our
financial condition and results of operations are influenced significantly by
general economic conditions, including the absolute level of interest rates, as
well as changes in interest rates and the slope of the yield curve.




Our
activities, like other financial institutions, inherently involve the assumption
of interest rate risk. Interest rate risk is the risk that changes in market
interest rates will have an adverse impact on our financial condition and
results of operations. Interest rate risk is determined by the maturity and
repricing characteristics of our assets, liabilities and off-balance-sheet
contracts. Interest rate risk is measured by the variability of financial
performance and economic value resulting from changes in interest rates.
Interest rate risk is the primary market risk affecting our financial
performance.




We
believe that the greatest source of interest rate risk to us results from the
mismatch of maturities or repricing intervals for our rate sensitive assets,
liabilities and off-balance-sheet contracts. This mismatch, or “gap,“ is
generally characterized by a substantially shorter maturity structure for
interest-bearing liabilities than interest-earning assets. Additional interest
rate risk results from






42






mismatched
repricing indices and formulae (basis risk and yield curve risk), and product
caps and floors and early repayment or withdrawal provisions (option risk),
which may be contractual or market driven, that are generally more favorable to
customers than to us.




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




Departures of key
personnel or directors may impair our operations.




Our
success depends in large part on the services and efforts of our key personnel
and on our ability to attract, motivate and retain highly qualified employees.
Competition for employees is intense, and the process of locating key personnel
with the combination of skills and attributes required to execute our business
plan may be lengthy. In addition, we are currently required to notify the OCC in
advance prior to adding or changing any of our senior executive
officers.




We
face strong competition within our market areas.




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




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




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




We may
also be hindered in our ability to compete by certain regulatory restrictions
recently placed on us, including a prohibition on our total loans exceeding the
level of total loans on our balance sheet at December 31, 2008 until we have
adopted and implemented satisfactory credit and concentration risk management
processes, further limitations on our asset growth and restrictions on the
effective yield we can offer on deposits.






43






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. In addition, as noted above, the Bank’s
regulators have imposed further limits on its ability to make new
loans.




We
are subject to extensive government regulation and supervision.




We are
subject to extensive regulation and supervision. Banking regulations are
primarily intended to protect depositors’ funds, federal deposit insurance funds
and the banking system as a whole, and not holders of our common stock. These
regulations affect our lending practices, capital structure, investment
practices, dividend policy and growth, among other things. Congress and federal
regulatory agencies continually review banking laws, regulations and policies
for possible changes. Changes to statutes, regulations or regulatory policies,
including changes in interpretation or implementation of statutes, regulations
or policies, could affect us in substantial and unpredictable ways. Such changes
could subject us to additional costs, limit the types of financial services and
products we may offer and/or increase the ability of non-banks to offer
competing financial services and products, among other things. Failure to comply
with laws, regulations or policies could result in sanctions by regulatory
agencies, civil money penalties and/or reputational damage, which could have a
material adverse effect on our business, financial condition and results of
operations. While we have policies and procedures designed to prevent any such
violations, there can be no assurance that such violations will not occur. In
addition, we may be subject to new legislation in response to negative
developments in the financial industry and the economy, which also could have a
material adverse effect on our results of operations and financial
condition.




The
level of our commercial and construction real estate loan portfolio may subject
us to additional regulatory scrutiny.




The FDIC,
the Federal Reserve Board and the OCC, have promulgated joint guidance on sound
risk management practices for financial institutions with concentrations in
commercial real estate lending. Under the guidance, a financial institution
that, like us, is actively involved in commercial real estate lending should
perform a risk assessment to identify concentrations. A financial institution
may have a concentration in commercial real estate lending if, among other
factors, (i) total reported loans for construction, land development, and other
land represent 100% or more of total capital or (ii) total reported loans
secured by multifamily and non-farm residential properties, loans for
construction, land development and other land and loans otherwise sensitive to
the general commercial real estate market, including loans to commercial real
estate related entities, represent 300% or more of total capital. Management
should also employ heightened risk management practices including board and
management oversight and strategic planning, development of underwriting
standards, risk assessment and monitoring through market analysis and stress
testing. We have concluded that we have a concentration in commercial real
estate and construction lending under the foregoing standards. While we believe
we have implemented policies and procedures with respect to our commercial real
estate and construction loan portfolios consistent with this guidance, bank
regulators could require us to implement additional policies and procedures
consistent with their interpretation of the guidance which could result in
additional costs to us.






44







Our
real estate lending also exposes us to the risk of environmental
liabilities.





In the
course of our business, we may foreclose and take title to real estate, and
could be subject to environmental liabilities with respect to these properties.
We may be held liable to a governmental entity or to third persons for property
damage, personal injury, investigation and clean-up costs incurred by these
parties in connection with environmental contamination, or may be required to
investigate or clean up hazardous or toxic substances, or chemical releases at a
property. The costs associated with investigation or remediation activities
could be substantial. In addition, as the owner or former owner of a
contaminated site, we may be subject to common law claims by third parties based
on damages and costs resulting from environmental contamination emanating from
the property. If we ever become subject to significant environmental
liabilities, our business, financial condition and results of operations could
be materially and adversely affected. In addition, we may not have adequate
remedies against the prior owner or other responsible parties or could find it
difficult or impossible to sell the affected properties, which could also
materially adversely affect our business, financial condition and results of
operations.





A
natural disaster could harm our business.





Historically,
California has been susceptible to natural disasters, such as earthquakes,
floods and wildfires. These natural disasters could harm our operations through
interference with communications, including the interruption or loss of our
computer systems, which could prevent or impede us from gathering deposits,
originating loans and processing and controlling the flow of business, as well
as through the destruction of facilities and our operational, financial and
management information systems. Additionally, natural disasters could negatively
impact the values of collateral securing our loans and interrupt our borrowers’
abilities to conduct their businesses in a manner to support their debt
obligations, either of which could result in losses and increased provisions for
credit losses.





Changes
in accounting standards may affect our performance.




Our
accounting policies and methods are fundamental to how we record and report our
financial condition and results of operations. From time to time there are
changes in the financial accounting and reporting standards that govern the
preparation of our financial statements. These changes can be difficult to
predict and can materially impact how we report and record our financial
condition and results of operations. In some cases, we could be required to
apply a new or revised standard retroactively, resulting in restating prior
period financial statements.







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




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






45






Our
information systems may experience an interruption or breach in
security.




We rely
heavily on communications and information systems to conduct our business. Any
failure, interruption or breach in security of these systems could result in
failures or disruptions in our customer relationship management, general ledger,
deposit, loan and other systems. While we have policies and procedures designed
to prevent or limit the effect of the failure, interruption or security breach
of our information systems, there can be no assurance that any such failures,
interruptions or security breaches will not occur or, if they do occur, that
they will be adequately addressed. The occurrence of any failures, interruptions
or security breaches of our information systems could damage our reputation,
result in a loss of customer business, subject us to additional regulatory
scrutiny, or expose us to civil litigation and possible financial liability, any
of which could have a material adverse effect on our financial condition and
results of operations.




If
we fail to maintain an effective system of internal control over financial
reporting, we may not be able to accurately report our financial results or
prevent fraud, and, as a result, investors and depositors could lose confidence
in our financial reporting, which could materially adversely affect our
business, the trading price of our common stock and our ability to attract
additional deposits.




In
connection with the enactment of the Sarbanes-Oxley Act of 2002 and the
implementation of the rules and regulations promulgated by the SEC, we document
and evaluate our internal control over financial reporting in order to satisfy
the requirements of Section 404 of the Sarbanes-Oxley Act. This requires us to
prepare an annual management report on our internal control over financial
reporting, including among other matters, management’s assessment of the
effectiveness of internal control over financial reporting. If we fail to
identify and correct any deficiencies in the design or operating effectiveness
of our internal control over financial reporting or fail to prevent fraud,
current and potential shareholders and depositors could lose confidence in our
internal controls and financial reporting, which could materially adversely
affect our business, financial condition and results of operations, the trading
price of our common stock and our ability to attract additional deposits. In our
management’s report on internal control over financial reporting included in
this 10-K filing, we concluded that our internal control over financial
reporting was not effective as of December 31, 2008 due to a material weakness
identified in our policies relating to the determination of the allowance for
loan losses. See Item 9A(T). Controls and Procedures – Management’s Report on
Internal Control Over Financial Reporting.




We
will not pay dividends in the foreseeable future, and may never pay
dividends.




We do not
plan to pay cash dividends in the foreseeable future. The declaration and
payment of dividends is within the discretion of our Board of Directors. The
Board’s decision to declare and pay dividends, if any, is dependent upon the
Bank’s earnings, financial condition, its need to retain earnings for use in the
business and any other pertinent factors including various regulatory
requirements. The board of directors of the Bank intends to retain earnings to
promote growth and build capital and recover any losses incurred in prior
periods. The Bank is currently prohibited by the regulators from paying
dividends without regulatory approval until our accumulated deficit has been
eliminated. Accordingly, we do not expect to receive dividends from the Bank in
the foreseeable future. In addition, due to its undercapitalized status as of
March 31, 2009, the Bank is currently prohibited from paying
dividends.







46






Risks
Relating to Our Common Stock




The
price of our common stock may fluctuate significantly, and this may make it
difficult for you to resell the common stock when you want or at prices you find
attractive.




We cannot
predict how the shares of our common stock will trade in the future. The market
price of our common stock will likely continue to fluctuate in response to a
number of factors including the following, most of which are beyond our control,
as well as the other factors described in this "Risk Factors"
section:




·
            actual
      or anticipated quarterly fluctuations in our operating and financial
      results;


·
            developments
      related to investigations, proceedings or litigation that involve
      us;


·
            actions
      taken against us by regulatory
authorities;


·
            actions
      of our current shareholders, including sales of common stock by existing
      shareholders and our directors and executive
  officers;


·
            fluctuations
      in the stock price and operating results of our
    competitors;


·
            regulatory
      developments; and


·
            developments
      related to the financial services
industry.





Our
shares do not at this time qualify for listing on any national securities
exchange, and we cannot assure you that our shares will ever be listed on a
national securities exchange. Prior to the close of trading on May 18, 2009, our
shares were traded on the OTC Bulletin Board and at least one company made a
market in our common stock. After the close of trading on May 18, 2009, our
common stock was removed from the OTC Bulletin Board because we had not filed
our 2008 10-K by that date. Our common stock is currently traded in the pink
sheets. While one or more market makers may apply for the reinstatement of our
common stock to the OTC Bulletin Board after we have filed our Quarterly Report
on Form 10-Q for the quarter ended March 31, 2009, no assurance can be given
that such an application will be made or, if made, whether or when the
application will be accepted. As a result of the removal of our common stock
from the OTC Bulletin Board, our common stock may become more volatile and less
liquid, our shareholders could find it more difficult to dispose of, or to
obtain accurate quotations as to the market value of, our common stock, and the
market value of our common stock could continue to decline.




Because
the shares are not listed on a national securities exchange, a broadly followed,
established trading market for our common stock may never develop or be
maintained. This limited trading market for our common stock may further reduce
the market value of the common stock and make it difficult to buy or sell our
shares on short notice. The limited trading market could also result in a wider
spread between the bid and ask price for the stock, meaning the highest price
being offered for shares for sale at any particular time may be further from the
lowest price being offered by buyers for the stock at the moment than if the
stock were more actively traded (the difference between the bid and ask price
being the “spread“ for the stock). This could make it more difficult to sell a
large number of shares at on time and could mean the sale of a large number of
shares at one time could depress the market price.




The
market price of our common stock may also be affected by market conditions
affecting the stock markets in general. These conditions may result in
(i) volatility in the level of, and fluctuations in, the market prices of
stocks generally and, in turn, our common stock and (ii) sales of
substantial amounts of our common stock in the market, in each case that could
be unrelated or disproportionate to changes in our operating performance. These
broad market fluctuations may adversely affect the market prices of our common
stock. For these reasons, our common stock may not be appropriate as a
short-term investment, and you should be prepared to hold our common stock
indefinitely.






47








There
may be future sales of additional common stock or other dilution of our equity,
which may adversely affect the market price of our common stock.




The OCC
has required us to develop a plan to substantially increase our regulatory
capital ratios in excess of the regulatory minimums, which may involve our
issuance of securities. We are not restricted from issuing additional common
stock, including any debt securities that are convertible into or exchangeable
for, or that represent the right to receive, common stock or any substantially
similar securities. The market price of our common stock could decline as a
result of sales by us of a large number of shares of common stock or similar
securities in the market after this offering or the perception that such sales
could occur.




The
federal banking laws limit the ownership of our common stock.




Because
we are a bank holding company, purchasers of 10% or more of our common stock may
be required to obtain approvals under the Change in Bank Control Act of 1978, as
amended, or Bank Holding Company Act of 1956, as amended (and in certain cases
such approvals may be required at a lesser percentage of ownership).
Specifically, under regulations adopted by the Federal Reserve, (a) any other
bank holding company may be required to obtain the approval of the Federal
Reserve to acquire or retain 5% or more of the common stock and (b) any person
other than a bank holding company may be required to obtain the approval of the
Federal Reserve to acquire or retain 10% or more of the common
stock.




Our
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 May
13, 2009, our directors and executive officers owned 302,135 shares of our
common stock, which represents approximately 11.68% of our issued and
outstanding common stock. Additionally, we have issued warrants and stock
options to our directors and stock options to our executive officers. If our
directors and executive officers exercised all of their warrants and stock
options, they would own shares upon exercise representing approximately 18.90%
of our then outstanding common stock.




Due to
their significant ownership interests, our directors and executive officers may
be able to exercise significant influence over our management and business
affairs. 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 other shareholders.




Our
articles of incorporation and bylaws and the laws of the State of California
contain provisions that could make a takeover more difficult.




Our
articles of incorporation and bylaws, and the corporate laws of the State of
California, include provisions designed to provide our board of directors with
time to consider whether a hostile takeover offer is in our and our
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 our shares.




These
provisions include the availability of authorized, but unissued shares, for
issuance from time to time at the discretion of our board of directors; bylaw
provisions enabling the board of directors to increase the size of the board and
to fill the vacancies created by the increase; and 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.






48






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 our
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.




The securities
purchase agreement between us and the U.S. Treasury limits our ability to pay
dividends on and repurchase our common stock.




On January 16, 2009, we issued
$4.12 million in
liquidation amount of our Series A and Series B preferred stock to the U.S.
Treasury pursuant to the TARP Capital Purchase Program. The securities purchase
agreement between us and the Treasury provides that unless the shares of
the preferred stock have been transferred or redeemed by us in whole, (i) until
the third anniversary of the Treasury’s investment in our preferred stock, any
dividends on our common stock are prohibited without the prior approval of the
Treasury, (ii) after the third anniversary and prior to the tenth anniversary of
the Treasury’s investment, any increase in dividends on our common stock (if we
then pay dividends on our common stock) of more than 3% per annum are prohibited
without the Treasury’s prior approval and (iii) after the tenth anniversary of
the Treasury’s investment, dividends on our common stock are prohibited. In
addition, unless the shares of preferred stock have been transferred or redeemed
in whole, (i) until the tenth anniversary of the Treasury’s investment, the
Treasury’s consent is required for any share repurchases other than repurchases
of the preferred stock and repurchases of shares of junior preferred stock or
shares of common stock in connection with any benefit plan in the ordinary
course of business and consistent with past practice and (ii) after the tenth
anniversary of the Treasury’s investment, any such repurchases are prohibited.
Furthermore, we may not pay any
dividends on our common stock unless we are current in our dividend payments onthe preferred stock issued
to the Treasury. On May 14, 2009, we notified the Treasury that we would not be
paying dividends on the preferred stock issued to the Treasury on the May 15,
2009 scheduled dividend payment date. Accordingly, at this time we
arenot current in our dividend payments on
the preferred stock issued to the Treasury.




These restrictions could have a negative
effect on the value of our common stock.





The Series A and Series B Preferred
Stock issued in January 2009 impacts net income (loss) available to our common
stockholders and earnings (loss) per common share.




The dividends declared on the Series A
and Series B preferred stock will reduce the net income (loss) available to
common stockholders and our earnings (loss) per common share. The Series A and Series B preferred
stock will also receive preferential treatment in the event of liquidation,
dissolution or winding up of Pacific Coast National
Bancorp.





Holders of the Series A and Series B
Preferred Stock issued in January 2009 have limited voting
rights.




Until and unless we are in arrears on
our dividend payments on the Series A and Series B preferred stock for six
dividend periods, whether or not consecutive, the holders of the Series A and
Series B preferred stock will have novoting rights except with respect to
certain fundamental changes in the terms of the Series A and Series B preferred
stock and certain other matters and except as may be required by California law.
If, however, dividends on the Series A and Series B preferred stock are not paid in full for six
dividend periods, whether or not consecutive, the total number of positions on
the






49








Pacific Coast National Bancorp Board of
Directors will increase by two and the holders of the Series A and Series B
preferred stock,acting as a class with any other parity
securities having similar voting rights, will have the right to elect two
individuals to serve in the new director positions. This right and the
terms of such directors will end when we have paid in full all
accruedand unpaid dividends for all past
dividend periods. As noted above, on May 14, 2009, we notified the Treasury that
we would not be paying dividends on the Series A and Series B preferred stock on
the May 15, 2009 scheduled dividend payment date.
















50


Item 1B. Unresolved Staff
Comments




None.




Item
      2.
            Properties




The Bank
maintains two locations. Its main branch location, which is also the principal
executive office of the Company, is located at 905 Calle Amanecer, Suite 100,
San Clemente, California 92673. The Bank occupies 10,130 square feet of the main
lobby-accessed ground floor of a 45,000 square foot, freestanding, three-story
office building. The Bank also operates a branch office located at the
intersection of North El Camino Real and Garden View in Encinitas, California,
which is approximately 37 miles south of the main office. The branch office
occupies 4,284 square feet in a commercial building in a developed commercial
center. The Bank has entered into lease agreements with respect to each of the
banking locations. The aggregate commitments under the leases are set forth in
the notes to the audited financial statements included in this Form 10-K. 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




A special
meeting of the Company’s shareholders was held on January 15, 2009, at which the
Company’s shareholders voted on a proposal to amend the Company’s certificate of
incorporation to authorize the issuance of up to 1,000,000 shares of preferred
stock. Set forth below are the results of the vote on that matter, shown in
number of shares and as a percentage of the total shares outstanding, which was
approved by the Company’s shareholders:




Votes
For: 1,578,270 shares or 62.0%      Votes
Against: 64,260 shares or 2.5%




Abstentions:
24,250 or 1.0%       Broker Non-Votes:
0









PART
II




Item
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities




Market
Price of Common Stock




Prior to
the close of trading on May 18, 2009, the Company’s common stock was traded over
the counter on the OTC Bulletin Board under the symbol “PCST.OB“. After the
close of trading on May 18, 2009, the Company’s common stock was removed from
the OTC Bulletin Board because we had not filed






51






our 2008
10-K by that date. The Company’s common stock is currently traded in the pink
sheets. While one or more market makers may apply for the reinstatement of the
Company’s common stock to the OTC Bulletin Board after the Company has filed its
Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, no assurance
can be given that such an application will be made or, if made, whether or when
the application will be accepted.  Continental Stock Transfer &
Trust Company is the Company’s transfer agent and registrar, and is able to
respond to inquiries from shareholders on its website: www.continentalstock.com
or at its mailing address: 17 Battery Place, 8th Floor, New York, New York,
10004. The following table sets forth the high and low sales prices of the
Company’s common stock for the periods indicated below.


Year Ended December 31,
      2008:
                High
                
                LowFirst
    Quarter
                
                $         7.25
                
                $         5.25Second
    Quarter
                6.75
                
                4.50Third
    Quarter
                
                5.00
                
                3.05Fourth
    Quarter
                7.00
                
                2.85Year Ended December 31,
      2007:
                High
                
                LowFirst
    Quarter
                
                $       12.00
                
                $         9.60Second
    Quarter
                11.00
                
                9.85Third
    Quarter
                
                10.00
                
                8.75Fourth
    Quarter
                9.00
                
                6.50








Holders




As of
March 31, 2009, there were approximately 531 holders of record of the Company’s
common stock.




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 build capital and to recover
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. In addition, because the Bank was undercapitalized under regulatory
capital guidelines as of March 31, 2009, it is currently prohibited from paying
dividends. For additional discussion of legal and regulatory restrictions on the
payment of dividends, see “Part I – Item 1. Description of Business –
Supervision and Regulation.“




52


On January 16, 2009,as part of
the TARP Capital Purchase Program of the United States Department of the
Treasury, the Company sold to the Treasury 4,120 shares of the Company’s Fixed
Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A preferred
stock“), having a liquidation preference amount of $1,000 per share, for a
purchase price of $4,120,000 in cash and (ii) issued to the Treasury a warrant
(the “Warrant“) to purchase 206.00206 shares of the Company’s Fixed Rate
Cumulative Perpetual Preferred Stock, Series B (the “Series B preferred stock“),
at an exercise price of $0.01 per share. Immediately after the issuance of the
Warrant, the Treasury exercised the Warrant in a cashless exercise resulting in
the net issuance of 206 shares of the Series B preferred Stock, having a
liquidation preference amount of $1,000 per share, to the Treasury. The Series A
preferred stock entitles its holder(s) to cumulative dividends on the
liquidation preference amount on a quarterly basis at a rate of 5% per annum for
the first five years, and 9% per annum thereafter. The Series B preferred stock
entitles its holder(s) to cumulative dividends on the liquidation preference
amount on a quarterly basis at a rate of 9% per annum from the date of
issuance.







The securities purchase agreement
between us and the Treasury provides that unless the shares of the
preferred stock have been transferred or redeemed by us in whole, (i) until the
third anniversary of the Treasury’s investment in our preferred stock, any
dividends on our common stock are prohibited without the prior approval of the
Treasury, (ii) after the third anniversary and prior to the tenth anniversary of
the Treasury’s investment, any increase in dividends on our common stock (if we
then pay dividends on our common stock) of more than 3% per annum are prohibited
without the Treasury’s prior approval and (iii) after the tenth anniversary of
the Treasury’s investment, dividends on our common stock are prohibited. In
addition, unless the shares of preferred stock have been transferred or redeemed
in whole, (i) until the tenth anniversary of the Treasury’s investment, the
Treasury’s consent is required for any share repurchases other than repurchases
of the preferred stock and repurchases of shares of junior preferred stock or
shares of common stock in connection with any benefit plan in the ordinary
course of business and consistent with past practice and (ii) after the tenth
anniversary of the Treasury’s investment, any such repurchases are prohibited.
Furthermore, we may not pay any
dividends on our common stock unless we are current in our dividend payments on
the preferred stock issued to the Treasury. On May 14, 2009, we notified the
Treasury that we would not be paying dividends on the preferred stock issued to the Treasury on
the May 15, 2009 scheduled dividend payment date. Accordingly, at this time we
are not current in our dividend payments on the preferred stock issued to the
Treasury.




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.  The following table sets
forth information as of December 31, 2008 regarding that plan.






53







Equity Compensation Plan
      InformationPlan
    Category
                Number of Securities to be issued
      upon exercise of outstanding options, warrants, and
      rights
                Weighted-average exercise price of
      outstanding options, warrants and rights
                Number of securities remaining
      available for future issuance under equity compensation plans (excluding
      securities reflected in column (a))(a)
                (b)
                ( c)Equity compensation plans approved
      by security holders
                671,249
                $                     9.74
                94,201Equity compensation plans not
      approved by security holders
                -
                -
                -Total
                671,249
                $                     9.74
                94,201








Item 6.
            Selected
      Financial Data




Not
required.









Item 7.
            Management’s Discussion and Analysis of Financial Condition and Results of
      Operations




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




General




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




Our
principal markets include the coastal regions of Southern Orange County and
Northern San Diego County. As of December 31, 2008, on a consolidated basis, we
had total assets of $142.9 million, net loans of $128.3 million, total deposits
of $137.2 million and shareholders’ equity of $5.3 million. We currently operate
through our main branch office located at 905 Calle Amanecer in San Clemente,
California and a branch office at 499 North El Camino Real in Encinitas,
California.






54








Our
principal business consists of attracting retail deposits from the general
public and investing those funds, along with borrowed funds, in commercial real
estate loans, construction and development loans, commercial loans and to a
lesser extent, consumer loans, including residential second mortgage loans. The
Bank offers a broad array of deposit services including demand deposits, regular
savings accounts, money market accounts, certificates of deposit and individual
retirement accounts.




We are
significantly affected by prevailing economic conditions as well as government
policies and regulations concerning, among other things, monetary and fiscal
affairs, housing and financial institutions. Deposit flows are influenced by a
number of factors, including interest rates paid on competing time deposits,
other investments, account maturities, and the overall level of personal income
and savings. Lending activities are influenced by the demand for funds, the
number and quality of lenders, and regional economic cycles. Sources of funds
for lending activities of the Bank include primarily deposits, payments on loans
and income provided from operations.




Our
results of operations are primarily dependent upon our net interest income,
which is the difference between interest income and interest expense. Interest
income is a function of the balances of loans and investments outstanding during
a given period and the yield earned on these loans and investments. Interest
expense is a function of the amount of deposits and borrowings outstanding
during the same period and interest rates paid on these deposits and borrowings.
Our results of operations are also affected by our provision for loan losses,
service charges and fees, gains from sales of loans, commission income, other
income, operating expenses and income taxes.




Recent
Events




The
global and U.S. economies, and the economy of the local communities in which we
operate, experienced a rapid decline in 2008. The financial markets and the
financial services industry in particular suffered unprecedented disruption,
causing many financial institutions to fail or require government intervention
to avoid failure. These conditions were brought about largely by the erosion of
U.S. and global credit markets, including a significant and rapid deterioration
of the mortgage lending and related real estate markets. This deterioration was
extremely dramatic in the fourth quarter of 2008. This deterioration led to a
substantial increase in classified assets of the Bank. As a result of the
significant increase in the classified assets in the fourth quarter of 2008, an
additional provision for loan loss of $6.8 million was recorded compared to $1.1
million recorded in the first three quarters of 2008. This deterioration also
led to the regulatory requirements and restrictions placed on us in
2009.  See “Item 1. Business-Regulatory Restrictions.”




Overview
of Financial Condition and Results of Operations




We
incurred a net loss for 2008 of ($8.8) million or ($3.74) per share, as compared
to a net loss of ($4.0) million, or ($1.77) per share, during 2007. The increase
in loss per share for the year was primarily attributable to a 574% increase in
the provision for loan losses and an increase of 5% in non-interest expenses
which is net of a reduction in non-cash expense related to our adoption of FAS
123R to $195 thousand in 2008 compared to $770 thousand for 2007. These
increases in expenses were offset by an increase of 54% in net interest income
and a 42% increase in non-interest income. The 2008 loss resulted in a return on
average assets of (6.6%) and a return on average equity of (75.7%). The 2007
loss resulted in a return on average assets of (5.3%) and a return on average
equity of (28.1%).




During
2008, our net interest margin narrowed and the level of our nonperforming loans
increased substantially. These trends are primarily attributable to
nonperforming residential construction loans, the effect of declining short-term
interest rates and the economic slowdown that began during this period. As rates
have declined, our yields on adjustable rate loans also declined. This decline
was






55






compounded
by the adverse effect of a significant increase in the level of non-accrual
loans and other nonperforming assets. Reflecting these generally lower market
interest rates as well as the changes in our asset mix and a higher level of
non-accrual loans, the yield on earning assets for the year ended December 31,
2008 decreased by 99 basis points compared to the year ended December 31, 2007,
while funding costs for the year ended December 31, 2008 decreased by 122 basis
points compared to the year ended December 31, 2007. Our net interest rate
spread increased to 3.39% for the year ended December 31, 2008 as compared to
3.16% for the year ended December 31, 2007. Importantly, during the first half
of this year, the Federal Reserve was aggressively lowering short-term interest
rates. Due to the aggressive lowering of interest rates by the Federal Reserve
Board, we anticipate continued compression of our net interest margin. In
addition, to the extent the current economic recession continues or deepens, our
nonperforming assets may increase, further negatively impacting our results of
operations.




In
response to the challenging economic environment and the regulatory requirements
and restrictions recently imposed on us (see “Item 1. Business—Regulatory
Restrictions“), we plan to take a number of tactical actions aimed at preserving
existing capital, reducing our lending exposures and associated capital
requirements and increasing liquidity. The tactical actions include, but are
not limited to the following: slowing loan originations, growing retail
deposits, reducing brokered deposits, seeking commercial loan participation and
sales arrangements with other lenders or private equity sources and reducing
operating costs. Our goal is to achieve profitability by controlling our growth,
stabilizing our losses, managing our problematic assets and reducing overall
expenses. We are working on the following four primary objectives as a
basis for long-term success of our franchise:





·
            Improve
      Asset Quality.We have taken proactive steps to resolve our
      non-performing loans, including negotiating repayment plans, forbearances,
      loan modifications and loan extensions with our borrowers when
      appropriate. We also have established a separate department to monitor and
      attempt to reduce our exposure to a further deterioration in asset
      quality. We plan to apply more conservative underwriting practices to our
      new loans, including, among other things, requiring more detailed credit
      information in certain circumstances, increasing the amount of required
      collateral or equity requirements and reducing loan-to-value
      ratios.




·
            Control
      Asset Growth and Improve Regulatory Capital Ratios.We plan to
      control our asset growth which should help reduce our risk profile and
      improve capital ratios through reductions in the amount of outstanding
      loans and securities through a slowing of loan originations and through
      normal principal amortization, and a corresponding reduction of
      liabilities. We may also seek commercial loan participation and sales
      arrangements with other lenders or private equity sources. As noted under
      “Regulatory Restrictions,“ we are currently prohibited from increasing our
      loans above the level as of December 31, 2008 until we have adopted and
      implemented satisfactory credit and concentration risk management
      processes




·
            Continued
      Expense Control.We will make it a priority to identify cost
      savings opportunities throughout all phases of
  operations.




·
            Increase
      Core Deposits and Other Retail Deposit Products.We will seek to
      increase core deposits and other retail deposit products. As noted under
      “Regulatory Restrictions,“ we are currently prohibited from accepting,
      renewing or rolling over brokered
deposits.




We are
also evaluating various
strategic options, including capital raising alternatives, the sale of our
Encinitas branch office and a sale or merger of our company. In this regard, we
have been in extensive discussions with several parties regarding the
possibility of a substantial equity investment in






56






the
Company, which could also entail a rights offering to existing shareholders, or
a possible sale of the Company. While we plan to focus on the tactical actions
described about and pursue strategic alternatives, as has been widely publicized, access to
capital markets is extremely limited in the current economic environment, and we
can give no assurances thatour efforts will be successful and will
result in sufficient capital preservation or infusion.Our ability to decrease our levels of
non-performing assets is also vulnerable to market conditions as our
construction loan borrowers rely on an active real estate market as a source of
repayment, and the sale of loans in this market is difficult. If the real estate
market does not improve, our level of non-performing assets may continue to
increase.





While we
believe that we are taking
appropriate steps to respond to these economic risks and regulatory actions,
further deterioration in the economic environment or additional regulatory
actions could adversely affect our operations.




Critical
accounting policies




Our
accounting policies are integral to understanding the results reported. In
preparing our consolidated financial statements, we are required to make
judgments and estimates that may have a significant impact upon our reported
financial results. Certain accounting policies require us to make significant
estimates and assumptions, which have a material impact on the carrying value of
certain assets and liabilities, and are considered critical accounting policies.
The estimates and assumptions used are based on historical experiences and other
factors, which are believed to be reasonable under the circumstances. Actual
results could differ significantly from these estimates and assumptions, which
could have a material impact on the carrying value of assets and liabilities at
the balance sheet dates and results of operations for the reporting periods. For
example, our determination of the adequacy of our allowance for loan losses is
particularly susceptible to management’s judgment and estimates. The following
is a brief description of our current accounting policies involving significant
management valuation judgments.




Allowance
for loan losses




The
allowance for loan losses represents management’s best estimate of probable
losses inherent in the existing loan portfolio. The allowance for loan losses is
increased by the provision for loan losses charged to expense and reduced by
loans charged off, net of recoveries. The provision for loan losses is
determined based on management’s assessment of several factors including, among
others, the following: 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 experiences, the levels of classified and nonperforming
loans and the results of regulatory examinations.





The
adequacy of the allowance is determined using two different methods to determine
a range for which the allowance is recorded. The first method is an analysis of
the portfolio by segment or loan type, and involves classifying the loans by
type and applying historical loss rates using an 8 year rolling average
determined from Call Report data for all banks obtained from the Federal Reserve
Board website. To this number is added specific reserves for impaired loans as
established by management. The second method involves classifying the portfolio
by risk weighting and applying a loss factor for each rating, which includes
loans classified as substandard, substandard non-accrual, and doubtful. Again,
the related






57






reserves
for loans classified as impaired are added to arrive at a total allowance, which
by Board policy must be at least 90% of the higher calculation under the two
methods. In addition, qualitative, or “Q“, factors are used to adjust the
general allowance. These Q factors include changes in lending policies and
procedures, in national and local economic conditions, in the nature and volume
of the loan portfolio, in the tenure of the lending staff, in the non-performing
loans, and in the quality of the loan review system. In addition, the existence
and effect of concentrations within the portfolio and the effect of external
factors are also taken into account





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




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





Loans are
considered impaired if, based on current information and events, it is probable
that the Company 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 the fair value of the collateral, less
estimated costs to dispose of the asset. 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 condition of the various markets in which
collateral may be sold may all affect the required level of the allowance for
loan losses and the associated provision for loan losses.




Deferred
Taxes




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






58







Ability
to Continue as Going Concern





Our
independent registered public accounting firm in their audit report for fiscal
year 2008 has expressed substantial doubt about our ability to continue as a
going concern, noting in their report that we have suffered significant losses
from operations since inception, had an accumulated deficit of $20.8 million as
of December 31, 2008 and have regulatory capital deficiencies that must be
addressed. Continued operations may depend on our ability to comply with the
requirements our regulators have imposed on us (discussed below) and the
financing or other capital required to do so may not be available or may not be
available on acceptable terms. Our audited financial statements were prepared
under the assumption that we will continue our operations on a going concern
basis, which contemplates the realization of assets and the discharge of
liabilities in the normal course of business. Our financial statements do not
include any adjustments that might be necessary if we are unable to continue as
a going concern.





The following discussion focuses on our financial condition and results
of operations as of and for the years ended December 31, 2008 and 2007,
presented on a consolidated basis.




Comparison
of Results of Operations for the Years Ended December 31, 2008 and
2007.




Net
Interest Income and Net Interest Margin




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




Net
interest income for 2008 before the provision for loan losses was $5.4 million
compared to $3.5 million for 2007. This growth was attributable to the increase
in the volume of earning assets and the greater percentage of loans as a part of
earning assets in 2008.




During
2008, loans accounted for 93% of average earning assets, with a weighted average
yield of 6.88%, compared to 2007 when 81% of the average earning assets were
loans, with a weighted average yield of 8.08%. The increase in loans as a
percentage of average earning assets occurred as a result of significantly
increased loan originations in 2008 and a reduction in fed funds sold in 2008 in
order to provide funding for the loan growth. The decrease in the average yield
resulted from the overall decrease in market rates resulting from the interest
rate cuts made by the Federal Reserve Board. Total loan interest income was $8.2
million, including net loan fees of $450 thousand, for 2008 compared to $4.8
million in total loan interest income, including $24 thousand in loan fees, in
2007. The increase in net loan fees resulted from increased loan brokering
activities in 2008 compared to the prior year.




Other
earning assets consist of investments, capital stock of the Federal Reserve
Bank, time deposits with other financial institutions and overnight fed funds.
Also, in 2008 the Federal Reserve Bank began paying nominal interest on reserve
balances. Fed funds sold averaged $8.9 million in 2008 with an average yield of
2.11% compared to an average of $10.7 million in 2007 with an average yield of
5.24%.






59








The
decrease in the rate in 2008 compared to 2007 was the result of decreases in
rates set by the Federal Reserve Board. Investments, capital stock of the
Federal Reserve Bank, and time deposits with other financial institutions
averaged $498 thousand with a yield of 5.16% for 2008 compared to 2007 with an
average of $3.3 million with a yield of 5.06%. The yield increased in 2008 due
to the elimination of lower-yielding investment securities. The average yield on
Federal Reserve Bank and Other Securities decreased due to the introduction of
interest paid on reserve balances, at a yield of approximately 50 basis points.
Total interest earned on other earning assets was $26 thousand in 2008 compared
to $38 thousand in 2007 due to lower market interest rates.




Interest-bearing
liabilities, consisting of deposits and fed funds purchased averaged $95.9
million with an average rate of 3.15% during 2008, compared with $45.4 million
in interest-bearing deposits at a rate of 4.37% for 2007. Total interest expense
was $3.0 million in 2008 compared to $2.0 million in 2007. The decrease in the
average rate on deposit products was the result of general decrease in market
rates and the repricing of $37 million in time deposit maturities during 2008.
The increases in deposits during 2008 occurred as a result of our marketing
campaigns, the cross-selling of deposit products to our borrowers, direct sales
calls and utilization of brokered deposits in order to fund increased loan
demand.




As of
December 31, 2008, $35.6 million in brokered funds were on deposit with an
average rate of 2.87%. Total interest expense for these deposits was $955
thousand in 2008. These deposits are included in Time Deposits of $100,000 and
greater for $400 thousand and Other Time certificates of deposits for $35.2
million. As of December 31, 2007, $28.2 million in brokered funds were on
deposit with an average rate of 4.94%. Total interest expense for these deposits
was $331 thousand in 2007. These deposits are included in Other Time certificate
of deposits. Because we were “undercapitalized“ under regulatory capital
guidelines as of March 31, 2009, we are currently prohibited from accepting,
renewing or rolling over brokered deposits. See “Item 1. Business-Regulatory
Restrictions.“




The net
interest margin was 4.19% for 2008 compared to 4.81% for 2007. Non-interest
bearing demand account balances averaged $23.9 million for 2008, representing
20.0% of total deposits as compared to $16.9 million, representing 27.1% of
total deposits for 2007. While the dollar amount of demand deposits has
continually increased, the percentage of demand deposits to total deposits has
decreased. This is the result of an increase in money market accounts in
response to the variable-rate account and the increase in time deposits to
maintain liquidity as the loan portfolio has grown.




We earned
$5.4 million in net interest income on average interest-earning assets of $128.6
million for 2008 compared to $3.5 million in net interest income on $72.9
million in average earning assets for 2007. Net interest income before provision
for loan losses increased by $1.9 million due primarily to the increase in
volume of earning assets, and decreased by $264 thousand due primarily to lower
interest rates.




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







60







2008
                                                                                                                                
                                                                                                                                
                                                                                                                                2007Average Balance
                                                                                                                                
                                                                                                                                
                                                                                                                                Interest
                                                                                                                                
                                                                                                                                
                                                                                                                                Average
      Yield / Cost
                                                                                                                                
                                                                                                                                
                                                                                                                                Average Balance
                                                                                                                                
                                                                                                                                
                                                                                                                                Interest
                                                                                                                                
                                                                                                                                
                                                                                                                                Average
      Yield / CostAssets:
                                                                                                                                
                                                                                                                                ($
      in thousands)Interest-earning
      Assets:Net
      Loans Receivable (1)(2)
                                                                                                                                
                                                                                                                                $
                                                                                                                                119,215
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                8,200
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                6.88
                                                                                                                                %
                                                                                                                                
                                                                                                                                $
                                                                                                                                58,873
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                4,759
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                8.08
                                                                                                                                %Investment
      Securities
                                                                                                                                
                                                                                                                                
                                                                                                                                -
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                -
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                2,648
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                128
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.85
                                                                                                                                %Investment
      in capital stock of Federal Reserve Bank and Other
      Investments
                                                                                                                                
                                                                                                                                
                                                                                                                                498
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                26
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                5.16
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                656
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                39
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                5.95
                                                                                                                                %Fed
      funds sold
                                                                                                                                
                                                                                                                                
                                                                                                                                8,928
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                188
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                2.11
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                10,725
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                562
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                5.24
                                                                                                                                %Total
      interest-earning assets
                                                                                                                                
                                                                                                                                
                                                                                                                                128,641
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                8,414
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                6.54
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                72,902
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                5,488
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                7.53
                                                                                                                                %Noninterest-earning
      assets
                                                                                                                                
                                                                                                                                
                                                                                                                                3,483
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                3,763Total
      Assets
                                                                                                                                
                                                                                                                                $
                                                                                                                                132,124
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                76,665Liabilities
      and Stockholders' EquityMoney
      Market and Savings Deposits
                                                                                                                                
                                                                                                                                $
                                                                                                                                48,269
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                1,165
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                2.41
                                                                                                                                %
                                                                                                                                
                                                                                                                                $
                                                                                                                                29,390
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                1,301
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.43
                                                                                                                                %Interest-bearing
      Checking
                                                                                                                                
                                                                                                                                
                                                                                                                                4,100
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                53
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                1.29
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                3,161
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                42
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                1.33
                                                                                                                                %Time
      Deposits of $100,000 or more
                                                                                                                                
                                                                                                                                
                                                                                                                                4,324
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                185
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.28
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                3,114
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                163
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                5.23
                                                                                                                                %Other
      Time Deposits
                                                                                                                                
                                                                                                                                
                                                                                                                                39,155
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                1,614
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.12
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                9,752
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                478
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.90
                                                                                                                                %Fed
      funds purchased
                                                                                                                                
                                                                                                                                
                                                                                                                                99
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                2
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                2.02
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                -
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                -Total
      Interest-bearing liabilities
                                                                                                                                
                                                                                                                                
                                                                                                                                95,947
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                3,019
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                3.15
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                45,417
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                1,984
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.37
                                                                                                                                %Non-interest
      bearing checking accounts
                                                                                                                                
                                                                                                                                
                                                                                                                                23,920
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                16,866Non-interest
      bearing liabilities
                                                                                                                                
                                                                                                                                
                                                                                                                                663
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                448Stockholders'
      Equity
                                                                                                                                
                                                                                                                                
                                                                                                                                11,594
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                13,934Total
      Liabilities andStockholders'
      Equity
                                                                                                                                
                                                                                                                                $
                                                                                                                                132,124
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                76,665Net
      Interest Income
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                5,395
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                $
                                                                                                                                3,504Net
      Interest Spread (3)
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                3.39
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                3.16
                                                                                                                                %Net
      Interest Margin (4)
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.19
                                                                                                                                %
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                4.81
                                                                                                                                %




(1)
            Loan
      fees are included in total interest income as follows: 2008 $450 thousand;
      2007 $24 thousand.




(2)
            Amount
      includes nonaccrual loans.




(3)
            Net
      interest spread represents the yield earned on average total
      interest-earning assets less the rate paid on average interest-bearing
      liabilities.




(4)
            Net
      interest margin is computed by dividing the annualized net interest income
      by average total interest-earning
assets.






61







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 2008 compared
to 2007. Because of the Bank’s growth in 2008, changes due to volume account for
a significant majority of the overall change. Information is provided in each
category with respect to (i) changes attributable to changes in volume (changes
in volume multiplied by prior rate), (ii) changes attributable to changes in
rate (changes in rate multiplied by prior volume), and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated to the changes due to volume.




Year Ended December 31, 2008
      Compared to December 31, 2007Increase/(Decrease)  in
      Net Interest IncomeDue ToRate
                                    
                                    
                                    Volume
                                    
                                    
                                    Net($
      in thousands)Interest-earning
      Assets:Net Loans Receivable
                                    
                                    $
                                    (709
                                    )
                                    
                                    $
                                    4,150
                                    
                                    
                                    $
                                    3,441Investment Securities
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (128
                                    )
                                    
                                    
                                    (128
                                    )Investment in capital stock of
                                      Federal Reserve Bank and Other Investments
                                    
                                    
                                    (5
                                    )
                                    
                                    $
                                    (8
                                    )
                                    
                                    
                                    (13
                                    )Fed Funds
                                    
                                    
                                    (336
                                    )
                                    
                                    $
                                    (38
                                    )
                                    
                                    
                                    (374
                                    )Total
                                    
                                    
                                    (1,050
                                    )
                                    
                                    
                                    3,976
                                    
                                    
                                    
                                    2,926Noninterest-earning
      assetsTotal AssetsLiabilities and Stockholders'
      EquityMoney Market and Savings Deposits
                                    
                                    
                                    (592
                                    )
                                    
                                    $
                                    456
                                    
                                    
                                    
                                    (136
                                    )Interest-bearing Checking
                                    
                                    
                                    (1
                                    )
                                    
                                    $
                                    12
                                    
                                    
                                    
                                    11Time Deposits of $100,000 or more
                                    
                                    
                                    (30
                                    )
                                    
                                    $
                                    52
                                    
                                    
                                    
                                    22Other Deposits
                                    
                                    
                                    (77
                                    )
                                    
                                    $
                                    1,213
                                    
                                    
                                    
                                    1,136Fed funds sold
                                    
                                    
                                    2
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    
                                    2Total
                                    
                                    
                                    (698
                                    )
                                    
                                    
                                    1,733
                                    
                                    
                                    
                                    1,035Net Change in Net Interest
      Income
                                    
                                    $
                                    (352)
                                    )
                                    
                                    $
                                    2,243
                                    
                                    
                                    $
                                    1,891








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






62








Provision
for loan losses




The
provision for loan losses is the annual cost of providing an allowance or
reserve for estimated probable losses on loans. The provision for loan losses
was $7.9 million in 2008 and $1.4 million in 2007. The increase in expense in
2008 was directly related to the $37.1 million increase in our loan portfolio
and the deterioration of construction, land development, and commercial loans.
Due to continued deterioration in loan quality, the Company expects to record a
provision for loan losses for the three months ended March 31, 2009 of
approximately $900 thousand.




The
allowance for loan losses reflects management’s judgment of the level of
allowance adequate to absorb estimated credit losses in the Bank’s loan
portfolio. The allowance for loan losses is determined based on management‘s
assessment of several factors including, among others, the following: review and
evaluation of individual loans, changes in the nature and volume of the loan
portfolio, current economic conditions and the related impact on specific
borrowers and industry groups, historical loan loss experiences and the levels
of classified and nonperforming loans. Because the Bank has a limited loss
history on which to build assumptions for future loan losses, during these time
periods a national bank peer group average was also used to estimate adequate
levels of loan loss reserves. There were net charge-offs of loans of $3.2
million during 2008 and no charge offs in 2007.




Additional
information regarding the calculation of the loan loss provision for 2008, the
factors considered by the Bank’s management in establishing the reserves and the
quality of the Bank’s loan portfolio is included in the section of this Report
titled "Part
I – Item 1. Business – Asset quality."




Noninterest
Income




For the
year ended December 31, 2008, non-interest income was $878 thousand which
included $685 thousand in gains on the sale of the guaranteed portion of SBA
loans and loan referral fees of $90 thousand. For the year ended December 31,
2007, non-interest income was $618 thousand which included, in addition to the
$392 thousand in gains on the sale of the guaranteed portion of SBA loans, a net
loss on the sale of investments of $12 thousand and loan referral fees of $175
thousand. To supplement net interest income and diversify the Bank‘s income
stream, in 2007 the Bank established a Real Estate Industries Group to generate
non-interest fee income by brokering commercial real estate loans in excess of
the Bank’s legal lending limit or that otherwise do not meet the Bank’s lending
criteria due to size, location, or other factors. Loan referral fees decreased
in 2008 due to reduced referral volume. The remaining non-interest income of
$104 thousand in 2008 and $51 thousand in 2007 was primarily related to service
charges on deposit accounts, which increased due to the increased volume of
deposits.




Noninterest
Expense




Total
noninterest expense was $7.1 million in 2008 as compared to $6.8 million in
2007. The major components of the 2008 expense as compared to 2007 expense are
discussed below.




Salaries
and employee benefits, the largest component of noninterest expense, totaled
$4.0 million for 2008 and $3.7 million for 2007. Included in salaries and
employee benefits for 2009 was $186 thousand representing a portion of the
expense for the employee stock options granted from May 16, 2005, through
December 31, 2008 as compared to $706 thousand in 2007. SFAS No. 123 (R)
requires compensation cost related to share-based payment transactions to be
recognized in the financial statements over the period that an employee provides
service in exchange for the award. Excluding the expense associated with SFAS
No. 123 (R), salaries and employee benefits increased by $776 thousand in 2008
compared with 2007. The increase in expense was the direct result of hiring
additional personnel to accommodate the growth in our operations during 2008.
Employee benefit costs, including employer






63






taxes and
group insurance, accounted for approximately 14.4% of the salary and employee
benefits expense in 2008 compared to 14.6% in 2007. As of December 31, 2008 and
2007, the Bank had 37 and 43 employees, with a full-time–equivalent of 36 and 40
employees, respectively. The Bank continues to improve its efficiency as
measured by the ratio of assets per employee. The volume of assets per employee
as of the end of 2008 was $4.0 million compared to $2.6 million at the end of
2007.




Occupancy
expense decreased to $954 thousand in 2008 from $995 thousand in 2007. The
decrease was primarily attributable to renegotiated contracts for phone and data
lines. Depreciation expense of fixed asset and tenant improvements for 2008 was
$364 thousand as compared to $359 thousand in 2007.




Professional
fees for 2008 were $512 thousand compared to $609 thousand in 2007. For 2008,
$141 thousand was paid in legal fees, related primarily to corporate matters
including SEC regulations, personnel matters. Internal and external audit fees
totaling $179 thousand, $73 thousand was paid to outside consultants for various
projects and $73 thousand was paid for compliance related training and support.
For 2007, $116 thousand was paid in legal fees, related primarily to corporate
matters including SEC regulations, personnel matters and stock option grants.
Internal and externalaudit fees totaling $228 thousand, $217
thousand was paid to outside consultants for various projects and $23 thousand
in compliance related training and support. The reduced audit expenses in 2008
are primarily attributable to reduced use of consultants in the credit
administration area and in preparation for compliance with Section 404 of
Sarbanes-Oxley. The remaining expenses within this category include loan
referral fees and third-party reimbursements.




Data
processing expenses for 2008 and 2007 totaled $524 thousand and $444 thousand
respectively. The increase in expenses in 2008 was primarily attributable to
increased costs from the core processor as contractual minimums were exceeded
and website support related to cash management products including the
introduction of remote deposit capture products. During 2008, network
administration was brought in-house resulting in a direct savings of $11
thousand; additional savings are anticipated as contracts are renegotiated or
eliminated.




For 2008
and 2007, office expenses totaled $478 thousand and $346 thousand, respectively.
The four areas that reflected the largest increases from 2007 to 2008 were auto
expense, supplies, correspondent bank charges and armored car expense. Auto
expenses increased to $117 thousand from $105 thousand due to an increase in the
number of calling officers and the cost of fuel. Office supply expense increased
to $90 thousand from $71 thousand due to an increase in the volume of copier
paper, loan files, and printer ink cartridges. Correspondent bank charges
increased to $36 thousand from $13 thousand due to an increase in the volume of
activity and a decrease in the earnings credit, which moves with the overnight
fed funds rate or other similar market rate. Armored car expense increased to
$101 thousand from $67 thousand due to an increase in the number of customers
using the service. Other items in this expense category include insurance,
including workers compensation insurance, check printing costs, meetings and
travel costs, publications, subscriptions and ATM surcharge refunds




Marketing
expenses totaled $363 thousand for 2008 and $272 thousand for 2007. This
category includes expenses related to publication of a quarterly newsletter,
periodic shareholder mailings, direct mail campaigns to local businesses, and
sponsorship of key community events. The year over year increase was primarily
due to the sponsorship of specific San Clemente community events, frequent press
releases and use of a marketing firm.




Regulatory
assessments increased dramatically in 2008 from 2007, to $136 thousand from $43
thousand. This increase was due to the federal deposit insurance premiums
payable on increased deposits. Regulatory assessments are expected to continue
to increase significantly in 2009, due to higher assessments that will be
payable to the OCC and higher deposit insurance premium rates because of the
Bank’s undercapitalized status as of March 31, 2009.






64






Loan-related
costs are primarily reserves for undisbursed loan funds, and costs related to
services that the Bank requests and pays and the borrower reimburses. The
reserves needed for undisbursed loans decreased from 2007 to 2008 as we stopped
originating construction loans. This allowed us to reverse $33 thousand in
expenses in 2008 compared to an expense of $48 thousand in 2007. The remaining
variance between 2007 and 2008 is related to the timing of the Bank expense and
borrower reimbursement for loan related services such as appraisals, tax
services, inspection fees and UCC filing fees.




Director-related
expenses decreased in 2008 as a result of not issuing any stock options to the
directors in 2008 and immediately vesting the options that were issued in 2007.
Stock option expense for 2008 was $9.0 thousand and for 2007 was $64.4
thousand.




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




Twelve
    Months
                          
                          Twelve
    MonthsEnded
                          
                          EndedDecember
31,
                          
                          December
  31,2008
                          
                          2007Data
    Processing
                          
                          $             523,842
                          
                          $             443,862Office
    Expenses
                          
                          477,573
                          
                          345,972Marketing
                          
                          363,027
                          
                          272,108Regulatory
      Assessments
                          
                          135,888
                          
                          43,370Insurance
    Costs
                          
                          88,845
                          
                          87,167Loan-related
      costs
                          
                          (1,041)
                          
                          66,005Recruiting
      Costs
                          
                          26,554
                          
                          87,573Director-related
      expenses
                          
                          9,597
                          
                          74,293Other
                          
                          50,864
                          
                          46,180$           1,675,149
                          
                          $           1,466,530








Income
Taxes




Two
thousand dollars in state taxes were paid during 2008 and 2007. No federal tax
expense or federal or state tax benefit has been recorded for 2008 and 2007
based upon net operating losses. We will begin to recognize an income tax
benefit when it becomes more likely than not that such benefit will be
realized.




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.







65






Comparison
of Financial Condition as of December 31, 2008 and 2007




Total
assets as of December 31, 2008, were $142.8 million, consisting primarily of
cash of $12.8 million and net loans of $128.3 million compared with total assets
as of December 31, 2007 of $112.5 million, consisting primarily of cash and fed
funds sold of $14.5 and net loans of $96.1 million. Total deposits as of
December 31, 2008 were $137.2 million compared with $99.0 million as of December
31, 2007, and shareholder‘s equity as of December 31, 2008 was $5.3 million
compared with $12.8 million as of December 31, 2007.




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




At
December 31, 2008, we had no federal funds (“fed funds“) sold, electing to move
our excess funds to a non-interest bearing checking account in order to maximize
the FDIC insurance on such funds. This decision was also due to the low interest
rate that was available for overnight investments. Normally, federal funds sold
allow us to meet Bank liquidity requirements and provide temporary holdings
until the funds can be otherwise deployed or invested. At December 31, 2007, we
had $12.8 million in fed funds sold.




Investment
Securities




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




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




We owned
no investment securities as of December 31, 2008 and 2007. During 2007 we sold
$7.9 million in investment securities held as available for sale, at a net loss
of $12 thousand.




At
December 31, 2008, we had Federal Reserve Bank stock carried at a cost of $365
thousand compared to December 31, 2007, at $405 thousand. At December 31, 2008,
this stock was not pledged as collateral for any purpose. For additional
information regarding our securities portfolio see “Item 1. Business –
Investments.“




Loan
Portfolio




Our
primary source of income is interest on loans. The real estate portion of the
loan portfolio is comprised of the following: mortgage loans secured typically
by commercial and multi-family residential properties, occupied by the borrower,
having terms of three to seven years with both fixed and floating rates;
revolving lines of credit granted to consumers, secured by equity in residential
properties; and construction loans. Construction loans consist primarily of
high-end, single-family residential properties,






66






primarily
located in the coastal communities, and commercial properties for
owner-occupied, have a term of less than one year and have floating rates and
commitment fees. Construction loans are typically made to builders that have an
established record of successful project completion and loan repayment. At
December 31, 2008, we held $57.6 million in commercial and multi-family real
estate loans outstanding, representing 42.9% of gross loans receivable, with
$154 thousand in undisbursed commitments. Of this total, $750 thousand were SBA
loans with no undisbursed commitments. The remaining real estate portfolio was
comprised of $34.5 million in construction loans representing 25.6% of gross
loans receivable with undisbursed commitments of $3.8 million, and $5.6 million
in revolving lines secured by equity in 1-4 family residences, representing 4.2%
of gross loans receivable with undisbursed commitments of $4.8
million.




The
commercial loan portfolio is comprised of lines of credit for working capital
and term loans to finance equipment and other business assets. The lines of
credit typically are limited to a percentage of the value of the assets securing
the line. Lines of credit and term loans typically are reviewed annually and can
be supported by accounts receivable, inventory, equipment and other assets of
the client‘s businesses. At December 31, 2008, we held $36.6 million in
commercial loans outstanding, representing 27.2% of gross loans receivable, and
undisbursed commitments of $22.4 million. Of this total, $6.6 million were SBA
loans with no undisbursed commitments.




The
consumer loan portfolio consists of personal lines of credit and loans to
acquire personal assets such as automobiles and boats. The lines of credit
generally have terms of one year and the term loans generally have terms of
three to five years. The lines of credit typically have floating rates. At
December 31, 2008, consumer loans totaled $231 thousand, representing less than
one percent of our gross loans receivable and undisbursed commitments of $126
thousand.




Loan
concentrations are considered to exist when there are amounts loaned to a
multiple number of borrowers engaged in similar activities that would cause them
to be similarly impacted by economic or other conditions. We have established
select concentration percentages within the loan portfolio. It also includes
groups of credit considered of either higher risk or worthy of further review as
part of its concentration reporting. As of December 31, 2008 real estate loans
comprised 72.7% of the total loan portfolio, as compared to 77.2% at December
31, 2007. Although significant, a high percentage of these loans are for
commercial purposes with real estate taken as collateral and owner occupied. In
addition, all the SBA loans, which are secured by real estate, are to
owner-users. Although classified as commercial real estate for reporting
purposes, the intended source of the cash flow to repay the obligations is from
the commercial enterprise of the borrower and not directly from the sale or
lease of the property. The assessment of the borrower‘s repayment
ability is therefore based on the financial strength of the business and not the
real estate held as collateral.




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




Management
may renew loans at maturity when requested by a customer whose financial
strength appears to support such a renewal or when such a renewal appears to be
in our best interest. We require payment of accrued interest in such instances
and may adjust the rate of interest, require a principal reduction, or modify
other terms of the loan at the time of renewal. For additional information
regarding our loan portfolio as of December 31, 2008 and 2007 see “Item 1.
Business – Lending services.“






67






Nonperforming
Assets




Nonperforming
assets consist of non-performing loans, other real estate owned and other
repossessed assets. Non-performing loans consist of loans in one or more of the
following categories: loans on nonaccrual status, loans 90 days or more past due
and still accruing interest, and loans that have been restructured resulting in
a reduction or deferral of interest or principal (referred to as “troubled debt
restructurings” or “TDRs”). At December 31, 2008 and December 31, 2007, the Bank
had $7.8 million and $2.5 million in non-performing loans, respectively, and no
other nonperforming assets.  Subsequent to December 31, 2008, an
additional $9.9 million in loans were placed on nonaccrual status.




Management
evaluates loan impairment according to the provisions of SFAS No. 114,
Accounting by Creditors for Impairment of a Loan. Under SFAS No. 114, loans are
considered impaired when it is probable that we will be unable to collect all
amounts due as scheduled according to the contractual terms of the loan
agreement, including contractual interest and principal payments.  By
definition, impaired loans as of a particular date may include loans that do not
fall within any of the “non-performing” categories described
above.  As of December 31, 2008, we had $21.0 million of loans
classified as impaired, including the $7.8 million of non-performing loans as of
that date.




For
additional information regarding non-performing assets and impaired loans, see
“Item 1. Business-Asset Quality.”




Allowance
for Loan Losses




Implicit
in our lending activities is the fact that loan losses will be experienced and
that the risk of loss will vary with the type of loan being made and the
creditworthiness of the borrower over the term of the loan. To reflect the
currently perceived risk of loss associated with the loan portfolio, additions
are made to the allowance for loan losses in the form of direct charges against
income to ensure that the allowance is available to absorb possible loan losses.
The factors that influence the amount include, among others, the remaining
collateral and/or financial condition of the borrowers, historical
loan loss, changes in the size and composition of the loan portfolio, and
general economic conditions. Management believes that our allowance for loan
losses as of December 31, 2008 was adequate to absorb the known and inherent
risks of loss in the loan portfolio at that date. While management believes the
estimates and assumptions used in its determination of the adequacy of the
allowance are reasonable, there can be no assurance that such estimates and
assumptions will not be proven incorrect in the future, or that the actual
amount of future provisions will not exceed the amount of past provisions or
that any increased provisions that may be required will not adversely impact our
financial condition and results of operations. See “Item 1A. Risk Factors—Risks
Relating to the Company and the Bank-If our allowance for loan losses is not
sufficient to cover actual loan losses or if we are required to increase our
provision for loan losses, our results of operations and financial condition
could be materially adversely affected” and “-We may be required to make further
increases in our provisions for loan losses and to charge off additional loans
in the future, which could adversely affect our results of operations.” In
addition, the determination of the amount of the Bank‘s allowance for loan
losses is subject to review by bank regulators, as part of the routine
examination process, which may result in the establishment of additional
reserves based upon their judgment of information available to them at the time
of their examination.




The
amount of the allowance equals the cumulative total of the provisions made from
time to time, reduced by loan charge-offs and increased by recoveries of loans
previously charged-off. Beginning with the second quarter of 2008, the adequacy
of our allowance for loan losses has been determined through a comparison to the
Bank‘s peer group as defined by the OCC. We will continue to maintain an
equivalent allowance until management has adequate historical data upon which to
base a different level. The peer group currently maintains an average allowance
for loan losses of approximately 1.25% of the






68






outstanding
principal. Our allowance was $6.6 million, or 4.86% of outstanding principal as
of December 31, 2008. Management increased the overall allowance from 1.25% to
4.86% as a result of the weakening in the real estate market in Southern
California, the deterioration in loan quality and our reserves on impaired
loans. During 2008 the Company incurred $3.5 million in
charge-offs.




In
addition, a separate allowance for credit losses on off-balance sheet credit
exposures is maintained for the undisbursed portion of approved loans. Although
the loss exposure to the Bank is reduced because the funds have not been
released to the borrower, under certain circumstances the Bank may be required
to continue to disburse funds on a troubled credit. As of December 31, 2008,
this allowance was $39 thousand.




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




For
additional information regarding the allowance for loan losses, see “Item 1.
Business-Asset Quality-Allowance for Loan Losses.”




Nonearning
Assets




Premises,
leasehold improvements and equipment totaled $550 thousand at December 31, 2008,
net of accumulated depreciation of $1.4 million compared to $887 thousand at
December 31, 2007, net of accumulated depreciation of $934 thousand. This
decrease occurred due to the ongoing depreciation of fixed assets net of new
purchases of $83 thousand.




Deposits




Deposits
are our primary source of funds. Demand, or non-interest bearing checking,
accounts as a percentage of total deposits were 22.4% at December 31, 2008,
compared to 17.8% at December 31, 2007. We had $35.6 million of brokered
certificates of deposit, equaling 26% of total deposits. At December 31, 2007,
we had $28.2 million in brokered deposits, equaling 29% of total deposits. Of
this total, $3.5 million consisted of public funds, none of which required
collateralization. Because the Bank was “undercapitalized“ under regulatory
capital guidelines as of March 31, 2009, we are currently prohibited from
accepting, renewing or rolling over brokered deposits. See “Item 1.
Business-Regulatory Restrictions.“




Return
on Equity and Assets




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







At
      December 31, 2008Return
      on average assets
              -6.63%Return
      on average equity
              -75.65%Dividend
      payout ratio
              0%Average
      Equity to Average Assets
              8.78%
   69
    At
      December 31, 2007Return
      on average assets
              -5.27%Return
      on average equity
              -29.01%Dividend
      payout ratio
              0%Average
      Equity to Average Assets
              18.18%







Off-Balance
Sheet Arrangements and Loan Commitments




In the
ordinary course of business, we enter into various off-balance sheet commitments
and other arrangements to extend credit that are not reflected in the
consolidated balance sheets of the Company. The business purpose of these
off-balance sheet commitments is the routine extension of credit. As of December
31, 2008, commitments to extend credit included approximately $265 thousand for
letters of credit, $25.5 million for revolving lines of credit arrangements
including $4.8 million in real-estate secured lines, and $5.8 million in unused
commitments for commercial and real estate secured loans. We face the risk of
deteriorating credit quality of borrowers to whom a commitment to extend credit
has been made.




Borrowings




The Bank
has access to a $5 million in federal funds lines on a secured basis through one
correspondent bank. The Bank also has the option of applying for a line of
credit through the discount window at the Federal Reserve Bank and from the
Federal Home Loan Bank of San Francisco. Given the Bank’s current
undercapitalized status, it may not be possible to obtain credit from the
Federal Reserve Bank or from the Federal Home Loan Bank of San Francisco.As of December 31, 2008,
there were no borrowings outstanding.




Capital
Resources and Capital Adequacy Requirements




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




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




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,






70






risk
weightings and other factors. 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.





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). The
following table sets forth the Bank’s capital ratios as of December 31,
2008.


To
      Be WellCapitalized
      UnderFor
      Capital
                
                
                Prompt
      CorrectiveActual
                
                
                Adequacy
      Purposes
                
                
                Action
      ProvisionsAmount
                
                
                
                
                
                Amount
                
                
                
                
                
                Amount(Thousands)
                
                
                Ratio
                
                
                (Thousands)
                
                
                Ratio
                
                
                (Thousands)
                
                
                RatioAs
      of December 31, 2008:Total
      Capital (to Risk-Weighted Assets)
                
                $
                7,045
                
                
                
                5.03%
                
                
                $
                11,213
                
                
                
                8.0%
                
                
                $
                14,017
                
                
                
                10.0%Tier
      1 Capital (to Risk-Weighted Assets)
                
                $
                5,243
                
                
                
                3.74%
                
                
                $
                5,607
                
                
                
                4.0%
                
                
                $
                8,410
                
                
                
                6.0%Tier
      1 Capital (to Average Assets)
                
                $
                5,243
                
                
                
                3.59%
                
                
                $
                5,839
                
                
                
                4.0%
                
                
                $
                7,299
                
                
                
                5.0%As
      of December 31, 2007:Total
      Capital (to Risk-Weighted Assets)
                
                $
                13,672
                
                
                
                11.55%
                
                
                $
                9,470
                
                
                
                8.0%
                
                
                $
                11,837
                
                
                
                10.0%Tier
      1 Capital (to Risk-Weighted Assets)
                
                $
                12,193
                
                
                
                10.30%
                
                
                $
                4,735
                
                
                
                4.0%
                
                
                $
                7,102
                
                
                
                6.0%Tier
      1 Capital (to Average Assets)
                
                $
                12,193
                
                
                
                12.19%
                
                
                $
                4,002
                
                
                
                4.0%
                
                
                $
                5,002
                
                
                
                5.0%







71










The
following table sets forth the Holding Company’s capital ratios as of December
31, 2008.


For
      CapitalActual
                  
                  
                  Adequacy
      PurposesAmount
                  
                  
                  
                  
                  
                  Amount(Thousands)
                  
                  
                  Ratio
                  
                  
                  (Thousands)
                  
                  
                  RatioAs
      of December 31, 2008:Total
      Capital (to Risk-Weighted Assets)
                  
                  $
                  7,060
                  
                  
                  
                  5.04%
                  
                  
                  $
                  11,213
                  
                  
                  
                  8.0%Tier
      1 Capital (to Risk-Weighted Assets)
                  
                  $
                  5,258
                  
                  
                  
                  3.75%
                  
                  
                  $
                  5,607
                  
                  
                  
                  4.0%Tier
      1 Capital (to Average Assets)
                  
                  $
                  5,258
                  
                  
                  
                  3.60%
                  
                  
                  $
                  5,839
                  
                  
                  
                  4.0%For
      CapitalActual
                  
                  
                  Adequacy
      PurposesAmount
                  
                  
                  
                  
                  
                  
                  Amount(Thousands)
                  
                  
                  Ratio
                  
                  
                  (Thousands)
                  
                  
                  RatioAs
      of December 31, 2007:Total
      Capital (to Risk-Weighted Assets)
                  
                  $
                  14,230
                  
                  
                  
                  12.03%
                  
                  
                  $
                  9,459
                  
                  
                  
                  8.0%Tier
      1 Capital (to Risk-Weighted Assets)
                  
                  $
                  12,751
                  
                  
                  
                  10.78%
                  
                  
                  $
                  4,730
                  
                  
                  
                  4.0%Tier
      1 Capital (to Average Assets)
                  
                  $
                  12,751
                  
                  
                  
                  12.74%
                  
                  
                  $
                  4,002
                  
                  
                  
                  4.0%









As indicated
above, the Bank did not meet its minimum capital requirements as of December 31,
2008, and was “significantly undercapitalized“ as of that date under the prompt
corrective action framework. As noted elsewhere in this report, as a result of
the Company’s downstreaming to the Bank of the proceeds the Company received in
January 2009 from its participation in the TARP Capital Purchase Program, the
Bank’s status improved to “undercapitalized“ as of March 31, 2009. See
“Supervision and Regulation—Regulation and Supervision of Pacific Coast National
Bank.“ The Bank is subject to a number of requirements and restrictions on its
operations imposed by the OCC. See “Item 1. Business-Regulatory Restrictions.“
The OCC also has proposed that the Bank achieve and maintain regulatory capital
ratios in excess of the regulatory minimums. Specifically, the Bank must develop
a plan, subject to the OCC’s review and nonobjection, to achieve ratios of Tier
1 capital to adjusted total assets of 9.0% and total risk-based capital to
risk-weighted assets of 11.0% by June 30, 2009, and ratios of Tier 1 capital to
adjusted total assets of 9.0% and total risk-based capital to risk-weighted
assets of 12.0% by September 30, 2009.





Liquidity
Management




At
December 31, 2008, the Company (excluding the Bank) had approximately $15
thousand in cash. These funds can be used for Company operations, investment and
for later infusion into the Bank and other corporate activities. The primary
source of liquidity for the Company will be dividends paid by the Bank. The Bank
is currently restricted from paying dividends without regulatory approval that
will not be granted until the accumulated deficit has been eliminated. The
Bank’s undercapitalized status as of March 31, 2009 also currently prohibits it
from paying dividends.




The Bank
had cash and cash equivalents of $12.8 million at December 31, 2008. The Bank‘s
liquidity is monitored by its staff, the Investment/Asset-Liability Committee
and the Board of Directors, who review historical funding requirements, current
liquidity position, sources and stability of funding, marketability of assets,
options for attracting additional funds, and anticipated future funding needs,
including the level of unfunded commitments.






72






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




The Bank
also has access to a secured borrowing line from a correspondent bank. This is
usually restricted to short time periods (30 days or less). The Bank also has
the option of applying for a line of credit with the Federal Home Loan Bank
(FHLB) or at the discount window of the Federal Reserve Bank.




As of
December 31, 2008, the Bank’s gross loan to deposit ratio was 98.3% and brokered
deposits represented 25.9% of total deposits. The Bank has relied on brokered
deposits as a source of liquidity to fund loan demand. However, the Bank’s
undercapitalized status currently prohibits it from acquiring, accepting or
rolling over brokered deposits. At December 31, 2008, the Bank had brokered
deposit balances totaling $35.6 million Of this amount, $34.8 million mature in
2009 and the remainder mature in 2010. In addition, the OCC has precluded the
Bank from increasing its loans above the total loans on its balance sheet as of
December 31, 2008 until it has adopted and implemented satisfactory credit and
concentration risk management processes. Further, as a result of the asset
quality and capital concerns impacting the Company, we have been addressing our
liquidity needed to maintain an adequate cash flow position to sustain
operations of the Company. As of May 17, 2009, we had approximately $37.0
million of cash and cash equivalents to satisfy pending repayments of brokered
deposits and other cash flow obligations. We also had $5 million in borrowing
capacity as of that date from our correspondent bank.


Recent
Accounting Pronouncements
  In
September 2006, the FASB issued SFAS 157, "Fair Value Measurements" ("SFAS
157"). SFAS 157 clarifies the principal that fair value should be based on the
assumptions market participants would use when pricing an asset or liability and
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. Under the standard, fair value measurements would be
separately disclosed by level within the fair value hierarchy. In February 2008,
the FASB issued FASB Staff Position (FSP) No. 157-2, "Effective Date of FASB
Statement No. 157", to partially defer FASB Statement No. 157 for nonfinancial
assets and nonfinancial liabilities, except those that are recognized or
disclosed at fair value in the financial statement on a recurring basis. SFAS
157 was effective for us on January 1, 2008, however for nonfinancial assets and
nonfinancial liabilities that are not recognized or disclosed at fair value on a
recurring basis the effective date is January 1, 2009. The remaining portion of
SFAS No 157 adopted on January 1, 2009 did not have a significant effect on our
financial position or results of operations. In October 2008, the FASB issued
FASB Staff Position (FSP) 157-3, “Determining the Fair Value of a Financial
Asset when the Market for That Asset Is Not Active”. This FSP clarifies the
application of SFAS 157 in a market that is not active. The impact of adoption
was not material.
  In April
2009, the FASB issued FSP 157-4, “Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability have Significantly Decreased and
Identifying Transactions that Are Not Orderly”. FSP 157-4 indicates that if an
entity determines that either the volume and/or level of activity for an asset
or liability has significantly decreased (from normal conditions for that asset
or liability) or price quotations or observable inputs are not associated with
orderly transactions, increased analysis and management judgment will be
required to estimate fair value. FSP 157-4 is effective for interim and annual
periods ending after June 15, 2009, with early adoption permitted. FSP 157-4
must be applied prospectively. The Company has elected to adopt FSP 157-4 in the
first quarter of 2009. The impact of adoption is not expected to be
material.
  In
December 2007, the FASB issued Statement No. 141 (revised 2007), “Business
Combinations” (“FAS 141(R)”), which establishes principles and requirements for
how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in an acquiree, including the recognition and measurement of goodwill
acquired in a business combination. FAS No. 141(R) is effective for fiscal years
beginning on or after December 15, 2008. Earlier adoption is prohibited. The
adoption of this standard is not expected to have a material effect on our
results of operations or financial position unless we engage in a business
combination.




73






Item
7A. Quantitative and Qualitative Disclosures About Market Risk
  Net
interest income, the Bank’s expected primary source of earnings, can fluctuate
with significant interest rate movements. The Company’s results of operations
depend 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. 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 overall results of operations, these measures may not be effective.
To lessen the impact of these fluctuations, the Bank manages the structure of
the balance sheet so that repricing opportunities exist for both assets and
liabilities in roughly equal amounts at approximately the same time intervals.
Imbalances in these repricing opportunities at any point in time constitute
interest rate sensitivity.
  Interest
rate risk is the most significant market risk affecting the Bank. Other types of
market risk, such as foreign currency risk and commodity price risk, do not
arise in the normal course of the Bank’s business activities. The ongoing
monitoring and management of this risk is an important component of the asset
and liability management process, which is governed by policies established by
the Company’s Board of Directors and carried out by the Bank’s
Investment/Asset-Liability Committee. The Investment/Asset-Liability Committee’s
objectives are to manage the exposure to interest rate risk over both the one
year planning cycle and the longer term strategic horizon and, at the same time,
to provide a stable and steadily increasing flow of net interest
income.


The
primary measurement of interest rate risk is earnings at risk, which is
determined through computerized simulation modeling. The primary simulation
model assumes a static balance sheet, using the balances, rates, maturities and
repricing characteristics of all of the Bank’s existing assets and liabilities.
Net interest income is computed by the model assuming market rates remaining
unchanged and comparing those results to other interest rate scenarios with
changes in the magnitude, timing and relationship between various interest
rates. At December 31, 2008, 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.






74






Interest
      Rate Shock(Dollars  in
      thousands)Rate
      Shock
                  -2%
                  
                  -1%
                  
                  Annualized
                  
                  +1%
                  
                  +2%"Prime"
      Rate
                  1.25%
                  
                  2.25%
                  
                  3.25%
                  
                  4.25%
                  
                  5.25%Net
      Interest Income Change
                  (280)
                  
                  (126)
                  
                  -
                  
                  (30)
                  
                  (66)%
      Change
                  -5.4%
                  
                  -2.4%
                  
                  -
                  
                  -0.6%
                  
                  -1.3%Market
      Value of Equity Change
                  1.0%
                  
                  
                  
                  -
                  
                  
                  
                  -2.4%Net
      Interest Margin
                  3.6%
                  
                  3.7%
                  
                  3.8%
                  
                  3.8%
                  
                  3.8%
   The
interest rate risk inherent in a bank‘s assets and liabilities may also be
determined by analyzing the extent to which such assets and liabilities are
“interest rate sensitive“ and by measuring the bank‘s interest rate sensitivity
“gap.“ An asset or liability is said to be interest rate sensitive within a
defined time period if it matures or reprices within that period. The difference
or mismatch between the amount of interest-earning assets maturing or repricing
within a defined period and the amount of interest-bearing liabilities maturing
or repricing within the same period is defined as the interest rate sensitivity
gap. A bank is considered to have a positive gap if the amount of
interest-earning assets maturing or repricing within a specified time period
exceeds the amount of interest-bearing liabilities maturing or repricing within
the same period. If more interest-bearing liabilities than interest-earning
assets mature or reprice within a specified period, then the bank is considered
to have a negative gap. Accordingly, in a rising interest rate environment, in
an institution with a positive gap, the yield on its rate sensitive assets would
theoretically rise at a faster pace than the cost of its rate sensitive
liabilities, thereby increasing future net interest income. In a falling
interest rate environment, a positive gap would indicate that the yield on rate
sensitive assets would decline at a faster pace than the cost of rate sensitive
liabilities, thereby decreasing net interest income. For a bank with a negative
gap, the reverse would be expected. 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, on a stand-alone basis, the Bank‘s amounts of
interest-earning assets and interest-bearing liabilities outstanding at December
31, 2008, which are anticipated, based upon certain assumptions, to reprice or
mature in each of the future time periods shown. The projected repricing of
assets and liabilities anticipates prepayments and scheduled rate adjustments,
as well as contractual maturities under an interest rate unchanged scenario
within the selected time intervals. While it is believed that such assumptions
are reasonable, there can be no assurance that assumed repricing rates will
approximate actual future deposit activity.


The table indicates a negative cumulative interest rate sensitivity gap
for the time periods up to and including 1-3 years, and a positive interest rate
sensitivity gap for 3 years and greater. For purposes of this report, an
estimate of $9 million was used for selling fed funds and non-interest sensitive
balances were decreased by the same amount.




75






As
      of December 31, 2008Volumes
      Subject to Repricing Within(Dollars
      in thousands)0-1
      Day
                
                2-90
      Days
                
                91-365
      Days
                
                1-3
      Years
                
                Over
      3 Years
                
                Non-Interest
      Sensitive
                
                TotalAssets:Cash,
      fed funds and other
                $          9,000
                
                $          -
                
                $          -
                
                $           -
                
                $        -
                
                $     3,835
                
                $    12,835Investments
      and FRB Stock
                -
                
                -
                
                -
                
                -
                
                365
                
                -
                
                365Loans  (1)
                -
                
                42,030
                
                20,772
                
                11,925
                
                52,003
                
                7,781
                
                134,511Fixed
      and other assets
                -
                
                -
                
                -
                
                -
                
                -
                
                (4,827)
                
                (4,827)Total
      Assets
                $          9,000
                
                $   42,030
                
                $   20,772
                
                $     11,925
                
                $  52,368
                
                $     6,789
                
                $  142,883Liabilities
      and Shareholders’ Equity:Interest-bearing
      checking, savings and money market accounts
                $         50,041
                
                $          -
                
                $          -
                
                $           -
                
                $        -
                
                $   30,726
                
                $    80,767Certificates
      of deposit
                -
                
                21,524
                
                34,044
                
                841
                
                -
                
                -
                
                56,409Borrowed
      funds
                -
                
                -
                
                -
                
                -
                
                -
                
                -
                
                -Other
      liabilities
                -
                
                -
                
                -
                
                -
                
                -
                
                447
                
                447Shareholders’
      equity
                -
                
                -
                
                -
                
                -
                
                -
                
                5,258
                
                5,258Total
      liabilities and shareholders’ equity
                $         50,041
                
                $   21,524
                
                $   34,044
                
                $         841
                
                $        -
                
                $   36,433
                
                $  142,883Interest
      rate sensitivity gap
                $       (41,041)
                
                $   20,506
                
                $  (13,273)
                
                $     11,084
                
                $  52,368Cumulative  interest
      rate sensitivity gap
                $       (41,041)
                
                $  (20,535)
                
                $  (33,808)
                
                $   (22,724)
                
                $  29,644Cumulative
      gap to total assets
                -28.7%
                
                -14.4%
                
                -23.7%
                
                -15.9%
                
                20.7%Cumulative
      interest-earning assets to cumulative interest-bearing
      liabilities
                18.0%
                
                71.3%
                
                68.0%
                
                78.7%
                
                127.8%(1)
      Excludes deferred fees and allowance for loan losses
                  (2)
      Includes deferred fees and allowance for loan losses
   
 Certain
shortcomings are inherent in the method of analysis presented in the gap table.
For example, although certain assets and liabilities may have similar maturities
or periods of repricing, they may react in different degrees to changes in
market interest rates. Additionally, certain assets, such as adjustable-rate
loans, have features that restrict changes in interest rates, both on a
short-term basis and over the life of the asset. More importantly, changes in
interest rates, prepayments and early withdrawal levels may deviate
significantly from those assumed in the calculations in the table. As a result
of these shortcomings, the Bank will focus more on earnings at risk simulation
modeling than on gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total assets within acceptable limits, the earnings at risk
simulation modeling is considered by management to be more informative in
forecasting future income at risk.


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




Item
8. Financial Statements and Supplementary Data




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






76




Report of Independent Registered Public
Accounting Firm
 
 To the Board of
Directors
 Pacific Coast National
Bancorp
 San Clemente,
California
 
 We have audited the consolidated balance
sheets of Pacific Coast National Bancorp and subsidiary (the Company) as of
December 31, 2008 and 2007, and the related consolidated statements of
operations, shareholders’ equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our 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, 2008 and 2007, and the results of their operations and their cash
flows for the years then ended, in conformity with U.S. generally accepted
accounting principles.
 
 The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.  As discussed in Note B
to the financial statements, the Company has suffered significant losses from
operations since inception, has an accumulated deficit of $21.6 million and has
regulatory capital deficiencies that must be addressed.  These matters
raise substantial doubt about the Company’s ability to continue as a going
concern.  Management’s plans in regard to these matters are also
described in Note B.  The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
 
 We were not engaged to examine
management’s assessment of the effectiveness of Pacific Coast National Bancorp
and subsidiary’s internal control over financial reporting as of December 31,
2008 included in the accompanying “Management’s Report on Internal Control over
Financial Reporting” and, accordingly, we do not express an opinion
thereon.
 
 
 McGladrey &
Pullen
 Irvine, California
 May 29, 2009
 
 
   77
  PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2008 and 2007
 
 ASSETS
  2008
                    
                    
                    2007Cash
      and due from banks
                    
                    $
                    12,834,668
                    
                    
                    $
                    1,688,892Federal
      funds sold
                    
                    
                    -
                    
                    
                    
                    12,785,000TOTAL CASH AND CASH EQUIVALENTS
                    
                    
                    12,834,668
                    
                    
                    
                    14,473,892Loans
                    
                    
                    
                    134,880,289
                    
                    
                    
                    97,874,131Less:
      Allowance for loan losses
                    
                    
                    ( 6,550,000
                    )
                    
                    
                    ( 1,814,860
                    )Loans:
      net of allowance for loan losses
                    
                    
                    128,330,289
                    
                    
                    
                    96,059,271Premises
      and equipment, net
                    
                    
                    550,193
                    
                    
                    
                    887,532Federal
      Reserve Bank stock, at cost
                    
                    
                    365,050
                    
                    
                    
                    405,150Accrued
      interest  receivable and other assets
                    
                    
                    802,831
                    
                    
                    
                    671,339$
                    142,883,031
                    
                    
                    $
                    112,497,184
 LIABILITIES
AND SHAREHOLDERS’ EQUITY
 DepositsNoninterest-bearing
      demand
                        
                        $
                        30,726,159
                        
                        
                        $
                        17,658,241Interest-bearing
      demand accounts
                        
                        
                        4,061,215
                        
                        
                        
                        3,951,566Money
      market
                        
                        
                        45,571,983
                        
                        
                        
                        35,961,965Savings
                        
                        
                        407,724
                        
                        
                        
                        248,780Time
      certificates of deposit of $100,000 or more
                        
                        
                        5,596,336
                        
                        
                        
                        3,177,552Other
      time certificates of deposit
                        
                        
                        50,813,187
                        
                        
                        
                        37,993,669TOTAL DEPOSITS
                        
                        
                        137,176,604
                        
                        
                        
                        98,991,773Accrued
      interest payable and other liabilities
                        
                        
                        448,116
                        
                        
                        
                        754,146TOTAL LIABILITIES
                        
                        
                        137,624,720
                        
                        
                        
                        99,745,919Shareholders'
      equityCommon
      stock - $0.01 par value; 10,000,000 shares authorized;issued
      and outstanding: 2,544,850 shares at December 31,2008
      and 2,281,700 outstanding at December 31, 2007
                        
                        
                        25,448
                        
                        
                        
                        22,817Additional
      paid-in capital
                        
                        
                        26,837,475
                        
                        
                        
                        25,561,705Accumulated
      deficit
                        
                        
                        (21,604,612
                        )
                        
                        
                        (12,833,257
                        )TOTAL SHAREHOLDERS' EQUITY
                        
                        
                        5,258,311
                        
                        
                        
                        12,751,265$
                        142,883,031
                        
                        
                        $
                        112,497,184
    The
accompanying notes are an integral part of these financial
statements.
 78
  PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 Years
Ended December 31, 2008 and 2007
  2008
                    
                    
                    2007Interest
      incomeInterest
      and fees on loans
                    
                    $
                    8,200,120
                    
                    
                    $
                    4,759,241Federal
      funds sold
                    
                    
                    188,025
                    
                    
                    
                    561,922Investment
      securities, taxable
                    
                    
                    -
                    
                    
                    
                    128,488Other
                    
                    
                    25,677
                    
                    
                    
                    38,652Total
      interest income
                    
                    
                    8,413,822
                    
                    
                    
                    5,488,303Interest
      expenseTime
      certificates of depositof
      $100,000 or more
                    
                    
                    185,214
                    
                    
                    
                    163,313Other
      deposits
                    
                    
                    2,831,623
                    
                    
                    
                    1,821,165Fed
      Funds Purchased
                    
                    
                    2,367
                    
                    
                    
                    -Total
      interest expense
                    
                    
                    3,019,204
                    
                    
                    
                    1,984,478Net
      interest income before
                      provision
      for loan losses
                    
                    
                    5,394,618
                    
                    
                    
                    3,503,825Provision
      for loan losses
                    
                    
                    7,936,741
                    
                    
                    
                    1,383,220Net
      interest income (loss)after
      provision for loan losses
                    
                    
                    ( 2,542,123
                    )
                    
                    
                    2,120,605Noninterest
      incomeService
      charges and fees
                    
                    
                    193,549
                    
                    
                    
                    237,431Gain
      on Sale of SBA loans
                    
                    
                    684,575
                    
                    
                    
                    392,490(Loss)
      on sale of investmentsecurities
                    
                    
                    -
                    
                    
                    
                    ( 12,047
                    )878,124
                    
                    
                    
                    617,874Noninterest
      expenseSalaries
      and employee benefits
                    
                    
                    3,964,388
                    
                    
                    
                    3,708,060Occupancy
                    
                    
                    954,018
                    
                    
                    
                    995,087Data
      Processing
                    
                    
                    523,842
                    
                    
                    
                    443,862Professional
      services
                    
                    
                    512,201
                    
                    
                    
                    608,871Other
                    
                    
                    1,151,307
                    
                    
                    
                    1,022,6687,105,756
                    
                    
                    
                    6,778,548(Loss)
      before income taxes
                    
                    
                    ( 8,769,755
                    )
                    
                    
                    ( 4,040,069
                    )Provision
      for income taxes
                    
                    
                    1,600
                    
                    
                    
                    1,600Net
      (loss)
                    
                    $
                    ( 8,771,355
                    )
                    
                    $
                    ( 4,041,669
                    )Per
      share dataWeighted-average
      shares outstanding
                    
                    
                    2,345,118
                    
                    
                    
                    2,281,686Net
      (loss), basic and diluted
                    
                    $
                    ( 3.74
                    )
                    
                    $
                    ( 1.77
                    )
   The
accompanying notes are an integral part of these financial
statements.
 79
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
Ended December 31, 2008 and 2007
 
 2008
                  
                  
                  2007Cash
      flows from operating activities:Net
      loss
                  
                  $
                  ( 8,771,355
                  )
                  
                  $
                  ( 4,041,669
                  )Adjustments
      to reconcile net loss to net cashused
      in operating activities:Depreciation
      and amortization
                  
                  
                  420,239
                  
                  
                  
                  423,529Provision
      for loan losses
                  
                  
                  7,936,741
                  
                  
                  
                  1,383,220Provision
      for off balance sheet contingencies
                  
                  
                  ( 33,306
                  )
                  
                  
                  48,203Origination
      of loans held for sale
                  
                  
                  (
      12,240,891
                  )
                  
                  
                  -(Accretion)
      of investment securities
                  
                  
                  -
                  
                  
                  
                  ( 6,486
                  )Proceeds
      from sale of loans
                  
                  
                  12,925,466
                  
                  
                  
                  -Gain
      on sale of loans
                  
                  
                  ( 684,575
                  )
                  
                  
                  ( 392,490
                  )Loss
      on sale of investment securities
                  
                  
                  -
                  
                  
                  
                  12,047Stock-based
      compensation
                  
                  
                  195,420
                  
                  
                  
                  770,851Increase
      in Other Assets
                  
                  
                  ( 128,492
                  )
                  
                  
                  ( 339,288
                  )Increase
      (decrease) in Other Liabilities
                  
                  
                  ( 272,722
                  )
                  
                  
                  381,351Net
      cash  used in operating activities
                  
                  
                  ( 653,475
                  )
                  
                  
                  ( 1,760,732
                  )Cash
      flows from investing activities:Proceeds
      from maturity of time deposits in other financial
    institutions
                  
                  
                  -
                  
                  
                  
                  1,000,000Proceeds
      from sale of investment securities
                  
                  
                  -
                  
                  
                  
                  7,937,814Net
      redemption of Federal Reserve Bank stock
                  
                  
                  40,100
                  
                  
                  
                  88,650Net
      (increase) in Loans
                  
                  
                  (
      40,207,760
                  )
                  
                  
                  (62,686,236
                  )Purchases
      of premises and equipment
                  
                  
                  ( 82,900
                  )
                  
                  
                  ( 165,956
                  )Net
      cash used in investing activities
                  
                  
                  (
      40,250,560
                  )
                  
                  
                  (53,825,728
                  )Cash
      flows from financing activities:Net
      increase in demand deposits and savings accounts
                  
                  
                  22,943,528
                  
                  
                  
                  23,186,574Net
      increase in time deposits
                  
                  
                  15,238,302
                  
                  
                  
                  35,955,127Proceeds
      from sale of stock
                  
                  
                  1,082,981
                  
                  
                  
                  -Proceeds
      from exercise of warrants
                  
                  
                  -
                  
                  
                  
                  2,500Net
      cash provided by financing activities
                  
                  
                  39,264,811
                  
                  
                  
                  59,144,201Net
      (decease) increase in cash andcash
      equivalents
                  
                  
                  ( 1,639,224
                  )
                  
                  
                  3,557,741Cash
      and cash equivalents at beginning of year
                  
                  
                  14,473,892
                  
                  
                  
                  10,916,151Cash
      and cash equivalents at end of year
                  
                  $
                  12,834,668
                  
                  
                  $
                  14,473,892Supplemental
      disclosure of cash flow information:Interest
      paid
                  
                  $
                  3,038,949
                  
                  
                  $
                  1,916,374Income
      taxes paid
                  
                  $
                  1,600
                  
                  
                  $
                  1,600Supplemental
      schedule of non-cash investing activities:
   The
accompanying notes are an integral part of these financial
statements.
 80
  PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 CONSOLIDATED
STATEMENT OF SHAREHOLDERS’ EQUITY
 Years
Ended December 31, 2008 and 2007
 AdditionalShares
                                      
                                      
                                      Common
                                      
                                      
                                      Paid-in
                                      
                                      
                                      AccumulatedOutstanding
                                      
                                      
                                      Stock
                                      
                                      
                                      Capital
                                      
                                      
                                      Deficit
                                      
                                      
                                      TotalBalance
      at December 31, 2006
                                      
                                      
                                      2,281,500
                                      
                                      
                                      $
                                      22,815
                                      
                                      
                                      $
                                      24,788,356
                                      
                                      
                                      $
                                      ( 8,791,588
                                      )
                                      
                                      $
                                      16,019,583Warrants
      Exercised
                                      
                                      
                                      200
                                      
                                      
                                      
                                      2
                                      
                                      
                                      
                                      2,498
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      2,500Stock-based
      Compensation
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      770,851
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      770,851Net
      Loss
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (4,041,669
                                      )
                                      
                                      
                                      (
      4,041,669
                                      )Balance
      at December 31, 2007
                                      
                                      
                                      2,281,700
                                      
                                      
                                      $
                                      22,817
                                      
                                      
                                      $
                                      25,561,705
                                      
                                      
                                      $
                                      (12,833,257
                                      )
                                      
                                      $
                                      12,751,265Proceeds
      from sale of stock, net
                                      
                                      
                                      263,150
                                      
                                      
                                      
                                      2,631
                                      
                                      
                                      
                                      1,080,350
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      1,082,981Stock-based
      Compensation
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      195,420
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      195,420Net
      Loss
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (8,771,355
                                      )
                                      
                                      
                                      (
      8,771,355
                                      )Balance
      at December 31, 2008
                                      
                                      
                                      2,544,850
                                      
                                      
                                      $
                                      25,448
                                      
                                      
                                      $
                                      26,837,475
                                      
                                      
                                      $
                                      (21,604,612
                                      )
                                      
                                      $
                                      5,258,311
 
 
   The
accompanying notes are an integral part of these financial
statements.
 81
  PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Organization
 
 Pacific
Coast National Bancorp, a bank holding company, is a California corporation that
incorporated on July 2, 2003. Pacific Coast National Bank (the “Bank”),
chartered as a national bank by the Office of the Comptroller of the
Currency,(the
OCC)is a
wholly-owned subsidiary of Pacific Coast National Bancorp. The Bank has been
organized as a single operating segment and maintains two branches in southern
Orange and northern San Diego Counties.  The Bank is primarily in the
business of taking deposits from and making loans to businesses and individuals
throughout Orange and San Diego counties.  The Bank’s primary source
of revenue is interest income from loans to customers. The Bank’s customers are
predominantly small and middle-market businesses and individuals. The Bank
opened for business on May 16, 2005.
 
 Principles of
Consolidation
 
 The
consolidated financial statements include the accounts of Pacific Coast National
Bancorp and the Bank, collectively referred to herein as the
“Company.”  All significant intercompany transactions have been
eliminated.
 
 Basis of
Presentation
 
 The
accounting and reporting policies of the Company are in accordance with
accounting principles generally accepted in the Unites States of America and
prevailing practices within the banking industry.  A summary of the
significant accounting policies consistently applied in preparation of the
accompanying financial statements follows:
 
 Use of Estimates in the
Preparation of Financial Statements
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and at the date of the financial statements and the reported amounts
of certain revenues and expenses during the reporting period.  Actual
results could differ from those estimates.
 
 Material
estimates common to the banking industry that are particularly susceptible to
significant change in the near term include, but are not limited to, the
determination of the allowance for loan losses, the determination of
compensation expense for stock options granted to employees and directors, and
valuation allowances associated with deferred tax assets, the recognition of
which is based on future taxable income.
 
 Presentation of Cash
Flows
 
 For the
purposes of reporting cash flows, cash and cash equivalents includes cash,
noninterest-earning deposits and federal funds sold.  Generally,
federal funds are sold for one day periods. Cash flows from loan originations
and principal payments and deposits are reported net.
 
 
 82
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Cash and Cash
Equivalents
 
 The
Company maintains amounts due from banks which exceed federally insured
limits.  The Company has not experienced nor does it anticipate any
losses in such accounts. The Bank is required to maintain a clearing balance of
$225 thousand with the Federal Reserve Bank of San Francisco.
 
 Federal Reserve Bank (FRB)
Stock
 
 As a
national bank, the Bank is a member of the Federal Reserve
System.  Members are required to own a certain amount of FRB stock
based upon a banks level of capital and surplus.  FRB stock is carried
at cost and classified as a restricted security.  At December 31, 2008
and 2007 the Bank owned $365 thousand and $405 thousand in FRB stock,
respectively.  The fair value of FRB stock at December 31, 2008 is
equal to the carrying amount of $365 thousand, as no ready market exists for
this stock and they have no quoted market value.
 
 Loans
 
 Loans are
reported at their outstanding unpaid principal balances reduced by the allowance
for loan losses and net of any deferred fees or costs on originated loans, or
unamortized premiums or discounts on purchased loans.  During the
year, as opportunities arise, we may periodically sell SBA loans and record
gains in accordance with Statement of Financial Accounting Standards (“SFAS
140”).  In connection with such sales we make certain representations
and warranties that are common in such sales.  During 2008 and 2007
there have been no claims on such representations and warranties and therefore
no liability has been recorded at December 31, 2008 or 2007.  At
December 31, 2008 and 2007 there were no significant amounts of loans held for
sale.
 
 Credit
and loan decisions are made by management and the board of directors in
conformity with loan policies established by the board of directors. The
Company’s practice is to charge-off any loan or portion of a loan when the loan
is determined by management to be uncollectible due to the borrower’s failure to
meet repayment terms, the borrower’s deteriorating or deteriorated financial
condition, the depreciation of the underlying collateral, the loan’s
classification as a loss by regulatory examiners, or other reasons.
  The
Company considers a loan to be impaired when it is probable that the Company
will be unable to collect all amounts due (principal and interest) according to
the contractual terms of the loan agreement.  Measurement of
impairment is based on the expected future cash flows of an impaired loan, which
are to be discounted at the loan’s effective interest rate, or measured by
reference to an observable market value, if one exists, or the fair value of the
collateral for a collateral-dependent loan.  The Company selects the
measurement method on a loan- by-loan basis except that collateral-dependent
loans for which foreclosure is probable are measured at the fair value of the
collateral less costs of disposition.
 
 Provision and Allowance for
Loan Losses
 
 Implicit
in the Company’s lending activities is the fact that loan losses will be
experienced and that the risk of loss will vary with the type of loan being made
and the creditworthiness of the borrower over the term of the
loan.  To reflect the currently perceived risk of loss associated with
the loan portfolio, additions are made to the allowance for loan losses in the
form of direct charges against income to ensure that the allowance is available
to absorb probable loan losses.  The factors that influence the amount
include, among others, the remaining
   83
    PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Provision and Allowance for
Loan Losses - continued
 collateral
and/or financial condition of the borrowers, historical and peer bank loan loss
experience, changes in the size and composition of the loan portfolio, and
current economic conditions.  In addition, regulatory agencies, as an
integral part of their examination process, periodically review the Company’s
allowance for loan losses, and may require the Company to recognize adjustments
to its allowance based on their judgment as to information available to them at
the time of their examination.   The amount of the allowance
equals the cumulative total of the provisions made to date reduced by loan
charge-offs and increased by recoveries of loans previously
charged-off.  In addition, a separate allowance for credit losses on
off-balance sheet credit exposures is maintained for the undisbursed portion of
approved loans. Although the loss exposure to the Company is reduced because the
funds have not been released to the borrower, under certain circumstances the
Company may be required to continue to disburse funds on a troubled
credit.
 
 Accrued Interest and Fees on
Loans
 
 Accrued
interest income is recognized daily in accordance with the terms of the note
based on the unpaid principal balance, using the effective interest method.
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. As of December 31, 2008 ten loans
were designated as nonaccrual loans. As of December 31, 2007 two loans were
designated as nonaccrual loans.
 
 Loan
origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield of the related loan.
 
 During
the second quarter of 2007 we implemented the accounting for loan fees and costs
as required under SFAS No. 91, “Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases”. Prior to this, loan fees had been deferred as required under FAS No. 91
but the associated loan costs had not been recognized.  In order to bring
the deferred loan costs current to June 30, 2007, $74 thousand in costs was
recognized, bringing net loan fees and costs to a negative, or loss, position.
The charging or waiving of loan fees is often negotiated during initial
discussions with the borrower.
  In order
to properly record the deferred loan costs as of June 30, 2007, $208 thousand in
costs primarily related to salaries and benefits, net of $74 thousand in
amortization, were deferred, bringing deferred loan fees and costs to a net cost
position.  Of the $208 thousand of net deferred costs recorded during the
quarter ended June 30, 2007, approximately $156 thousand ($0.06 per share at
December 31, 2006) related to the year ended December 31, 2006 and $36 thousand
($0.02 per share at March 31, 2007) related to the quarter ended March 31,
2007.  As the effect of the initial recording of deferred costs was not
material to the overall financial statements, we did not restate earnings for
the year ended December 31, 2006 or the quarter ended March 31,
2007.
 
 
 84
 
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 
 NOTE A - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES - Continued
 
 Premises and
Equipment
 
 Premises
and equipment are carried at cost less accumulated depreciation and
amortization.  Depreciation is computed using the straight-line method
over the estimated useful lives, which ranges from three to ten years for
furniture and fixtures. Expenditures for betterments or major repairs are
capitalized and those for ordinary repairs and maintenance are charged to
operations as incurred.
 
 Income Taxes
 
 Deferred
income taxes are computed using the asset and liability method, which recognizes
a liability or asset representing the tax effects, based on current tax law, of
future deductible or taxable amounts attributable to events that have been
recognized in the financial statements.  A valuation allowance is
established to reduce the deferred tax asset to the level at which it is “more
likely than not” that the tax asset or benefits will be
realized.  Realization of tax benefits of deductible temporary
differences and operating loss carryforwards depends on having sufficient
taxable income of an appropriate character within the carryforward
periods.
 
 In June,
2006, the FASB issued Financial Interpretation (“FIN”) No. 48, “Accounting for
Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in
income taxes recognized in the financials statements in accordance with SFAS No.
109, “Accounting For Income Taxes.” FIN No. 48 provides that a tax benefit from
an uncertain tax position may be recognized when it is more likely than not that
the position will be sustained upon examination, including resolutions of any
related appeals or litigation processes, based on the technical merits. Income
tax positions must meet a more-likely-than-not recognition threshold at the
effective date to be recognized upon the adoption of FIN 48 and in subsequent
periods. This interpretation also provides guidance on measurement,
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.
 
 We
adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes”, on January 1, 2007, with no effect on the
Company’s consolidated financial statements.
 
 Interest
and penalties, if any, related to uncertain tax positions are recorded in other
non-interest expense. Accrued interest and penalties, if any, are included in
other liabilities in the consolidated balance sheet.
 
 Financial
Instruments
 
 In the
ordinary course of business, the Company has entered into off-balance sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit, and standby letters of credit as described in Note
K.  Such financial instruments are recorded in the financial
statements when they are funded or related fees are incurred or
received.
 
 
 85
  
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE A - SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Loss Per
Share
 
 Basic
loss per common share is based on the weighted average number of common shares
outstanding during the period. The effects of potential common shares
outstanding during the period would be included in diluted loss per share;
however, the effect of potential shares is antidilutive during all periods
presented. As a result, the Company only reports basic loss per share. For the
years ended December 31, 2008 and 2007, the conversion of approximately 500 and
278,000, respectively, common shares issuable upon exercise of the employee
stock options and common stock warrants have not been included in the 2008 and
2007 loss per share computation because their inclusion would have been
antidilutive on loss per share.
 
 Stock-Based
Compensation
 
 Effective
January 1, 2006, the Company adopted SFAS 123(R), “Share-Based Payment” (SFAS
123(R)) utilizing the modified prospective approach. Prior to the adoption of
SFAS 123 (R) we accounted for stock option grants in accordance with APB Opinion
No. 25, “Accounting for Stock Issued to Employees” (the intrinsic method), and
accordingly recognized no compensation expense related to
employees.
 
 Under the
modified prospective approach, SFAS 123 (R) applies to new awards and to awards
that were outstanding on January 1, 2006 that are subsequently modified,
repurchased or cancelled. Under the modified prospective approach, compensation
cost recognized in 2006 includes compensation cost for all stock-based payments
granted prior to, but not yet vested as of January 1, 2006, based on the
grant-date fair value estimated in accordance with the original provision of
SFAS 123, and compensation cost for all share-based payments granted subsequent
to January 1, 2006, based on the grant-date fair value estimated in accordance
with the provisions of SFAS 123 (R).  Prior periods were not restated
to reflect the impact of adopting the new standard. During 2008 and 2007 the
Bank recognized pre-tax stock-based compensation expense of $195,420 and
$770,851, respectively, as a result of SFAS No. 123(R).
 
 As of
December 31, 2008, there was $26 thousand of unrecognized compensation cost
related to unvested stock options. This cost is expected to be recognized over a
weighted average period of approximately one year.
 
 Disclosure about Fair Value
of Financial Instruments
 
 SFAS No.
107 specifies the disclosure of the estimated fair value of financial
instruments.  The Company’s estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies.
 
 However,
considerable judgment is required to develop the estimates of fair
value.  Accordingly, the estimates are not necessarily indicative of
the amounts the Company could have realized in a current market
exchange.  The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value
amounts.
 
 Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements
   86
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE A - SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 Disclosure about Fair Value
of Financial Instruments - continued
 
 subsequent
to the balance sheet date and, therefore, current estimates of fair value may
differ significantly from the amounts presented in the accompanying
notes.
 
 Recent Accounting
Pronouncements
  In
September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS
157”). SFAS 157 clarifies the principal that fair value should be based on the
assumptions market participants would use when pricing an asset or liability and
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. Under the standard, fair value measurements would be
separately disclosed by level within the fair value hierarchy. In February 2008,
the FASB issued FASB Staff Position (FSP) No. 157-2, “Effective Date of FASB
Statement No. 157”, to partially defer FASB Statement No. 157 for nonfinancial
assets and nonfinancial liabilities, except those that are recognized or
disclosed at fair value  in the financial statement on a recurring
basis. SFAS 157 was effective for us on January 1, 2008, however for
nonfinancial assets and nonfinancial liabilities that are not recognized or
disclosed at fair value on a recurring basis the effective date is January 1,
2009. The remaining portion of SFAS No 157 adopted on January 1, 2009 did not
have a significant effect on our financial position or results of operations. In
October 2008, the FASB issued FASB Staff Position (FSP) 157-3, “Determining the
Fair Value of a Financial Asset when the Market for That Asset Is Not
Active”.  This FSP clarifies the application of SFAS 157 in a market
that is not active.  The impact of adoption was not
material.
 
 In April
2009, the FASB issued FSP 157-4, “Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability have Significantly Decreased and
Identifying Transactions that Are Not Orderly”.  FSP 157-4 indicates
that if an entity determines that either the volume and/or level of activity for
an asset or liability has significantly decreased (from normal conditions for
that asset or liability) or price quotations or observable inputs are not
associated with orderly transactions, increased analysis and management judgment
will be required to estimate fair value.  FSP 157-4 is effective for
interim and annual periods ending after June 15, 2009, with early adoption
permitted.  FSP 157-4 must be applied prospectively.  The
Company has elected to adopt FSP 157-4 in the first quarter of
2009.  The impact of adoption is not expected to be
material.
 
 In
December 2007, the FASB issued Statement No. 141 (revised 2007), “Business
Combinations” (“FAS 141(R)”), which establishes principles and requirements for
how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in an acquiree, including the recognition and measurement of goodwill
acquired in a business combination.  FAS No. 141(R) is effective for
fiscal years beginning on or after December 15, 2008.  Earlier
adoption is prohibited.  The adoption of this standard is not expected
to have a material effect on our results of operations or financial position
unless we engage in a business combination.
 
 Reclassifications
 
 Certain
reclassifications have been made in the 2007 consolidated financial statements
to conform to the presentation used in 2008.  These classifications are of
a normal recurring nature and had no effect on previously reported stockholders’
equity or net loss.
   87
  
 NOTE
B – REGULATORY ACTIONS, BUSINESS PLAN AND GOING CONCERN
CONSIDERATIONS
 
 In
connection with continuing turmoil in the economy, and more specifically, with
the California real estate market, we recorded a net loss of $8.8 million for
the year ended December 31, 2008.  This loss was primarily the result
of considerable increases in the provision for loan losses during the year,
which was compounded by a tightening interest margin caused by recent interest
rate reductions and increased amounts of non-accrual loans.  The
significant net loss caused the Banks ratio of total capital to risk weighted
assets to fall below the “adequately capitalized” requirements at December 31,
2008, as further described in Note N – Regulatory Matters.  The
culmination of net losses in recent quarters has had a negative impact on our
operations, liquidity and capital adequacy and has resulted in actions by our
regulators which restrict our operations as noted below.
 
 Regulatory
Matters
 
 The Bank
was recently examined by the OCC, its primary regulator.  At the
conclusion of the exam it was determined that the Bank’s previously
filed  December 31, 2008 quarterly Call Report needed to be amended as
a result of a necessary increase to the Bank’s provision for loan
losses.  This amended filing resulted in the Bank no longer meeting
the adequate capital quantitative measures established by
regulation.  See Note N.  The Bank’s Total Capital to
risk-weighted assets ratio which must be at least 8% for adequately capitalized
status, was 5.03% at December 31, 2008, though this ratio improved to 6.84%
(unaudited) as of March 31, 2009 as a result of the downstreaming by the Company
to the Bank of the proceeds the Company received in January 2009 of a $4.1
million investment from the United States Department of the Treasury pursuant to
the Treasury’s Troubled Asset Relief Program (“TARP”) Capital Purchase
Program.  See Note Q.  As also described in Note Q,
subsequent to December 31, 2008, the Bank  was notified by the OCC
that it imposed a number of requirements and restrictions on the Bank’s
operations, primarily due to the Bank’s reduced capital levels, deteriorating
asset quality and net losses.  In addition to the regulatory actions
already taken, it is anticipated that the Bank and/or the Company will receive
some form of written agreement from their primary regulators should the Bank and
the Company not bring their capital ratios up to a level that is
adequate.  If such an agreement were entered into, it is expected it
would require the Bank to, among other things, maintain certain capital levels,
restricting the use of brokered deposits, as well as reduce the number and
amount of classified loans.
 
 Business Plan and Going
Concern Considerations
 
 In
response to the challenging economic environment and increased regulatory
supervision, the Company plans to take a number of tactical actions aimed at
preserving existing capital, reducing lending exposures and associated capital
requirements and increasing liquidity. The tactical actions include, but are
not limited to the following: slowing loan originations, growing retail
deposits, reducing brokered deposits, seeking commercial loan participation and
sales arrangements with other lenders or private equity sources and reducing
operating costs.The plan focuses on four
primary objectives: (1) improving asset quality; (2) controlling asset growth
and improving regulatory capital ratios; (3) continued expense control; and (4)
increase core deposits and other retail deposit products.
 
 
 88
 
  PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
B – REGULATORY ACTIONS, BUSINESS PLAN AND GOING CONCERN CONSIDERATIONS –
continued
 
 Business Plan and Going
Concern Considerations - continued
 
 The
Company is evaluating
various strategic options, including capital raising alternatives, the sale of
the Bank’s Encinitas branch office and a sale or merger of the
Company.  In this regard, the Company has been in extensive
discussions with several parties regarding the possibility of a substantial
equity investment in the Company, which could also entail a rights offering to
existing shareholders, or a possible sale of the Company.  While the
Company plans to focus on the tactical actions described above and pursue
strategic alternatives, as has
been widely publicized, access to capital markets is extremely limited in the
current economic environment, andtherecanbeno assurances thatthe Company’s
efforts will be successful and will result in sufficient capital preservation or
infusion.The Company’sability to decreasethelevels of non-performing assets is also
vulnerable to market conditions as construction loan borrowers rely on an active
real estate market as a source of repayment, and the sale of loans in this
market is difficult. If the real estate market does not improve,thelevel of non-performing assets may
continue to increase.
 
 Further,
as a result of the asset quality and capital concerns impacting the Company, the
Company has been addressing the liquidity needed to maintain an adequate cash
flow position to sustain the operations of the Company.  As of May 17,
2009, the Company maintained the following sources of liquidity (unaudited) to
satisfy pending repayments of brokered deposits and other cash flow
obligations:
 
 ·
              $37.0
      million of cash and cash
equivalents.
 ·
              $5.0
      million of borrowing capacity at its correspondent
  bank.
 ·
              Additionally,
      the Company is continuously looking at strategic asset sales that could be
      facilitated without further impairment of capital, such as sales of
      certain assets, and potentially the sale of the bank branch in
      Encinitas.
 
 Due to
the conditions and events discussed herein, there is substantial doubt about the
Company’s ability to continue as a going concern.  Management has
determined that additional sources of liquidity and capital will be required to
continue operations through 2009 and beyond.  As noted above, the
Company has been in extensive discussions with several parties regarding the
possibility of a substantial equity investment in the Company, or a possible
sale of the Company.   However, to date, those efforts have not
yielded any definitive options.  As a result of the financial
condition of the Company, the regulators are continually monitoring the
Company’s liquidity and capital.
 
 
 89
 
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
B – REGULATORY ACTIONS, BUSINESS PLAN AND GOING CONCERN CONSIDERATIONS –
continued
 
 Business Plan and Going
Concern Considerations – continued
 
 Based on
the regulators' assessment of the Company’s ability to operate, they may take
other and further actions, including the issuance of an agreement as described
above.  The regulators have various enforcement tools available to
them, including the issuance of capital directives, orders to cease engaging in
certain business activities and the issuance of other orders or
agreements.  If a severe liquidity crises were to occur (the Bank were
unable to pay its liabilities when due) or a significant deterioration in the
Bank’s or the Company’s capital levels were experienced, the regulators could
place the Bank in receivership and upon such event, the FDIC would liquidate the
assets of the Bank.
 
 The
accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the discharge of
liabilities  in the normal course of business for the foreseeable
future, and do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets, or the amounts and
classification of liabilities that may result from the outcome of any
extraordinary regulatory action, which would affect the Company’s ability to
continue as a going concern.
 
 NOTE
C - INVESTMENT SECURITIES
 
 During
the first quarter of 2007, we made the decision to sell specific investments
issued by the Federal National Mortgage Association, or FNMA or Fannie Mae,
based on concerns that the underlying mortgages could be impacted by the events
in the sub-prime lending arena. The investment portfolio was sold in two phases
over the first and second quarters of 2007. These securities had been designated
as “held to maturity”.  We recorded a gain of $12 thousand on the sale
of $3.9 million in securities in the first quarter of 2007. We recorded a loss
of $24 thousand on the sale of $4 million in securities in the second quarter of
2007.
  NOTE
D – LOANS AND SUBSEQUENT EVENT
 
 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.
 
 
 90
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
D – LOANS  AND SUBSEQUENT EVENT- Continued
 
 The
composition of the loan portfolio at December 31 is as follows:
 2008
                        
                        
                        
                        
                        
                        2007Real
      estate1-4
      residential
                        
                        $
                        5,629,466
                        
                        
                        
                        4.2
                        %
                        
                        $
                        2,654,635
                        
                        
                        
                        2.7
                        %Multi-Family
                        
                        
                        2,110,061
                        
                        
                        
                        1.6
                        %
                        
                        
                        719,959
                        
                        
                        
                        0.7
                        %Non-farm,
      non-residential
                        
                        
                        55,507,910
                        
                        
                        
                        41.3
                        %
                        
                        
                        40,950,795
                        
                        
                        
                        41.9
                        %Construction
      & Land Development
                        
                        
                        34,466,448
                        
                        
                        
                        25.6
                        %
                        
                        
                        31,163,576
                        
                        
                        
                        31.9
                        %Commercial
                        
                        
                        36,565,534
                        
                        
                        
                        27.2
                        %
                        
                        
                        21,827,512
                        
                        
                        
                        22.4
                        %Consumer
                        
                        
                        231,289
                        
                        
                        
                        0.2
                        %
                        
                        
                        327,735
                        
                        
                        
                        0.3
                        %134,510,708
                        
                        
                        
                        100
                        %
                        
                        
                        97,644,212
                        
                        
                        
                        100
                        %Net
      deferred loan costs,
                          premiums
      and discounts
                        
                        
                        369,581
                        
                        
                        
                        
                        
                        
                        
                        229,919Allowance
      for loan losses
                        
                        
                        ( 6,550,000
                        )
                        
                        
                        
                        
                        
                        
                        ( 1,814,860
                        )$
                        128,330,289
                        
                        
                        
                        
                        
                        
                        $
                        96,059,271
  A
majority of the Bank’s commercial loan portfolio is with customers located
within California throughout its primary market area of Orange and San Diego
Counties. The Bank grants commercial loans to borrowers in a number of different
industries. The Bank’s real estate and construction loan portfolio, which is
72.6% of the Bank’s total loan portfolio as of December 31, 2008, consists of
loans on real estate located throughout Southern California. Changes in economic
conditions in Southern California may continue to result in losses that cannot
be reasonably predicted at this time.
 
 The Bank
has recently experienced significant declines in current valuations of real
estate collateral supporting significant portions of its loan portfolio in
2008.  If real estate values continue to decline and as updated
appraisals are received, the Bank may have to increase its allowance for loan
losses accordingly.
 
 Changes
in the allowance for loan losses are summarized as follows:
 2008
                      
                      
                      2007($
      in thousands)Balance
      at beginning of year
                      
                      $
                      1,815
                      
                      
                      $
                      432Provision
      charged to expense
                      
                      
                      7,937
                      
                      
                      
                      1,383Loans
      charged off
                      
                      
                      ( 3,470
                      )
                      
                      
                      -Recoveries
      on loans previously charged off
                      
                      
                      268
                      
                      
                      
                      -Balance
      at end of year
                      
                      $
                      6,550
                      
                      
                      $
                      1,815
   The Bank
had ten loans on which the accrual of interest has been discontinued with an
outstanding balance of $7.8 million as of December 31, 2008. The Bank had two
loans on which the accrual of interest has been discontinued with an outstanding
balance of $2.5 million as of December 31, 2007.
   91
  
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
D – LOANS AND SUBSEQUENT EVENT - Continued
 
 The table
below sets forth the amounts and categories of impaired and non-performing loans
in the Bank’s loan portfolio.
 2008
                            
                            
                            2007($
      in thousands)Net
      impaired loans, with a specific
                              allowance
      for loan losses under SFAS 114
                            
                            $
                            8,834
                            
                            
                            $
                            2,467Impaired
      loans without specific reserves
                            
                            
                            12,198
                            
                            
                            
                            -Total
      impaired loans
                            
                            $
                            21,032
                            
                            
                            $
                            2,467Related
      specific SFAS 114 allowance for
                              loan
      losses on impaired loans
                            
                            $
                            2,790
                            
                            
                            $
                            590Restructured
      loans
                            
                            $
                            882
                            
                            
                            $
                            -Total
      non-accrual loans (1)
                            
                            $
                            7,816
                            
                            
                            $
                            2,467Loans
      past due 90 days or more and still
                              accruing
                            
                            $
                            -
                            
                            
                            $
                            -Average
      balance during the year on impaired
                              loans
                            
                            $
                            21,673
                            
                            
                            $
                            2,456Interest
      income recognized on impaired
                              loans
                            
                            $
                            681
                            
                            
                            $
                            177
   (1)
              During
      the first quarter of 2009 Management placed an additional $9.9 million in
      loans on nonaccrual status.
 
 Net
impaired loans with an allocated allowance for loan losses represents 42.0% of
total impaired loans at December 31, 2008. These loans carry an allocated
allowance for loan losses of $2.8 million at December 31, 2008.  The
majority of the $21.0 million in impaired loans at December 31, 2008 are real
estate secured.
 
 Gross
interest income which would have been recorded had our non-accruing loans been
current in accordance with their original terms amounts to $343 thousand. We
received and recorded $153 thousand for such loans for the year ended December
31, 2008.  For the year ended December 31, 2007, gross interest income
which would have been recorded had our non-accruing loans been current in
accordance with their original terms amounts to $170 thousand. We received and
recorded $126 thousand for such loans for the year ended December 31,
2007.
 
 Management
may renew loans at maturity when requested by a customer whose financial
strength appears to support such a renewal or when such a renewal appears to be
in our best interest. We require payment of accrued interest in such instances
and may adjust the rate of interest, require a principal reduction, or modify
other terms of the loan at the time of renewal. Loan terms vary according to
loan type.
 
 At
December 31, 2008 the Company had one loan classified as restructured from its
original terms.  This fully disbursed loan was also classified as
impaired, with an allowance for loan losses, and treated as a non-accrual
loan.
  
 92
 
 
 NOTE
E - COMPANY PREMISES AND EQUIPMENT, NET
 
 The
composition of premises and equipment at December 31 is as
follows:
 
 2008
                                            
                                            
                                            2007($
      in thousands)Bank
      premises
                                            
                                            $
                                            404
                                            
                                            
                                            $
                                            398Furniture,
      fixtures and equipment
                                            
                                            
                                            1,500
                                            
                                            
                                            
                                            1,4231,904
                                            
                                            
                                            
                                            1,821Less
      accumulated depreciation
                                            
                                            
                                            1,354
                                            
                                            
                                            
                                            934$
                                            550
                                            
                                            
                                            $
                                            887
 
 NOTE
F - DEPOSITS
 
 At
December 31, 2008 the scheduled maturities of time deposits are as
follows:
 Time
      Deposits of $100,000 or more
                        
                        
                        Other
      Time Deposits
                        
                        
                        Total
      Time Deposits($
      in thousands)2009
                        
                        $
                        5,596
                        
                        
                        $
                        49,972
                        
                        
                        $
                        55,5682010
                        
                        
                        -
                        
                        
                        
                        752
                        
                        
                        
                        7522011
                        
                        
                        -
                        
                        
                        
                        89
                        
                        
                        
                        89Total
                        
                        $
                        5,596
                        
                        
                        $
                        50,813
                        
                        
                        $
                        56,409
 
  At
December 31, 2008, one customer’s balance, which was our largest depositor,
totaling $28.3 million, comprised approximately 21% of total deposits. These
balances are included in Other Time Deposits and are brokered deposits. In
addition, $400,000 in brokered deposits are included in Time Deposits of
$100,000 or more. $34.9 million in brokered deposits mature in 2009 and the
remaining $718,000 mature in 2010.
 
 NOTE
G - OTHER BORROWINGS
 
 The
Company may borrow up to $5,000,000 overnight on a secured basis from its
correspondent bank.  As of December 31, 2008, no amounts were
outstanding under these arrangements. The Bank borrowed against this line
frequently between September 24, 2008 and October 31, 2008, with the largest
borrowing being $4.2 million for one day.  The line has an annual
renewal date and the interest rate is indexed to the overnight fed funds rate at
the time of the draw.
 
 During
January 2009, one correspondent bank cancelled an unsecured line of credit to
the Bank, there had been no borrowings during 2008 under this line. The
remaining line now requires collateral in the form of loans or investment
securities.
 
 NOTE
H - INCOME TAXES
 
 Deferred
taxes are a result of differences between income tax accounting and generally
accepted accounting principles with respect to income and expense
recognition.  The following is a summary of the components of the net
deferred tax asset accounts recognized in the accompanying consolidated balance
sheet at December 31:
   93
   
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
H - INCOME TAXES - Continued
 2008
                    
                    
                    2007Deferred
      tax assets:Pre-Opening
      Expenses
                    
                    $
                    743,000
                    
                    
                    $
                    872,000Net
      loss carryforward
                    
                    
                    5,165,000
                    
                    
                    
                    2,823,000Allowance
      for loan losses
                    
                    
                    2,119,000
                    
                    
                    
                    658,000Other
                    
                    
                    
                    28,000
                    
                    
                    
                    46,000Total
      deferred tax assets
                    
                    
                    8,055,000
                    
                    
                    
                    4,399,000Deferred
      liabilities:Tax
      over book depreciation
                    
                    
                    ( 55,000
                    )
                    
                    
                    ( 32,000
                    )Accrual
      to cash
                    
                    
                    
                    ( 131,000
                    )
                    
                    
                    ( 16,000
                    )Total
      deferred tax liabilities
                    
                    
                    ( 186,000
                    )
                    
                    
                    ( 48,000
                    )Net
      deferred tax assets
                    
                    
                    7,869,000
                    
                    
                    
                    4,351,000Valuation
      Allowance
                    
                    
                    (7,869,000
                    )
                    
                    
                    (4,351,000
                    )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 $12.6 million for federal income and California franchise tax
purposes.  Federal net operating loss carry forwards, to the extent
not used, will begin to expire in 2025.  California net operating loss
carry forwards, to the extent not used, will begin to expire in
2017.
 
 The
provision for income tax expense (benefit) differs from the amount of expected
tax expense (benefit) to the amount computed by applying the statutory U. S.
Federal income tax rate to the (loss) before income taxes due to the
following:
 2008
                    
                    
                    2007Expected
      (benefit) expense at statutory rate:Federal
                    
                    $
                    (2,981,000
                    )
                    
                    $
                    (1,374,000
                    )State
                    
                    
                    ( 613,000
                    )
                    
                    
                    ( 238,000
                    )Increase
      in valuation allowance
                    
                    
                    3,518,000
                    
                    
                    
                    1,341,000Other
      permanent differencesStock
      Options
                    
                    
                    63,000
                    
                    
                    
                    240,163Other
                    
                    
                    14,600
                    
                    
                    
                    32,437Tax
      expense
                    
                    
                    $
                    1,600
                    
                    
                    $
                    1,600
 
  Because
the Company is in a net loss position for taxes, the tax provision is comprised
of the minimum California Franchise tax.
   94
  
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
H - INCOME TAXES – Continued
 
 The
Company adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes”, on January 1, 2007, with no effect on the
Company’s consolidated financial statements.  FIN No. 48 applies to
all open tax years, 2004 through 2007.  Based on the Company’s review
of tax positions taken, there are no material uncertain positions.
 
 Interest
and penalties, if any, related to uncertain tax positions are recorded in other
non-interest expense.  Accrued interest and penalties, if any, are
included in other liabilities in the consolidated balance sheet.  No
interest and penalties related to uncertain tax positions have been
accrued.
 
 NOTE
I - 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
$195,420 in 2008 and $770,851 in 2007. No tax benefit related to stock-based
compensation will be recognized until such time as the Company begins
recognizing its available deferred tax assets.
 
 A summary
of the status of the Bank’s stock option plan as of December 31, 2008 and
changes during the year ending thereon is presented below:
 As
      of December 31, 2008Prices
      of outstanding options
                  $6.00
      - $13.50Weighted
      average remaining contractual life of vested and expected to vest
      options
                  6.67
      yearsAggregate
      intrinsic value of options, vested and expected to
      vest
                  noneOptions
      vested and expected to vest
                  366,523Weighted
      average exercise price of vested and expected to vest
      options
                  $           10.29Weighted
      average exercise price of options
      exercisable
                  $           10.25Aggregate
      intrinsic value of options
      exercisable
                  noneWeighted
      average remaining contractual life of options
      exercisable
                  6.49
      yearsOptions
      exercisable remaining, end of
      period
                  346,110
 95
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
I - STOCK OPTIONS - continued
 
 The fair
value of each option was estimated using the Black-Scholes option pricing model
with the following assumptions presented below:
 2008
                  
                  2007Dividend
      Yield
                  
                  0.00%
                  
                  0.00%Expected
      volatility
                  
                  17.7%
      - 19.5%
                  
                  17.3%
      - 17.6%Risk
      Free Rate
                  
                  2.99%
      - 3.48%
                  
                  3.78%
      - 4.66%Expected
      Forfieture Rate - Employees
                  
                  35%
                  
                  10%
      - 51%Expected
      Forfieture Rate - Directors and Executive Officers
                  
                  5%
                  
                  5%
      - 8%Expected
      life of options (in years)
                  
                  6.5
      Years
                  
                  6.5
      YearsWeighted-Average
      Grant Date Fair Value
                  
                  $            1.61
                  
                  $            3.46
 
 Since the
Bank has a limited amount of historical stock activity the expected volatility
is based on the historical volatility of a specific bank that has similar
demographics and a longer trading history.  The expected term
represents the estimated average period of time that the options remain
outstanding.  Since the Bank does not have sufficient historical data
on the exercise of stock options, the expected term is based on the “simplified”
method that measures the expected term as the average of the vesting period and
the contractual term.  The risk free rate
of return reflects the grant date interest rate offered for zero coupon U.S.
Treasury bonds over the expected term of the options.  The following
table shows activity involving stock options during 2008 and
2007:
 2008
                      
                      
                      2007Weighted-
                      
                      
                      
                      
                      
                      Weighted-Average
                      
                      
                      
                      
                      
                      AverageShares
                      
                      
                      Exercise
      Price
                      
                      
                      Shares
                      
                      
                      Exercise
      PriceOutstanding
      at beginning of year
                      
                      
                      400,346
                      
                      
                      $
                      10.32
                      
                      
                      
                      384,965
                      
                      
                      $
                      10.34Granted
                      
                      
                      7,350
                      
                      
                      $
                      6.03
                      
                      
                      
                      55,548
                      
                      
                      $
                      10.09Exercised
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      -Forfeited
                      
                      
                      (23,097
                      )
                      
                      $
                      9.85
                      
                      
                      
                      (40,167
                      )
                      
                      $
                      10.13Outstanding
      at end of year
                      
                      
                      384,599
                      
                      
                      $
                      10.27
                      
                      
                      
                      400,346
                      
                      
                      $
                      10.32Options
      exercisable at year-end
                      
                      
                      346,110
                      
                      
                      $
                      10.25
                      
                      
                      
                      249,778
                      
                      
                      $
                      10.20Weighted-average
      fair value ofoptions
      granted during the year
                      
                      $
                      1.61
                      
                      
                      
                      
                      
                      
                      $
                      3.46
 96
   
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
J – 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:
 
 2008
                    
                    
                    2007Beginning
      Balance
                    
                    $
                    2,423,127
                    
                    
                    $
                    1,948,392Additions
                    
                    
                    1,272,787
                    
                    
                    
                    1,981,649Reclassifications
                    
                    
                    -
                    
                    
                    
                    (1,500,000
                    )Payments
                    
                    
                    (1,572,109
                    )
                    
                    
                    (6,914
                    )Ending
      Balance
                    
                    $
                    2,123,805
                    
                    
                    $
                    2,423,127Weighted
      Average Interest Rate
                    
                    
                    6.6
                    %
                    
                    
                    7.3
                    %
  Also in
the course of ordinary business, certain officers, directors, shareholders, and
employees of the Company have deposits with the Company. In the Company’s
opinion, all deposit relationships with such parties are made on substantially
the same terms including interest rates and maturities, as those prevailing at
the time of comparable transactions with other persons. The balance of directors
and executive officer deposits at December 31, 2008 and 2007, was approximately
$2.0 million and $625 thousand respectively.
 
 NOTE
K – COMMITMENTS AND CONTINGENCIES
 
 Financial Instruments with
off-balance sheet risk
 The
Company’s exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those
commitments.  Commitments to extend credit (such as the unfunded
portion on lines of credit and commitments to fund new loans) as of December 31,
2008 amounts to approximately $31.3 million of which approximately $265 thousand
is related to irrevocable letters of credit.  The Company uses the
same credit policies in these commitments as is done for all of its lending
activities.  As such, the credit risk involved in these transactions
is essentially the same as that involved in extending loan facilities to
customers.
 
 Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Because many of the
commitments are expected to expire without being drawn upon, the total amounts
do not necessarily represent future cash requirements.  The Company
evaluates each client's credit worthiness on a case-by-case
basis.  The amount of collateral obtained if deemed necessary by the
Company is based on management's credit evaluation of the
customer.  The majority of the Company's commitments to extend credit
and standby letters of credit is secured by real estate.  The
liability for off balance sheet risk as of December 31, 2008 was
$39,000.
 
 Lease
Commitments
 The
Company entered into a ten-year lease for its main office in San Clemente,
California and a five-year lease for a banking office in Encinitas, California.
The leases began on June 1, 2005 and August 1, 2004, respectively and have
renewal options for two five-year periods and three three-year periods
respectively. In August of 2006,
   97
  
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
K – COMMITMENTS AND CONTINGENCIES – continued
 
 Lease Commitments –
continued
 
 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 $442 thousand and $491 thousand for the
periods ending December 31, 2008 and 2007. Such “stepped” rent expense is
recorded on the straight-line basis over the expected life of the
lease.
 
 The
approximate future minimum payments for these leases are as
follows:
 2009
                  $     366,2002010
                  265,1002011
                  271,3002012
                  277,6002013
                  284,000Thereafter
                  412,400$  1,876,600
 
 NOTE
L - 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, 2008
and 2007, 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. The exercise price for these warrantswas $12.50 per share. A total of 456,001
warrants were issued in May 2005,454,301of whichwere outstandingat December 31, 2007.These warrants expired on
May 16, 2008.
 
 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
   98
    PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
L – WARRANTS - continued
 
 exercise
price of the warrants because they will be able to purchase shares of our common
stock at a price that is less than the then current market value. If the Bank’s
capital falls below the minimum level required by the OCC, management may be
directed to require the holders to exercise or forfeit their
warrants.
 
 In
connection with a private placement during the third and fourth quarters of
2008, the Company sold an aggregate of 25 units, for an aggregate purchase price
of $1,250,000 ($50,00,000 per unit), consisting of an aggregate of 263,150
shares of the Company’s common stock (10,526 shares per unit) and warrants,
exercisable for three-years, to purchase an aggregate of 52,650 shares of the
Company’s common stock (2,106 shares per unit) at an exercise price of $4.75 per
share.   As of December 31, 2008, all 52,650 of such warrants
were outstanding.
 
 
 NOTE
M - FAIR VALUES OF FINANCIAL INSTRUMENTS
 
 Effective
January 1, 2008, the Company adopted SFAS No. 157 (SFAS 157), “Fair Value
Measurements.”  The adoption of SFAS 157 did not have a material
impact on the Company’s financial position or results of
operations.  SFAS 157 defines fair value, established a framework for
measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements.  Fair value is defined
under SFAS 157 as the price that would be received for an asset or paid to
transfer a liability (an exit price) in the principal market for the asset or
liability in an orderly transaction between market participants on the
measurement date.  In support of this principal, SFAS 157 establishes
a fair value hierarchy which requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs when measuring
fair value.  The standard describes three levels of inputs that may be
used to measure fair value:
 
 Level
1:   Quoted prices (unadjusted) for identical assets or
liabilities in active markets that the entity has the ability to access as of
the measurement date.
 
 Level
2:   Significant other observable inputs other than Level 1
prices such as quoted prices for similar assets or liabilities; quoted prices in
markets that are not active; or other inputs that are observable or can be
corroborated by observable market data.
 
 Level
3:   Significant unobservable inputs that reflect a reporting
entity’s own assumptions about the assumptions that market participants would
use in pricing an asset and liability.
 
 For the
year ended December 31, 2008, the application of valuation techniques applied to
similar assets and liabilities has been consistent.
 
 The
Company did not have any assets or liabilities at December 31, 2008 that are
measured and recorded at fair value on a recurring basis.
 
 Certain
assets are measured at fair value on a nonrecurring basis; that is, the
instruments are not measured at fair value on an ongoing basis, but are subject
to fair value adjustments in certain circumstances (for example, when their is
evidence of impairment).  The flowing table presents such assets at
December 31, 2008.
  
 99
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
M - FAIR VALUES OF FINANCIAL INSTRUMENTS - Continued
  Fair
      Value Measurements UsingQuoted
      Prices
                
                Significant
      Other
                
                Significant
      Otherin
      Active Markets
                Observable
                
                Unobservalbewith
      Identical Assets
                
                Inputs
                
                InputsTotal
                
                (Level
      1)
                
                (Level
      2)
                
                (Level
      3)Impaired
      Loans withSpecific
      Reserves
                
                $     7,333,000
                
                $                 -
                
                $                  -
                
                $                  7,333,000
 
 Impaired
loans.  The specific reserves for collateral dependent impaired loans
are based on the fair value of the collateral less estimated cost to sell of
approximately $1.3 million.  The carrying amount of these 10 loans net
of specific reserves is approximately $6.0 million (See Note D).  The
fair value of collateral is determined based on third-party
appraisals.  In some cases, adjustments are made to the appraised
values due to various factors, including age of the appraisal, age of
comparables included in the appraisal, and known changes in the market and in
the collateral.  When significant adjustments are based on
unobservable inputs, such as when a current appraised value is not available or
management determines the fair value of the collateral is further impaired below
appraised value and there is no observable market price, the resulting fair
value measurement has been categorized as a Level 3 measurement.
 
 In
accordance with FASB Statement No. 107, “Disclosures About Fair Value of
Financial Instruments”, a summary of the estimated fair value of the Bank’s
financial instruments as of December 31, 2008 and 2007 is presented below. The
estimated fair value amounts have been determined by management using available
market information and appropriate valuation methodologies.
 
 However,
considerable judgment is necessary to interpret market data to develop the
estimates of the fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Bank could realize in a current market
exchange. The use of different assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts. Statement No. 107
excludes certain financial instruments and all non-financial assets and
liabilities from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Bank.
Although management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current fair value estimates may differ significantly from amounts
presented herein.
 
 The
following methods and assumptions were used to estimate the fair value of
significant financial instruments:
 
 Financial
Assets
 
 The
carrying amounts of cash, short term investments, due from balances and accrued
interest are considered to approximate fair value.  Short term
investments include federal funds sold, and interest bearing deposits with other
banks.
   100
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
M - FAIR VALUES OF FINANCIAL INSTRUMENTS - Continued
 
 For
variable rate loans that reprice frequently and that have experienced no
significant change in credit risk, fair
 
 values
are based on carrying values.  Fair values for all other loans are
estimated based on discounted cash flows, using interest rates currently being
offered for loans with similar terms to borrowers with similar credit quality
and additionally, the Company considers its credit worthiness in determining the
fair value.  Prepayments prior to the repricing date are not expected
to be significant.  Loans not held for sale are expected to be held to
maturity and any unrealized gains or losses are not expected to be
realized.
 
 Financial
Liabilities
 
 The
carrying amounts of deposit liabilities payable on demand and accrued interest
are considered to approximate fair value.  For fixed maturity
deposits, fair value is estimated by discounting estimated future cash flows
using currently offered rates for deposits of similar remaining
maturities.
 
 Off-Balance Sheet Financial
Instruments
 
 The fair
value of commitments to extend credit and standby letters of credit is estimated
using the fees currently charged to enter into similar
agreements.  The fair values of these financial instruments are not
deemed to be material.
 
 The
estimated fair value of financial instruments is summarized as
follows:
  
 The fair
value
 estimates
 December
      31, 2008
                  
                  
                  December
      31, 2007Carrying
                  
                  
                  Fair
                  
                  
                  Carrying
                  
                  
                  FairValue
                  
                  
                  Value
                  
                  
                  Value
                  
                  
                  ValueFinancial
      Assets:Cash
      and cash equivalents
                  
                  $
                  12,834,668
                  
                  
                  $
                  12,834,668
                  
                  
                  $
                  14,473,892
                  
                  
                  $
                  14,473,892Loans
      receivable, net
                  
                  
                  128,330,289
                  
                  
                  
                  126,439,557
                  
                  
                  
                  96,059,271
                  
                  
                  
                  97,855,604Federal
      Reserve Bank stock
                  
                  
                  365,050
                  
                  
                  
                  365,050
                  
                  
                  
                  405,150
                  
                  
                  
                  405,150Accrued
      interest receivable
                  
                  
                  497,243
                  
                  
                  
                  497,243
                  
                  
                  
                  396,961
                  
                  
                  
                  396,961Financial
      Liabilities:Time
      deposits
                  
                  $
                  56,409,523
                  
                  
                  $
                  56,878,030
                  
                  
                  $
                  41,171,221
                  
                  
                  $
                  41,709,626Other
      deposits
                  
                  
                  80,767,081
                  
                  
                  
                  80,767,081
                  
                  
                  
                  57,820,552
                  
                  
                  
                  57,820,552Accrued
      interest payable
                  
                  
                  448,116
                  
                  
                  
                  448,116
                  
                  
                  
                  754,146
                  
                  
                  
                  754,146
  The fair
value estimates presented herein are based on pertinent information available to
management as of December 31, 2008 and 2007.  Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since that date and, therefore, current fair value
estimates may differ significantly from amounts presented herein.
   101
   PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
M - FAIR VALUES OF FINANCIAL INSTRUMENTS - Continued
 
 Interest Rate
Risk
 
 The
Company assumes interest rate risk (the risk to the Company’s earnings and
capital from changes in interest rate levels) as a result of its normal
operations.  As a result, the fair values of the Company’s financial
instruments as well as its future net interest income, will change when interest
rate levels change and that change may be either favorable or unfavorable to the
Company.
 
 Interest
rate risk exposure is measured using interest rate sensitivity analysis to
determine our change in net portfolio value and net interest income resulting
from hypothetical changes in interest rates.  If potential changes to
net portfolio value and net interest income resulting from hypothetical interest
rate changes are not within the limits established by the Board of Directors,
the Board of Directors may direct management to adjust the asset and liability
mix to bring interest rate risk within board-approved limits.  As of
December 31, 2008, the Company’s interest rate risk profile was within all
Board-prescribed limits.
 
 NOTE
N - 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).  As indicated in the table below, the Bank did not meet its
minimum capital requirements as of December 31, 2008, and is now subject to
certain regulatory requirements and restrictions on its
operations.  See Note Q.    The Bank’s capital
ratios for December 31, 2008, indicated that the Bank was significantly
under-capitalized. The Office of the Comptroller of the Currency (“OCC”)
subsequently issued a series of letters requiring the Bank to bring risk-based
capital levels to 12% and Tier I capital to 9% in the near term.
 
 
 102
 
 
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
N - REGULATORY MATTERS - Continued
 
 To
      Be WellCapitalized
      UnderFor
      Capital
                    
                    
                    Prompt
      CorrectiveActual
                    
                    
                    Adequacy
      Purposes
                    
                    
                    Action
      ProvisionsAmount
                    
                    
                    
                    
                    
                    Amount
                    
                    
                    
                    
                    
                    Amount(Thousands)
                    
                    
                    Ratio
                    
                    
                    (Thousands)
                    
                    
                    Ratio
                    
                    
                    (Thousands)
                    
                    
                    RatioAs
      of December 31, 2008:Total
      Capital (to Risk-Weighted Assets)
                    
                    $
                    7,045
                    
                    
                    
                    5.03%
                    
                    
                    $
                    11,213
                    
                    
                    
                    8.0%
                    
                    
                    $
                    14,017
                    
                    
                    
                    10.0%Tier
      1 Capital (to Risk-Weighted Assets)
                    
                    $
                    5,243
                    
                    
                    
                    3.74%
                    
                    
                    $
                    5,607
                    
                    
                    
                    4.0%
                    
                    
                    $
                    8,410
                    
                    
                    
                    6.0%Tier
      1 Capital (to Average Assets)
                    
                    $
                    5,243
                    
                    
                    
                    3.59%
                    
                    
                    $
                    5,839
                    
                    
                    
                    4.0%
                    
                    
                    $
                    7,299
                    
                    
                    
                    5.0%As
      of December 31, 2007:Total
      Capital (to Risk-Weighted Assets)
                    
                    $
                    13,672
                    
                    
                    
                    11.55%
                    
                    
                    $
                    9,470
                    
                    
                    
                    8.0%
                    
                    
                    $
                    11,837
                    
                    
                    
                    10.0%Tier
      1 Capital (to Risk-Weighted Assets)
                    
                    $
                    12,193
                    
                    
                    
                    10.30%
                    
                    
                    $
                    4,735
                    
                    
                    
                    4.0%
                    
                    
                    $
                    7,102
                    
                    
                    
                    6.0%Tier
      1 Capital (to Average Assets)
                    
                    $
                    12,193
                    
                    
                    
                    12.19%
                    
                    
                    $
                    4,002
                    
                    
                    
                    4.0%
                    
                    
                    $
                    5,002
                    
                    
                    
                    5.0%
 
 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.  In addition, because it was not
adequately capitalized as of December 31, 2008, the Bank is subject to certain
requirements and restrictions as described in Note Q.
 
 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
O - 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.
 
 
 103
 
  
 PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
  NOTE
P – OTHER EXPENSES
 
 A summary
of other expenses for the years ended December 31 is as follows:
 2008
                        
                        
                        2007Office
      Expenses
                        
                        $
                        477,573
                        
                        
                        $
                        345,972Marketing
                        
                        
                        363,027
                        
                        
                        
                        272,108Regulatory
      Assessments
                        
                        
                        135,888
                        
                        
                        
                        43,370Insurance
      Costs
                        
                        
                        88,845
                        
                        
                        
                        87,167Recruiting
      Costs
                        
                        
                        26,554
                        
                        
                        
                        87,573Director-related
      expenses
                        
                        
                        9,597
                        
                        
                        
                        74,293Other
                        
                        
                        49,823
                        
                        
                        
                        112,185$
                        1,151,307
                        
                        
                        $
                        1,022,668
  
 
 NOTE
Q – SUBSEQUENT EVENTS
 
 Regulatory
Restrictions
 
 Subsequent
to December 31, 2008, the Bank was notified by the OCC that it has imposed a
number of requirements and restrictions on the Bank’s operations, primarily due
to the Bank’s reduced capital levels, deteriorating asset quality and net
losses.  These requirements and restrictions: (i) require the Bank to
notify the OCC in advance prior to adding or replacing a director or senior
executive officer; (ii) generally prohibit the Bank or the Company from making
severance or indemnification payments without complying with certain
restrictions, including obtaining prior regulatory approval for such payments;
(iii) prohibit the Bank from increasing its loans above the amount it had on its
balance sheet as of December 31, 2008 until it has adopted and implemented
satisfactory credit and concentration risk management processes; (iv) prohibit
the Bank from accepting, renewing or rolling over brokered deposits and restrict
the effective yield it can offer on deposits; (v) require the Bank to submit a
capital restoration plan to the OCC; (vi) prohibit the Bank from allowing its
average total assets during any calendar quarter to exceed its average total
assets during the preceding calendar quarter unless (A) the OCC has accepted the
Bank’s capital restoration plan, (B) the increase in the Bank’s assets is
consistent with the plan, and (C) the Bank’s ratio of tangible equity to assets
increases during the calendar quarter at a rate sufficient to enable the Bank to
become adequately capitalized within a reasonable time; (vii) prohibit the Bank
from acquiring or establishing a financial subsidiary and preclude the Bank from
expedited treatment on certain regulatory applications and require it to file
regulatory applications in advance for certain activities instead of
after-the-fact notices; and (viii) will increase the Bank’s semi-annual
assessment payable to the OCC.  The Bank may also be subject to higher
deposit insurance premiums.  The OCC also has proposed that the Bank
achieve and maintain regulatory capital ratios in excess of the regulatory
minimums.  Specifically, the Bank must develop a plan, subject to the
OCC’s review and non-objection, to achieve ratios of Tier 1 capital to adjusted
total assets of 9.0% and total risk-based capital to risk-weighted assets of
11.0% by June 30, 2009, and ratios of Tier 1 capital to adjusted total assets of
9.0% and total risk-based capital to risk-weighted assets of
   104
   PACIFIC COAST NATIONAL
BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
Q – SUBSEQUENT EVENTS - continued
 
 Regulatory
Restrictions- continued
 
 12.0% by
September 30, 2009.  In addition, the Company was notified by the
Federal Reserve Bank of San Francisco that the Company may not declare or pay
any dividends or make any extraordinary payments to any entity or related party
without prior approval of the Federal Reserve Bank of San Francisco. It is
possible that additional regulatory requirements and restrictions will be
imposed on the Bank and/or the Company.
 
 Amendment to Articles of
Incorporation
 
 On
January 15, 2009 the Company’s shareholders approved an amendment to the
Company’s Articles of Incorporation to authorize the issuance of up to 1,000,000
shares of preferred stock.  The preferred stock was authorized to
allow the Company to participate in the TARP Capital Purchase Program as
described below.
 
 TARP
Capital Purchase Program
 
 On January 16, 2009,as part of
the TARP Capital Purchase Program of the United States Department of the
Treasury, the Company sold to the Treasury 4,120 shares of the Company’s Fixed
Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A preferred
stock”), having a liquidation preference amount of $1,000 per share, for a
purchase price of $4,120,000 in cash and (ii) issued to the Treasury a warrant
(the “Warrant”) to purchase 206.00206 shares of the Company’s Fixed Rate
Cumulative Perpetual Preferred Stock, Series B (the “Series B preferred stock”),
at an exercise price of $0.01 per share.  Immediately after the
issuance of the Warrant, the Treasury exercised the Warrant in a cashless
exercise resulting in the net issuance of 206 shares of the Series B preferred
Stock, having a liquidation preference amount of $1,000 per share, to the
Treasury.  The Series A preferred stock entitles its holder(s) to
cumulative dividends on the liquidation preference amount on a quarterly basis
at a rate of 5% per annum for the first five years, and 9% per annum
thereafter.  The Series B preferred stock entitles its holder(s) to
cumulative dividends on the liquidation preference amount on a quarterly basis
at a rate of 9% per annum from the date of issuance.
 
 Subject
to the prior approval of the Federal Reserve Board, the Series A and Series B
preferred stock are redeemable at the option of the Company in whole or in part
at a redemption price of 100% of the liquidation preference amount plus any
accrued and unpaid dividends, provided that such stock may be redeemed prior to
the first dividend payment date falling after the third anniversary of the issue
date (i.e., prior to February 15, 2012) only if (i) the Company has raised
aggregate gross proceeds in one or more Qualified Equity Offerings (as defined
below) of at least $1,030,000 (in the case of the Series A preferred stock) and
$51,500 (in the case of the Series B preferred stock) and (ii) the aggregate
redemption price does not exceed the aggregate net proceeds from such Qualified
Equity Offerings.  None of the shares of Series A preferred stock may
be redeemed until all of the shares of Series B preferred stock have been
redeemed.  A “Qualified Equity Offering” is defined as the sale for
cash by the Company of common stock or preferred stock that qualifies as Tier 1
capital under applicable regulatory capital guidelines.  In addition, the
enactment of the American Recovery and Reinvestment Act of 2009 permits a
participant in the TARP Capital Purchase Program to repay the Treasury without
the need to raise new capital, subject to the Treasury’s consultation with the
participant’s appropriate regulatory agency.
 
 On May 15,
2009, the Company notified the Treasury that the Company would not be paying
dividends on the Series A and Series B preferred stock on the May 15, 2009
scheduled dividend payment date.  As a result, the Company is not
current in its dividend payments on the Series A and Series B preferred
stock.  The terms of
   105
   PACIFIC
COAST NATIONAL BANCORP AND SUBSIDIARY
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
 
 NOTE
Q – SUBSEQUENT EVENTS – continued
 
 TARP
Capital Purchase Program- continued
 
 the
Series A and Series B preferred stock provide that if dividends on the Series A
and Series B preferred stock are not paid in full for six dividend periods,
whether or not consecutive, the total number of positions on the Company’s board
of directors will increase by two and the holders of the Series A and Series B
preferred stock, acting as a class with any other parity securities having
similar voting rights, will have the right to elect two individuals to serve in
the new director positions.  This right and the terms of such
directors will end when the Company has paid in full all accrued and unpaid
dividends on the Series A and Series B preferred stock for all past dividend
periods.










106








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




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




ITEM
9A(T). Controls and Procedures




Evaluation
of Disclosure Controls and Procedures




As of December 31, 2008, the
Company‘s management, with the participation of
the Company‘s principal executive and financial
officer, evaluated the effectiveness of the Company‘s disclosure controls and proceduresas defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the“Exchange Act“). Based on this evaluation, for the
reasons discussed below under“Management’s Report on Internal Control Over
Financial Reporting,“theCompany‘s principal executive and financial
officer concluded that as of December 31, 2008, the Company‘s disclosure controls and procedures
were not effective.





Changes in Internal Control Over
Financial Reporting





There were no changes in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred
during the quarter ended December 31, 2008, that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting. The annual report of management on the effectiveness of internal
control over financial reporting is set forth below under "Management's Report
on Internal Control Over Financial Reporting."








Management’s
Report on Internal Control Over Financial Reporting




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




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




Management, with the participation of
the principal executive and financial officer, assessed the effectiveness of our
internal control over financial reporting as of December 31, 2008. In making
this assessment, we used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control – Integrated
Framework. Based on this assessment, management, with the participation of the
principal executive and financial officer, believes that, as of December 31,
2008, our internal control over financial reporting is not effective based on
those criteria.




107


In
connection with a recent examination conducted by the OCC, the Bank’s primary
regulator, it was determined at the conclusion of the examination,that the
Bank’s previously filed December 31, 2008 quarterly Call Report needed to be
amended as a result of a necessary increase to the Bank’s provision for loan
losses.





McGladrey
and Pullen, LLP, the Company‘s independent registered public accounting firm,
advised the Board of Directors, the Audit Committee and Management of a
significant internal control deficiency that they consider to be a material
weakness. A material weakness is a deficiency, or a combination of deficiencies,
in internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Company‘s annual or interim
financial statements will not be prevented or detected on a timely basis. The
following material weakness has been identified:




The
Company made a significant adjustment to the allowance for loan loss that was
material to the consolidated financial statements for the year ended December
31, 2008. This adjustment was a result of inadequate internal control policies
as it relates to the determination of the allowance for loan losses. The
methodology and systems in place for the establishment of both general and
specific reserves on loans needs revision in order to adequately estimate the
expected losses in the Company’s loan portfolio. Specifically, under the current
economic conditions, a shorter time period should be used in developing the
Company’s  general reserve in accordance with Statement of Financial
Accounting Standards No. 5. Further, the system for the identification and
evaluation of impaired loans and resulting implications to revenue recognition
needs revision to be compliant with generally accepted accounting
principles.




Plan
of Remediation of Material Weaknesses




Management
recognizes the material weakness identified under “Management’s Report On
Internal Control Over Financial Reporting“ above and has determined that
preliminary actions are necessary to address the aforementioned material
weakness including having:




·
            Our
      accounting department and senior management work closely together in order
      to determine the levels of allowance for our classified assets in our
      portfolio.





·
            We
      also will begin the process of designing and implementing and continuing
      to enhance controls to aid in the remediation of the material weakness to
      ensure correct preparation, review, presentation and disclosure of the
      Company’s consolidated financial statements. Management will continue to
      monitor, evaluate and test the operating effectiveness of these
      controls.







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






108


ITEM
9B. Other Information




None.




PART
III




Item
10. Directors, Executive Officers and Corporate Governance




Executive
Officers and Directors of the Registrant




The
executive officers of the Company are identified below.




Michael S. Hahn, age 50, is a
Director and the President and Chief Executive Officer of Pacific Coast National
Bancorp and Pacific Coast National Bank. He served as Chief Operating Officer of
the Bank prior to his becoming Chief Executive Officer upon the retirement of
Colin M. Forkner in May 2008. Mr. Hahn is a San Diego County native and has more
than twenty-six years of community banking experience in the Bank’s service
areas. Mr. Hahn began his banking career with California First Bank which became
Union Bank of California, where he served for nineteen years in various
management and officer capacities, including Coastal Business Banking Center
Manager, where he managed the bank’s business banking in South Orange County and
North San Diego County which supported the commercial lending for twenty-one
branch offices. While at Union Bank of California, Mr. Hahn also served for
eighteen months as Chairman of Vice Chairman, Richard Hardtack’s advisory board.
Mr. Hahn’s banking career with Union Bank of California was briefly interrupted
from 1998 to 2000 when he left to join Temecula Valley Bank, N.A. as Senior Vice
President and Manager to assist them in opening their second de novo office in
Fallbrook, California. Following his time with Temecula Valley Bank, N.A., he
rejoined Union Bank of California to re-open and expand their business banking
office in Oceanside, California where he served until October 31, 2003 when he
left the bank to organize Pacific Coast National Bank. Mr. Hahn holds a Bachelor
of Science degree in Business and Management from the University of Redlands and
Associates in Arts degree in Real Estate from Palomar Community College. Mr.
Hahn is also a graduate of the prestigious leadership program, LEAD San Diego.
He has also been actively involved in numerous leadership positions with local
non-profit organizations, including the San Clemente Sunrise Rotary, the San
Clemente Chamber of Commerce, Fallbrook Village, Encinitas/La Costa and
Shadowridge/Vista Rotary Clubs, the Downtown Encinitas Mainstreet Association,
the Vista Economic Development Association and various local chapters of the
Boys and Girls Club. Mr. Hahn was honored to be named Rotarian Businessman of
the year for 2007 for Rotary District 5320.




Nancy M. DeCou, age 51, was
appointed as the Bank’s Executive Vice President and Chief Credit Officer
effective May 5, 2009. Prior to joining the Bank, Ms. DeCou served as Senior
Vice President and Senior Loan Officer of East West Bank’s Desert Community Bank
division since 1993. Prior to that, Ms. DeCou held a variety of positions with
other financial institutions. Ms. DeCou has more than 33 years of experience in
banking. Ms. DeCou is a graduate of the Pacific Coast Banking School Masters
Level program for bank executives, the University of Oklahoma National Banking
School and the American Bankers Association Lending School. Ms. DeCou also
attended the University of San Diego and Grossmont College, San
Diego.






109








David L. Adams, age 55,currently serves as the
Bank’s Executive Vice President, Chief Lending Officer and manager of the Real
Estate Industries Group. As previously reported, on May 8, 2009, Mr. Adams
notified the Bank of his resignation, to take effect June 5, 2009. Mr. Adams
will continue to serve as Executive Vice President and Chief Lending Officer
until that date. Mr. Adams joined the Bank in April 2008 Prior to joining the
Bank, he served as Executive Vice President at Vineyard Bank in Irvine,
California. Prior to that, his career included positions with Hawthorne Savings
Bank, Downey Savings & Loan and California First Bank. Throughout his career
his emphasis has been in real estate lending and development. Mr. Adams has over
37 years of experience with financial institutions. Mr. Adams obtained his
Bachelor of Arts degree in economic and business administration from Point Loma
Nazarene University in San Diego, California.




The
directors of the Company and the Bank other than Messrs. Forkner and Hahn are
identified below.




Thomas J. Applegate, age 56,
is a Director of Pacific Coast National Bancorp and Pacific Coast National Bank.
He is a partner with the public accounting firm of CEA, LLP, and has been
actively engaged in the public accounting industry for the past 29 years. He has
been licensed as a certified public accountant by the State of California
since May 1981. A California native, Mr. Applegate is a graduate of San Diego
State University. He has served on the faculty of Palomar College and National
University and currently serves as an advisory director of the boards of two
large private companies. Mr. Applegate is active member of the Chamber of
Commerce, Rotary International, California Society of Certified Public
Accountants, the American Institute of Certified Public Accountants, North
County Estate Planning Group of San Diego and a founding member of ENDOW
CARLSBAD, a community foundation.




Michael V. Cummings, age 67,
is a Director of Pacific Coast National Bancorp and Pacific Coast National Bank.
After serving over 35 years in the banking arena he retired in 2000. He has been
engaged in providing bank consulting services since that time. Prior to that, he
served in various executive management positions with Manufacturers Bank,
Southern California Bank, Bank of California and Security Pacific National Bank.
Mr. Cummings earned his Associates of Arts degree from El Camino College in 1963
and furthered his studies at California State University at Fullerton, majoring
in Business Administration. Mr. Cummings has lived or worked in our primary
service area for more than twenty years.




Fred A. deBoom, age 73, is a
Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
has been a director of Acacia Research (NASDAQ) and Combimatrix (NASDAQ) for 10
years and has served as a managing partner in Sonfad Associates, a merger and
acquisition consulting firm for the past eight years. Before joining Sonfad
Associates, he served for five years as the vice president and manager of Tokei
Bank’s Pasadena office and in a similar capacity for Union Bank during the
nine-year period preceding his time with Tokei Bank. For the seventeen years
prior to that, he was a vice president and manager for First Interstate Bank.
Mr. deBoom received a Bachelor of Arts degree from Michigan State University and
a Master of Business Administration degree in finance from the University of
Southern California. Mr. deBoom has been a San Clemente resident since
1995.




Colin M. Forkner, age 65, is
a Director and retired as Chief Executive Officer of Pacific Coast National
Bancorp and Pacific Coast National Bank in May 2008. Before joining us, Mr.Forkner
had retired as President and Chief Executive Officer of California First
National Bank, an Irvine, California-based bank that he founded in 1999. Before
his retirement from California First National Bank, Mr. Forkner had been
actively engaged in banking for over forty years, during which time he held
numerous senior executive management positions with Security Pacific
Corporation, The Bank of California, Mitsubishi Bank of California, Northern
Trust Bank of California and California First National Bank. He began his
banking career in 1965 with






110






Security
Pacific Corporation where he served in numerous management capacities, including
Executive Vice President. He left Security Pacific Corporation in 1986 to become
Executive Vice President and Director of Strategic Planning, Marketing &
Acquisitions for the Bank of California. Next he was appointed Chief Executive
Officer of the affiliated institution, Mitsubishi Bank of California where he
remained until heading its merger in 1989 with The Bank of California. Mr.
Forkner then remained with The Bank of California in several executive officer
capacities, including Executive Vice President and Chief Credit Officer, and
Chairman and Chief Executive Officer of the non-traditional investments
affiliate. Mr. Forkner left The Bank of California in 1991 to join Community
Bank, where he served as Executive Vice President and Chief Administrative
Officer, before joining Northern Trust Bank of California as Managing Director,
where he served for four years. He left Northern Trust Bank in 1997 to found
California First National Bank and serve as its President and Chief Executive
Officer. Mr. Forkner is a director and active alumnus of The Peter F. Drucker
Graduate School of Management, Claremont Graduate University. He also completed
the Graduate School of Financial Management, Stanford University Graduate School
after earning a degree in Economic Theory from Claremont Men’s
College.




David Johnson, age 62, is a
Director of Pacific Coast National Bank and a Director andChairman
of the Audit Committee of Pacific Coast National Bancorp. He currently serves as
Vice President-Finance and a major stockholder of Affinity Medical Technologies,
LLC, an Irvine-based manufacturer of medical supplies. Prior to being a founder
of Affinity Medical Technologies, he served for six years as a senior executive
officer of First Plus Bank in Tustin, California, first as a Director and
thereafter as Chief Financial Officer and President. Mr. Johnson is a former
certified public accountant and partner with the accounting firm of McGladrey
& Pullen, LLP. During his eighteen years with the firm, he had extensive
experience auditing banks and financial institutions. Mr. Johnson is a graduate
of the University of Minnesota, where he earned a Bachelor of Arts in Accounting
and currently is a resident of Irvine, California.




Dennis C. Lindeman, age 61,
is Chairman of the Board of Pacific Coast National Bancorp and Pacific Coast
National Bank. He is a Certified Financial Planner and has spent the last twenty
years providing comprehensive business and financial planning services to
closely-held business owners, executives and their families throughout Southern
California. Mr. Lindeman is a veteran of the United States Marine Corps, where
he served for twenty years, primarily in operational planning and command
capacities, before retiring as a Lieutenant Colonel. Mr. Lindeman has been
actively involved in leadership capacities with numerous community
organizations. Mr. Lindeman received a Bachelor of Arts degree in Economics from
Luther College. He is also a graduate of the United States International
University, where he received a Master of Business Administration degree in
Finance. He has lived in Fallbrook for the past twenty-five years.




James M. Morrison, age 39, is
a Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
is the President of James M. Morrison Insurance Services, Inc., a position he
has held since founding that company in 2002. Mr. Morrison has been in the
insurance brokerage business since 1989. Mr. Morrison has been actively involved
in leadership positions with a number of professional and community
organizations. Mr. Morrison is a graduate of the University of San Diego, where
he earned a Bachelor of Business Administration degree.




Denis H. Morgan, age 56, is a
Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
is a registered civil engineer and a licensed general contractor in the states
of California, Florida and Nevada. He served as the President and Chief
Executive Officer of Pacific 17 until the business was acquired by Alcoa in
November 2001. He has been active in investing in real estate opportunities
since 1989 and is currently investing in and developing multi-family units in
California, Arizona and New York. Mr. Morgan has also been actively






111






involved
in numerous community organizations. His volunteer activities include service as
Finance Chairperson for the United Negro College Fund (San Diego), as corporate
sponsor to the Urban League, Neighborhood House, National Association for the
Advancement of Colored People (NAACP) and several other organizations that
provide educational, housing, and financial support to the community. Mr. Morgan
is a graduate of the University of Guyana, where he earned an HTD in Civil
Engineering and a Bachelor of Engineering degree in Highway Engineering. He also
earned a Master of Science degree in Structural Engineering from the City
University of London.




Charles T. Owen, age 68, is a
Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
is the President and Chief Executive Officer of the Carlsbad (California)
Chamber of Commerce, a position he has held since 2004. From 1987 to 1990 and
from 1992 to 2004, he served as President and Publisher of The San Diego
Business Journal, and from 1990 to 1992 he served as President of TCS
Publishing, a subsidiary of TCS Enterprises. After retiring from the U.S. Marine
Corps as a Captain in 1981, Mr. Owen served as Division Director and Vice
President of the Greater San Diego Chamber of Commerce. Mr. Owen has extensive
experience as a bank director and has served on numerous civic boards and
committees. Mr. Owen is a graduate of Vincennes University, Vincennes, Indiana,
where he earned an Associate of Science degree, Chapman University, Orange
California, where he earned a Bachelor of Arts degree, and National University,
San Diego, California, where he earned a Master of Business Administration
degree.




John Vuona, age 51, is a
Director of Pacific Coast National Bancorp and Pacific Coast National Bank. He
is a partner in the accounting firm of Bentson & Vuona, LLP, which he
founded in 1995. Prior to forming the firm, he served as a senior manager with
McGladrey & Pullen, LLP and as a partner in the firm of Gillespie, Lefevie,
Lokietz & Vuona. Over his career, Mr. Vuona has worked extensively with
closely-held companies in the areas of financial, manufacturing, distribution,
service and construction industries. He is a certified public accountant and a
member of the American Institute of Certified Public Accountants and the
California Society of Certified Public Accountants. Mr. Vuona is a graduate of
Babson College, where he earned a Bachelor of Science degree in Accounting. He
also completed a Master of Science degree in Taxation at the University of
Southern California. Mr. Vuona currently resides in Rancho Santa Margarita,
California.




Code
of Ethics




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






112






Audit
Committee Membership




The
members of the Audit Committee are Dennis Lindeman, Thomas Applegate and David
Johnson (Chairman). Our board of directors has determined that each member of
the Audit Committee satisfies the independence requirements of the Securities
and Exchange Commission and the listing standards of the NASDAQ Stock Market.
Our Board has also determined that Mr. Johnson qualifies as an “audit committee
financial expert“ under Item 407(d)(5) of Regulation S-K under the Exchange Act
and has the requisite accounting or related financial expertise required under
the listing standards of the NASDAQ Stock Market.




Section
16(a) Beneficial Ownership Reporting Compliance




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




To our
knowledge, based solely on a review of the copies of such reports furnished to
us and written representations that no other reports were required, during the
fiscal year ended December 31, 2008, all Section 16(a) filing requirements
applicable to its officers, directors and greater than 10% beneficial owners
were complied with.




Item
11. Executive Compensation




Compensation
Philosophy




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




Compensation
Structure




The base
compensation for the executive officers of Pacific Coast National Bancorp named
in the Summary Compensation Table is intended to be competitive with that paid
in comparable situated industries, taking into account the scope of
responsibilities. The goals of the Compensation Committee in establishing
Pacific Coast National Bancorp’s executive compensation program
are:






113








·
            to
      compensate the executive officers of Pacific Coast National Bancorp fairly
      for their contributions to Pacific Coast National Bancorp’s short, medium
      and long-term performance; and




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




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




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




Compensation
Restrictions under TARP Capital Purchase Program and American Recovery and
Reinvestment Act of 2009




TARP Capital Purchase
Program. In January 2009, we participated in the TARP Capital Purchase
Program of the United States. Department of the Treasury (the “Treasury“),
pursuant to which the Treasury invested $4.12 million in our preferred stock. As
a participant in the TARP Capital Purchase Program, we are subject to the
following restrictions and requirements with respect to compensation paid to our
“senior executive officers,“ which includes each of Mr. Hahn, Ms. Stalk and Mr.
Adams:




·
            A
      prohibition from making “golden parachute payments“ over the limits in
      Section 280G of the Internal Revenue Code to our senior executive officers
      triggered by an involuntary termination of employment (but not based
      solely on a change in control).




·
            Make
      any bonus or incentive compensation payment to a senior executive officer
      that is based on financial statements or financial performance subject to
      repayment (often referred to as a “clawback“) if such financial statements
      or performance figures later prove to be materially
      inaccurate.






114








·
            Review
      within 90 days of the TARP Capital Purchase Program closing and annually
      thereafter our senior executive bonus and incentive compensation programs
      to determine if they encourage our senior executive officers to take
      unnecessary and excessive risks that threaten the value of our
      company.




·
            Limit
      our tax deduction for compensation earned annually by each of the senior
      executive officers to $500,000.




As part
of the analysis and decision-making process relating to our participation in the
TARP Capital Purchase Program, the Compensation Committee and the Board of
Directors were apprised of these restrictions and requirements on executive
compensation. Our participation in the TARP Capital Purchase Program was a
catalyst for several actions by the Compensation Committee and our senior
executive officers:




·
            Each
      senior executive officer entered into a compensation modification
      agreement and executed a waiver consenting to the restrictions and
      limitations required by the TARP Capital Purchase Program
      rules.




·
            The
      Committee conducted a review of our senior executive incentive programs
      from a risk perspective and concluded that they do not encourage
      unnecessary or excessive risk.




American Recovery and Reinvestment
Act of 2009.On February
17, 2009, President Obama signed into law the American Recovery and Reinvestment
Act of 2009 (the “ARRA“). The ARRA amends, among other things, the TARP Capital
Purchase Program legislation by directing the Treasury to issue regulations
implementing strict limitations on compensation paid or accrued by financial
institutions, like us, participating in the TARP Capital Purchase Program. These
limitations are to include:





·
            A
      prohibition on paying or accruing bonus, incentive or retention
      compensation for at least the five most highly compensated employees,
      other than certain awards of long-term restricted stock or bonuses payable
      under existing employment
agreements;




·
            A
      prohibition on making any payments to the five highest paid executive
      officers and the next five most highly compensated employees for departure
      from our company other than compensation earned for services rendered or
      accrued benefits;




·
            Subjecting
      bonus, incentive and retention payments made to the five highest paid
      executive officers and the next 20 most highly compensated employees to
      repayment (clawback) if based on statements of earnings, revenues, gains
      or other criteria that are later found to be materially
      inaccurate;




·
            A
      prohibition on any compensation plan that would encourage manipulation of
      reported earnings;




·
            Establishment
      by the Board of Directors of a company-wide policy regarding excessive or
      luxury expenditures including office and facility renovations, aviation or
      other transportation services and other activities or events that are not
      reasonable expenditures for staff development, reasonable performance
      incentives or similar measures in the ordinary course of
      business;






115








·
            Submitting
      a “say-on-pay“ proposal to a non-binding vote of stockholders, whereby
      stockholders vote to approve the compensation of executives as disclosed
      pursuant to the executive compensation disclosures included in our annual
      meeting proxy statement; and




·
            A
      review by the Treasury of any bonus, retention awards or other
      compensation paid to the five highest paid executive officers and the next
      20 most highly compensated employees prior to February 17, 2009 to
      determine if such payments were excessive and negotiate for the
      reimbursement of such excess
payments.




As noted,
the ARRA directs the Treasury to issue regulations implementing the foregoing.
There are numerous questions regarding the scope of the limitations and the
requirements of the ARRA. None of the regulations mandated by the law have been
issued to date. Pending the issuance of regulations, the Board, Compensation
Committee and management are reviewing the requirements of the ARRA, its impact
on compensation on a current and going forward basis, and the effect of the
law’s requirements on our competitive position. Actions required by the ARRA and
consideration of competitive factors may include changes to the form and amount
of compensation paid to our executive officers, including adjustments to base
salaries, the reduction or elimination of bonus compensation, issuance of
long-term restricted stock awards and modifications to existing agreements.
Because of this uncertainty regarding the impact of the ARRA, except as
expressly mentioned otherwise, the following discussion does not address the
effect, if any, compliance with the ARRA may have on our executive compensation
program and references to the TARP Capital Purchase Program refer to its
requirements as applicable prior to the ARRA. All of the TARP-related
restrictions on our executive compensation program will remain in place so long
as the Treasury holds the securities we issued under the TARP Capital Purchase
Program.




Annual
Compensation




The
annual compensation of the executive officers of Pacific Coast National Bank
consists of a base salary and an auto allowance or the use of a company-owned
auto. In the future, annual performance bonuses may be paid; however, as is
typically the case with de novo or “start-up“ banks, they are prohibited under
an agreement with our primary banking regulators until such time as the bank is
profitable. In addition, as noted above, so long as the Treasury holds the
securities we issued under the TARP Capital Purchase Program, we will be subject
to the TARP-related restrictions on executive compensation.




Stock
Incentive Plan




The board
of directors and shareholders have approved the Pacific Coast National Bancorp
2005 Stock Incentive Plan. Stock options are currently the primary source of
long-term incentive compensation for the executive officers and directors of
Pacific Coast National Bancorp and Pacific Coast National Bank. Each of the
employees, executive officers, members of senior management and directors of
Pacific Coast National Bancorp and Pacific Coast National Bank is eligible to
participate in the 2005 Stock Incentive Plan. Pursuant to their respective
employment agreements, we issued to Colin M. Forkner, Michael S. Hahn, and
former Chief Financial Officer Terry A. Stalk options to purchase 91,200,
91,200, 12,500 and 57,000 stock options, respectively. In 2006, the Compensation
Committee made a discretionary award to each of the three executive officers of
an additional 4,416 stock options based on the successful completion of the
first year of operations at the bank. In 2007, the Compensation Committee made a
discretionary award to Colin M. Forkner and Michael S. Hahn each of 4,926 stock
options, and to Terry A. Stalk of 14,926 stock options, based on the successful
completion of the second year of operations at the Bank. There were no stock
options awards given in 2008.






116






Employment
Agreements and Change in Control Severance Agreement




Set forth
below is a description of our employment agreement with Mr. Hahn, our change in
control severance agreement with Mr. Adams and the employment contracts we had
in place with Mr. Forkner prior to his retirement and with Ms. Stalk prior to
her resignation. We are currently generally prohibited under FDIC regulations
from providing severance benefits to executive officers without prior regulatory
approval.




Mr.
Hahn




We
entered into a new employment agreement with Michael S. Hahn in connection with
his becoming President and Chief Executive Officer of Pacific Coast National
Bancorp and Pacific Coast National Bank, which superseded his prior employment
agreement regarding his employment as President and Chief Operating Officer of
Pacific Coast National Bancorp and Pacific Coast National Bank. The term of the
new agreement is for five (5) years ending on May 15, 2013 and will
automatically renew for successive one year terms following the end of the
initial five year term unless either party provides notice that it will not seek
to renew the agreement.




Under the
terms of the prior agreement, Mr. Hahn initially received a minimum base
salary of $135,000 per year. Following the first year of the prior agreement,
the annual base salary was reviewed by the board of directors and increased to
$141,750. Following the second year of the agreement, the annual base salary was
reviewed by the board of directors and increased to $160,000. The new employment
agreement increased Mr. Hahn’s minimum annual base salary to $190,000 and
entitles him to an annual incentive bonus opportunity of up to 15% of annual
base salary. Mr. Hahn is eligible to participate in any benefit programs
applicable to executive officers of Pacific Coast National Bancorp and Pacific
Coast National Bank, receives life and long-term disability benefits, membership
at a club deemed beneficial to the Bank’s presence in the local community and an
automobile allowance or use of a company-leased vehicle.




As under
the prior employment agreement, the new employment agreement provides that if
Mr. Hahn’s employment is terminated by Pacific Coast National Bancorp and
Pacific Coast National Bank without cause, he will be entitled to a lump sum
severance payment equal to his then-current annual base salary. The new
employment agreement increased the lump sum payment Mr. Hahn would receive in
the event of a change in control from 199% of his base amount (as defined in
Section 280G of the Internal Revenue Code) to 299% of his base
amount.




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




In
reviewing the 2008 compensation of Mr. Hahn, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believes that Mr. Hahn’s total
compensation for 2008 was reasonable and competitive based on the overall
performance of Pacific Coast.






117






Mr.
Forkner




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




Mr. Forkner’s
employment agreement also provided for the issuance of options to purchase
91,200 shares of common stock at an exercise price of $10.00 per share,
exercisable within 10 years from the date of grant. 30,000 of the options
are being treated as incentive stock options, and 61,200 are being treated as
non-statutory stock options, all of which vest ratably over a period of three
years beginning on the date of grant. In addition, Mr. Forkner’s employment
agreement provided that if his employment were terminated by the Bank without
cause, he would have been entitled to a lump sum severance payment equal to his
then-current annual base salary. The employment agreement also provided that in
the event of a change in control, he would have received a lump sum payment
equal to 199% of his base amount (as defined in Section 280G of the Internal
Revenue Code).




In
reviewing the 2008 compensation of Mr. Forkner, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believes that Mr. Forkner’s total
compensation for 2008 was reasonable and competitive based on the overall
performance of Pacific Coast.




Ms.
Stalk




We were a
party to an employment agreement with Terry A. Stalk regarding her employment as
Chief Financial Officer of the Bank, prior to her resignation on April 24,
2009.




Under the
terms of the agreement, Ms. Stalk initially received an annual base salary of
$125,000. Following the first year of the agreement, the annual base salary was
reviewed by the board of directors and increased to $131,250. Following the
second year of the agreement, the annual base salary was reviewed by the board
of directors and increased to $150,000. Following the third year of the
agreement, the annual base salary was reviewed by the board of directors and
increased to $165,000, effective June 1, 2008. Ms. Stalk was eligible to
participate in any incentive compensation plan and all other benefit programs
adopted by the Bank plus other customary benefits such as health, dental and
life insurance, membership fees to banking and professional organizations and an
automobile allowance.




Ms.
Stalk’s employment agreement also provided for the issuance of options to
purchase 57,000 shares of common stock at an exercise price of $10.00 per share,
exercisable within 10 years from the date of grant, subject to continued
service. In addition, Ms. Stalk’s employment agreement provided that if her
employment were terminated by the Bank without cause, she would have be entitled
to a lump sum severance payment equal to her then-current annual base salary.
The employment agreement also provided that in the event of a change in control,
she would have received a lump sum payment equal to 299% of her base amount (as
defined in






118






Section
280G of the Internal Revenue Code). This payment amount was increased from 199%
of Ms. Stalk’s base amount as a result of an amendment to her employment
agreement entered into in December 2008. As a result of her resignation, no
severance payment has been or will be paid to Ms. Stalk under her employment
agreement.




In
reviewing the 2008 compensation of Ms. Stalk, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believes that Ms. Stalk’s total
compensation for 2008 was reasonable and competitive based on the overall
performance of Pacific Coast.




Mr.
Adams




We have
entered into a change in control agreement with David L. Adams, which provides
that in the event of a change in control while he is employed by the Bank, he
will receive a lump sum payment equal to 299% of his base amount (as defined in
Section 280G of the Internal Revenue Code). This payment amount was increased
from 199% of Mr. Adams’ base amount as a result of an amendment to his change in
control agreement entered into in December 2008. As previously reported, on May
8, 2009, Mr. Adams notified the Bank of his resignation, to take effect June 5,
2009. Mr. Adams will continue to serve as Executive Vice President and Chief
Lending Officer until that date.




In
reviewing the 2008 compensation of Mr. Adams, the Compensation Committee and
board of directors undertook the same evaluation set forth above with respect to
executive officers. The Compensation Committee believed that Mr. Adams’ total
compensation for 2008 was reasonable and competitive based on the overall
performance of Pacific Coast National Bancorp.




Executive
Compensation Deductibility




Section
162(m) of the Internal Revenue Code generally disallows a tax deduction to
public companies for compensation in excess of $1,000,000 paid to a company’s
chief executive officer or any of the three other most highly compensated
officers. Section 162(m) specifically exempts certain performance-based
compensation from the deduction limit. The board of directors and Compensation
Committee generally intends to limit non-performance based compensation and
grant awards under the 2005 Stock Incentive Plan, consistent with terms of
Section 162(m) so that the awards will not be subject to the $1,000,000
deductibility limit. In addition, as a result of our participation in the TARP
Capital Purchase Program, we agreed to be subject to amendments to Section
162(m) which limit the deductibility of all compensation, including performance
based compensation, to $500,000 per executive with respect to any taxable year
during which the Treasury retains its TARP Capital Purchase Program investment
in our company.




Executive
Compensation Tables




Summary
Compensation Table




The
following table sets forth for each of our named executive officers for the
years ended December 31, 2008 and 2007: (i) the dollar value of base salary and
bonus earned; (ii) for options granted to each named executive officer, the
dollar amount recognized by the Company for such options in accordance with FAS
123 (R); (iii) the dollar value of earnings for services pursuant to awards
granted under non-equity incentive plans; (iv) the change in pension value and
non-qualified deferred compensation earnings; (v) all other compensation; and,
finally, (vi) the dollar value of total compensation.






119





Summary
      Compensation TableName and Principal
      Position
              
              Year
              
              Salary
              
              Bonus
              
              Stock
Awards
              
              Option Awards
      (1)
              
              Non-Equity Incentive Plan
      Compensation
              
              Change in Pension Value and
      Non-qualified Deferred Compensation Earnings
              
              All Other
      Compensation
              
              Total
($)($)
              ($)
              ($)
              ($)
              ($)
              ($)
              ($)Colin M.
      Forkner
              
              2008
              
              76,154
              
              -
              
              -
              
              55,637
              
              -
              
              -
              
              20,000
              (3)
              151,791Former Chief
      Executive
              2007
              
              175,769
              
              -
              
              -
              
              206,301
              
              -
              
              -
              
              32,954
              
              415,025Officer (2)Michael S.
    Hahn
              
              2008
              
              178,000
              
              -
              
              -
              
              58,079
              
              -
              
              -
              
              26,201
              (4)
              262,280President
              2007
              
              152,279
              
              -
              
              -
              
              198,767
              
              -
              
              -
              
              24,484
              
              375,530Chief
    ExecutiveOfficer (2)Terry A.
    Stalk
              
              2008
              
              158,077
              
              -
              
              -
              
              53,428
              
              -
              
              -
              
              37,815
              (5)
              249,319Former Chief
      Financial
              2007
              
              142,067
              
              -
              
              -
              
              146,879
              
              -
              
              -
              
              38,900
              
              327,846Officer (7)David S.
    Adams
              
              2008
              
              133,692
              
              -
              
              -
              
              4,257
              
              95,030
              
              -
              
              16,959
              (6)
              249,938Executive
    Vice
              2007
              
              N/A
              
              N/A
              
              N/A
              
              N/A
              
              N/A
              
              N/A
              
              N/A
              
              N/APresidentChief Lending Officer
      (8)
  (1)
              Reflects the dollar amounts
      recognized for financial statement reporting purposes for the years ended
      December 31, 2008 and 2007 in accordance with SFAS No. 123(R), of
      stock options awarded to the named executive officers. The assumptions
      used in the calculation of these amounts are included in Note I of
      the Notes to Consolidated Financial Statements contained in
      Item  8 of this report.(2)
              Effective May 16, 2008, Mr.
      Forkner retired as our Chief Executive Officer and Mr. Hahn, who was
      serving as our President & Chief Operating Officer, became our
      President & Chief Executive Officer.(3)
              Includes an auto allowance of $750
      per month, gasoline, auto insurance, and toll road charges reimbursements
      through May 2008, and annual life insurance
    premiums.(4)
              Includes use of a company-owned
      car, auto maintenance, gasoline, auto insurance, and toll road charges
      reimbursements, and annual life insurance
  premiums.(5)
              Includes an auto allowance of $500
      per month or use of a company-owned car, gasoline, auto insurance, and
      toll road charges reimbursements, annual life insurance premiums, and the
      cost of lodging several nights per week because Mrs. Stalk lives out of
      the area.(6)
              Includes an auto allowance of $500
      per month, auto maintenance, gasoline, auto insurance, and toll road
      charges reimbursements.(7)
              Ms. Stalk resigned effective April
      24, 2009.(8)
              Mr. Adams became Chief Lending
      Officer in April 2008 and has submitted his resignation, to take effect
      June 5, 2009.  No compensation information is provided for 2007
      because Mr. Adams was not an executive officer during that
      year.




120






Outstanding
Equity Awards at Fiscal Year End




The
following table sets forth information on outstanding option awards held by the
named executive officers at December 31, 2008, including the number of shares
underlying both exercisable and unexercisable portions of each stock option as
well as the exercise price and the expiration date of each outstanding option as
of December 31, 2008.














































121


Outstanding Equity Awards at December
31, 2008 Year-End Table




(Executive
Officers)


Option
    AwardsNumber of Securities Underlying
      Unexercised Options (#)
              
              Number of Securities Underlying
      Unexercised Options (#)
              
              Equity Incentive Plan
      Awards:
              
              Option Exercise Price
      ($)
              
              Option Expiration
      DateName
              
              Exercisable
              
              Unexercisable
              Number of Securities Underlying
      Unexercised UnearnedColin M.
      Forkner
              
              91,200
              
              
              
              -
              
              $10.00
              
              5/14/20154,416
              
              
              
              -
              
              $13.25
              
              5/14/20164,926
              
              
              
              -
              
              $10.50
              
              5/13/2017Terry A.
    Stalk
              
              57,000
              
              
              
              -
              
              $10.00
              
              5/14/20154,416
              
              
              
              -
              
              $13.25
              
              5/14/20169,951
              
              
              
              -
              
              $10.50
              
              5/13/20174,975
              
              -
              
              $10.50
              
              5/13/2017Michael S.
    Hahn
              
              91,200
              
              
              
              -
              
              $10.00
              
              5/14/20154,416
              
              
              
              -
              
              $13.25
              
              5/14/20163,284
              
              
              
              -
              
              $10.50
              
              5/13/20171,642
              
              -
              
              $10.50
              
              5/13/2017David Adams
              
              333
              
              
              
              -
              
              $10.50
              
              4/30/2017167
              
              -
              
              $10.50
              
              4/30/20171,667
              
              
              
              -
              
              $6.00
              
              4/17/20183,333
              
              -
              
              $6.00
              
              4/17/2018




Health
and insurance benefits




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




DIRECTOR COMPENSATION




Meetings
of our board of directors are held regularly each month. We do not -currently
make cash payments to directors for any service provided as a director. Under
the 2005 Stock Incentive Plan, directors may be compensated for their service to
the Company with non-statutory stock options. We do not intend to begin
compensating our directors with cash payments for their service until Pacific
Coast National Bancorp and Pacific Coast National Bank become profitable. The
table below sets for the compensation for 2008 for our outside directors during
2008. Inside directors (currently Mr. Forkner and Hahn) are not compensated for
their service as directors. For information regarding the compensation paid to
the inside directors, see “Executive Compensation Tables-Summary Compensation
Table.“






122





Name
              
              Fees Earned or Paid in
      Cash
              
              Stock
Awards
              
              Option
    Awards
              
              Non-Equity Incentive Plan
      Compensation
              
              Change in Pension Value and
      Non-qualified Deferred Compensation Earnings
              
              All Other
      Compensation
              
              Total($)
              ($)
              ($) (1)
              ($)
              ($)
              ($)
              ($)Thomas J.
      Applegate
              
              -
              
              -
              
              2,052
              
              -
              
              -
              
              -
              
              2,052Michael V. Cummings
      (2)
              
              -
              
              -
              
              1,094
              
              -
              
              -
              
              17,497
              
              18,591David E. Davies
      (3)
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -Fred A.
    deBoom
              
              -
              
              -
              
              912
              
              -
              
              -
              
              -
              
              912Colin M. Forkner
      (4)
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -David
    Johnson
              
              -
              
              -
              
              1,094
              
              -
              
              -
              
              -
              
              1,094Dennis C.
      Lindeman
              
              -
              
              -
              
              1,185
              
              -
              
              -
              
              -
              
              1,185Dennis H.
      Morgan
              
              -
              
              -
              
              1,094
              
              -
              
              -
              
              -
              
              1,094James M.
      Morrison
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -Charles T.
      Owens
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -John Vuona
              
              -
              
              -
              
              912
              
              -
              
              -
              
              -
              
              912(1)
              Reflects the dollar amounts
      recognized for financial statement reporting purposes for the year ended
      December 31, 2008 in accordance with SFAS No. 123(R), of stock options
      awarded to the outside directors. The assumptions used in the calculation
      of these amounts are included in Note I of the Notes to Consolidated
      Financial Statements contained in Item  8 of this
      report.  As of December 31, 2008, total shares underlying stock
      options held by the outside directors were as follows: Mr. Applegate -
      3,611 shares; Mr. Cummings - 2,666 shares; Mr. deBoom - 2,222 shares; Mr.
      Forkner - 100,542 shares; Mr. Johnson - 2,666 shares; Mr. Lindeman - 2,888
      shares; Mr. Morgan - 2,666 shares; Mr. Vuona - 2,222
      shares.(2)
              Mr. Cummings provided consulting
      services to the Bank in regards to specific credit matters during the
      fourth quarter of 2008. These services included an analysis of the credit
      process, the Bank's credit reporting, and the analysis of the adequacy of
      the aloowance for loan losses. During this time he relinquished his
      position as chairman of the Directors' Credit Committee to the Vice
      Chairman to avoid any conflicts of interest.(3)
              Mr. Davies ceased to be a director
      upon the expiration of his term at our annual meeting of stockholders held
      on September 9, 2008.(4)
              Effective May 16, 2008, Mr.
      Forkner retired as our Chief Executive Officer. Compensation received by
      Mr. Forkner is reported on the Executive Compensation table. He received
      no additional compensation in his role as an outside director since his
      retirement.






123





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




This
following table sets forth information regarding the beneficial ownership of the
common stock of the Company as of April 6, 2009, for:




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




·
            each
      officer named in the summary compensation
table;




·
            each
      of our directors and director nominees;
and




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




Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission and includes sole or shared voting and/or and investment
power with respect to the securities. Subject to applicable community property
laws, the persons named in the table have sole voting and investment power with
respect to all shares of common stock shown as beneficially owned by them
individually. Shares shown in the table include shares beneficially owned
directly, in retirement accounts, in a fiduciary capacity or by certain
affiliated entities or family members of the persons named in the table. Shares
of common stock issuable upon exercise of options and warrants that are
exercisable within sixty days of April 6, 2009 are included in beneficial
ownership and are deemed outstanding for the purpose of computing the percentage
ownership of the person holding those options and other rights, and the group as
a whole, but are not deemed outstanding for computing the percentage ownership
of any other person.


Name
      of Beneficial Owner
                                                                
                                                                Number
      of
                                                                  Shares
                                                                  Beneficially
                                                                  Owned
                                                                
                                                                Percent
                                                                  of
                                                                  Class
                                                                  (14)Greater
      Than 5% Shareholders:NoneDirectors
      and Named Executive Officers:Thomas
      J. Applegate
                                                                
                                                                50,710
                                                                (1)
                                                                
                                                                1.99%Michael
      V. Cummings
                                                                
                                                                7,777
                                                                (2)
                                                                
                                                                *Fred
      A. deBoom
                                                                
                                                                25,654
                                                                (3)
                                                                
                                                                1.00%Colin
      M. Forkner
                                                                
                                                                109,542
                                                                (4)
                                                                
                                                                4.14%Michael
      S. Hahn
                                                                
                                                                119,312
                                                                (5)
                                                                
                                                                4.50%David
      Johnson
                                                                
                                                                68,694
                                                                (6)
                                                                
                                                                2.68%Dennis
      C. Lindeman
                                                                
                                                                65,920
                                                                (7)
                                                                
                                                                2.57%Denis
      H. Morgan
                                                                
                                                                74,798
                                                                (8)
                                                                
                                                                2.92%James
      M. Morrison
                                                                
                                                                16,382
                                                                (9)
                                                                
                                                                *Charles
      T. Owen
                                                                
                                                                2,100
                                                                
                                                                
                                                                *John
      Vuona
                                                                
                                                                33,486
                                                                (10)
                                                                
                                                                1.31%David
      L. Adams (15)
                                                                
                                                                17,966
                                                                (11)
                                                                
                                                                *Terry
      A. Stalk (16)
                                                                
                                                                76,366
                                                                (12)
                                                                
                                                                2.93%All
      directors and executive officers as a group (14 persons)
                                                                
                                                                668,707
                                                                (13)
                                                                
                                                                22.97%




124









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




Notes to beneficial ownership
      table(1)    Includes
      options to acquire 3,611 shares of common stock and warrants to acquire
      4,212 shares of common stock.(2)    Includes
      options to acquire 1,777 shares of common stock and warrants to acquire
      4,000 shares of common stock.(3)    Includes
      options to acquire 2,222 shares of common stock and warrants to acquire
      6,106 shares of common stock.(4)    Includes
      options to acquire 100,542 shares of common stock.(5)    Includes
      options to acquire 98,900 shares of common stock and warrants to acquire
      10,000 shares of common stock.(6)    Includes
      options to acquire 2,666 shares of common stock and warrants to acquire
      12,424 shares of common stock.(7)    Includes
      options to acquire 2,888 shares of common stock and warrants to acquire
      16,106 shares of common stock.(8)    Includes
      options to acquire 2,666 shares of common stock and warrants to acquire
      12,106 shares of common stock.(9)    Includes
      warrants to acquire 2,106 shares of common stock.(10)  Includes options to
      acquire 2,222 shares of common stock and warrants to acquire 8,212 shares
      of common stock.(11)  Includes options to
      acquire 334 shares of common stock and warrants to acquire 2,106 shares of
      common stock(12)  Includes options to
      acquire 71,336 shares of common stock.(13)  Includes options
      to acquire 290,079 shares of common stock and warrants to acquire 77,378
      shares of common stock.(14) 
      Calculated based on 2,544,850 shares of common stock outstanding as of
      April 6, 2009, plus optionsand
      warrants exercisable within 60 days of April 6, 2009, for the individual
      or the group, as applicable.(15)  Mr.
      Adams has submitted his resignation, to take effect June5,
      2009.(16)  Ms.
      Stalk resigned effective April 24, 2009.





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




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




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




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






125






Director
Independence




Our Board
of Directors has determined that each of our current directors, except Messrs.
Forkner and Hahn, is independent under the listing standards of the NASDAQ Stock
Market. Mr. Forkner retired as Chief Executive Officer of Pacific Coast National
Bancorp and Pacific Coast National Bank in May 2008. Mr. Hahn currently serves
as the Company’s and the Bank’s President and Chief Executive Officer, and
served as the Chief Operating Officer of the Bank prior to his becoming Chief
Executive Officer upon Mr. Forkner’s retirement..




Item
14. Principal Accountant Fees and Services.




The
following table shows the fees paid by us for the audit and other services
provided by our independent registered public accounting firm, McGladrey &
Pullen, LLP (M&P) and RSM McGladrey, Inc. (an affiliate of M&P), for
2008 and 2007.




2008
                                                      
                                                      
                                                      2007Audit Fees
                                                      
                                                      $
                                                      249,930
                                                      
                                                      
                                                      $
                                                      170,200Audit-related
      Fees
                                                      
                                                      
                                                      40,750
                                                      
                                                      
                                                      
                                                      8,300Tax Fees
                                                      
                                                      
                                                      12,930
                                                      
                                                      
                                                      
                                                      -All Other
    Fees
                                                      
                                                      
                                                      2,200
                                                      
                                                      
                                                      
                                                      11,634Total
                                                      
                                                      $
                                                      305,810
                                                      
                                                      
                                                      $
                                                      190,134





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




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




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






126






PART
IV.




Item
15. Exhibits and Financial Statement Schedules




(a)(1)                      Financial
Statements: See Part II. Item 8. Financial Statements and Supplementary
Data.




(a)(2)
Financial Statement Schedules: All financial statement schedules have been
omitted as the required information is not required under the related
instructions or is not applicable.




(a)(3)
Exhibits:




Number
                                                    Description3.1
                                                    Articles
      of incorporation, as amended3.1a
                                                    Certificate
      of Determination of Fixed Rate Cumulative Perpetual Preferred Stock,
      Series A (“Series A Preferred Stock“) ******3.1b
                                                    Certificate
      of Determination of Fixed Rate Cumulative Perpetual Preferred Stock,
      Series B (“Series B Preferred Stock“) ******3.2
                                                    Bylaws,
      as amended4.1
                                                    Specimen
      common stock certificate*4.1a
                                                    Form
      of certificate for the Series A Preferred Stock ******4.1b
                                                    Form
      of certificate for the Series B Preferred Stock******4.2
                                                    See
      Exhibits 3.1, 3.1a, 3.1b and 3.2 for provisions of the articles of
      incorporation and bylaws defining rights of holders of the common
      stock4.3
                                                    Letter
      Agreement dated January 16, 2009 between Pacific Coast National Bancorp
      and United States Department of the Treasury pertaining to the election of
      directors by the holder(s) of the Series A and Series B Preferred
      Stock ******10.1
                                                    Office
      Lease dated as of July 5, 2004**10.2
                                                    Lease
      dated as of December 6, 2003**10.3
                                                    Letter
      Agreement, including Schedule A, and Securities Purchase Agreement, dated
      January 16, 2009, between Pacific Coast National Bancorp and United States
      Department of the Treasury, with respect to the issuance and sale of the
      Series A and Series B Preferred Stock******10.4
                                                    Form
      of Pacific Coast National Bancorp Organizers’ Warrant
      Agreement*10.5
                                                    Form
      of Pacific Coast National Bancorp Shareholders’ Warrant
      Agreement*10.6
                                                    Form
      of Pacific Coast National Bancorp, Inc. 2005 Stock Incentive
      Plan+*10.7
                                                    Form
      of Employment Agreement by and between Pacific Coast National Bank and
      Michael Hahn+*******10.7a
                                                    Amendment
      to Employment Agreement by and between Pacific Coast National Bank and
      Michael Hahn+10.8
                                                    Form
      of Change in Control Agreement by and between Pacific Coast National Bank
      and David L. Adams****10.8b
                                                    Amendment
      to Change in Control Agreement by and between Pacific Coast National Bank
      and David L. Adams+10.9
                                                    Form
      of Compensation Modification Agreement and Waiver executed by each of
      Michael Hahn and David L. Adams+******10.10
                                                    Form
      of Incentive Stock Option Agreement+***10.11
                                                    Form
      of Nonqualified Stock Option Agreement+***10.12
                                                    Amendment
      To Lease Date Change to Office Lease dated as of February 23,
      2005*****









127








Number
                                                                Description10.13
                                                                Second
      Amendment to Office Lease dated as of March 1, 2006
  *****10.14
                                                                Form
      of Warrant Certificate for Warrants issued on September 30,
      200810.15
                                                                Form
      of Warrant Certificate for Warrants issued on November 3,
    200814
                                                                Code
      of Ethics***21
                                                                Subsidiaries
      of Registrant*****31.1
                                                                Certification
      of Principal Executive Officer Pursuant to Rule 13a-14(a) of the
      Securities Exchange Act31.2
                                                                Certification
      of Principal Financial Officer Pursuant to Rule 13a-14(a) of the
      Securities Exchange Act32
                                                                Certification
      Pursuant to Rule 13a-14(b) of the Securities Exchange Act and 18 U.S.C.
      §1350.*
                                                                Previously
      filed as an exhibit to the registration statement on Form SB-2 filed by
      the registrant with the Securities and Exchange Commission on September 8,
      2004.**
                                                                Previously
      filed as an exhibit to the registrant’s quarterly report on Form 10-QSB
      for the quarter ended March 31, 2005.***
                                                                Previously
      filed as an exhibit to the registrant’s annual report on Form 10-KSB for
      the year ended December 31, 2005.****
                                                                Previously
      filed as an exhibit to the registrant’s quarterly report on Form 10-QSB
      for the quarter ended June 30, 2007.*****
                                                                Previously
      filed as an exhibit to the registrant’s annual report on Form 10-KSB for
      the year ended December 31, 2006.******
                                                                Previously
      filed as an exhibit to the registrant’s current report on Form 8-K filed
      on January 21, 2009.*******
                                                                Previously
      filed as an exhibit to the registrant’s quarterly report on Form 10-Q for
      the quarter ended June 30, 2008.+
                                                                Indicates
      a compensatory plan or
contract.


(b)           See
(a)(3) above.




128


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.




PACIFIC
COAST NATIONAL BANCORP, INC.





By: /s/ Michael S.
Hahn


Michael
S. Hahn


President
and Chief 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/ Michael S. Hahn
                              President
      and Chief Executive Officer and Director
                              June
      1, 2009Michael
      S. Hahn
                              (Principal
      Executive Officer, Principal Financial Officer and Principal Accounting
      Officer)/s/ Thomas J. Applegate
                              Director
                              June
      1, 2009Thomas
      J. Applegate/s/ Michael Cummings
                              Director
                              June
      1, 2009Michael
      Cummings/s/ Fred A. de Boom
                              Director
                              June
      1, 2009Fred
      A. de Boom/s/ Colin M. Forkner
                              Director
                              June
      1, 2009Colin
      M. Forkner/s/ David Johnson
                              Director
                              June
      1, 2009David
      Johnson/s/ Dennis Lindeman
                              Director
      and Chairman of the Board of Directors
                              June
      1, 2009Dennis
      Lindeman/s/ Denis H. Morgan
                              Director
                              June
      1, 2009Denis
      H. Morgan/s/ James M. Morrison
                              Director
                              June
      1, 2009James
      T. Morrison/s/ Charles T. Owens
                              Director
                              June
      1, 2009Jack
      Vuona/s/John Vuona
                              Director
                              June
      1, 2009John
      Vuona





129