UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10 – Q




(MARK
ONE)


[X] QUARTERLY REPORT PURSUANT TO
SECTION 13 OR15(D)OF
THE SECURITIES EXCHANGE ACT OF 1934


For
the quarterly period ended September 30, 2008




[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE
ACT




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)(949) 361- 4300(Registrant’s
      telephone number, including area code)


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


Yes [X]
No [   ]




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 definitions of “large accelerated filer,” “accelerated
filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.




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
number of shares outstanding of the issuer’s Common Stock as
of  November 12, 2008, was 2,544,850 shares.







PACIFIC
COAST NATIONAL BANCORP




INDEX




PART I –
FINANCIAL INFORMATION




PAGEItem
      1 - Financial StatementsConsolidated
      Balance Sheets at September 30, 2008 (unaudited) and December 31,
      2007
              3Consolidated
      Statements of Operations for the three  and nine months
      ended
                September
      30, 2008 (unaudited) and 2007 (unaudited)
              4Consolidated
      Statement of Cash Flows for the nine months ended
                September
      30, 2008 (unaudited) and 2007 (unaudited)
              5Consolidated
      Statement of Shareholders’ Equity as of September 30, 2008
      (unaudited)
              6Condensed
      Notes to Unaudited Consolidated Financial Statements
              7Item
      2 - Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
              11Item
      3 – Quantitative and Qualitative Disclosures About Market
    Risk
              28Item
      4T - Controls and Procedures
              30PART
      II - OTHER INFORMATIONItem
      1 - Legal
      Proceedings
              31Item
      1A – Risk Factors
              31Item
      2 - Unregistered
      Sales of Equity Securities and Use of Proceeds
              32Item
      3 - Defaults
      upon Senior Securities
              32Item
      4 - Submission
      of Matters to a Vote of Security Holders
              32Item
      5 - Other
      Information
              32Item
      6 - Exhibits
              32Signatures
              33










INTRODUCTORY
NOTE – FORWARD LOOKING STATEMENTS




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 quarterly
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 the Company
undertakes no obligation to update any forward-looking statement.




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




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




·
            the
      loss of key personnel;




·
            the
      failure of assumptions;




·
            changes
      in various monetary and fiscal policies and
  regulations;




·
            changes
      in policies by regulatory agencies and other governmental initiatives
      affecting the financial services
industry;




·
            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 the Bank’s loan
      portfolio;




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




·
            the
      combination of continuing asset growth and lack of profitability could
      change the Bank’s status from well-capitalized to adequately-capitalized,
      resulting in higher FDIC insurance premiums and restrictions on the amount
      of brokered deposits the Bank could
hold;




·
            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
      economics in the United States and
abroad;




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




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















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




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




·
            competition
      from bank and non-bank competitors;




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




·
            the
      ability to grow our core
businesses;




·
            decisions
      to change or adopt new business
strategies;




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




·
            technological
      changes;




·
            the
      cost and outcome of any litigation;




·
            changes
      in consumer spending and savings habits;
and




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




These
factors and the risk factors referred to in “Business-Risk Factors” in the
Company’s Annual Report on Form 10-KSB filed with the SEC (and available free of
charge through www.sec.gov)
for the year ended December 31, 2007 and in Item 1A of this Form 10-Q could
cause actual results or outcomes to differ materially from those expressed in
any forward-looking statements made by the Company, and you should not place
undue reliance on any such forward-looking statements.  Any
forward-looking statement speaks only as of the date on which it is made and the
Company undertakes no obligation to update any forward-looking statement or
statements to reflect events or circumstances after the date on which such
statement is made or to reflect the occurrence of unanticipated
events.  New factors emerge from time to time, and it is not possible
for us to predict which factors, if any, will arise.  In addition, the
Company cannot assess the impact of each factor on the Company’s business or the
extent to which any factor, or combination of factors, may cause actual results
to differ materially from those contained in any forward-looking
statements.




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.









PART I - FINANCIAL
INFORMATION






ITEM
1.  Financial
Statements




PACIFIC
COAST NATIONAL BANCORP


CONSOLDIATED
BALANCE SHEETS





ASSETS




September 30,
      2008(unaudited)
              
              
              December 31,
      2007Cash and due from
      banks
              
              $
              7,382,951
              
              
              $
              1,688,892Federal funds
      sold
              
              
              -
              
              
              
              12,785,000TOTAL CASH AND CASH
      EQUIVALENTS
              
              
              7,382,951
              
              
              
              14,473,892Loans
              
              
              
              130,344,503
              
              
              
              97,874,131Less: Allowance for loan
      losses
              
              
              ( 1,727,822
              )
              
              
              ( 1,814,860
              )Loans, net of allowance for loan
      losses
              
              
              128,616,681
              
              
              
              96,059,271Premises and equipment,
      net
              
              
              628,214
              
              
              
              887,532Federal Reserve Bank stock, at
      cost
              
              
              354,200
              
              
              
              405,150Accrued interest receivable and
      other assets
              
              
              1,090,765
              
              
              
              671,339TOTAL
ASSETS
              
              $
              138,072,811
              
              
              $
              112,497,184






LIABILITIES
AND SHAREHOLDERS’ EQUITY






DepositsNoninterest-bearing
      demand
              
              $
              24,470,420
              
              
              $
              17,658,241Interest-bearing
      demand accounts
              
              
              4,218,540
              
              
              
              3,951,566Money market and
      Savings accounts
              
              
              58,067,706
              
              
              
              36,210,745Time
      certificates of deposit of $100,000 or more
              
              
              20,189,162
              
              
              
              3,177,552Other time
      certificates of deposit
              
              
              17,366,910
              
              
              
              37,993,669TOTAL
    DEPOSITS
              
              
              124,312,738
              
              
              
              98,991,773Fed Funds
      Purchased
              
              
              1,040,000
              
              
              
              -Accrued interest and other
      liabilities
              
              
              546,585
              
              
              
              754,146TOTAL
      LIABILITIES
              
              
              125,899,323
              
              
              
              99,745,919Shareholders'
      equityCommon stock -
      $0.01 par value; 10,000,000 shares authorized;issued
      and outstanding: 2,492,220 shares at September 30,2008
      and 2,281,700 shares at December 31, 2007
              
              
              24,922
              
              
              
              22,817Additional
      paid-in capital
              
              
              26,591,810
              
              
              
              25,561,705Accumulated
      deficit
              
              
              ( 14,443,244
              )
              
              
              ( 12,833,257
              )TOTAL SHAREHOLDERS'
      EQUITY
              
              
              12,173,488
              
              
              
              12,751,265TOTAL LIABILITIES AND
      SHAREHOLDERS' EQUITY
              
              $
              138,072,811
              
              
              $
              112,497,184





See
accompanying condensed notes to unaudited consolidated financial
statements




3


PACIFIC
COAST NATIONAL BANCORP


CONSOLIDATED
STATEMENTS OF OPERATIONS (UNAUDITED)




Three Months
                Ended
                September 30,
                2008
              
              Three Months
                Ended
                September 30,
                2007
              
              Nine Months
                Ended
                September 30,
                2008
              
              Nine Months
                Ended
                September 30,
                2007Interest
    incomeInterest and fees on
      loans
              
              $
              2,211,623
              
              
              $
              1,408,465
              
              
              $
              6,154,524
              
              
              $
              3,024,384Federal funds
      sold
              
              
              33,280
              
              
              
              114,481
              
              
              
              181,873
              
              
              
              465,479Investment securities,
      taxable
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              128,488Other
              
              
              5,313
              
              
              
              7,068
              
              
              
              16,873
              
              
              
              32,233Total interest
      income
              
              
              2,250,216
              
              
              
              1,530,014
              
              
              
              6,353,270
              
              
              
              3,650,584Interest
      expenseTime certificates of
      depositof $100,000 or
      more
              
              
              190,819
              
              
              
              36,094
              
              
              
              355,605
              
              
              
              126,424Other
    deposits
              
              
              557,930
              
              
              
              507,630
              
              
              
              1,936,864
              
              
              
              1,086,480Fed Funds
      Purchased
              
              
              1,392
              
              
              
              -
              
              
              
              1,392
              
              
              
              -Total interest
      expense
              
              
              750,141
              
              
              
              543,724
              
              
              
              2,293,861
              
              
              
              1,212,904Net interest income before
      provision for loan losses
              
              
              1,500,075
              
              
              
              986,290
              
              
              
              4,059,409
              
              
              
              2,437,680Provision for loan
      losses
              
              
              489,250
              
              
              
              254,049
              
              
              
              1,137,900
              
              
              
              572,409Net interest income
      afterprovision for loan
      losses
              
              
              1,010,825
              
              
              
              732,241
              
              
              
              2,921,509
              
              
              
              1,865,271Noninterest
      incomeService charges and
      fees
              
              
              30,320
              
              
              
              130,826
              
              
              
              163,204
              
              
              
              156,978Gain on Sale of SBA
      loans
              
              
              248,780
              
              
              
              186,756
              
              
              
              667,335
              
              
              
              320,467Loss on sale of
      investmentsecurities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              ( 12,047
              )279,100
              
              
              
              317,582
              
              
              
              830,539
              
              
              
              465,398Noninterest
      expenseSalaries and employee
      benefits
              
              
              921,391
              
              
              
              902,611
              
              
              
              3,030,305
              
              
              
              2,707,273Occupancy
              
              
              231,866
              
              
              
              228,653
              
              
              
              720,116
              
              
              
              740,915Professional
      services
              
              
              108,360
              
              
              
              158,539
              
              
              
              330,612
              
              
              
              393,821Other
              
              
              414,104
              
              
              
              340,100
              
              
              
              1,279,402
              
              
              
              1,028,2671,675,721
              
              
              
              1,629,903
              
              
              
              5,360,435
              
              
              
              4,870,276(Loss) before income
      taxes
              
              
              (385,796
              )
              
              
              (580,080
              )
              
              
              (1,608,387
              )
              
              
              (2,539,607
              )Provision for income
      taxes
              
              
              -
              
              
              
              -
              
              
              
              1,600
              
              
              
              1,600Net (loss)
              
              $
              (385,796
              )
              
              $
              (580,080
              )
              
              $
              (1,609,987
              )
              
              $
              (2,541,207
              )Per share
    dataWeighted-average shares
      outstanding
              
              
              2,283,988
              
              
              
              2,281,700
              
              
              
              2,282,468
              
              
              
              2,281,682Net (loss),
      basic and diluted
              
              $
              (0.17
              )
              
              $
              (0.25
              )
              
              $
              (0.71
              )
              
              $
              (1.11
              )





See
accompanying condensed notes to unaudited consolidated financial
statements.


4


PACIFIC
COAST NATIONAL BANCORP


CONSOLIDATED
STATEMENT OF CASH FLOWS (UNAUDITED)






Nine Months Ended September 30,
      2008
              
              
              Nine Months Ended September 30,
      2007Cash flows from operating
      activities:Net loss
              
              $
              (1,609,987
              )
              
              $
              (2,541,207
              )Adjustments to reconcile net loss
      to net cash provided by(used in) operating
      activities:Depreciation and
      amortization
              
              
              321,017
              
              
              
              313,681Provision for loan
      losses
              
              
              1,137,900
              
              
              
              572,409Provision for off balance sheet
      contingencies
              
              
              1,694
              
              
              
              38,477Accretion of premium or (discount)
      on investment securities
              
              
              -
              
              
              
              (6,486
              )Loss on sale of available for sale
      securities
              
              
              -
              
              
              
              12,047Gain on sale of
      loans
              
              
              (667,335
              )
              
              
              (320,467
              )Stock-based
      compensation
              
              
              183,910
              
              
              
              678,260Net (increase) in Other
      Assets
              
              
              (419,426
              )
              
              
              (276,991
              )Net increase (decrease) in Other
      Liabilities
              
              
              (209,255
              )
              
              
              266,331Net cash provided by (used in)
      operating activities
              
              
              (1,261,482
              )
              
              
              (1,263,946
              )Cash flows from investing
      activities:Proceeds from maturity of time
      deposits in other financial institutions
              
              
              -
              
              
              
              1,000,000Proceeds from sale of available
      for sale investment securities
              
              
              -
              
              
              
              7,937,814Net redemption of Federal Reserve
      Bank stock
              
              
              50,950
              
              
              
              39,800Proceeds from sale of
      loans
              
              
              12,441,174
              
              
              
              5,856,224Net (increase) in
      Loans
              
              
              (45,469,149
              )
              
              
              (47,824,261
              )Purchases of premises and
      equipment
              
              
              (61,699
              )
              
              
              (92,038
              )Net cash used in investing
      activities
              
              
              (33,038,724
              )
              
              
              (33,082,461
              )Cash flows from financing
      activities:Net increase in demand deposits
      and savings accounts
              
              
              28,936,114
              
              
              
              22,148,101Net increase (decrease) in time
      deposits
              
              
              (3,615,149
              )
              
              
              12,957,508Net increase in fed funds
      purchased
              
              
              1,040,000
              
              
              
              -Proceeds from exercise of
      warrants
              
              
              -
              
              
              
              2,500Proceeds from sale of stock,
      net
              
              
              848,300
              
              
              
              -Net cash provided by financing
      activities
              
              
              27,209,265
              
              
              
              35,108,109Net increase (decrease) in cash
      and cash equivalents
              
              
              (7,090,941
              )
              
              
              761,702Cash and cash equivalents at
      beginning of period
              
              
              14,473,892
              
              
              
              10,916,151Cash and cash equivalents at end
      of period
              
              $
              7,382,951
              
              
              $
              11,677,853Supplemental disclosure of cash
      flow information:Interest
    paid
              
              $
              2,306,297
              
              
              $
              1,174,930Income taxes
      paid
              
              $
              1,600
              
              
              $
              1,600Supplemental schedule of non-cash
      investing activities:Transfer of held to maturity
      securities to available for sale
              
              $
              -
              
              
              $
              7,937,275




See
accompanying condensed notes to unaudited consolidated financial
statements


5


PACIFIC
COAST NATIONAL BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)


AS
OF SEPTEMBER 30, 2008





AdditionalShares
              
              
              Common
              
              
              Paid-in
              
              
              AccumulatedOutstanding
              
              
              Stock
              
              
              Capital
              
              
              Deficit
              
              
              TotalBalance at December 31,
      2007
              
              
              2,281,700
              
              
              $
              22,817
              
              
              $
              25,561,705
              
              
              $
              ( 12,833,257
              )
              
              $
              12,751,265Proceeds from sale of stock,
      net
              
              
              210,520
              
              
              
              2,105
              
              
              
              846,195
              
              
              
              
              
              
              
              848,300Stock-based
      Compensation
              
              
              -
              
              
              
              -
              
              
              
              183,910
              
              
              
              -
              
              
              
              183,910Net Loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (1,609,987
              )
              
              
              (1,609,987
              )Balance at September 30,
      2008
              
              
              2,492,220
              
              
              $
              24,922
              
              
              $
              26,591,810
              
              
              $
              ( 14,443,244
              )
              
              $
              12,173,488


































See accompanying condensed notes to
unaudited consolidated financial statements






6








PACIFIC
COAST NATIONAL BANCORP


CONDENSED
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





Note
1 – Basis of Presentation




The
consolidated financial statements include the Company and its wholly-owned
subsidiary, the Bank. All significant inter-company accounts have been
eliminated on consolidation.




The
accounting principles followed by the Company and the methods of applying these
principles conform with accounting principles generally accepted in the United
States of America, or GAAP, and with general practices within the banking
industry. In preparing financial statements in conformity with GAAP, management
is required to make estimates and assumptions that affect the reported amounts
in the financial statements. Actual results could differ significantly from
those estimates. Material estimates common to the banking industry that are
particularly susceptible to significant change in the near term include, but are
not limited to, the determination of the allowance for loan losses, the
estimation of compensation expense related to stock options granted to employees
and directors, and valuation allowances associated with deferred tax assets, the
recognition of which are based on future taxable income.




The
consolidated interim financial statements included in this report are unaudited
but reflect all adjustments which, in the opinion of management, are necessary
for a fair presentation of the financial position and results of operations for
the interim periods presented. All such adjustments are of a normal recurring
nature. The results of operations for the three and nine month periods ended
September 30, 2008 are not necessarily indicative of the results of a full
year’s operations. For further information, refer to the audited financial
statements and footnotes included in the Company’s annual report on Form 10-KSB
for the year ended December 31, 2007.




Note
2 – Loss Per Share




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 would be antidilutive during the periods
presented. For the three and nine months ended September 30, 2008, the
conversion of approximately no and 1,000, respectively, common shares issuable
upon exercise of the employee stock options and common stock warrants have not
been included in the 2008 loss per share computation because their inclusion
would have been antidilutive on loss per share. For the three and nine months
ended September 30, 2007, the conversion of approximately 12,500 and 366,000,
respectively, common shares issuable upon exercise of the employee stock options
and common stock warrants have not been included in the 2007 loss per share
computation because their inclusion would have been antidilutive on loss per
share.




Note
3 – Stock-Based Compensation




The
Company follows SFAS 123(R), “Share-Based Payment” utilizing the modified
prospective approach.  SFAS 123(R) applies to new awards and to awards
that were outstanding on January 1, 2006 that are subsequently repurchased or
cancelled. Under the modified prospective approach, compensation cost recognized
includes compensation cost for all share-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 provisions 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.




As of
September 30, 2008, there was approximately $40 thousand of unrecognized
compensation cost related to unvested stock options. This cost is expected to be
recognized over a weighted average period of approximately 1 year.




The fair
value at the grant date of stock-based awards to employees is calculated through
the use of option-pricing models, even though such models were developed to
estimate the fair value of freely tradable fully transferable options with
vesting restrictions which significantly differ from the Company’s stock option
awards. These models also require subjective assumptions, including future stock
price volatility and expected time to exercise, which greatly affect the
calculated value.






7








Outstanding
unvested stock options generally vest ratably over three years based upon
continuous service. The Company accounts for these grants as separate grants and
recognizes share-based compensation cost using the straight-line method for each
separate vesting portion.









Note
4 – Fair Value Measurements




SFAS No. 157,Fair Value
Measurements,which the Company adopted effective
January 1, 2008,defines
fair value, establishes a framework for measuring fair value, establishes a
three-levelvaluation hierarchy for disclosure of
fair value measurement and enhances disclosure requirements for fair value
measurements. The valuation hierarchy is based upon the transparency of inputs
to the valuation of an asset or liability as of the measurement date. The three
levels are defined as follow:





Level 1:  Inputs to the valuation methodology are
quoted prices (unadjusted) for identical assets or liabilities in active
markets.


Level 2:  Inputs to the valuation methodology
include quoted prices for similar assets and liabilities in active markets and
inputs that are observable for the asset or liability, either directly or
indirectly, for substantially the full term of the financial
instrument.


Level 3:  Inputs to the valuation methodology are
unobservable and significant to the fair value measurement.




Following is a description of the
valuation methodologies used for instruments measured at fair value, as well as
the general classification of such instruments pursuant to the valuation
hierarchy:





Assets





Impaired
loans





SFAS No. 157 applies to loans measured
for impairment using the practical expedients permitted by SFAS No.
114,Accounting by Creditors for Impairment of a Loan, including impaired loans measured at
an observable market price (if available), or at the fair value of the loan’s
collateral (if the loan is collateral dependent). Fair value of the loan’s
collateral, when the loan is dependent on collateral, is determined by
appraisals or independent valuation which is then adjusted for the cost related
to liquidation of the collateral.At September 30, 2008, we had ten loans
that were considered impaired for a total of $7.0 million. Upon being classified
as impaired, charge offs were taken to reduce the balance of each loan to an
estimate of the collateral fair market value less cost to dispose. This estimate
was a level 3 valuation. There was no direct impact on the income statement. The
charge-offs were recorded as a reduction in the allowance for loan
losses.





Note
5 – Loans




The composition of the loan portfolio
at September 30, 2008 and December 31, 2007, was as follows:


September 30,
      2008
              
              
              December 31,
      2007Real estate
              
              (Dollars in
      thousands)1-4 residential
      (1)
              
              $
              5,512
              
              
              
              4.2
              %
              
              $
              2,655
              
              
              
              2.7
              %Multi-Family
              
              
              2,117
              
              
              
              1.6
              %
              
              
              720
              
              
              
              0.7
              %Non-farm,
      non-residential
              
              
              51,168
              
              
              
              39.4
              %
              
              
              40,951
              
              
              
              41.9
              %Construction & Land
      Development
              
              
              37,344
              
              
              
              28.7
              %
              
              
              31,164
              
              
              
              31.9
              %Commercial
              
              
              33,653
              
              
              
              25.9
              %
              
              
              21,827
              
              
              
              22.4
              %Consumer
              
              
              167
              
              
              
              0.1
              %
              
              
              327
              
              
              
              0.3
              %129,961
              
              
              
              100
              %
              
              
              97,644
              
              
              
              100
              %Net deferred loan costs, premiums
      and discounts
              
              
              384
              
              
              
              
              
              
              
              230Allowance for loan
      losses
              
              
              ( 1,728
              )
              
              
              
              
              
              
              ( 1,815
              )$
              128,617
              
              
              
              
              
              
              $
              96,059(1) Comprised of second mortgage
      home loans under home equity lines of credit.






8






At
September 30, 2008, and December 31, 2007, the Bank had total commitments to
lend outstanding of $37.3 million and $29.5 million respectively.




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. 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 is
collateralized, less costs to sell.




At
September 30, 2008, the Bank had five construction loans with outstanding
balances of $4.9 million, four commercial loans with outstanding balances
of  $2.0 million, and one consumer loan with an outstanding balance of
$89 thousand, all of which were considered impaired compared to two construction
loans which were considered impaired at December 31, 2007 for $2.5
million.




One
construction loan for $1.0 million was excluded from the impaired loan totals as
it is in escrow at this time. The escrow is expected to close on or about
November 14, 2008. If the property is not sold, the $1.0 million would be added
to the impaired loan total. At this time the collateral is valued higher than
the outstanding loan amount. Therefore no additional reserves would be required.
If property values continue to decline, however, this could change.




If a loan
is real-estate collateral-dependent and considered impaired, the outstanding
principal is reduced through a charge off to the estimated fair value, which may
be the property’s 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 continued deterioration in
collateral value. Therefore, the related allowance for loan losses on impaired
loans represents only the allowance for non-real estate collateral dependent
loans. As of September 30, 2008, six impaired loans for $3.1 million were not
considered real-estate collateral-dependent and had allowances for losses
totaling $648 thousand.




The
following table provides information on impaired  loans:




September 30,
      2008
              
              
              December 31,
      2007(Dollars in
      thousands)Impaired loans with a valuation
      allowance   (1)
              
              
              
              $
              3,054
              
              
              $
              2,467Impaired loans without a valuation
      allowance
              
              
              
              
              3,921
              
              
              
              -Total impaired
      loans
              
              
              
              $
              6,975
              
              
              $
              2,467Valuation allowance related to
      impaired loans
              
              
              
              $
              648
              
              
              $
              590Net recorded investment in
      impaired loans
              
              
              
              $
              6,327
              
              
              $
              1,877Average balance during the year on
      impaired loans
              
              
              
              $
              7,323
              
              
              $
              2,456Cash collections applied to reduce
      principal balances
              
              
              
              $
              272
              
              
              $
              -Interest income recognized on cash
      collections
              
              
              
              $
              286
              
              
              $
              126






(1) At
September 30, 2008, $350 thousand in impaired loans with specific reserves held
SBA guarantees for approximately $175 thousand.




The
following table sets forth the activity for the nine months ended September 30,
2008 and 2007 in our allowance for loan losses account.






9





2008
              
              
              2007($ in
      thousands)Balance at beginning of
      year
              
              $
              1,815
              
              
              $
              432Provision charged to
      expense
              
              
              1,138
              
              
              
              1,383Total loans charged
      off
              
              
              ( 1,493
              )
              
              
              -Recoveries on loans previously
      charged off
              
              
              268
              
              
              
              -Balance at end of
      period
              
              $
              1,728
              
              
              $
              1,815




Note
6 – Other Expenses




A summary of other expenses for the
three and nine months ended September 30, 2008 and 2007 is as
follows:


Three Months Ended September 30,
      2008
              Three Months Ended September 30,
      2007
              Nine Months Ended September 30,
      2008
              Nine Months Ended September 30,
      2007Data
    Processing
              
              $                 123,238
              
              $                 115,467
              
              $                 405,198
              
              $                 311,394Office
    Expenses
              
              105,258
              
              93,586
              
              351,503
              
              242,275Marketing
              
              82,026
              
              68,290
              
              275,998
              
              196,621Regulatory
      Assessments
              
              43,359
              
              2,694
              
              96,122
              
              27,916Insurance
    Costs
              
              19,586
              
              24,485
              
              74,481
              
              79,586Director-related expenses
      (1)
              
              1,518
              
              5,996
              
              7,449
              
              70,247Other  (2)
              
              39,120
              
              29,582
              
              68,652
              
              100,228$                  414,104
              
              $                  340,100
              
              $                1,279,402
              
              $                1,028,267(1) Consists primarily of costs
      associated with training conferences and director stock option
      expense.(2) Consists primarily of costs
      associated with recruiting expenses and the annual meeting printing and
      mailing costs.




Note
7 – Income Taxes




We adopted the provisions of Financial
Accounting Standards Board, or FASB, Interpretation No. 48, Accounting for Uncertainty in Income
Taxes – an interpretation of FASB State No. 109, or FIN 48, on January 1,
2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in an enterprise’s financial statements in accordance with FASB Statement No.
109, Accounting for Income
Taxes. FIN 48 prescribes a threshold and a measurement process for
recognizing in the financial statements a tax position taken or expected to be
taken in a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. We have determined that there are no significant
uncertain tax positions requiring recognition in our financial
statements.




The Company will classify any interest
required to be paid on an underpayment of income taxes as interest expense. Any
penalties assessed by a taxing authority will be classified as other
expense.




No federal or state tax expense or
benefit has been recorded for the quarters ended September 2008 and 2007 due to
the Company’s operating losses.







Note
8 - Current Accounting Pronouncements





In
September 2006, the Financial Accounting Standards Board, or FASB, issued
Statement No. 157, “Fair Value Measurements” (SFAS 157). SFAS No. 157 defines
the fair value, establishes a framework for measuring fair value and expands
disclosure of fair value measurements. SFAS No. 157 applies under other
accounting pronouncements that require or permit fair value measurements and
accordingly, does not require any new fair value measurements. We adopted SFAS
No. 157 as of January 1, 2008 and the adoption did not have a material impact on
the consolidated financial statements or results of operations of the
Company.






10







In
February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities - Including an Amendment of FASB Statement No.
115”. SFAS 159 permits an entity to choose to measure many financial instruments
and certain other items at fair value. Most of the provisions of SFAS 159 are
elective; however, the amendment to SFAS 115, “Accounting for Certain
Investments in Debt and Equity Securities”, applies to all entities with
available for sale or trading securities. For financial instruments elected to
be accounted for at fair value, an entity will report the unrealized gains and
losses in earnings. We adopted SFAS No. 159 on January 1, 2008. We chose not to
elect the option to measure the fair value of eligible financial assets and
liabilities.





Note
9 – Sale of Stock





The Company recently completed a
private placement transaction in which it sold an aggregate of 25 units, for an
aggregate purchase price of $1,250,000 ($50,000 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.  Twenty units were sold in
September 2008 (13 of which, for $650,000, were purchased by directors and an
executive officer of the Company) and five units were sold in November
2008.  The offering resulted in net proceeds of approximately $848
thousand as of September 30, 2008, and an additional $236 thousand by November
4, 2008.







Note
10– Reclassifications





Certain reclassifications have been
made in the 2007 consolidated financial statements and footnotes to conform to
the presentation used in 2008 with no change to previously reported net loss or
shareholders’ equity.




ITEM
2.  Management’s
Discussion and Analysis of Financial Condition and Results of
Operations




The
following discussion and analysis address the Company’s consolidated financial
condition as of September 30, 2008 compared to December 31, 2007, and results of
operations for the three and nine months ended September 30, 2008 and 2007. The
discussion should be read in conjunction with the financial statements and the
notes related thereto which appear elsewhere in this Quarterly Report on
Form 10-Q.




Critical Accounting
Policies





Our
accounting policies are integral to understanding the results
reported.  In preparing our consolidated financial statements, the
Company is required to make judgments and estimates that may have a significant
impact upon our reported financial results.  Certain accounting
policies require the Company 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, the Company’s
determination of the adequacy of its allowance for loan losses is particularly
susceptible to management’s judgment and estimates.  The following is
a brief description of the Company’s 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. The first method 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 (“FRB”)
website. To this






11






number is
added the reserves for loans classified as substandard, substandard non-accrual,
and doubtful, as established by management. The second method involves
classifying the portfolio by risk weighting and applying a loss factor for each
rating, again using the FRB historic database to determine appropriate factors
as the Bank has limited loss history. Again, the related reserves for the loans
classified as substandard, substandard non-accrual, and doubtful, are added to
the general allowance to arrive at a total allowance. 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.





Stock-Based
Compensation





The
Company accounts for stock-based employee compensation as prescribed by SFAS
123(R), Share-Based
Payment. SFAS 123(R) requires compensation costs related to share-based
payment transactions to be recognized in the financial statements over the
period that an employee provides service in exchange for the award.




The
Company uses the Black-Scholes option pricing model to estimate the fair values
of the options granted.  The estimates that are a part of the
calculation for the compensation costs include the average life of the stock
options, the future price of the Company’s stock when the options are exercised,
and the average forfeiture rate of pre-vested options. These estimates have
significant influence over the final expense and the Company does not have a
history on which to base these assumptions. Please refer to Note H – Stock Optionsof the
Notes to Consolidated Financial Statements of the December 31, 2007
10-KSB.







Deferred
Tax Assets





Management
estimates the need for a valuation allowance on deferred tax assets by comparing
the total recorded to the amount available for carry back and the amount that
will be utilized by estimated future earnings.







12






Executive
Overview




Introduction




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




The
Company recently completed a private placement transaction in which it sold an
aggregate of 25 units, for an aggregate purchase price of $1,250,000 ($50,000
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.  Twenty
units were sold in September 2008 (13 of which, for $650,000, were purchased by
directors and an executive officer of the Company) and five units were sold in
November 2008.  The offering resulted in net proceeds of approximately
$848 thousand as of September 30, 2008, and an additional $236 thousand by
November 4, 2008.




The
Bank’s principal markets include the coastal regions of Southern Orange County
and Northern San Diego County, California.   As of September 30,
2008, the Company had, on a consolidated basis, total assets of $138.1 million,
net loans of $128.6 million, total deposits of $124.3 million, and shareholders’
equity of $12.2 million.  The Bank currently operates through a 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.




The Company incurreda net loss for thethird quarter of 2008of $(386) thousandor $(0.17)per share, as compared toa net loss of$(580) thousandor $(0.25)per share,during the same period of
2007. Theimprovementin the2008quarter was primarily attributable to
a52% increase in the net
interest income due to an increase in earning assets, partially offset
by a 3% increase in non-interest expenses and a provision for loan losses which
increased by 92%




The Company incurreda net loss for thenine months ended September 30, 2008 of$(1.6) millionor $(0.71)per share, ascompared toa net loss of$(2.5) millionor $(1.11)per share,during the same period of
2007. Theimprovementinthe 2008 periodwas primarily attributable to
a66% increase in the net
interest income due to an increase in earning assets and a 78%
increase in non-interest
income due primarily to gain on sales of SBA loans, partially offset by a 10%
increase in non-interest expenses and a 99% increase in the provision for loan
losses.




The
following discussion focuses on the Company’s financial condition as of
September 30, 2008 compared to December 31, 2007 and results of operations for
the three and nine months ended September 30, 2008 and 2007.




Results
of Operations




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 the three and nine months ended September 30, 2008, before
the provision for loan losses was $1.5 million and $4.1 million compared to $986
thousand and $2.4 million for the same time periods in 2007. This growth was
attributable to the increase in the volume of earning assets and the greater
percentage of loans comprising earning assets in the 2008 periods.






13








During
the three months ended September 30, 2008, loans accounted for 95% of average
earning assets, with a weighted average yield of 6.94%, compared to the same
period in 2007 when 88% of the average earning assets were loans, with a
weighted average yield of 8.33%. The increase in loans as a percentage of
average earning assets occurred primarily as a result of significantly increased
loan originations in the second half of 2007 and the first nine months of 2008.
The decrease in the average yield resulted primarily from the decrease in market
rates prompted by the actions of the Federal Reserve Board over the last year.
Total loan interest income was $2.2 million, including net loan fees of $135
thousand, for the three months ended September 30, 2008 compared to $1.4 million
in total loan interest income, including $16 thousand in net loan costs, for the
same period in 2007.





During
the first nine months of 2008, loans accounted for 92% of average earning
assets, with a weighted average yield of 7.20%, compared to the first nine
months of 2007 when 77% of the average earning assets were loans, with a
weighted average yield of 8.22%. The increase in loans as a percentage of
average earning assets occurred primarily as a result of significantly increased
loan originations in the second half of 2007 and the first nine months of 2008.
The decrease in the average yield resulted primarily from the decrease in market
rates prompted by the actions of the Federal Reserve Board over the last year.
Total loan interest income was $6.2 million, including net loan fees of $323
thousand, for the first nine months of 2008 compared to $3.0 million in total
loan interest income, including $(5) thousand in net loan costs, in the first
nine months of 2007.





Other
earning assets may from time to time consist of investments, capital stock of
the Federal Reserve Bank, time deposits with other financial institutions and
overnight fed funds. For the three months ended September 30, 2008, fed funds
sold averaged $6.4 million with an average yield of 2.06% compared to the same
period in 2007 with average fed funds sold of $9.0 million with an average yield
of 5.06%. The remaining earning assets for the three months ended September 30,
2008, consisted of stock in the Federal Reserve Bank with an average yield of
5.95% compared to the same period in 2007 with other earning assets consisting
of stock in the Federal Reserve Bank averaging $454 thousand with an average
yield of 6.18%.  The decrease in the average yields resulted primarily
from the decrease in market rates prompted by the actions of the Federal Reserve
Board over the last year.




For the
first nine months of 2008, fed funds sold averaged $10.0 million with an average
yield of 2.41% compared to the first nine months of 2007 with average fed funds
sold of $11.5 million with an average yield of 5.39%. The remaining earning
assets for the first nine months of 2008 consisted of stock in the Federal
Reserve Bank with an average yield of 5.99% compared to the first nine months of
2007 with other earning assets consisting of investment securities and stock in
the Federal Reserve Bank averaging $3.5 million with an average yield of
6.18%.




Interest-bearing
liabilities, consisting of deposits and fed funds purchased, averaged $99.9
million with an average rate of 2.98% during the three months ended September
30, 2008, compared with $48.0 million in interest-bearing deposits at a rate of
4.50% for the same period in 2007. The decrease in the average rate on deposit
products was the result of decreases in market rates as a result of actions
taken by the Federal Reserve Board in recent months, offset by higher-rate time
deposits obtained through brokers.  The increase in deposits was a
result of our marketing campaign, the cross-selling of deposit products to our
borrowers, direct sales calls and the utilization of brokered deposits to fund
increased loan originations.




Interest-bearing
liabilities averaged $92.3 million with an average rate of 3.31% during the
first nine months of 2008, compared with $37.9 million in interest-bearing
deposits at a rate of 4.28% for the same period in 2007. The decrease in the
average rate on deposit products was the result of decreases in market rates as
a result of actions taken by the Federal Reserve Board in recent months, offset
by higher-rate time deposits obtained through brokers.  The increase
in deposits was a result of our marketing campaign, the cross-selling of deposit
products to our borrowers, direct sales calls and the utilization of brokered
deposits to fund increased loan originations.




Due to
strong loan demand, we began utilizing brokered deposits in the second quarter
of 2007. As discussed under “Capital Resources and Capital Adequacy Management”,
we seek to limit the amount of brokered deposits as their utilization typically
would be expected to increase our overall cost of funds. As of September 30,
2008, $19.7 million in brokered funds were on deposit with an average rate of
3.4%, compared with $11.2 million in brokered funds on deposit as of September
30, 2007, with an average rate of 5.4%, and $28.2 million in brokered funds as
of December 31, 2007, with an average rate of 4.9%.




During
the third quarter of 2008 and in response to customer demand, we began offering
reciprocal deposits through the CDAR program. This program allows a customer to
deposit funds in excess of the FDIC insurance through Pacific Coast National
Bank into other financial institutions. These institutions place reciprocal






14






deposits
with the Bank, maximizing the FDIC insurance coverage. As of September 30, 2008,
$2.2 million shown as brokered funds were reciprocal deposits.




Non-interest
bearing demand account balances averaged $25.2 million and $22.9 million for the
three and nine months ended September 30, 2008, representing 20% of total
deposits in each period. This compares with $17.8 million and $16.4 million for
the same periods in 2007, representing 27% and 30% respectively of total
deposits in each period. While the dollar amount of demand deposits continues to
increase, the percentage of demand deposits to total deposits has decreased.
This is the result of a significant increase in money market accounts and the
increase in time deposits to maintain liquidity as the loan portfolio has grown.
The growth in money market accounts was the result of marketing efforts of new
personnel in the San Clemente office, which has allowed us to not renew some
brokered time deposits as they have matured.




The net
interest margin was 4.47% and 4.35% for the three and nine months ended
September 30, 2008, compared to 5.12% and 5.07% for the same periods in
2007.  We earned $1.5 million in net interest income on average
interest-earning assets of $133.1 million and $4.1 million on average earning
assets of $124.3 million for the three and nine months ended September 30, 2008.
For the same periods in 2007, we earned $986 thousand on average
interest-earning assets of $76.5 million and $2.4 million on average
interest-earning assets of $64.2 million, respectively. For the three and nine
months ended September 30, 2008 compared to the same periods in 2007, net
interest income before provision for loan losses increased by $597 thousand due
to the increase in volume of earning assets, and decreased by $83 thousand due
to changes in interest rates, and increased by $1.9 million due to the increase
in volume of earning assets, and decreased by $244 thousand due to changes in
interest rates.




The
following tables set forth our average balances of assets, liabilities and
shareholders’ equity, in addition to the major components of net interest income
and the net interest margin for the three and nine month periods
indicated.






15





Three
      Months Ended September 30, 2008
              
              
              Three
      Months Ended September 30, 2007Average
                Balance
              
              
              Interest
              
              
              Average
                Yield
      /
                Cost(4)
              
              
              Average
                Balance
              
              
              Interest
              
              
              Average
                Yield
      /
                Cost(4)(Dollars
      in thousands)Assets:Interest-earning
      Assets:Net
      Loans Receivable(1)
              
              $
              126,346
              
              
              $
              2,212
              
              
              
              6.94
              %
              
              $
              67,092
              
              
              $
              1,408
              
              
              
              8.33
              %Investment
      in capital stock of Federal Reserve Bank and
                Other
      Investments
              
              
              354
              
              
              
              5
              
              
              
              5.95
              %
              
              
              454
              
              
              
              7
              
              
              
              6.18
              %Fed
      funds sold
              
              
              6,406
              
              
              
              33
              
              
              
              2.06
              %
              
              
              8,968
              
              
              
              115
              
              
              
              5.06
              %Total
      interest-earning assets
              
              
              133,106
              
              
              
              2,250
              
              
              
              6.71
              %
              
              
              76,514
              
              
              
              1,530
              
              
              
              7.93
              %Noninterest-earning
      assets
              
              
              3,977
              
              
              
              
              
              
              
              
              
              
              
              3,426Total
      Assets
              
              $
              137,083
              
              
              
              
              
              
              
              
              
              
              $
              79,940Liabilities
      and Shareholders' EquityMoney
      Market and Savings Deposits
              
              $
              51,106
              
              
              $
              294
              
              
              
              2.28
              %
              
              $
              32,365
              
              
              
              372
              
              
              
              4.56
              %Interest-bearing
      Checking
              
              
              4,468
              
              
              
              14
              
              
              
              1.24
              %
              
              
              3,229
              
              
              
              11
              
              
              
              1.31
              %Time
      Deposits of $100,000 or more
              
              
              20,771
              
              
              
              191
              
              
              
              3.64
              %
              
              
              2,844
              
              
              
              36
              
              
              
              5.04
              %Other
      Time Deposits
              
              
              23,279
              
              
              
              250
              
              
              
              4.26
              %
              
              
              9,546
              
              
              
              125
              
              
              
              5.20
              %Fed
      funds purchased
              
              
              230
              
              
              
              1
              
              
              
              2.40
              %
              
              
              -
              
              
              
              -Total
      Interest-bearing liabilities
              
              
              99,854
              
              
              
              750
              
              
              
              2.98
              %
              
              
              47,985
              
              
              
              544
              
              
              
              4.50
              %Non-interest
      bearing checking accounts
              
              
              25,199
              
              
              
              
              
              
              
              
              
              
              
              17,835Non-interest
      bearing liabilities
              
              
              593
              
              
              
              
              
              
              
              
              
              
              
              415Shareholders'
      Equity
              
              
              11,437
              
              
              
              
              
              
              
              
              
              
              
              13,705Total
      Liabilities andShareholders'
      Equity
              
              $
              137,083
              
              
              
              
              
              
              
              
              
              
              $
              79,940Net
      Interest Income
              
              
              
              
              
              $
              1,500
              
              
              
              
              
              
              
              
              
              
              $
              986Net
      Interest Spread(2)
              
              
              
              
              
              
              3.73
              %
              
              
              
              
              
              
              
              
              
              
              3.44
              %Net
      Interest Margin(3)
              
              
              
              
              
              
              4.47
              %
              
              
              
              
              
              
              
              
              
              
              5.12
              %(1)Loan
      fees (costs) are included in total interest income as follows: 2008 $135
      thousand; 2007 $16 thousand.(2)Net
      interest spread represents the yield earned on average total
      interest-earning assets less therate
      paid on average interest-bearing liabilities.(3)Net
      interest margin is computed by dividing annualized net interest income by
      average totalinterest-earning
      assets.






16








Nine
      Months Ended September 30, 2008
              
              
              Nine
      Months Ended September 30, 2007Average Balance
              
              
              Interest
              
              
              Average
      Yield / Cost(4)
              
              
              Average Balance
              
              
              Interest
              
              
              Average
      Yield / Cost(4)(Dollars
      in thousands)Assets:Interest-earning
      Assets:Net
      Loans Receivable(1)
              
              $
              113,889
              
              
              $
              6,155
              
              
              
              7.20
              %
              
              $
              49,199
              
              
              $
              3,024
              
              
              
              8.22
              %Investment
      Securities
              
              
              -
              
              
              
              -
              
              
              
              4.85
              %
              
              
              2,752
              
              
              
              129
              
              
              
              6.24
              %Investment
      in capital stock of Federal Reserve Bank and
                Other
      Investments
              
              
              375
              
              
              
              17
              
              
              
              5.99
              %
              
              
              732
              
              
              
              32
              
              
              
              5.88
              %Fed
      funds sold
              
              
              10,044
              
              
              
              182
              
              
              
              2.41
              %
              
              
              11,541
              
              
              
              466
              
              
              
              5.39
              %Total
      interest-earning assets
              
              
              124,308
              
              
              
              6,353
              
              
              
              6.81
              %
              
              
              64,224
              
              
              
              3,651
              
              
              
              7.60
              %Noninterest-earning
      assets
              
              
              3,162
              
              
              
              
              
              
              
              
              
              
              
              4,561Total
      Assets
              
              $
              127,470
              
              
              
              
              
              
              
              
              
              
              $
              68,785Liabilities
      and Shareholders' EquityMoney
      Market and Savings Deposits
              
              $
              45,759
              
              
              $
              868
              
              
              
              2.53
              %
              
              $
              26,428
              
              
              
              880
              
              
              
              4.45
              %Interest-bearing
      Checking
              
              
              3,975
              
              
              
              41
              
              
              
              1.37
              %
              
              
              3,208
              
              
              
              32
              
              
              
              1.33
              %Time
      Deposits of $100,000 or more
              
              
              13,518
              
              
              
              356
              
              
              
              3.50
              %
              
              
              3,435
              
              
              
              126
              
              
              
              4.92
              %Other
      Time Deposits
              
              
              28,945
              
              
              
              1,029
              
              
              
              4.74
              %
              
              
              4,812
              
              
              
              175
              
              
              
              4.85
              %Fed
      funds purchased
              
              
              77
              
              
              
              1
              
              
              
              2.41
              %
              
              
              -
              
              
              
              -Total
      Interest-bearing liabilities
              
              
              92,274
              
              
              
              2,295
              
              
              
              3.31
              %
              
              
              37,883
              
              
              
              1,213
              
              
              
              4.28
              %Non-interest
      bearing checking accounts
              
              
              22,917
              
              
              
              
              
              
              
              
              
              
              
              16,353Non-interest
      bearing liabilities
              
              
              700
              
              
              
              
              
              
              
              
              
              
              
              374Shareholders'
      Equity
              
              
              11,579
              
              
              
              
              
              
              
              
              
              
              
              14,175Total
      Liabilities andShareholders'
      Equity
              
              $
              127,470
              
              
              
              
              
              
              
              
              
              
              $
              68,785Net
      Interest Income
              
              
              
              
              
              $
              4,058
              
              
              
              
              
              
              
              
              
              
              $
              2,438Net
      Interest Spread(2)
              
              
              
              
              
              
              3.50
              %
              
              
              
              
              
              
              
              
              
              
              3.32
              %Net
      Interest Margin(3)
              
              
              
              
              
              
              4.35
              %
              
              
              
              
              
              
              
              
              
              
              5.07
              %(1)Loan
      fees (costs) are included in total interest income as follows: 2008 $323
      thousand; 2007 $(5) thousand.(2)Net
      interest spread represents the yield earned on average total
      interest-earning assets less therate
      paid on average interest-bearing liabilities.(3)Net
      interest margin is computed by dividing annualized net interest income by
      average totalinterest-earning
      assets.(4)Annualized




The
following tables present 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 the three and
nine months ended September 30, 2008 compared to the same periods in 2007.
Because of our significant loan and deposit growth, changes due to volume
account for most 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) and (ii) changes attributable to changes in rate
(changes in rate multiplied by prior volume), and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.






17






Three Months Ended September 30,
      2008 Compared to Three Months Ended September 30,
    2007Increase/(Decrease)  in
      Net Interest IncomeDue ToRate
              
              Volume
              
              NetInterest-earning
      Assets:
              
              (Dollars in
      thousands)Net Loans
      Receivable
              
              $          (234)
              
              $            1,038
              
              $               804Investment
      Securities
              
              -
              
              -
              
              -Investment in capital stock of
                Federal Reserve Bank and Other
                Investments
              (0)
              
              (2)
              
              (2)Fed funds
    sold
              
              (68)
              
              (14)
              
              (82)Total
              
              (302)
              
              1,022
              
              720Interest-bearing
      Liabilities:Money Market and Savings
      Deposits
              (186)
              
              108
              
              (78)Interest-bearing
      Checking
              
              (1)
              
              4
              
              3Time Deposits of $100,000 or
      more
              
              (10)
              
              165
              
              155Other Time
      Deposits
              
              (22)
              
              148
              
              125Fed funds
      purchased
              
              -
              
              1
              
              1Total
              
              (219)
              
              425
              
              206Net Change in Net Interest
      Income
              
              $           (83)
              
              $               597
              
              $               514
   Nine Months Ended September 30,
      2008 Compared to Nine Months Ended September 30,
    2007Increase/(Decrease)  in
      Net Interest IncomeDue ToRate
              
              Volume
              
              NetInterest-earning
      Assets:
              
              (Dollars in
      thousands)Net Loans
      Receivable
              
              $          (377)
              
              $            3,508
              
              $            3,131Investment
      Securities
              
              (29)
              
              (100)
              
              (129)Investment in capital stock of
      Federal Reserve Bank and Other Investments
              1
              
              (16)
              
              (15)Fed funds
    sold
              
              (257)
              
              (27)
              
              (284)Total
              
              (662)
              
              3,364
              
              2,702Interest-bearing
      Liabilities:Money Market and Savings
      Deposits
              (379)
              
              367
              
              (12)Interest-bearing
      Checking
              
              1
              
              8
              
              9Time Deposits of $100,000 or
      more
              
              (37)
              
              266
              
              230Other Time
      Deposits
              
              (4)
              
              858
              
              854Fed funds
      purchased
              
              -
              
              1
              
              1Total
              
              (418)
              
              1,500
              
              1,082Net Change in Net Interest
      Income
              
              $          (244)
              
              $            1,864
              
              $            1,620


18






Provision
for Loan Losses




A
provision for loan losses is determined that is considered sufficient to
maintain an allowance to absorb probable losses inherent in the loan portfolio
as of the balance sheet date.  For additional information concerning
this determination, see the section of this discussion and analysis captioned
“Allowance for Loan
Losses.”




In the
three and nine months ended September 30, 2008 and 2007, the provision for loan
losses was $489 thousand and $1.1 million compared to $254 thousand and $572
thousand, respectively.




There
were eight loans for $5.5 million on nonaccrual, one impaired loan for $562
thousand still accruing interest and one restructured loan for $954 thousand for
a total of $7.0 million in loans considered impaired as of September 30, 2008.
During the three months ended September 30, 2008, one commercial loan for $350
thousand previously reported as impaired was charged off and a recovery of $174
thousand on a charged-off construction loan was received. There were no
charge-offs, recoveries or non-performing loans during the same periods in
2007.




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 insufficient history on which to
build assumptions for future loan losses, a national bank peer group average is
also used to estimate adequate levels of loan loss reserves.




Noninterest
Income




Non-interest
income for the three and nine months ended September 30, 2008 was $279 thousand
including $249 thousand from gain on sale of the guaranteed portion of SBA
loans, and $831 thousand including $667 thousand from gain on sale of the
guaranteed portion of SBA loans, respectively. For the same periods in 2007,
non-interest income was $318 thousand including $187 thousand from gain on sale
of the guaranteed portion of SBA loans, and $465 thousand including $320
thousand from gain on sale of the guaranteed portion of SBA loans. Loan
brokerage fees were $0 thousand and $90 thousand for the three and nine months
ended September 30, 2008 compared to $114 thousand for the three and nine month
periods ended September 30, 2007. The decrease in loan broker fees is the result
of the sharp decrease in the number of financial institutions willing to extend
credit on real estate-collateralized projects. During the three and nine months
ended September 30, 2007, we had a loss on the sale of available-for-sale
securities of $0 and $12 thousand, respectively. Fees on deposit accounts make
up the remainder of the noninterest income for all periods, and the increases in
these fees during the 2008 periods were due to the increase in the volume of
deposits. Deposit fees and service charges were $30 thousand, $73 thousand, $17
thousand and $43 thousand for the three and nine month periods of 2008 and 2007,
respectively.





Noninterest
Expense




Total
noninterest expense was $1.7 million and $5.4 million for the three and nine
months ended September 30, 2008, respectively, compared to $1.6 million and $4.9
million for the same periods in 2007. The major components of the expense are
discussed below.  Our infrastructure, personnel and fixed operating
base can support a substantially larger asset base. As a result, we believe we
can cost-effectively grow and control noninterest expenses relative to revenue
growth.




Salaries
and employee benefits totaled $921 thousand for the third quarter, and $3.0
million for the first nine months of 2008 compared to $903 thousand and $2.7
million for the third quarter and first nine months of 2007. Included in this
category for the three and nine months ended September 30, 2008 were $11
thousand and $176 thousand representing a portion of the expense for the
employee stock options granted from May 16, 2005, through September 30, 2008. In
the three and nine months ended September 30, 2007, this expense was $92
thousand and $618 thousand. Excluding the expense associated with stock options,
salaries and employee benefits increased by $100 thousand and $764 thousand,
respectively in the three and nine months ended September 30, 2008 compared with
the same periods in 2007. The increase occurred due to the hiring of additional
personnel to accommodate the growth in the Bank’s customer base, but is also the
result of the implementation of FAS No. 91 in the second quarter of 2007. In the
second quarter of 2007, FAS No. 91 was implemented resulting in recovered salary
costs associated with loan generation of $281 thousand. This expense represented
the costs for loans outstanding at the time of implementation. Employee benefit
costs including employer taxes and group insurance accounted for approximately
17% of the salary and employee benefits expense in the three and nine months
ended September 30, 2008, compared to 18% in the same periods in 2007. The Bank
employed 37 full-time equivalent






19






(FTE)
employees as of September 30, 2008 compared to 38 FTE as of September 30, 2007.
The volume of assets per employee as of the end of the third quarter of 2008 was
$3,730,000 compared to $2,362,000 at the end of September 2007.




Occupancy
and equipment expenses totaled $232 thousand and $720 thousand for the three and
nine months ended September 30, 2008, compared to $229 thousand and $741
thousand for the three and nine months ended September 30,
2007.  Depreciation expense of fixed asset and tenant improvements for
the three and nine months ended September 30, 2008, were $132 thousand and $321
thousand compared to the same periods in 2007 of $89 thousand and $265
thousand.




Professional
fees for the three and nine months ended September 30, 2008, were $108 thousand
and $331 thousand compared to $159 thousand and $394 thousand for the same time
periods in 2007. The decrease in 2008 is primarily due to reduced legal fees
resulting from a fixed-fee contract and a reduction in the use of consultants
related to preparation for compliance with Sarbanes-Oxley.




A summary
of other expenses for the three and nine months ended September 30, 2008 and
2007 is as follows:


Three Months Ended September 30,
      2008
              Three Months Ended September 30,
      2007
              Nine Months Ended September 30,
      2008
              Nine Months Ended September 30,
      2007Data
    Processing
              
              $                 123,238
              
              $                 115,467
              
              $                 405,198
              
              $                 311,394Office
    Expenses
              
              105,258
              
              93,586
              
              351,503
              
              242,275Marketing
              
              82,026
              
              68,290
              
              275,998
              
              196,621Regulatory
      Assessments
              
              43,359
              
              2,694
              
              96,122
              
              27,916Insurance
    Costs
              
              19,586
              
              24,485
              
              74,481
              
              79,586Director-related expenses
      (1)
              
              1,518
              
              5,996
              
              7,449
              
              70,247Other  (2)
              
              39,120
              
              29,582
              
              68,652
              
              100,228$                  414,104
              
              $                  340,100
              
              $                1,279,402
              
              $                1,028,267(1) Consists primarily of costs
      associated with training conferences and director stock option
      expense.(2) Consists primarily of costs
      associated with recruiting expenses and the annual meeting printing and
      mailing costs.






Data
processing expenses increased for the three and nine months ended September 30,
2008 compared to the same periods in 2007 due primarily to costs associated with
new cash management products for deposit customers such as Remote Deposit
Capture and online wire originations. Network administration fees have increased
as the Bank has increased capacity by automating more processes rather than
increasing staff. Beginning in the third quarter of 2008 some of the network
administration duties have been brought in-house, resulting in reduced data
processing costs.




Office
Expenses increased for the three and nine months ended September 30, 2008
compared to the same periods in 2007 due primarily to auto expenses, which have
increased due to the cost of fuel and an increase in the number of business
development staff, armored and courier expenses, which have increased as the
Bank’s customer base has grown, and correspondent bank charges, due to increased
activity in these accounts and reduced earnings credits.




Marketing
expenses have increased for the three and nine months ended September 30, 2008
compared to the same periods in 2007 due primarily to an enhanced quarterly
newsletter with expanded distribution, and an increased number of press
releases.




Regulatory
assessments have increased as we have grown.  Assessments are paid to
the FDIC and the OCC based on quarterly reported numbers.




Director-related
expenses decreased for the three and nine months ended September 30, 2008
compared to the same periods in 2007 due primarily director stock option
expenses. In 2007, the directors were given stock






20






options
in lieu of cash compensation which were immediately vested. Director stock
option expense for the first nine months of 2007 was $60 thousand, compared with
$7 thousand for the same period in 2008. No options in lieu of cash compensation
have been granted to the directors in 2008.




Income
Taxes




Two
thousand in state taxes were paid during the second quarter of 2008 and 2007. No
federal tax expense or federal or state tax benefit has been recorded for the
quarters ended September 30, 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.




On
October 8, 2008, Governor Schwarzenegger signed into law tax legislation with
immediate and retroactive negative tax effects. For taxpayers with net business
income of $500,000 or more, the new provisions suspend carryovers of net
operating losses (NOLs) to 2008 and 2009, and suspend the use of business
credits in those years in excess of 50% of a taxpayer's net tax. Any credits not
allowed may be carried over for a period that will be extended by the period of
suspension. NOLs for taxable years after 2007 will have a carryover period of 20
years (rather than the 10 years previously in effect) and the NOL carryovers
suspended in 2008 and 2009 will have 10 years added to their carryover
periods.




Financial
Condition as of September 30, 2008




Total
assets as of September 30, 2008 were $138.1 million, consisting primarily of
cash of $7.4 million and net loans of $128.6 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 million and net loans of $96.1 million  Total
deposits as of September 30, 2008 were $124.3 million compared with $99.0
million as of December 31, 2007, and shareholder’s equity as of September 30,
2008 was $12.2 million compared with $12.8 million as of December 31,
2007.




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




At
September 30, 2008, we had no federal funds (“fed funds”) sold. Federal funds
sold allow us to meet 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. The decrease in fed funds was due to the
increase in net loans and the decrease in brokered deposits.




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 our 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.




At
September 30, 2008 and December 31, 2007, our securities consisted solely of
Federal Reserve Bank Stock, having a book and estimated fair value of $354
thousand and $405 thousand, respectively, and a weighted average yield of 5.99%.
At September 30, 2008, this stock was not pledged as collateral for any
purpose.




Loan
Portfolio




Our
primary source of income is interest on loans. The following table presents the
composition of the loan portfolio by category as of the dates
indicated:






21









September 30,
      2008
              
              December 31,
      2007Real estate
              
              (Dollars in
      thousands)1-4 residential
      (1)
              
              $
              5,512
              
              
              
              4.2
              %
              
              $
              2,655
              
              
              
              2.7
              %Multi-Family
              
              
              2,117
              
              
              
              1.6
              %
              
              
              720
              
              
              
              0.7
              %Non-farm,
      non-residential
              
              
              51,168
              
              
              
              39.4
              %
              
              
              40,951
              
              
              
              41.9
              %Construction & Land
      Development
              
              
              37,344
              
              
              
              28.7
              %
              
              
              31,164
              
              
              
              31.9
              %Commercial
              
              
              33,653
              
              
              
              25.9
              %
              
              
              21,827
              
              
              
              22.4
              %Consumer
              
              
              167
              
              
              
              0.1
              %
              
              
              327
              
              
              
              0.3
              %129,961
              
              
              
              100
              %
              
              
              97,644
              
              
              
              100
              %Net deferred loan costs, premiums
      and discounts
              
              
              384
              
              
              
              
              
              
              
              230Allowance for loan
      losses
              
              
              ( 1,728
              )
              
              
              
              
              
              
              ( 1,815
              )$
              128,617
              
              
              
              
              
              
              $
              96,059(1) Comprised of second mortgage
      home loans under home equity lines of credit.




Net loans
as a percentage of total assets were 93.2% as of September 30, 2008, and 85.4%
as of December 31, 2007.




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; second mortgage loans under revolving lines of credit
granted to consumers, secured by equity in residential properties. Construction
loans consist primarily of high-end, single-family residential properties,
primarily located in the coastal communities, and commercial properties for
owner-occupied, have a term of less than one year and have floating rates and
commitment fees.  Construction loans are typically made to builders
that have an established record of successful project completion and loan
repayment. At September 30, 2008, we held $53.3 million in commercial and
multi-family real estate loans outstanding, representing 41.0% of gross loans
receivable, and undisbursed commitments of $900 thousand. Of this total, $6.8
million were SBA loans with $389 thousand in undisbursed commitments. The
remaining real estate portfolio was comprised of $37.3 million in construction
loans representing 28.7% of gross loans receivable with undisbursed commitments
of $10.4 million, and $5.5 million in second mortgage loans under 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 September
30, 2008, we held $33.7 million in commercial loans outstanding, representing
25.9% of gross loans receivable, and undisbursed commitments of $23.1 million.
Of this total, $7.9 million were SBA loans with $816 thousand in 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 September 30, 2008, consumer loans totaled $167 thousand,
representing 0.1% of gross loans receivable and undisbursed commitments of $124
thousand.  Of this total, $89 thousand were SBA loans with no
undisbursed commitments.




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 September 30, 2008, real
estate loans, including construction loans, comprised 73.9% of the total loan
portfolio. A high
percentage of these loans are for commercial purposes with owner occupied real
estate taken as collateral.  In addition, all the SBA loans 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.






22





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.  The following table shows the maturity distribution of
loans as of September 30, 2008:


As of September 30,
      2008(Dollars in
      thousands)One Year
              
              Over 1 Yearor Less
              
              through 5
    Years
              
              Over 5
      Years
              
              TotalFixed Rate
              
              Floating or
                Adjustable
    Rate
              Fixed Rate
              
              Floating or
                Adjustable
    RateReal estate —
      secured
              1,597
              
              5,570
              
              2,795
              
              6,280
              
              42,555
              
              58,797Real estate —
      construction
              32,052
              
              -
              
              5,292
              
              -
              
              -
              
              37,344Commercial
              14,051
              
              5,867
              
              2,364
              
              3,932
              
              7,439
              
              33,653Consumer
              10
              
              42
              
              -
              
              -
              
              115
              
              167Total
              $      47,710
              
              $       11,479
              
              $           10,452
              
              $    10,212
              
              $             7,554
              
              $    129,961




Nonperforming
Loans and Other 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: impaired loans, 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.
At September 30, 2008 and December 31, 2007, the Bank had $7.0 million and $2.5
million in non-performing loans, respectively, and no other non-performing
assets.




Other
loans of concern consist of loans where information about possible credit
problems of the borrower is known, causing management to have serious doubts as
to the ability of the borrower to comply with the present loan payment terms and
which may result in the inclusion of such loan in one of the nonperforming asset
categories. In addition, an internally classified loan list is maintained
pursuant to federal regulations that helps management assess the overall quality
of the loan portfolio and the adequacy of the allowance for loan
losses.  Loans classified as “substandard” are those loans with clear
and defined weaknesses, such as highly leveraged positions, unfavorable
financial ratios, uncertain repayment resources or poor financial condition,
which may jeopardize recoverability of the loan.  Loans classified as
“doubtful” are those loans that have characteristics similar to substandard
loans, but also have an increased risk that loss may occur or at least a portion
of the loan may require a charge-off if liquidated at
present.  Although loans classified as substandard do not duplicate
loans classified as doubtful, both substandard and doubtful loans may include
some loans that are past due at least 90 days, are on nonaccrual status or have
been restructured.  Loans classified as “loss” are those loans that
are in the process of being charged-off.




Of the
$7.0 million in non-performing loans at September 30, 2008, eight loans for a
total of $6.5 million were classified as “substandard” and two loans for a total
of $438 thousand were classified as “doubtful”. This compares to two substandard
loans for a total of $2.5 million at December 31, 2007.  Other loans
of concern, not included in non-performing loans, consisted of one construction
loan for a total of $1.0 million at September 30, 2008 compared to three loans
for a total of $619 thousand at December 31, 2007.  Two loans, for a
total of $1.5 million including one restructured loan for $954 thousand,
continue to accrue interest. The remaining loans are on
non-accrual.




The table
below provides information with respect to the Bank’s non-performing loans as of
the dates indicated:


September
      30, 2008
              
              
              December
      31, 2007(Dollars
      in thousands)Impaired
      loans with a valuation allowance
              
              
              (1
              )
              
              $
              3,054
              
              
              $
              2,467Impaired
      loans without a valuation allowance
              
              
              
              
              
              
              3,921
              
              
              
              -Total
      impaired loans
              
              
              
              
              
              $
              6,975
              
              
              $
              2,467Valuation
      allowance related to impaired loans
              
              
              
              
              
              $
              648
              
              
              $
              590Net
      recorded investment in impaired loans
              
              
              
              
              
              $
              6,327
              
              
              $
              1,877Average
      balance during the year on impaired loans
              
              
              
              
              
              $
              7,323
              
              
              $
              2,456Cash
      collections applied to reduce principal balances
              
              
              
              
              
              $
              272
              
              
              $
              -Interest
      income recognized on cash collections
              
              
              
              
              
              $
              286
              
              
              $
              126Nonaccrual
      LoansReal
      estate
              
              
              
              
              
              $
              -
              
              
              $
              -Construction
      & Land Development
              
              
              
              
              
              
              3,359
              
              
              
              2,467Commercial
              
              
              
              
              
              
              2,011
              
              
              
              -Consumer
              
              
              
              
              
              
              89
              
              
              
              -Accruing
      loans past due 90 days or more
              
              
              
              
              
              
              -
              
              
              
              -Troubled
      debt restructuring
              
              
              
              
              
              
              954
              
              
              
              -Total
      Nonaccrual and restructured debt
              
              
              (2
              )
              
              $
              6,413
              
              
              $
              2,467Nonperforming
      (impaired) loans as a percent of total gross loans
              
              
              
              5.37
              %
              
              
              2.53
              %Allowance
      for loan losses to nonperforming (impaired) loans
              
              
              
              25
              %
              
              
              74
              %Allowance
      for loan losses to classified loans net of related allowance for impaired
      loans
              
              
              
              17
              %
              
              
              65
              %(1)
      As of September 30, 2008, $350 thousand in impaired loans held SBA
      guarantees for approximately $175 thousand.(2)All
      of this amount is reflected in the total impaired loans shown
      above.








Management’s
classification of a loan as nonaccrual or restructured is an indication that
there is reasonable doubt as to the full collectability of principal and/or
interest on the loan. At this point, we stop recognizing interest income on the
loan and reverse any uncollected interest that had been accrued but unpaid.
Additional payments made by the borrower are applied to the principal balance.
If the loan deteriorates further due to a borrower’s bankruptcy or similar
financial problems, unsuccessful collection efforts or a loss classification,
the remaining balance of the loan is then charged off. These loans may or may
not be collateralized, but collection efforts are continuously
pursued.




The loans
that have been classified as non-performing since December 31, 2007, are
primarily construction loans. These loans have been classified based on current
appraisals which reflect the general deterioration in the real estate market,
especially in the Inland Empire region of Southern California. $350 thousand of
the classified commercial loans and all of the classified consumer loans are
part of the Bank's SBA loan portfolio.  The Bank is working with the
borrowers and the SBA to liquidate assets as partial repayment on these
loans.  The remaining $1.7 million in classified commercial loans are
collateralized with furniture, fixtures, and equipment at multiple
locations.  The Bank is in the initial phases of negotiating with the
borrower and the final disposition of these loans is not known at this
time..




Of the
two loans that were classified as impaired at December 31, 2007, one loan for
$967 was renegotiated with the borrower, paid down to $954 thousand and is shown
above as restructured debt at September 30, 2008. 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 the third quarter we
received a payoff of $1 million and recoveries of $174 thousand on this
loan.




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. Impaired loans are measured for
impairment based on the






23






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 is collateralized, less costs to
sell.




If a loan
is real-estate collateral-dependent and considered impaired, the outstanding
principal is reduced through a charge off to the estimated fair value, which may
be the property’s 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 continued deterioration in
collateral value. Therefore, the related allowance for loan losses on impaired
loans represents only the allowance for non-real estate collateral dependent
loans. As of September 30, 2008, six impaired loans for $3.1 million were not
considered real-estate collateral-dependent and had allowances for losses
totaling $648 thousand.









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 ofSeptember
30, 2008was adequate to
absorb the known and inherent risks of loss in the loanportfolio 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 availableto 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.  The adequacy of the allowance is determined
using two different methods to determine a range. The first method 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 the reserves for loans
classified as substandard, substandard non-accrual, and doubtful, as established
by management. The second method involves classifying the portfolio by risk
weighting and applying a loss factor for each rating, again using the FRB
historic database to determine appropriate factors as the Bank has limited loss
history. Again, the related reserves for the loans classified as substandard,
substandard non-accrual, and doubtful, are added to the general allowance to
arrive at a total allowance. In addition, qualitative, or “Q”, factors are used
to increase historical losses. These Q factors include changes in lending
policies and procedures, in national and local economic conditions, in the
mature 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.





We made
provisions for loan losses of $1.1 million for the nine months ended September
30, 2008, as compared to provisions of $572 thousand for the comparable period
of 2007. The increase was attributable to a $2.8 million increase in
non-performing assets, a 34% increase in net loans from December 31, 2007, and
the continuing real estate slump in Southern California. The housing slump in
Southern California and the nation and its uncertain future have unfavorably
impacted our homebuilding borrowers and the value of their collateral. At
September 30, 2008, we had outstanding construction loans to developers for
tract projects and single homes for sale to unidentified buyers totaling
$15.4 million, representing 12% of our loan portfolio, and additional
commitments for these projects in the amount of $1.2 million. We began
curtailing the origination of construction loans in early 2008, and these types
of loans now represent a smaller portion of our loan portfolio (29% at September
30, 2008 from 32% at December 31, 2007). We do not intend to originate any
material amount of new construction loans under present market conditions, and
we expect that construction loans will decrease through 2008, both in total
amount and as a percentage of our loan portfolio. While we have increased our
loan loss provisions, a prolonged or deeper decline in the housing market will
negatively impact our homebuilder borrowers. We will continue to monitor this
closely to determine whether further loan loss provisions are required. We do
expect credit losses in our residential construction loan portfolio to remain at
elevated levels well into the remainder of 2008.






24







The
credit quality of our loans will be influenced by underlying trends in the
economic cycle, particularly in Southern California, and other factors which are
beyond management’s control. Accordingly, no assurance can be given that we will
not sustain loan losses that in any particular period will be sizable in
relation to the Allowance. Although we believe that we employ an appropriate
approach to downgrading credits that are experiencing slower than projected
sales and/or increases in loan to value ratios, subsequent evaluation of the
loan portfolio by us and by our regulators, in light of factors then prevailing,
may require increases in the Allowance through changes to the provision for loan
losses.





Our
allowance was $1.7 million, or 1.33% of outstanding principal as of September
30, 2008.




In
addition, a separate allowance for credit losses on off-balance sheet credit
exposures is maintained for the undisbursed portion of certain types of approved
loans. Although our loss exposure is reduced because the funds have not been
released to the borrower, under certain circumstances we may be required to
continue to disburse funds on a troubled credit. As of September 30, 2008, this
allowance was $74 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. Our
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.  During the nine months ended September 30, 2008, charge-offs
totaling $1.5 million were taken, with $350 thousand related to a commercial
loan and the remainder related to construction loans. During the same period,
recoveries of $268 thousand were received from the construction loans previously
charged off.




Nonearning
Assets




Premises,
leasehold improvements and equipment totaled $628 thousand at September 30,
2008, net of accumulated depreciation of $1.3 million compared to $888 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 $62 thousand.




Deposits




Deposits
are our primary source of funds.  Demand, or non-interest bearing
checking, accounts as a percentage of total deposits were 20.0% at September 30,
2008, compared to 17.8% at December 31, 2007.




The
following table sets forth the amount and maturities of the time deposits as of
September 30, 2008:






25




At September 30,
      2008Time Deposits of $100,00 or
      more
              Other Time
      Deposits
              Total Time
      Deposits(Dollars in
      thousands)Three months or
      less
              $                      1,269
              
              13,213
              
              $                14,482Over three months through six
      months
              6,876
              
              1,154
              
              8,030Over six months through 12
      months
              5,836
              
              2,878
              
              8,714Over 12
    months
              6,208
              
              122
              
              6,330Total
              $                    20,189
              
              $          17,367
              
              $                37,556






We had
$19.7 million of brokered certificates of deposit at September 30, 2008. $14.8
million are shown above in the Time Deposits of $100,000 or More category while
$4.9 million represent individual deposits of less than $100 thousand and are
shown in the Other Time Deposit category. The records identifying the individual
depositors are maintained either by us or the broker. Of this total, $97
thousand consisted of public funds, none of which required collateralization.
Also in this total is $2.2 million in “reciprocal” deposits whereby customers of
Pacific Coast National Bank, utilizing the CDAR program, have placed deposits in
other financial institutions to maximize their FDIC insurance and reciprocal
deposits have been placed in Pacific Coast National Bank. In the table above
$14.8 million in brokered funds are shown as part of Time Deposits of $100,000
or More with maturities of $4.4 million in Over three months through six months,
$4.2 million in Over six month through 12 months, and $6.2 million in Over 12
months. In the table above $4.9 million in brokered funds are shown as part of
Other Time Deposits with maturities of $4.7 million in Three months or less and
$200 thousand in Over 12 months. At December 31, 2007, we had $28.2 million in
brokered deposits. We intend to limit non-local and brokered deposits to 35% or
less of total deposits.




Return
on Equity and Assets




The
following table sets forth certain information regarding our return on equity
and assets for the nine months ended September 30, 2008:






At September 30,
      2008Return on
      assets
              -1.68%Return on
      equity
              -18.52%Dividend payout
      ratio
              0%Equity to assets
      ratio
              8.8%


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 September 30, 2008, commitments to extend
credit included approximately $265 thousand for letters of credit, $26.5 million
for revolving lines of credit arrangements including $4.8 million in real-estate
secured lines, and $10.8 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; however, we
currently expect no significant credit losses from these commitments and
arrangements.




Borrowings




The Bank
has access to a variety of borrowing sources including $8 million in federal
funds lines through two correspondent banks. The Bank also has the option of
applying for a line of credit from the Federal Home Loan Bank of San Francisco.
As of September 30, 2008, the Bank had $1.0 million in outstanding fed funds
purchased. As of December 31, 2007, there were no borrowings
outstanding.




Capital
Resources and Capital Adequacy Requirements




Private Placement.As noted
above, under “Executive Overview—Introduction,” the Company recently completed a
private placement of common stock and warrants in which it received aggregate
gross proceeds of $1,250,000, $1,000,000 of which was received in September 2008
with the remainder received in November 2008. Together with existing funds at
the holding company level, this enabled the Company to downstream $1.1 million
to the Bank on September 30, 2008.






26






TARP Capital Purchase Program.In response to the crises affecting the banking industry and financial
markets, in October 2008, the Emergency Economic Stabilization Act of 2008
(the “EESA”) was signed into law. Pursuant to the EESA, the U. S. Department of
Treasury (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. The
Treasury announced that, pursuant to this authorization, it will be purchasing
equity stakes in U.S. financial institutions. Under this program, known as the
Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital
Purchase Program”), from the $700 billion authorized by the EESA, the
Treasury will make $250 billion of capital available to U.S. financial
institutions in the form of preferred stock issued by these institutions, in an
amount equal to not less than 1% of the institution’s risk-weighted assets and
not more than the lesser of 3% of the institution’s risk-weighted assets and $25
billion.  In conjunction with the purchase of an institution’s
preferred stock, the Treasury will receive warrants to purchase the
institution’s common stock with an aggregate market value equal to 15% of the
total amount of the preferred investment. Participating financial institutions
will be required to adopt the Treasury’s standards for executive compensation
for the period during which the Treasury holds securities issued under the TARP
Capital Purchase Program and be restricted from increasing dividends to common
shareholders or repurchasing common stock for three years without the consent of
the Treasury.  We have applied to the TARP Capital Purchase Program
for the maximum investment by Treasury, which would enable us to receive up to
approximately $4.1 million in additional capital.





The
foregoing description of the TARP Capital Purchase Program is based on the
information currently available regarding the terms of the TARP Capital Purchase
Program. Treasury has indicated that there may be separate terms applicable to
companies, such as us, whose stock is not listed on a national securities
exchange, but has not yet made those terms available. Accordingly, some of the
terms applicable to us, if we are approved by Treasury to participate in the
TARP Capital Purchase Program, could differ from those described
above.







Regulatory Capital.Risk-based capital guidelines are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks, to
account for off-balance sheet exposure, and to minimize disincentives for
holding liquid assets.  Under the regulations, assets and off-balance
sheet items are assigned to broad risk categories, each with appropriate
weights.  The resulting capital ratios represent capital as a
percentage of total risk weighted assets and off-balance sheet
items.  Under the prompt corrective action regulations, to be
adequately capitalized a bank must maintain minimum ratios of total capital to
risk-weighted assets of 8.00%, Tier 1 capital to risk-weighted assets of 4.00%,
and Tier 1 capital to total assets of 4.00%.  Failure to meet these
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company’s business, financial condition and results of
operations.




As of
September 30, 2008, the Bank was categorized as well-capitalized.  A
well-capitalized institution must maintain a minimum ratio of total capital to
risk-weighted assets of at least 10.00%, a minimum ratio of Tier 1 capital to
risk weighted assets of at least 6.00%, and a minimum ratio of Tier 1 capital to
total assets of at least 5.00% and must not be subject to any written order,
agreement, or directive requiring it to meet or maintain a specific capital
level.




The
following table sets forth the Bank’s capital ratios as of the dates
specified:






27







To Be
  WellCapitalized
      UnderFor Capital
              
              Prompt
      CorrectiveActual
              
              
              
              Adequacy
      Purposes
              Action
      ProvisionsAmount
              
              
              
              Amount
              
              
              
              Amount(Thousands)
              Ratio
              
              (Thousands)
              Ratio
              (Thousands)
              RatioAs of September 30,
      2008:Total Capital
      (to Risk-Weighted Assets)
              $        13,885
              
              10.11%
              
              $        10,987
              
              8.0%
              
              $        13,734
              
              10.0%Tier 1 Capital
      (to Risk-Weighted Assets)
              $        12,167
              
              8.86%
              
              $          5,493
              
              4.0%
              
              $          8,240
              
              6.0%Tier 1 Capital
      (to Average Assets)
              $        12,167
              
              8.88%
              
              $          5,483
              
              4.0%
              
              $          6,854
              
              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
              
              10.31%
              
              $          4,735
              
              4.0%
              
              $          7,102
              
              6.0%Tier 1 Capital
      (to Average Assets)
              $        12,193
              
              12.19%
              
              $          4,002
              
              4.0%
              
              $          5,002
              
              5.0%








It is
possible that the Bank’s capital ratios could drop to “adequately capitalized”
from “well capitalized” if the strong growth in earning assets continues without
the raising of sufficient additional capital.





The
following table sets forth the Company’s capital ratios as of the dates
specified:


For
  CapitalActual
              
              Adequacy
      PurposesAmount
              
              
              
              Amount(Thousands)
              Ratio
              
              (Thousands)
              RatioAs of September 30,
      2008:Total Capital
      (to Risk-Weighted Assets)
              $        13,891
              
              10.11%
              
              $        10,987
              
              8.0%Tier 1 Capital
      (to Risk-Weighted Assets)
              $        12,173
              
              8.86%
              
              $          5,493
              
              4.0%Tier 1 Capital
      (to Average Assets)
              $        12,173
              
              8.88%
              
              $          5,483
              
              4.0%As 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%








Liquidity
Management




At
September 30, 2008, the Company (excluding the Bank) had approximately $6
thousand in cash. An additional $250 thousand was received in November 2008 in
connection with our recently completed private placement of common stock and
warrants.  See “—Capital Resources and Capital Adequacy Requirements.”
These funds can be used for Company operations, investment and for later
infusion into the Bank and other corporate activities.  The primary
source of liquidity for the Company will be dividends paid by the
Bank.  The Bank is currently restricted from paying dividends without
regulatory approval that will not be granted until the accumulated deficit has
been eliminated. Existing restrictions also require the Bank to maintain its
“well-capitalized” status under regulatory capital guidelines in order to pay
dividends to the Company.




The Bank
had cash and cash equivalents of $7.4 million, or 5.4% of total Bank assets, at
September 30, 2008. This is below the guidelines that the Bank has in place, and
steps are being taken to increase liquidity. These steps include increasing the
amount of brokered funds on deposit with the Bank and selling the guaranteed
portion of SBA 504 loans. The Bank’s liquidity is monitored by its staff, the
Investment/Asset-Liability Committee and the Board of Directors, who review
historical funding requirements, current liquidity position, sources and
stability of funding, marketability of assets, options for attracting additional
funds, and anticipated future funding needs, including the level of unfunded
commitments.




The
Bank’s primary sources of funds are currently retail and commercial deposits,
loan repayments, other short-term borrowings, and other funds provided by
operations.  While scheduled loan repayments and maturing investments
are relatively predictable, deposit flows and early loan prepayments are more
influenced by interest rates, general economic conditions, and
competition.  The Bank maintains investments in liquid assets based
upon






28






management’s
assessment of (1) the need for funds, (2) expected deposit flows, (3) yields
available on short-term liquid assets, and (4) objectives of the asset/liability
management program.




The Bank
also has access to borrowing lines from two correspondent banks for a total of
$8 million. These are usually restricted to short time periods (30 days or
less). The Bank also has the option of applying for a line of credit with the
Federal Home Loan Bank of San Francisco (FHLB). As of September 30, 2008, the
Bank purchased $1.0 million in overnight fed funds through on of its borrowing
lines.




The Bank
currently utilizes brokered funds to support loan demand. Traditionally these
funds come at a higher cost than local, “core”, deposits. These funds are rate
sensitive and therefore easy to attract or discourage depending on the needs of
the Bank. The pricing and availability of brokered funds are contingent upon the
Bank remaining well-capitalized.




The Bank
often sells the guaranteed portion of SBA loans at a premium. The Bank could
also sell the unguaranteed portion of these loans, which amounted to $14 million
at September 30, 2008, and sell other loans as well, if management deemed this
necessary for liquidity needs. In extreme circumstances, the Bank could postpone
the funding of loans until deposits could be raised to provide the necessary
liquidity.




As loan
demand increases, greater pressure is being exerted on the Bank’s
liquidity.  However, it is management’s intention to maintain a loan
to deposit ratio in the range of 90% - 105%. Given this goal, the Bank will not
aggressively pursue lending opportunities if sufficient funding sources (i.e., deposits, Fed Funds,
other borrowing lines) are not available.  We intend to limit
non-local and brokered deposits to 35% or less of total deposits. As of
September 30, 2008, the loan to deposit ratio was 103% and brokered deposits
represented 16% of total deposits.




Item
3.  Quantitative and Qualitative Disclosure About Market
Risk




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





Interest
rate risk is the most significant market risk affecting the
Bank.  Other types of market risk, such as foreign currency risk and
commodity price risk, do not arise in the normal course of the Bank’s business
activities.  Interest rate risk can be defined as the exposure to a
movement in interest rates that could have an adverse effect on the net interest
income or the market value of the Bank’s financial instruments.  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 September 30, 2008, an analysis was performed
using the Risk Monitor model provided by Fidelity Regulatory Solutions and
utilizing the Bank’s September 30, 2008 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






29






in equity
capital represent the changes in the present value of the balance sheet without
regards to business continuity, otherwise known as “liquidation
value”.




Interest Rate
      ShockShock
              -2%
              
              -1%
              
              Annualized
              
              +1%
              
              +2%Fed Funds
    Rate
              -0.50%
              
              0.50%
              
              1.50%
              
              2.50%
              
              3.50%Net Interest Income
      Change
              (328)
              
              (152)
              
              -
              
              4
              
              6% Change
              -5.2%
              
              -2.4%
              
              -
              
              0.1%
              
              0.1%Equity Capital Change
      %
              -5.0%
              
              -1.8%
              
              -
              
              1.3%
              
              3.1%Net Interest
      Margin
              4.57%
              
              4.71%
              
              4.83%
              
              4.83%
              
              4.83%







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 assetor 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  periodand 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 netinterest 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 the following
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
September 30, 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.


As
      of September 30, 2008Volumes
      Subject to Repricing Within0-1
      Day
              
              
              2-90
      Days
              
              
              91-365
      Days
              
              
              1-3
      Years
              
              
              Over
      3
                Years
              
              
              Non-
                Interest
      Sensitive
              
              
              Total(Dollars
      in thousands)Cash,
      fed funds and other
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              7,383
              
              
              $
              7,383Investments
      and FRB Stock
              
              
              -
              
              
              
              
              
              
              
              -
              
              
              
              -
              
              
              
              354
              
              
              
              -
              
              
              
              354Loans  (1)
              
              
              -
              
              
              
              53,504
              
              
              
              12,616
              
              
              
              9,231
              
              
              
              50,813
              
              
              
              5,459
              
              
              
              131,623Fixed
      and other assets
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              374
              
              
              
              374Total
      Assets
              
              $
              -
              
              
              $
              53,504
              
              
              $
              12,616
              
              
              $
              9,231
              
              
              $
              51,167
              
              
              $
              13,216
              
              
              $
              139,734Interest-bearing
      checking, savings and
                money
      market accounts
              
              $
              62,286
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              24,470
              
              
              $
              86,757Certificates
      of deposit
              
              
              -
              
              
              
              14,482
              
              
              
              16,744
              
              
              
              6,330
              
              
              
              -
              
              
              
              -
              
              
              
              37,556Fed
      funds purchased
              
              
              1,040
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,040Other
      liabilities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              547
              
              
              
              547Stockholders’
      equity
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              12,173
              
              
              
              12,173Total
      liabilities and stockholders’ equity
              
              $
              63,326
              
              
              $
              14,482
              
              
              $
              16,744
              
              
              $
              6,330
              
              
              $
              -
              
              
              $
              37,190
              
              
              $
              138,073Interest
      rate sensitivity gap
              
              $
              (63,326
              )
              
              $
              39,022
              
              
              $
              (4,128
              )
              
              $
              2,901
              
              
              $
              51,167Cumulative  interest
      rate sensitivity gap
              
              $
              (63,326
              )
              
              $
              (24,304
              )
              
              $
              (28,432
              )
              
              $
              (25,531
              )
              
              $
              25,636Cumulative
      gap to total assets
              
              
              -45.3
              %
              
              
              -17.4
              %
              
              
              -20.3
              %
              
              
              -18.3
              %
              
              
              18.3
              %Cumulative
      interest-earning assets to
                cumulative
      interest-bearing liabilities
              
              
              0.0
              %
              
              
              68.8
              %
              
              
              69.9
              %
              
              
              74.7
              %
              
              
              125.4
              %(1)
      Excludes deferred fees and allowance for loan
    losses.






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




Item
4T.  Controls and Procedures




As of
September  30, 2008, the Company’s management, with the participation
of the Company’s chief executive officer and chief financial officer, evaluated
the effectiveness of the Company’s disclosure controls and procedures as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended. Based on this evaluation, the Company’s chief executive officer and
chief financial officer concluded that as of September 30, 2008, the Company’s
disclosure controls and procedures were effective to ensure that the information
required to be disclosed by the Company in reports that it files or submits
under the Exchange Act is accumulated and communicated to the Company’s
management (including the chief executive officer and chief financial officer)
to allow timely decisions regarding required disclosure, and is recorded,
processed, summarized and reported with in the time periods specified in the
Securities and Exchange Commission’s rules and forms.




During
the quarter ended September 30, 2008, no change occurred in the Company’s
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, the Company’s internal control over
financial reporting.




30





PART II - OTHER
INFORMATION






ITEM
1.  Legal
Proceedings




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




ITEM
1A.  Risk Factors




Our business is subject to general
economic risks that could adversely impact our results of operations and
financial condition.





·
            Changes
      in economic conditions, particularly a further economic slowdown in
      Southern California, could hurt our
business.




Our
business is directly affected by market conditions, trends in industry and
finance, legislative and regulatory changes, and changes in governmental
monetary and fiscal policies and inflation, all of which are beyond our
control.  In 2007, the housing and real estate sectors experienced an
economic slowdown that has continued into 2008.  Further deterioration
in economic conditions, in particular within the Southern California real estate
markets, could result in the following consequences, among others, any of which
could hurt our business materially:




·
            loan
      delinquencies may increase;


·
            problem
      assets and foreclosures may
increase;


·
            demand
      for our products and services may decline;
and


·
            collateral
      for loans made by us, especially real estate, may decline in value, in
      turn reducing a customer’s borrowing power and reducing the value of
      assets and collateral securing our
loans.





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 operations and profitability 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 profitability.  We do not have the ability of a larger
institution to spread the risks of unfavorable local economic conditions across
a large number of diversified economies.  Any sustained period of
increased payment delinquencies, foreclosures or losses caused by adverse market
or economic conditions in Southern California could adversely affect the value
of our assets, revenues, profitability and financial condition.




·
            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.  We anticipate that further
declines in the Southern California real estate markets will hurt our
business.  As of September 30, 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.  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.




·
            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.






31








Negative developments in the financial
industry and credit markets may continue to adversely impact our financial
condition and results of operations.





Negative
developments beginning in the latter half of 2007 in the sub-prime mortgage
market and the securitization markets for such loans, together with other
factors, have resulted in uncertainty in the financial markets in general and a
related general economic downturn, which have continued in 2008.  Many
lending institutions, including us, have experienced declines in the performance
of their loans, including construction and land loans, multifamily loans,
commercial loans and consumer loans.  Moreover, competition among
depository institutions for deposits and quality loans has increased
significantly. In addition, the values of real estate collateral supporting many
construction and land, commercial and multifamily and other commercial loans and
home mortgages have declined and may continue to decline. Bank and bank holding
company stock prices have been negatively affected, as has the ability of banks
and bank holding companies to raise capital or borrow in the debt markets
compared to recent years. These conditions may have a material adverse effect on
our financial condition and results of operations.  In addition, as a
result of the foregoing factors, there is a potential for new federal or state
laws and regulations regarding lending and funding practices and liquidity
standards, and bank regulatory agencies are expected to be very aggressive in
responding to concerns and trends identified in examinations, including the
expected issuance of formal enforcement orders.  Negative developments
in the financial industry and the impact of new legislation in response to those
developments could restrict our business operations, including our ability to
originate or sell loans, and adversely impact our results of operations and
financial condition.




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 U.S. Treasury Department (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
(“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
(“CPP”).  Under the CPP, Treasury will purchase equity securities from
participating institutions.





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 and is
not covered by deposit insurance premiums paid by the banking
industry.  In addition, the Federal Deposit Insurance Corporation has
implemented two temporary programs to provide deposit insurance for the full
amount of most non-interest bearing transaction accounts through the end of 2009
and to guarantee certain unsecured debt of financial institutions and their
holding companies through June 2012.  Financial institutions have
until December 5, 2008 to opt out of these two programs.  The purpose
of these legislative and regulatory actions is to stabilize the U.S. banking
system.





The EESA
and the other regulatory initiatives described above may not have their desired
effects.  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
impacted.




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 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, if needed or desired, and on our business, financial condition
and results of operations.







Other than as set forth above, there
have been no material changes to the risk factors set forth in Part I, Item 1 of
the Company’s Annual Report on Form 10-KSB for the year ended December 31,
2007.




ITEM
2.  Unregistered
Sales of Equity Securities and Use of Proceeds




The
information required by Item 701 of Regulation S-K has previously been reported
by the Company on Form 8-K. .






32








ITEM
3.  Defaults
Upon Senior Securities




None.




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




OnSeptember 9, 2008, the Company held its annual meeting of
stockholders.  Set forth below are the results of the election of
directors and the ratification of the appointment of McGladrey & Pullen, LLP as the
Company’s independent accountants for the year
ending December 31, 2008.




Election of Directors:
  Name
              Votes For
              Votes
  WithheldThomas J.
      Applegate
              1,511,861
              85,495Michael
    Cummings
              1,470,961
              126,395Fred A.
deBoom
              1,510,861
              86,495Colin Forkner
              1,502,561
              94,795Michael Hahn
              1,502,436
              94,795David Johnson
              1,511,861
              85,495Dennis C.
      Lindeman
              1,511,336
              86,020James
Morrison
              1,510,861
              86,495Denis Hugh
    Morgan
              1,510,861
              86,495Charles
      Owens
              1,510,861
              86,495John Vuona
              1,510,861
              86,495
  Ratification of Appointment of
Auditors
  Votes For
              Votes Against
              Abstentions1,527,561
              6,575
              63,220


ITEM
5.  Other
Information




None.




ITEM
6.  Exhibits




(a)
            Exhibits














Exhibit
      Number
            Description
      of Exhibit3.1
            Articles
      of Incorporation of the Company (filed as Exhibit 3.1 to the Company’s
      Registration Statement on Form SB-2 filed on September 8, 2004 (File No.
      333-11859) and incorporated herein by reference3.2
            Bylaws
      of the Company (filed as Exhibit 3.2 to the Company’s Registration
      Statement on Form SB-2 filed on September 8, 2004 (File No. 333-118859)
      and incorporated herein by reference31.1
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200231.2
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200232.1
            Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.







33








SIGNATURES




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




PACIFIC
      COAST NATIONAL BANCORPDate:
      November 14, 2008
              By:
              /s/  Michael S.
    HahnMichael
      S. HahnPresident
      & Chief Executive OfficerDate:  November
      14, 2008
              By:
              /s/  Terry
  StalkTerry
      StalkChief
      Financial
Officer