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                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

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

        For the fiscal year ended December 31, 2006

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

        For the  transition  period from  __________ to __________

                        Commission file number: 000-49892

                              PACIFIC STATE BANCORP
             ------------------------------------------------------
             (Exact name of Registrant as specified in its charter)

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

            1899 W. March Lane
               Stockton, CA                               95207
  (Address of principal executive offices)              (Zip Code)

       Registrant's telephone number, including area code: (209) 870-3213

           Securities registered pursuant to Section 12(b) of the Act:

Title of each class:              Name of each exchange on which registered:
Common Stock, no par value                The NASDAQ Stock Market, LLC

           Securities registered pursuant to Section 12(g) of the Act:
                           Common Stock, no par value

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

Indicate  by  check  mark if the  Registrant  is not  required  to file  reports
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes [ ]    No [X]

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

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

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated  filer, or a non-accelerated  filer (as defined in rule 12b-2 of the
Exchange Act).

Large accelerated filer  [ ]  Accelerated filer  [ ]  Non-accelerated filer [X]

Indicate by check mark whether the  registrant is a shell company (as defined in
rule 12b-2 of the Exchange Act).
Yes [ ]    No [X]

The aggregate market value of voting and non-voting stock held by non-affiliates
of the  Registrant was  approximately  $30,627,469 as of June 30, 2006 which was
calculated  based on the last reported sale of the Company's  Common Stock prior
to June 30, 2006. This calculation does not reflect a determination that certain
persons are affiliates of the Registrant for any other purpose.

Common stock, no par value 3,676,718 shares outstanding as of March 15, 2007.

                       DOCUMENTS INCORPORATED BY REFERENCE

 Annual Report to Shareholders for Fiscal Year Ended December 31, 2006 (Part II)
       Proxy Statement for 2007 Annual Meeting of Shareholders (Part III)

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                                TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>        <C>                                                                           <C>
PART 1.

Item 1.    Business                                                                       2
Item 1A.   Risk Factors                                                                  12
Item 1B.   Unresolved Staff Comments                                                     14
Item 2.    Properties                                                                    15
Item 3.    Legal Proceedings                                                             15
Item 4.    Submission of Matters to a Vote of Security Holders                           15

PART II.

Item 5.    Market for Registrant's Common Equity, Related Stockholder
           Matters and Issuer Purchases of Equity Securities                             17
Item 6.    Selected Financial Data                                                       17
Item 7.    Management's Discussion and Analysis of Financial Condition
            and Results of Operation                                                     17
Item 7A.   Quantitative and Qualitative Disclosures about Market Risk                    17
Item 8.    Financial Statements and Supplementary Data                                   17
Item 9.    Changes In and Disagreements with Accountants on Accounting and
            Financial Disclosure                                                         17
Item 9A    Controls and Procedures                                                       17
Item 9B    Other Information                                                             18

PART III.

Item 10.   Directors, Executive Officers and Corporate Governance                        19
Item 11.   Executive Compensation                                                        19
Item 12.   Security Ownership of Certain Beneficial Owners and Management
            and Related Stockholder Matters                                              19
Item 13.   Certain Relationships and Related Transactions and Director Independence      19
Item 14.   Principal Accountant Fees and Services                                        17

PART IV.

Item 15.   Exhibits, Financial Statement Schedules                                       20
           Signatures                                                                 21-22
           Index of Exhibits                                                             23
</TABLE>

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                              PACIFIC STATE BANCORP
                              STOCKTON, CALIFORNIA
                                    FORM 10-K
                       FISCAL YEAR ENDED DECEMBER 31, 2006
                                     PART I

ITEM 1. BUSINESS

        Forward Looking Statements

Certain statements  discussed or incorporated by reference in this Annual Report
including, but not limited to, information concerning possible or assumed future
results of  operations of the Company set forth in the  Management's  Discussion
and   Analysis  of   Financial   Condition   and  Results  of   Operation,   are
forward-looking  statements within the meaning of the Securities Exchange Act of
1934 (the "Exchange  Act").  Forward-looking  statements  include  statements in
which  words  such  as  "expect,"  "anticipate,"  "intend,"  "plan,"  "believe,"
"estimate,"  "consider" or similar  expressions  are used. The Company's  actual
future  results  and  shareholder   values  may  differ  materially  from  those
anticipated and expressed in these forward-looking  statements,  which are based
on management's  beliefs and assumptions and on information  currently available
to  management,  and are  subject to risks and  uncertainties  that could  cause
actual  results  to differ  materially  from  those  projected.  Such  risks and
uncertainties  include,  among others, (1) competitive  pressures in the banking
industry;  (2) changes in the interest rate  environment;  (3) general  economic
conditions,  either  nationally  or  regionally;  (4) changes in the  regulatory
environment;  (5) changes in business conditions and inflation;  and (6) changes
in securities markets. Many of these factors are beyond the Company's ability to
control or predict.  Investors are  cautioned  not to put undue  reliance on any
forward-looking statements. In addition, the Company does not have any intention
or  obligation  to update  forward-looking  statements  contained in this Annual
Report, even if new information,  future events or other circumstances have made
them incorrect or misleading. Except as specifically noted herein all references
to the "Company" refer to Pacific State Bancorp, a California corporation

        General Description of Business

        Pacific  State  Bancorp is a holding  company with one bank  subsidiary,
Pacific State Bank,  (the "Bank"),  and two  unconsolidated  subsidiary  grantor
trusts, Pacific State Statutory Trusts I and II. Pacific State Bancorp commenced
operations  on June 24,  2002 when it acquired  all the shares of Pacific  State
Bank under a plan of reorganization  approved by the Bank's  shareholders on May
9, 2002. The Bank is a California  state chartered bank formed November 2, 1987.
The Bank is a member of the Federal Reserve System. The Bank's primary source of
revenue  is  providing  loans  to  customers  who  are  predominantly  small  to
middle-market businesses and middle-income individuals.  Pacific State Statutory
Trusts I and II are  unconsolidated,  wholly  owned  statutory  business  trusts
formed in June 2002 and March 2004,  respectively  for the exclusive  purpose of
issuing and selling trust preferred securities.

        The Bank conducts a general  commercial  banking business,  primarily in
the  five  county  region  that  comprises  Alameda,   Calaveras,  San  Joaquin,
Stanislaus and Tuolumne  counties,  and offers  commercial  banking  services to
residents  and employers of  businesses  in the Bank's  service area,  including
professional firms and small to medium sized retail and wholesale businesses and
manufacturers.  The Company as of March 15, 2007 had 84 employees,  including 36
officers.  The Bank  does not  engage in any  non-bank  lines of business.

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The business of the Bank is not to any  significant  degree  seasonal in nature.
The Bank has no  operations  outside  California  and has no material  amount of
loans  or  deposits  concentrated  among  any  one or  few  persons,  groups  or
industries.  The Bank  operates nine  branches  with its  Administrative  Office
located at 1899 W. March Lane, in Stockton, California;  additional branches are
located in downtown  Stockton and in the  communities  of Angels  Camp,  Arnold,
Groveland,  Lodi,  Modesto  and Tracy and a limited  service  branch in Hayward,
California.

        Pacific  State  Bancorp  common stock trades on the NASDAQ Global Market
under the symbol of "PSBC".

        Business Plan

        The  focus  of the  Company's  business  plan  is to  attract  "Business
Relationship" small, medium and large accounts,  but not to the exclusion of any
other business which the Company can reasonably and profitably attract. In order
to provide a level of  service  to  attract  such  customers,  the  Company  has
structured  its  specific  services  and  charges  on a basis  which  management
believes  to be  profitable,  taking  into  consideration  other  aspects of the
account relationship. The Company offers a full range of banking services to its
customers  intended  to  attract  the  following  specific  types  of  accounts:
relatively large consumer accounts; professional group and association accounts,
including the accounts of groups or firms of physicians, dentists, attorneys and
accountants; and accounts of small to medium-sized businesses engaged in retail,
wholesale, light industrial, manufacturing, agricultural and service activities.

        Trust Subsidiaries

        The  Company  during  2002  and  2004  established  two  business  trust
subsidiary  grantor  trusts,  Pacific  State  Statutory  Trusts  I and  II  (the
"Trusts")  for  the  sole  purpose  of  issuing  capital  securities   ("Capital
Securities")  pursuant  to  declarations  of  trust  (the  "Declarations").  The
proceeds from the sale of the Capital  Securities  were loaned to the Company as
subordinated  debentures  (the  "Debentures")  issued to the Trusts  pursuant to
indentures  (the  "Indentures").  Interest  payments on the Debentures will flow
through the Trust Trusts to the Pooling  Vehicles,  which are the holders of the
Capital   Securities   and  similar   securities   issued  by  other   financial
institutions.  Payments of  distributions  by the Trusts to the Pooling Vehicles
are  guaranteed  by  the  Company.  See  Note 8 to  the  Company's  consolidated
financial statements at Item 8, Financial Statements and Supplementary data.

        Proceeds from the issuance of the 2002 subordinated debentures were used
to  provide  the Bank with an  additional  $4.5  million  in capital in order to
support the continued  growth of the Bank. The remaining  $500,000 was placed in
the Company for general  corporate  purposes.  Proceeds from the issuance of the
2004  subordinated  debentures  were used to provide the Bank with an additional
$3.5 million in capital in order to support the continued growth of the Bank.

        Product Lines and Services

        The Bank currently offers the following  general banking services at all
of its branches:  commercial,  construction,  agricultural and real estate loans
and personal  credit lines,  interest on checking,  U.S.  Savings bond services,
domestic and foreign drafts, banking by appointment, automatic transfer of funds
between savings and checking accounts, business courier services, remote capture
of deposits  for  businesses,  checking  and savings  accounts  for personal and
business  purposes,  domestic letters of credit,

3
<PAGE>

a depository for MasterCard and Visa drafts,  federal depository services,  cash
management  assistance,  wire and  telephone  transfers,  Individual  Retirement
Accounts, Health Savings Accounts, time certificates of deposit, courier service
for  non-cash  deposits,  Visa and  MasterCard,  revolving  lines of  credit  to
consumers secured by deeds of trust on private  residences,  unsecured overdraft
protection credit lines attached to checking accounts, ATM cards and MasterMoney
debit cards via the Star, Cirrus, Plus, MasterCard and Visa networks.

        The Bank is not authorized to offer trust services.  The Federal Reserve
Bank of San Francisco is the Company's primary correspondent  relationship.  The
Bank currently also has correspondent  relationships  with City National Bank in
Beverly Hills, California,  First Tennessee Bank in Memphis,  Tennessee, Bank of
the West in Walnut Creek, California, U. S. Bank, Minneapolis,  Minnesota, Wells
Fargo Bank, San Francisco,  California,  Federal Home Loan Bank of San Francisco
and Pacific Coast Bankers Bank, San Francisco, California.

        The Bank recognizes that, in order to be competitive,  it must attract a
certain number of consumer accounts.  Individual  Retirement Accounts,  Visa and
MasterCard,  revolving lines of credit to consumers secured by deeds of trust on
private residences,  and unsecured overdraft protection credit lines attached to
checking  accounts  currently  offered  by  the  Bank  are  designed  to  appeal
particularly to consumers. Moreover, participation in a large-scale ATM networks
assists the Company in competing for consumer accounts.

        The Bank is an approved  Small Business  Administration  and 504 lender,
FSA, USDA Business and  Industry,  USDA  Part-time  Farmer  Program,  FHA and VA
lender and  California  Capital  lender.  The Bank is a  national  leader in the
underwriting of U.S.  Department of Agriculture  business and industry loans, as
well as a Preferred Lender for this program.

Marketing

        The basic marketing strategy of the Bank is to retain the Bank's initial
market share and to increase the Bank's  penetration of the market over the long
term via  expansion  east and west of  Stockton,  California  in small to medium
sized  communities.  The Bank  attempts to  accomplish  this by providing a full
range of  personalized  banking  services to small and medium  size  businesses,
professionals and individuals within Alameda, Calaveras, San Joaquin, Stanislaus
and Tuolumne Counties.

        The Bank's  marketing  plan aims to provide  for  strong  continuity  in
banker-customer  relationships,  a high  degree of  convenience  for  customers,
prompt  response in the handling of loan  requests,  and  personal  attention to
needs of individual customers.  The marketing plan also includes a commitment to
lend the  Bank's  deposits  back into the areas  from  which  they are  derived,
thereby assisting in the building activity, population growth and other changes,
which are  occurring  in the market area.  By focusing  the Bank's  relationship
toward its community the Bank attempts to establish  strong  continuity with its
customers.

        The Directors of the Company are active in business  development through
personal contacts and personal participation in local activities.  The Directors
of the Company have a strong  commitment to community  banking.  They believe in
business development by actively participating in community events.

        Local advertising and publicity in local papers also are used to attract
business and to acquaint potential customers with the Bank's services.

4
<PAGE>

        Competition

        The Bank's  service area  consists of Alameda,  Calaveras,  San Joaquin,
Stanislaus and Tuolumne Counties.  The banking business in California generally,
and  specifically in the Bank's primary market area, is highly  competitive with
respect to both loans and  deposits.  The  banking  business is  dominated  by a
relatively small number of major banks,  which have many offices  operating over
wide geographic areas. Many of the major commercial banks offer certain services
(such as international,  trust and securities brokerage services), which are not
offered  directly by the Bank. By virtue of their greater total  capitalization,
such  banks  have  substantially   higher  lending  limits  than  the  bank  and
substantial advertising and promotional budgets.

        In the past, an independent  bank's  principal  competitors for deposits
and loans have been other banks  (particularly  major  banks),  savings and loan
associations  and  credit  unions.  To a  lesser  extent,  competition  was also
provided  by thrift  and  loans,  mortgage  brokerage  companies  and  insurance
companies. Other institutions,  such as brokerage houses, credit card companies,
and even retail  establishments  have offered new investment  vehicles,  such as
money-market  funds,  which also  compete with banks.  The  direction of federal
legislation in recent years seems to favor  competition  between different types
of financial institutions and to foster new entrants into the financial services
market, and it is anticipated that this trend will continue.

        To compete with major  financial  institutions  in its service area, the
Bank relies upon specialized  services,  responsive  handling of customer needs,
local promotional activity, and personal contacts by its officers, directors and
staff,  as opposed to large  multi-branch  banks,  which  compete  primarily  by
interest rates and multiple branch  locations.  For customers whose loan demands
exceed the Bank's  lending  limits,  the Bank seeks to arrange  funding for such
loans on a participation basis with its correspondent banks or other independent
commercial banks.

        Supervision and Regulation

        The  Company is  principally  regulated  by the  Federal  Reserve  Board
("FRB").  The Bank is principally  regulated by the California  Commissioner  of
Financial  Institutions  ("Commissioner"),  but is also subject to regulation by
the Federal Deposit  Insurance  Corporation  ("FDIC") and by its primary federal
regulator,  the FRB. These agencies  govern most of the Company's and the Bank's
business,  including  capital  requirements,  loans,  investments,  mergers  and
acquisitions, borrowings, dividends, branch locations and other similar matters.
In addition,  the Bank's business is affected by general economic conditions and
by the  monetary  and fiscal  policies of the United  States  government.  These
policies influence, for example, the Federal Reserve's open market operations in
U.S. Government  securities,  the reserve  requirements  imposed upon commercial
banks,  the discount rates  applicable to borrowings from the Federal Reserve by
banks,  and other  similar  matters which impact the growth of the Bank's loans,
investments and deposits and the interest rates which the Bank charges and pays.

        Proposals to change the laws and  regulations  governing the  operations
and taxation of financial  institutions are frequently made in Congress,  in the
California  legislature and before various regulatory and professional agencies.
Major  changes and the impact such changes  might have are  difficult to predict
with  accuracy.  Certain  significant  recently  proposed  or  enacted  laws and
regulations are discussed below.

5
<PAGE>

        Interstate Banking.  Since 1995, initial entry into California by merger
or acquisition  involving an out-of state  institution  must be  accomplished by
acquisition of or merger with an existing whole bank which has been in existence
for at least five years.

        Capital  Requirements.  The  Company and the Bank are subject to certain
regulatory  capital  requirements  administered  by the FRB and the FDIC.  Under
capital adequacy  guidelines and the regulatory  framework for prompt corrective
action,  the Company and the Bank must meet  specific  capital  guidelines  that
involve  quantitative   measures  of  their  assets,   liabilities  and  certain
off-balance sheet items as calculated under regulatory accounting practices. The
Company's and the Bank's capital amounts and classifications are also subject to
qualitative  judgments by the regulators  about the components,  risk weightings
and other factors.

        The  Uniform  Financial   Institutions   Rating  System  classifies  and
evaluates  the  soundness of financial  institutions  according to the so-called
"CAMELS" criteria, an acronym for capital adequacy,  asset quality,  management,
earnings,  liquidity  and  sensitivity  to market  risk,  (including  changes in
interest rates, foreign exchange rates,  commodity prices or equity prices which
may adversely affect an institution's earnings and capital).

        Prompt  Corrective  Action  regulations  (the "PCA  Regulations") of the
federal bank regulatory agencies establish five capital categories in descending
order (well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically  undercapitalized),  assignment to which depends
upon the institution's total risk-based capital ratio, Tier 1 risk-based capital
ratio,  and  leverage  ratio.  Institutions  classified  in  one  of  the  three
undercapitalized  categories are subject to certain  mandatory and discretionary
supervisory   actions,   which   include   increased   monitoring   and  review,
implementation  of  capital   restoration  plans,  asset  growth   restrictions,
limitations upon expansion and new business activities,  requirements to augment
capital,  restrictions upon deposit gathering and interest rates, replacement of
senior executive  officers and directors,  and requiring  divestiture or sale of
the  institution.  The Bank is currently  classified as a well  capitalized bank
pursuant to the PCA regulations.

        As of December  31,  2006,  the Bank's total  risk-based  capital  ratio
(approximately  11.2%) and its  leverage  ratio  (approximately  9.7%)  exceeded
minimum levels.  It is not expected that compliance with the risk-based  capital
guidelines  or minimum  leverage  requirements  will have a  materially  adverse
effect on the business of the Bank in the reasonably foreseeable future.

Premiums for Deposit Insurance

The Bank's deposits are currently insured to a maximum of $100,000 per depositor
($250,000 for certain  retirement  accounts)  through the Deposit Insurance Fund
("DIF")  administered by the FDIC. The Bank is required to pay deposit insurance
premiums,  which are assessed semiannually and paid quarterly.  In November 2006
the FDIC adopted a new risk-based  insurance assessment system effective January
1, 2007 designed to tie what banks pay for deposit insurance more closely to the
risks they pose.  The FDIC also  adopted a new base  schedule  of rates that the
FDIC can adjust up or down,  depending  on the needs of the DIF, and set initial
premiums  for 2007 that range  from 5 cents per $100 of  domestic  deposits  for
banks in the lowest risk category to 43 cents per $100 of domestic  deposits for
banks in the highest risk category. The new assessment system is not expected to
result in a material impact on the Bank.

The FDIC is also  empowered to make special  assessments  on insured  depository
institutions  in  amounts  determined  by the  FDIC to be  necessary  to give it
adequate  assessment income to repay amounts borrowed from the U.S. Treasury and
other sources or for any other purpose the FDIC deems necessary.

6
<PAGE>

The FDIC is authorized to terminate a depository institution's deposit insurance
upon a finding by the FDIC that the institution's  financial condition is unsafe
or unsound or that the institution has engaged in unsafe or unsound practices or
has violated any  applicable  rule,  regulation,  order or condition  enacted or
imposed by the institution's regulatory agency.

        Community   Reinvestment   Act.   Community   Reinvestment  Act  ("CRA")
regulations  evaluate the Bank's lending to low and moderate income  individuals
and businesses  across a four-point  scale from  "outstanding"  to  "substantial
noncompliance,"  and are a factor in regulatory review of applications to merge,
or  establish  new  branches.  In  addition,  any  Bank  rated  in  "substantial
noncompliance"   with  the  CRA   regulations  may  be  subject  to  enforcement
proceedings. The Bank has a current rating of "satisfactory" CRA compliance.

        Safety and Soundness  Standards.  Federal bank  regulations  for insured
financial institutions establish safety and soundness standards for (1) internal
controls,   information   systems  and   internal   audit   systems;   (2)  loan
documentation;  (3) credit underwriting;  (4) interest rate exposure;  (5) asset
growth; (6) compensation,  fees and benefits; and (7) excessive compensation. If
an agency determines that an institution fails to meet any standard  established
by the guidelines, the agency may require the financial institution to submit to
the agency an acceptable plan to achieve compliance with the standard.  Agencies
may elect to initiate  enforcement action in certain cases where failure to meet
one or more of the standards  could threaten the safe and sound operation of the
institution.  The  Company  has not been and does not expect to be  required  to
submit a safety and soundness  compliance  plan because of a failure to meet any
of the safety and soundness standards.

        Sarbanes-Oxley Act of 2002

        The  Sarbanes-Oxley  Act of 2002 (the  "SOA") was  enacted  to  increase
corporate  responsibility,  to provide for enhanced penalties for accounting and
auditing  improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate  disclosures pursuant to the
securities laws.

        The SOA is the most far-reaching U.S. securities  legislation enacted in
    many  years.  The SOA  generally  applies to all  companies,  both U.S.  and
    non-U.S.,  that  file or are  required  to file  periodic  reports  with the
    Securities  and  Exchange  Commission,  ("the  SEC"),  under the  Securities
    Exchange  Act of 1934.  Since the  enactment  of the SOA, the SEC has issued
    numerous new and proposed regulations to implement SOA requirements.

        The  SOA   represents   significant   federal   involvement  in  matters
    traditionally  left to state regulatory  systems,  such as the regulation of
    the  accounting  profession,  and  to  state  corporate  law,  such  as  the
    relationship between a board of directors and management and between a board
    of directors and its committees.

        The SOA addresses, among other matters:

    o   Duties, responsibilities and qualifications of the audit committee;
    o   certification of financial statements by the chief executive officer and
        the chief financial officer;

7
<PAGE>

    o   the  forfeiture  of bonuses or other  incentive-based  compensation  and
        profits from the sale of an issuer's  securities by directors and senior
        officers in the twelve month period following initial publication of any
        financial statements that later require restatement;
    o   a prohibition on insider trading during pension plan black out periods;
    o   disclosure of off-balance sheet transactions;
    o   a prohibition on certain personal loans to directors and officers;
    o   expedited filing  requirements for forms which disclose  transactions by
        officers and directors in Company stock ;
    o   disclosure of a code of ethics and of any change or waiver of such code;
    o   new   requirements  for  auditing  and  reporting  on  Company  internal
        controls;
    o   "real time" filing of periodic reports;
    o   the  formation  of a public  company  accounting  oversight  board  (the
        "PCAOB")   with   authority  to  set  auditing,   quality   control  and
        independence  standards and investigate and discipline public accounting
        firms;
    o   auditor  independence; and
    o   various increased criminal penalties for violations of securities laws.

        The SEC has and PCAOB have  issued  final rules  covering  most of these
    topics,  but it is to be expected  that these rules may be altered as future
    experience requires.

         Although we anticipate that we will incur additional expense in
complying with the provisions of the SOA, management does not expect that such
compliance will have a material impact on our results of operation or financial
condition.

        Financial Services Modernization Legislation

        On  November  12,  1999,  the  Gramm-  Leach-Bliley  Act  of  1999  (the
"Financial  Services  Modernization  Act") was signed  into law.  The  Financial
Services  Modernization  Act is intended to  modernize  the banking  industry by
removing  barriers  to  affiliation  among  banks,   insurance  companies,   the
securities industry and other financial service providers. It provides financial
organizations  with the flexibility of structuring such  affiliations  through a
holding company structure or through a financial  subsidiary of a bank,  subject
to certain limitations.  The Financial Services  Modernization Act establishes a
new type of bank holding company,  known as a financial  holding company,  which
may engage in an expanded  list of  activities  that are  "financial in nature,"
which include  securities  and  insurance  brokerage,  securities  underwriting,
insurance  underwriting  and  merchant  banking.  The  Company  has  not  sought
"financial holding company" status and has no present plans to do so.

        The  Financial  Services  Modernization  Act also sets forth a system of
functional  regulation  that  makes the  Federal  Reserve  Board  the  "umbrella
supervisor"  for holding  companies,  while providing for the supervision of the
holding company's subsidiaries by other federal and state agencies.

        In addition,  the Bank is subject to other  provisions  of the Financial
Services  Modernization  Act,  including  those  relating  to CRA,  privacy  and
safe-guarding  confidential  customer  information,  regardless  of whether  the
Company elects to become a financial  holding  company or to conduct  activities
through a  financial  subsidiary  of the Bank.  The Company  does not,  however,
currently  intend to file  notice  with the  Federal  Reserve  Board to become a
financial holding company or to engage in expanded financial  activities through
a financial subsidiary of the Bank.

8
<PAGE>

        The  Company  and the Bank do not believe  that the  Financial  Services
Modernization Act will have a material adverse effect on their operations in the
near-term.  However, to the extent that it permits banks,  securities firms, and
insurance companies to affiliate, the financial services industry may experience
further  consolidation.  The Financial Services Modernization Act is intended to
grant to  community  banks  certain  powers  as a matter  of right  that  larger
institutions  have  accumulated on an ad hoc basis.  Nevertheless,  this act may
have the result of increasing the amount of  competition  that the Company faces
from  larger  institutions  and  other  types of  companies  offering  financial
products, many of which may have substantially more financial resources than the
Company.

        USA Patriot Act of 2001

        On October  26,  2001,  President  Bush  signed the USA Patriot Act (the
"Patriot  Act"),  which  includes  provisions  pertaining to domestic  security,
surveillance   procedures,   border   protection,   and  terrorism  laws  to  be
administered  by the  Secretary  of the  Treasury.  Title III of the Patriot Act
entitled, "International Money Laundering Abatement and Anti-Terrorist Financing
Act of 2001"  includes  amendments  to the Bank  Secrecy  Act which  expand  the
responsibilities  of financial  institutions in regard to anti-money  laundering
activities  with particular  emphasis upon  international  money  laundering and
terrorism  financing  activities  through  designated  correspondent and private
banking  accounts.  Certain  surveillance  provisions  of the  Patriot  Act were
scheduled  to expire on December 31,  2005,  but the  deadline was  postponed to
allow time for evaluation of such  provisions,  and on March 9, 2006,  President
Bush signed  legislation to reauthorize the Patriot Act,  incorporating  certain
civil liberty protections approved by Congress.

        Section  313(a) of the  Patriot  Act  prohibits  any  insured  financial
institution such as Pacific State Bancorp from providing  correspondent accounts
to  foreign  banks  which  do  not  have a  physical  presence  in  any  country
(designated  as "shell  banks"),  subject to certain  exceptions  for  regulated
affiliates of foreign banks. Section 313(a) also requires financial institutions
to take reasonable steps to ensure that foreign bank correspondent  accounts are
not being used to indirectly  provide  banking  services to foreign shell banks,
and Section 319(b) requires  financial  institutions to maintain  records of the
owners and agent for  service of  process  of any such  foreign  banks with whom
correspondent accounts have been established.

        Section 312 of the Patriot  Act  creates a  requirement  for special due
diligence for correspondent accounts and private banking accounts. Under Section
312, each financial  institution that establishes,  maintains,  administers,  or
manages a private  banking  account  or a  correspondent  account  in the United
States for a non-United States person,  including a foreign individual  visiting
the United States,  or a  representative  of a non-United  States person,  shall
establish appropriate,  specific, and, where necessary,  enhanced, due diligence
policies,  procedures,  and controls that are reasonably  designed to detect and
record instances of money laundering through those accounts.

        The Company and its  subsidiaries are not currently aware of any account
relationships  between the Company and its banking  subsidiaries and any foreign
bank or other person or entity as described  above under Sections  313(a) or 312
of the Patriot Act. The terrorist  attacks on September 11, 2001 have  realigned
national  security  priorities  of the  United  States and it is  reasonable  to
anticipate that the United States Congress may enact  additional  legislation in
the future to combat terrorism including  modifications to existing laws such as
the  Patriot Act to expand  powers as deemed  necessary.  The effects  which the
Patriot Act and any  additional  legislation  enacted by Congress  may have upon
financial  institutions is uncertain;  however,  such  legislation  would likely
increase  compliance  costs and thereby  potentially have an adverse effect upon
the Company's results of operations.

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<PAGE>

        Transactions between Affiliates

        Transactions  between a bank and its "affiliates" are quantitatively and
qualitatively  restricted  under the Federal  Reserve Act.  The Federal  Reserve
Board issued Regulation W on October 31, 2002, which comprehensively  implements
Sections  23A and  23B of the  Federal  Reserve  Act.  Sections  23A and 23B and
Regulation W restrict loans by a depository institution to its affiliates, asset
purchases  by  a  depository   institution   from  its  affiliates,   and  other
transactions between a depository  institution and its affiliates.  Regulation W
unifies in one public document the Federal Reserve  Board's  interpretations  of
Section 23A and 23B. Regulation W had an effective date of April 1, 2003.

New Accounting Pronouncements

        Effective  January 1, 2006, the Company  adopted  Statement of Financial
Accounting  Standards No. 123 (R),  Share-Based  Payment ("SFAS 123 (R)"). Under
SFAS 123(R), compensation cost recognized for all awards that vest subsequent to
the date of adoption based on the grant-date  fair value estimated in accordance
with SFAS 123(R). The grant-date fair value is estimated using the Black-Scholes
option-pricing formula, which involves making estimates of the assumptions used,
including the expected term of the option,  expected  volatility over the option
term,  expected dividend yield over the option term and risk-free interest rate.
In addition,  when  determining  the  compensation  expense to amortize over the
vesting period, management makes estimates about the expected forfeiture rate of
options.

        Accounting for Uncertainty in Income Taxes

                In July 2006,  the FASB issued  Financial  Accounting  Standards
Interpretation No. 48 (FIN 48),  Accounting for Uncertainty in Income Taxes - An
Interpretation  of FASB  statement No. 109. FIN 48 clarifies the  accounting for
uncertainty in income taxes recognized in an enterprise's  financial  statements
in accordance with FASB Statement No. 109,  Accounting for Income Taxes.  FIN 48
also  prescribes  a  recognition  threshold  and  measurement  standard  for the
financial statement  recognition and measurement of an income tax position taken
or  expected  to be taken in a tax  return.  FIN 48 also  provides  guidance  on
derecognition,  classification,  interest and  penalties,  accounting in interim
periods,  disclosures  and  transitions.  FIN 48 is  effective  for fiscal years
beginning after December 15, 2006.

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

                The  provisions  of FIN 48 were  effective  for the  Company  on
January  1,  2007  and are to be  applied  to all  tax  positions  upon  initial
application   of   this   standard.   Only   tax   positions   that   meet   the
more-likely-than-not   recognition  threshold  at  the  effective  date  may  be
recognized or continue to be recognized upon adoption.

                The  cumulative  effect of applying the provisions of FIN 48, if
any,  will be  reported  as an  adjustment  to the  opening  balance of retained
earnings  for the  fiscal  year of  adoption.  Management  does not  expect  the
adoption of FIN 48 to have a material impact on the Company's financial position
or results of operations.

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<PAGE>

        Fair Value Measurements

                In September 2006, the FASB issued Statement No. 157 (SFAS 157),
Fair Value  Measurements.  SFAS 157 defines fair value,  establishes a framework
for measuring fair value and expands  disclosures about fair value measurements.
SFAS 157  applies  whenever  other  standards  require  (or  permit)  assets  or
liabilities  to be  measured  at fair  value but does not expand the use of fair
value  in any new  circumstances.  In this  standard,  the  FASB  clarifies  the
principle that fair value should be based on the assumptions market participants
would use when  pricing the asset or  liability.  In support of this  principle,
SFAS 157  establishes a fair value  hierarchy that  prioritizes  the information
used to develop those assumptions.  The provisions of SFAS 157 are effective for
financial  statements  issued for fiscal years beginning after November 15, 2007
and interim periods within those fiscal years. The provisions  should be applied
prospectively, except for certain specifically identified financial instruments.
Management does not expect the adoption of SFAS 157 to have a material impact on
the Company's financial position or result of operations.

        Accounting for Purchases of Life Insurance

                In September 2006, the FASB ratified the consensuses  reached by
the  Emerging  Issues  Task Force (the Task Force) on Issue No. 06-5 (EITF 06-5)
Accounting  for the Purchases of Life  Insurance -  Determining  the Amount that
Could be Realized in Accordance with FASB Technical Bulletin No.85-4 (FTB 85-4).
FTB 85-4  indicates  that the amount of the asset  included in the balance sheet
for life insurance  contracts  within its scope should be "the amount that could
be realized  under the  insurance  contract as of the date of the  statement  of
financial  position."  Questions  arose in applying  the guidance in FTB 85-4 to
whether "the amount that could be realized"  should  consider 1) any  additional
amounts included in the contractual terms of the insurance policy other than the
cash  surrender  value and 2) the  contractual  ability to surrender  all of the
individual-life  policies (or  certificates in a group policy) at the same time.
EITF 06-5 determined that "the amount that could be realized" should 1) consider
any additional  amounts  included in the contractual  terms of the policy and 2)
assume  the  surrender  of an  individual-life  by  individual-life  policy  (or
certificate by  certificate  in a group  policy).  Any amount that is ultimately
realized by the policy holder upon the assumed surrender of the final policy (or
final certificate in a group policy) shall be included in the "amount that could
be realized." An entity should apply the  provisions of EITF 06-5 through either
a change in  accounting  principle  through a  cumulative-effect  adjustment  to
retained  earnings  as of the  beginning  of the year of adoption or a change in
accounting principle through retrospective application to all prior periods. The
provisions of EITF 06-5 are effective for fiscal years  beginning after December
15,  2006.  Management  does not believe  the  adoption of EITF 06-5 will have a
material impact on the Company's financial position or results of operations.

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

                In September 2006, the FASB ratified the consensuses  reached by
the  Task  Force  on  Issue  No.  06-4  (EITF  06-4)   Accounting  for  Deferred
Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life
Insurance  Arrangements.  A  question  arose  when an  employer  enters  into an
endorsement  split-dollar  life  insurance  arrangement  related to whether  the
employer should  recognize a liability for the future benefits or premiums to be
provided to the employee.  EITF 06-4 indicates that an employer should recognize
a liability for future benefits and that a liability for the benefit  obligation
has not been settled  through the  purchase of an  endorsement  type policy.  An
entity  should  apply the  provisions  of EITF 06-4  either  through a change in
accounting principle through a cumulative-effect adjustment to retained earnings
as of the beginning of the year of

11
<PAGE>

adoption or a change in accounting principle through  retrospective  application
to all prior periods. The provisions of EITF 06-4 are effective for fiscal years
beginning  after  December  15,  2007.  Management  has  not yet  completed  its
evaluation of the impact that EITF 06-4 will have.

Consideration of the Effects of Prior Year Misstatements

        In September,  2006, the Securities  and Exchange  Commission  published
Staff  Accounting  Bulleting No. 108 (SAB 108)  Considering the Effects of Prior
Year  Misstatements  when  Quantifying  Misstatements  in Current Year Financial
Statements.  The  interpretations in SAB 108 were issued to address diversity in
practice in  quantifying  financial  statement  misstatements  and the potential
under current practice to build up improper  amounts on the balance sheet.  This
guidance will apply to the first fiscal year ending after  November 15, 2006, or
December  31,  2006  for the  Company.  The  adoption  of SAB 108 did not have a
material impact on the Company's financial position or results of operations and
no cumulative adjustment was required.

        WHERE YOU CAN FIND MORE INFORMATION

        Under  the  Securities  Exchange  Act of  1934  Sections  13 and  15(d),
periodic  and  current   reports  must  be  filed  with  the  SEC.  The  Company
electronically  files the  following  reports  with the SEC:  Form 10-K  (Annual
Report),  Form 10-Q  (Quarterly  Report),  Form 8-K  (Current  Report),  insider
ownership  reports  and Form DEF 14A (Proxy  Statement).  The  Company  may file
additional forms. The SEC maintains an Internet site, www.sec.gov,  in which all
forms filed electronically may be accessed free of charge.

        The     Company     links     these     reports    to    its     website
(www.pacificstatebank.com)  as soon as reasonably  practicable after filing them
with the SEC.  None of the  information  on or  hyperlinked  from the  Company's
website is incorporated into this Annual Report on Form 10-K.

ITEM 1A. RISK FACTORS

        The Company and its subsidiary,  Pacific State Bank, conduct business in
an environment  that includes  certain risks  described below which could have a
material  adverse  effect on the  Company's  business,  results  of  operations,
financial condition,  future prospects and stock price. You are also referred to
the  matters  described  under  the  heading  "Cautionary  Statements  Regarding
Forward-Looking  Statements," for additional  information regarding factors that
may affect the Company's business.

    o   The Company's  business is subject to interest rate risk, and variations
in interest rates may negatively affect its financial performance.

        Changes in the interest  rate  environment  may reduce the Company's net
interest income. It is expected that the Company will continue to realize income
from the  differential  or  "spread"  between  the  interest  earned  on  loans,
securities  and other  interest-earning  assets,  and interest paid on deposits,
borrowings  and other  interest-bearing  liabilities.  Net interest  spreads are
affected by the difference between the maturities and repricing  characteristics
of interest-earning assets and interest-bearing  liabilities.  In addition, loan
volume and yields are  affected by market  interest  rates on loans,  and rising
interest  rates   generally  are   associated   with  a  lower  volume  of  loan
originations.  We cannot assure you that we can minimize the Company's  interest
rate risk. In addition,  an increase in the general level of interest  rates may
adversely  affect the ability of certain  borrowers  to pay the  interest on and
principal  of their  obligations.  Accordingly,  changes  in  levels  of  market
interest rates could  materially and adversely affect the Company's net interest
spread, asset quality, loan origination volume and overall profitability.

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<PAGE>

    o   The Company faces strong  competition from financial  service  companies
and other  companies that offer banking  services,  which can hurt Pacific State
Bancorp' business.

        The  Company's   subsidiary,   Pacific  State  Bank,   conducts  banking
operations principally in Stockton California and San Joaquin County.  Increased
competition  in the Bank's  market may  result in  reduced  loans and  deposits.
Ultimately,  it may not be able to  compete  successfully  against  current  and
future competitors. Many competitors offer the banking services that are offered
by the  Bank  in its  service  area.  These  competitors  include  national  and
super-regional banks, finance companies, investment banking and brokerage firms,
credit unions,  government-assisted  farm credit programs, other community banks
and  technology-oriented  financial  institutions  offering online services.  In
particular,  the Bank's  competitors  include several major financial  companies
whose greater resources may afford them a marketplace advantage by enabling them
to maintain  numerous  banking  locations and mount  extensive  promotional  and
advertising campaigns. Additionally, banks and other financial institutions with
larger   capitalization  and  financial   intermediaries  not  subject  to  bank
regulatory restrictions have larger lending limits and are thereby able to serve
the credit needs of larger  customers.  Areas of  competition  include  interest
rates for loans and deposits,  efforts to obtain deposits, and range and quality
of products and services provided,  including new technology-driven products and
services.   Technological   innovation   continues  to   contribute  to  greater
competition  in  domestic  and  international   financial  services  markets  as
technological  advances,  such as  Internet-based  banking  services  that cross
traditional  geographic  bounds,  enable  more  companies  to provide  financial
services. If the Bank is unable to attract and retain banking customers,  it may
be unable to continue its loan growth and level of deposits, which may adversely
affect its and the  Company's  results of  operations,  financial  condition and
future prospects.

    o   Changes in economic  conditions could result in an economic  downturn in
Northern California which could adversely affect the Company's business.

        The Company's business is directly affected by factors such as economic,
political  and  market  conditions,   broad  trends  in  industry  and  finance,
legislative and regulatory  changes,  changes in government  monetary and fiscal
policies  and  inflation,  all of which are  beyond  the  Company's  control.  A
deterioration in economic conditions locally, regionally or nationally including
as the result of terrorist activities within and outside California could result
in an  economic  downturn  in Northern  California  and  trigger  the  following
consequences, any of which could adversely affect the Company's business:

    o   loan delinquencies and defaults may increase;

    o   problem assets and foreclosures may increase;

    o   demand for the Company's products and services may decline;

    o   low cost or non-interest bearing deposits may decrease; and

    o   collateral for loans may decline in value,  in turn reducing  customers'
borrowing  power,  and reducing the value of assets and collateral as sources of
repayment of existing loans.
    o   The Company has a concentration risk in real estate related loans.

13
<PAGE>

        At  December  31,  2006,  approximately  70.7%  of  the  Company's  loan
portfolio  consisted  of real estate  related  loans.  Substantially  all of the
Company's  real  property  collateral  is  located in its  operating  markets in
Stockton,  California  and San Joaquin  County.  A  substantial  decline in real
estate values in the Company's  primary  market areas could occur as a result of
an economic  downturn,  or other  events  including  natural  disasters  such as
earthquakes,  fires, and floods.  Such a decline in values could have an adverse
impact on the Company by limiting  repayment of defaulted  loans through sale of
the real estate  collateral  and by likely  increasing  the number of  defaulted
loans to the extent that the  financial  condition of its borrowers is adversely
affected  by  such a  decline  in  values.  Those  events  could  necessitate  a
significant  increase in the  provision  for loan and lease  losses  which could
adversely affect the Company's results of operations,  financial condition,  and
future prospects.

    o   The Company and its subsidiary Bank are subject to extensive regulation,
which could adversely affect its business.

        The  Company's  and the  Bank's  operations  are  subject  to  extensive
regulation  by state and  local  governmental  authorities  and are  subject  to
various laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations.  The Company believes that it and
its subsidiary Bank are in substantial  compliance in all material respects with
laws, rules and regulations  applicable to the conduct of its business.  Because
the Company's  business is highly  regulated,  the laws,  rules and  regulations
applicable to it are subject to regular modification and change. There can be no
assurance that these laws,  rules and  regulations,  or any other laws, rules or
regulations, will not be adopted in the future, which could make compliance much
more difficult or expensive, restrict the Company's ability to originate, broker
or sell loans, further limit or restrict the amount of commissions,  interest or
other charges  earned on loans  originated or sold by the Company,  or otherwise
adversely affect the Company's results of operations,  financial  condition,  or
future prospects.

    o   The  Company's  allowance  for loan  losses may not be adequate to cover
actual  losses.

        Like all financial institutions,  the Company maintains an allowance for
loan losses to provide for loan defaults and non-performance,  but its allowance
for loan losses may not be adequate to cover  actual loan  losses.  In addition,
future  provisions  for loan losses could  materially  and adversely  affect the
Company's operating results. The Company's allowance for loan losses is based on
prior  experience,  as  well  as an  evaluation  of the  risks  in  the  current
portfolio.  The amount of future losses is  susceptible  to changes in economic,
operating and other conditions,  including changes in interest rates that may be
beyond the Company's  control,  and these losses may exceed  current  estimates.
Federal regulatory  agencies,  as an integral part of their examination process,
review the Company's  loans and  allowance for loan losses.  Although we believe
that the  Company's  allowance  for loan  losses is  adequate  to cover  current
losses, we cannot assure you that it will not further increase the allowance for
loan losses or that  regulators  will not require it to increase this allowance.
Either of these  occurrences could materially and adversely affect the Company's
earnings.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

Inapplicable

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<PAGE>

ITEM 2. PROPERTIES

        The Company owns its March Lane (Stockton),  Modesto,  Groveland, Angels
Camp, Arnold and Hayward branch facilities. The Company purchased the March Lane
office for $866,700 in 1992. The Company's  executive officers and support staff
were  located  in the March Lane  building  from 1997 to 2004.  During  2001 the
Company purchased an adjacent  building to the March Lane office,  for $747,000,
in order to expand its administrative  functions. The executive offices, finance
department, central operations and data processing were moved into these offices
in 2004.  The Company  repossessed  the Modesto  building and  converted it to a
banking branch in 1996. The Modesto land was purchased in 1999 for $524,000. The
Company  purchased the Arnold Branch for $600,000 as part of its 1997  expansion
into branches  acquired from Valliwide Bank. A portion of the building,  located
at 1013 Blagen Road, is leased to First American Title. The lease is expected to
generate $10,000 in 2007.  During 2000 the Company  purchased a lot in Groveland
and  purchased a lot in Angels Camp in order to build and  relocate  the current
Branch offices.  These sites offer the Company better visibility and demonstrate
commitment to the communities we serve. The Groveland property was purchased for
$148,000  and  construction  was  completed  in January  2003.  The Angels  Camp
property was  purchased  for $200,000 and was  completed in the third quarter of
2003. The Company purchased the building in Hayward for $1,800,000 in July 2006.

        All other Company  premises are leased.  The Company's total rentals for
premises and equipment for fiscal year 2006 were approximately $319,000.

        The Company is currently in the fifteenth year of a  sixteen-year  gross
level lease for its main  office  located in downtown  Stockton.  The  Company's
projected lease expense for 2007 under this lease is approximately  $200,000 per
year, and will increase annually at a rate of 3% per year.

        In 1999,  the Company  entered into a 10-year  lease with two options to
extend for an additional 5 years each for the building in Tracy. The annual rent
for 2006 was $$75,000 and will increase  annually at a rate of 3% per year.  The
Company's  projected  lease  expense for 2007 under this lease is  approximately
$77,000

        In 2005,  the Company  entered into a 10-year lease with four options to
extend for an additional 5 years each for the building in Lodi.  The annual rent
commenced in 2006 upon  completion  of the building  and  occupation  by Pacific
State Bank. The rent for 2006 under this lease was $91,000. The estimated annual
rent for 2007 under  this lease is  approximately  $180,000,  and will  increase
annually at a rate of 3% per year.

ITEM 3. LEGAL PROCEEDINGS.

        There are no material  pending  legal  proceedings,  other than ordinary
routine litigation  incidental to its business,  to which the Company is a party
or of which any of its property is the subject.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters  were  submitted to vote of the  security  holders  during the fourth
quarter of the period covered by this report.

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<PAGE>

ITEM (*) EXECUTIVE OFFICERS OF THE REGISTRANT.

        The following table presents certain information regarding the executive
officers of the Company:

        NAME                AGE  POSITION(S)                    SINCE
        -----------------   ---  ----------------------------   -----
        Steven A. Rosso     52   President and CEO/Director     1992
        Gary A. Stewart     57   Executive VP/CCO/Director      1996
        JoAnne Roberts      50   Vice President/CFO             2004

(*) Included pursuant to General Instruction (G)(3).

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<PAGE>

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S  COMMON EQUITY,  RELATED STOCKHOLDER MATTERS AND
        ISSUER PURCHASES OF EQUITY SECURITIES

        See information under the caption "Market Price for Registrant's  Common
Equity,  Dividends and Related Stockholder Matters" in the Company's 2006 Annual
Report to Shareholders, which information is incorporated here by reference.

ITEM 6. SELECTED FINANCIAL DATA

        See  information  under the  caption  "Selected  Financial  Data" in the
Company's 2006 Annual Report to Shareholders,  which information is incorporated
here by reference.

ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATION.

        See information under the caption "Management's  Discussion and Analysis
of Financial  Condition and Results of  Operation" in the Company's  2006 Annual
Report to Shareholders which information is incorporated here by reference.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISLOSURES ABOUT MARKET RISK.

        See information  under the caption  "Liquidity and Market Risk" and "Net
Interest Income  Simulation" in the Company's 2006 Annual Report to Shareholders
which information is incorporated here by reference.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        See  Report  of   Independent   Registered   Public   Accounting   Firm,
Consolidated  Balance  Sheet,  Consolidated  Statement  of Income,  Consolidated
Statement of Changes in Shareholders' Equity,  Statement of Cash Flows and Notes
to Consolidated Financial Statements, all contained in the Company's 2006 Annual
Report to Shareholders, which information is incorporated here by reference.

ITEM 9. CHANGES  IN  AND  DISAGREEMENTS   WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
        FINANCIAL DISCLOSURE.

        None

ITEM 9A. CONTROLS AND PROCEDURES

        The Chief Executive  Officer and Chief Financial  Officer of the Company
have concluded, based on their evaluation as of the end of the period covered by
this Annual  Report on Form 10-K,  that the  Company's  disclosure  controls and
procedures are effective to ensure that information  required to be disclosed by
the  Company  in the  reports  filed or  submitted  by it under  the  Securities
Exchange  Act of 1934,  as  amended,  is  recorded,  processed,  summarized  and
reported  within  the time  periods  specified  in the  rules  and  forms of the
Securities and Exchange Commission, and include controls and procedures designed
to ensure  that  information  required  to be  disclosed  by the Company in such
reports is accumulated and communicated to the Company's  management,  including
the  Company's  Chief  Executive  Officer  and  Chief  Financial   Officer,   as
appropriate to allow timely decisions regarding required disclosure.  The design
of any system of controls is based in part upon

17
<PAGE>

certain  assumptions about the likelihood of future events,  and there can be no
assurance  that any design will succeed in achieving  its stated goals under all
potential future conditions, regardless of how remote.

        There were no significant  changes in the Company's internal controls or
in other factors during the last quarter of 2006 that have materially  affected,
or are reasonably likely to materially  affect,  the Company's internal controls
over financial reporting.

ITEM 9B. OTHER INFORMATION

None

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<PAGE>

                                    PART III

        Certain  information  required by Part III is  incorporated by reference
from the Company's  definitive  Proxy  Statement to be filed with the Securities
and Exchange  Commission in connection with the  solicitation of proxies for the
Company's 2007 Annual Meeting of Shareholders (the "Proxy Statement").

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

        The information  required by this item is incorporated by reference from
the table of directors in the Proxy  Statement  and from  information  under the
heading "Corporate Governance."

ITEM 11. EXECUTIVE COMPENSATION.

        The information  required by this item is incorporated by reference from
the Proxy  Statement,  including all  information  under the caption  "Executive
Compensation ."

ITEM 12. SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT  AND
         RELATED STOCKHOLDER MATTERS.

        The information  required by this item is incorporated by reference from
the  Proxy  Statement,  including  information  under  the  captions  "Principal
Shareholders" and "Stock Ownership of Management."

ITEM  13.  CERTAIN   RELATIONSHIPS  AND  RELATED   TRANSACTIONS,   AND  DIRECTOR
           INDEPENDENCE.

        The information  required by this item is incorporated by reference from
the Proxy Statement,  including all information under the subheadings  "Director
Independence" and "Transactions with Management."

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

        The information  required by this item is incorporated by reference from
the Proxy Statement,  including all information under the subheading  "Principal
Accountant Fees and Services."

19
<PAGE>

                                     PART IV

ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

        (a)     (1)

        The following financial statements of the Company included in the Annual
Report to  Shareholders  for the year ended  December  31,  2006,  are filed and
incorporated by reference in Item 8 of this report

                (i)     Report of Independent Registered Public Accounting Firm,
                        dated March 26 2007.
                (ii)    Consolidated Balance Sheet, December 31, 2006 and 2005.
                (iii)   Consolidated  Statement of Income:  Years ended December
                        31, 2006, 2005 and 2004.
                (iv)    Consolidated   Statement  of  Changes  in  Shareholders'
                        Equity: Years ended December 31, 2006, 2005 and 2004.
                (v)     Consolidated   Statement  of  Cash  Flows:  Years  ended
                        December 31, 2006, 2005 and 2004.
                (vi)    Notes to Consolidated Financial Statements.

        (2)     All Schedules have been omitted  because they are not applicable
                or not  required or because the  information  is included in the
                financial statements or the notes thereto or is not material.

        (3)     Exhibits  filed  with  this  report  are  listed in the Index to
                Exhibits below, which is incorporated herein by reference.

        (b)     The  Exhibits  listed  on the  Index of  Exhibits  are filed and
        incorporated here by reference.

        (c)     All Schedules have been omitted  because they are not applicable
        or not required, or because the information is included in the financial
        statements or the notes thereto or is not material.

20
<PAGE>

                                   SIGNATURES

        Pursuant to the  requirements  of Section 13 of the Securities  Exchange
Act of 1934,  the Company has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.

Date:    March 29, 2007                   PACIFIC STATE BANCORP


                                          By: /s/  Steven A. Rosso
                                              ----------------------------------
                                              Steven A. Rosso
                                              President/Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities and on the dates indicated.

Date:    March 29, 2007                   By: /s/  Steven A. Rosso
                                              ----------------------------------
                                              Steven A. Rosso
                                              President and Chief Executive
                                              Officer Director

Date:    March 29, 2007                   By: /s/  JoAnne Roberts
                                              ----------------------------------
                                              JoAnne Roberts
                                              Vice President/CFO
                                              (Principal Financial Officer)
                                              (Principal Accounting Officer)

Date:    March 29, 2007                   By: /s/  Michael L. Dalton
                                              ----------------------------------
                                              Michael L. Dalton
                                              Director and Vice Chairman
                                              Chairman of the Audit Committee

Date:    March 29, 2007                   By: /s/  Harold Hand
                                              ----------------------------------
                                              Harold Hand
                                              Director and Chairman of the Board

Date:    March 29, 2007                   By: /s/  Patricia A. Hatton
                                              ----------------------------------
                                              Patricia A. Hatton
                                              Director and Chairperson of the
                                              Director Loan Committee

Date:    March 29, 2007                   By: /s/  Steven J. Kikuchi
                                              ----------------------------------
                                              Steven J. Kikuchi
                                              Director and Secretary of the
                                              Board

Date:    March 29, 2007                   By: /s/  Maxwell Freeman
                                              ----------------------------------
                                              Maxwell Freeman
                                              Director

Date:    March 29, 2007                   By: /s/  Yoshikazu Mataga
                                              ----------------------------------
                                              Yoshikazu Mataga
                                              Director

21
<PAGE>

Date:    March 29, 2007                   By: /s/ Gary A. Stewart
                                              ----------------------------------
                                              Gary A. Stewart
                                              Executive Vice President/CLO
                                              Director

Date:    March 29, 2007                   By: /s/ Kathleen Verner
                                              ----------------------------------
                                              Kathleen Verner
                                              Director

Date:    March 29, 2007                   By: /s/ Russell G. Munson
                                              ----------------------------------
                                              Russell G. Munson
                                              Director

22
<PAGE>

                              LIST OF EXHIBITS

3.1     Articles of  Incorporation,  as amended.  Incorporated by reference from
        Exhibit  3.1  filed  with the  Company's  Form  10-K for the year  ended
        December 31, 2004.
3.2     Bylaws.  Incorporated  by  reference  from  Exhibit  3.2 filed  with the
        Company's  Registration  Statement  No.  333-84908  on Form  S-4EF  (the
        "S-4").
4       Agreement  to file copy of  Indenture  for the  Company's  $5 Million of
        Floating Rate Junior  Subordinated  Deferrable  Interest  Debentures due
        2032  issued  to  Pacific  State  Statutory  Trust  I.  Incorporated  by
        reference  from the Company's  Form 10-K for the year ended December 31,
        2002.
4.1     Agreement to file copy of Indenture  for the  Company's  $3.5 Million of
        Floating Rate Junior  Subordinated  Deferrable  Interest  Debentures due
        2034  issued  to  Pacific  State  Statutory  Trust II.  Incorporated  by
        reference  from the Company's  Form 10-K for the year ended December 31,
        2003.
10.1    Lease Agreement for Main Office.  Incorporated by reference from Exhibit
        10.1 filed with the S-4.
10.2    Lease Agreement for Lodi Office.  Incorporated by reference from Exhibit
        10.2 to the  Company's  Form 10-K for the year ended  December  31, 2005
        (the "2005 10-K").
10.3    Lease  Agreement,  Tracy Branch Office.  Incorporated  by reference from
        Exhibit 10.3 filed with the S-4.
10.4*   Employment   Agreement   (Steven  A.  Rosso)  dated  October  20,  2005.
        Incorporated by reference from Exhibit 10.4 to the 2005 10-K.
10.5.1* Form of Salary  Continuation  Agreement.  Incorporated by reference from
        Exhibit 10.5.1 to the 2005 10-K .
10.5.2* Form of Split Dollar  Agreement.  Incorporated by reference from Exhibit
        10.5.2 to the 2005 10-K .
10.6*   1997 Stock Option  Plan.  Incorporated  by  reference  from Exhibit 10.6
        filed with the Company's Quarterly Report on Form 10-Q for the quarterly
        period ending September 30, 2003.
13      The  portions  of the  Pacific  State  Bancorp  2006  Annual  Report  to
        Shareholders  which have been  incorporated  by  reference  in Items 5-8
        herein are filed with the Commission.
21      List of Subsidiaries
23      Consent of Independent Registered Public Accounting Firm
31.1    Certification   of  the  Chief   Executive   Officer   (section  302  of
        Sarbanes-Oxley Act).
31.2    Certification   of  the  Chief   Financial   Officer   (section  302  of
        Sarbanes-Oxley Act).
32.1    Certification of Chief Executive  Officer pursuant to section 906 of the
        Sarbanes-Oxley Act.
32.2    Certification of Chief Financial  Officer pursuant to section 906 of the
        Sarbanes-Oxley Act
*        Denotes management contract or compensatory arrangement

23
<PAGE>

EXHIBIT 13

Dear Shareholder, Customers and Friends:

In looking back over the 2006 calendar  year Pacific State Bancorp  exceeded the
expectations  of  management  and the many  financial  experts.  We believe that
PSBC's  continued  efforts of controlled  growth and sound risk  management will
enable our company's  success to continue in 2007. The company's efforts towards
branding  and branch  development  contributed  to much of our asset  growth and
financial  success in 2006. In reviewing 2006 performance  Pacific State Bancorp
achieved   the   following;    an   increase   in   market   capitalization   of
$79,601,000.00with  a closing  stock  price of  $21.74.  PSBC also  produced  an
average return on equity of 22.91%,  an average  return on assets of 1.67%%,  an
efficiency ratio of 53.05% and maintained a net interest margin of 5.76%.

Pacific State  Bancorp was able to attain the above  referenced  performance  by
growing assets to  $386,752,000  or a 24.92%  increase over 2005. As well,  PSBC
posted  net  income of  $5,543,000  which is an  increase  of  29.33%  over 2005
earnings.  Management  was able to provide  this type of  financial  performance
while opening a new branch in Lodi,  California  and moving the loan center from
Castro Valley to Hayward,  California. In addition substantial improvements were
made to the  infrastructure  of the bank's management  information  system which
improved  PSB-Online  and the overall  information  technologies  security.  The
bank's decision to improve the information technology also enabled management to
upgrade asset pricing models and enterprise wide risk monitoring.

Other very important  financial  performance  numbers that are most relevant are
the basic earnings per share and diluted  earnings per share for 2006. The basic
earnings per share amounted to $1.57 which was an increase of $0.34 per share or
27.64% over the 2005 eps. The diluted  earnings per share for the year are $1.41
it is an increase of $0.31 per share or 28.82% above 2006 eps. In addition it is
worth  noting that these  earnings  figures  were gained by  maintaining  strong
credit standards.  2007 closed as the fourth  consecutive year in which the bank
had zero non-performing assets/loans on our balance sheet.

With the  opening  of the Lodi  branch  Pacific  State  bank now  operates  in 9
locations,  8 cities and 5 counties. The management of Pacific State Bancorp and
Pacific  State  Bank  looks to grow the  institution  with in the foot print the
current  branch  system.  The  markets  that our bank serves are very strong and
dynamic.  Management continues to remain positive about the communities we serve
and the  customer  relations  we  have  earned.  In  closing  the  directorship,
management,  and staffs of Pacific  State  Bancorp and Pacific  State Bank would
like to express our extreme  gratitude to our  customers  and  shareholders  for
their continued support and brand loyalty.

Looking at 20 years and more!

/s/ Harold Hand                               /s/ Steven A. Rosso
----------------------------------            ----------------------------------
Harold Hand                                   Steven A. Rosso
Chairman of the Board of Directors            President and C. E. O.

24
<PAGE>

                             SELECTED FINANCIAL DATA

        The  information  set forth  below  should be read in  conjunction  with
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operation" and the Company's audited consolidated financial statements and notes
thereto, included elsewhere in this report.

<TABLE>
<CAPTION>
                                                                        YEAR ENDED DECEMBER 31,
                                                 -----------------------------------------------------------------------
(dollars in thousands, except per share data)       2006           2005           2004           2003           2002
----------------------------------------------   -----------    -----------    -----------    -----------    -----------
<S>                                              <C>            <C>            <C>            <C>            <C>
STATEMENTS OF INCOME:
Total Interest Income                            $    26,495    $    18,782    $    13,509    $    11,117    $     9,236
Net Interest Income                                   17,307         13,536         10,451          8,356          6,289
Provision for Loan Losses                                360             35            504            536            286
Total Non-interest Income                              2,583          2,481          2,525          1,978          1,636
Total Non-interest Expenses                           10,360          9,100          7,429          6,498          5,846
Provision for Income Taxes                             3,627          2,596          1,874          1,247            630
Net Income                                             5,543          4,286          3,169          2,053          1,163

BALANCE SHEETS:
Total Assets                                     $   386,752    $   309,611    $   254,361    $   200,924    $   180,295
Total Investments                                     23,107         28,539         23,582         15,512         12,173
Total Loans, net                                     287,318        241,556        199,535        157,138        135,272
Allowance for Loan Losses (ALL)                        2,478          2,356          2,214          1,653          1,306
Total Deposits                                       340,966        273,074        223,761        176,292        158,140
Subordinated Debentures                                8,764          8,764          8,764          5,155          5,155
Shareholders' Equity                                  29,059         21,373         16,830         13,459         11,320

PERFORMANCE RATIOS:
Return on Average Assets                                1.67%          1.53%          1.37%          1.07%          0.77%
Return on Average Equity                               22.91%         22.98%         21.64%         16.86%         11.27%
Average Equity to Average Assets                        7.30%          6.65%          6.34%          6.36%          6.80%
Tier 1 Risk-Based Capital                              10.65%         10.44%         10.10%         10.10%          9.40%
Total Risk-Based Capital                               11.83%         11.88%         12.60%         11.60%         11.40%
Net Interest Margin                                     5.76%          5.41%          5.14%          4.85%          4.63%
Average Earning Assets to Average Total Assets         93.33%         89.22%         88.18%         89.85%         89.48%
Nonperforming Assets to Total Assets                      --             --             --             --           0.48%
ALL to Total Loans                                      0.86%          0.98%          1.10%          1.05%          0.97%
Nonperforming Loans to ALL                                --             --             --             --          15.54%
Share Data (Common Shares Outstanding)             3,661,477      3,512,622      3,448,042      3,377,656      3,302,748
Book Value Per Share                             $      7.94    $      6.08    $      4.88    $      3.99    $      3.43
Basic Earnings Per Share                         $      1.57    $      1.23    $      0.92    $      0.61    $      0.36
Diluted Earnings Per Share                       $      1.41    $      1.10    $      0.84    $      0.59    $      0.34
</TABLE>

25

<PAGE>

[LOGO OF PERRY-SMITH LLP]                           400 Capitol Mail, Suite 1200
      (ACCOUNTANTS)                                         Sacramento, CA 95814
                                                             www.perry-smith.com
                                                                    916.441.1000

            REPORT OF INDENPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Shareholders and Board of Directors
Pacific State Bancorp and Subsidiary

        We have audited the accompanying  consolidated  balance sheet of Pacific
State  Bancorp and  subsidiary  as of December 31, 2006 and 2005 and the related
consolidated  statements  of income,  changes in  shareholders'  equity and cash
flows for each of the years in the  three-years  period ended December 31, 2006.
These consolidated  financial statements are the responsibility of the Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audits.

        We conducted our audits in  accordance  with the standards of the Public
Company  Accounting  Oversigned Board (United States).  Those standards  require
that we plan and perform the audits to obtain reasonable assurance about whether
the  consolidated  financial  statements are free of material  misstatement.  An
audit includes examining,  on a test basis,  evidence supporting the amounts and
disclosures in the consolidated  financial  statements.  An audit also including
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated  financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Pacific State Bancorp and  subsidiary as of December 31, 2006 and 2005,  and the
consolidated  results of their  operations  and their cash flows for each of the
years in the  three-year  period ended  December 31, 2006,  in  conformity  with
accounting principles generally accepted in the United States of America.

                                                             /s/ Perry-Smith LLP

March 29, 2007

26
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEET

                           December 31, 2006 and 2005
                      (In thousands, except share amounts)

<TABLE>
<CAPTION>
                                                           2006          2005
                                                        ----------    ----------
<S>                                                     <C>           <C>
                     ASSETS
Cash and due from banks                                 $   18,985    $   14,453
Federal funds sold                                          31,630         4,667
                                                        ----------    ----------
       Total cash and cash equivalents                      50,615        19,120

Investment securities (Notes 3 and 7)                       23,107        28,539
Loans, less allowance for loan losses of $2,478 in
   2006 and $2,356 in 2005 (Notes 4, 7, 10 and 13)         287,318       241,556
Premises and equipment, net (Note 5)                        11,957         9,511
Company owned life insurance (Note 14)                       6,079         4,411
Accrued interest receivable and other assets (Note 9)        7,676         6,474
                                                        ----------    ----------
       Total assets                                     $  386,752    $  309,611
                                                        ==========    ==========
                 LIABILITIES AND
              SHAREHOLDERS' EQUITY

Deposits:
   Non-interest bearing                                 $   73,197    $   68,657
   Interest bearing (Note 6)                               267,799       204,417
                                                        ----------    ----------
       Total deposits                                      340,996       273,074

Other borrowings (Note 7)                                    4,900         4,000
Subordinated debentures (Note 8)                             8,764         8,764
Accrued interest payable and other liabilities               3,033         2,400
                                                        ----------    ----------
         Total liabilities                                 357,693       288,238
                                                        ----------    ----------
Commitments and contingencies (Note 10)

Shareholders' equity (Note 11):
   Preferred stock - 2,000,000 shares
     authorized; none issued or outstanding                      -             -
   Common stock - no par value; 24,000,000 shares
     authorized; issued and outstanding -3,661,477
     shares in 2006 and 3,512,622 shares in 2005             9,651         7,556
   Retained earnings                                        19,455        13,912
   Accumulated other comprehensive loss, net of
     taxes (Notes 3 and 15)                                    (47)          (95)
                                                        ----------    ----------
       Total shareholders' equity                           29,059        21,373
                                                        ----------    ----------
       Total liabilities and shareholders' equity       $  386,752    $  309,611
                                                        ==========    ==========
</TABLE>

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

27
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                        CONSOLIDATED STATEMENT OF INCOME

              For the Years Ended December 31, 2006, 2005 and 2004
                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                        2006         2005         2004
                                                     ----------   ----------   ----------
<S>                                                  <C>          <C>          <C>
Interest income:

   Interest and fees on loans                        $   24,901   $   17,565   $   12,846
   Interest on Federal funds sold                           273          354           93
   Interest on investment securities:
     Taxable                                                 22          712          395
     Exempt from Federal income taxes                     1,299          151          175
                                                     ----------   ----------   ----------
         Total interest income                           26,495       18,782       13,509
                                                     ----------   ----------   ----------
Interest expense:
   Interest on deposits (Note 6)                          8,102        4,610        2,564
   Interest on borrowings (Note 7)                          376          109          128
   Interest on subordinated debentures (Note 8)             710          527          366
                                                     ----------   ----------   ----------
         Total interest expense                           9,188        5,246        3,058
                                                     ----------   ----------   ----------
         Net interest income before provision for
           loan losses                                   17,307       13,536       10,451

Provision for loan losses (Note 4)                          360           35          504
                                                     ----------   ----------   ----------
         Net interest income after provision
           for loan losses                               16,947       13,501        9,947
                                                     ----------   ----------   ----------
Non-interest income:
   Service charges                                          864          758        1,075
   Gain on sale of loans                                    294          809          445
   Other income                                           1,425          914        1,005
                                                     ----------   ----------   ----------
         Total non-interest income                        2,583        2,481        2,525
                                                     ----------   ----------   ----------
Non-interest expenses:
   Salaries and employee benefits (Notes 4 and 14)        5,479        4,742        3,814
   Occupancy (Notes 5 and 10)                               980          782          750
   Furniture and equipment (Notes 5 and 10)                 672          664          468
   Other expenses (Note 12)                               3,229        2,912        2,397
                                                     ----------   ----------   ----------
         Total non-interest expenses                     10,360        9,100        7,429
                                                     ----------   ----------   ----------
         Income before provision for income taxes         9,170        6,882        5,043

Provision for income taxes (Note 9)                       3,627        2,596        1,874
                                                     ----------   ----------   ----------
         Net income                                  $    5,543   $    4,286   $    3,169
                                                     ==========   ==========   ==========
Basic earnings per share (Note 11)                   $     1.57   $     1.23   $     0.92
                                                     ==========   ==========   ==========
Diluted earnings per share (Note 11)                 $     1.41   $     1.10   $     0.84
                                                     ==========   ==========   ==========
</TABLE>
                     The accompanying notes are an integral
                part of these consolidated financial statements.

28
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

            CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

              For the Years Ended December 31, 2006, 2005 and 2004
               (In thousands, except share and per share amounts)

<TABLE>
<CAPTION>
                                                                                               ACCUMULATED
                                                                                                   OTHER
                                                                                               COMPREHENSIVE
                                                       COMMON STOCK                               (LOSS)           TOTAL
                                               ----------------------------      RETAINED       INCOME (NET     SHAREHOLDERS'
                                                  SHARES          AMOUNT         EARNINGS        OF TAXES)         EQUITY
                                               ------------    ------------    ------------    -------------    -------------
<S>                                               <C>          <C>             <C>             <C>              <C>
Balance, January 1, 2004                          3,377,656    $      6,937    $      6,457    $          65    $      13,459

Net income                                                                            3,169                             3,169
Net change in unrealized gains on
   available-for-sale investment securities,
   net of tax                                                                                            (20)            (20)
Stock options exercised and related tax
   benefit (Note 11)                                 70,386             222                                               222
                                               ------------    ------------    ------------    -------------    -------------
Balance, December 31, 2004                        3,448,042           7,159           9,626               45           16,830

Net income                                                                            4,286                             4,286
Net change in unrealized gains (losses) on
   available-for-sale investment securities,
   net of tax                                                                                           (140)           (140)
Stock options exercised and related tax
   benefit (Note 11)                                 65,760             409                                               409
Repurchase and retirement of
   common stock                                      (1,180)            (12)                                              (12)
                                               ------------    ------------    ------------    -------------    -------------
Balance, December 31, 2005                        3,512,622           7,556          13,912              (95)          21,373

Net income                                                                            5,543                             5,543
Net change in unrealized losses on
   available-for-sale investment securities,
   net of tax                                                                                             48              48
Stock-based compensation expense                                        229                                               229
Stock options exercised and related tax
   benefit (Note 11)                                135,421           1,616                                             1,616
Proceeds from issuance of stock                      13,434             250                                               250
                                               ------------    ------------    ------------    -------------    -------------
Balance, December 31, 2006                        3,661,477    $      9,651    $     19,455    $         (47)   $      29,059
                                               ============    ============    ============    =============    =============
</TABLE>

<TABLE>
<CAPTION>
                                                                                   2006             2005             2004
                                                                               ------------    -------------    -------------
<S>                                                                            <C>             <C>              <C>
Comprehensive income (Note 15):
   Net income                                                                  $      5,543    $       4,286    $       3,169
                                                                               ------------    -------------    -------------
   Other comprehensive income (loss):
     Unrealized holding (losses) gains
       arising during the year, net of tax                                               48             (140)             (20)
     Less: reclassification adjustment
       for gains included in net
       income, net of tax                                                      ------------    -------------    -------------
         Net change in unrealized
           gains on available-for-sale
           investment securities                                                         48             (140)             (20)
                                                                               ------------    -------------    -------------
         Total comprehensive income                                            $      5,591    $       4,146    $      3,149
                                                                               ============    =============    =============
</TABLE>

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

29
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                      CONSOLIDATED STATEMENT OF CASH FLOWS

              For the Years Ended December 31, 2006, 2005 and 2004
                                 (In thousands)

<TABLE>
<CAPTION>
                                                          2006          2005          2004
                                                       ----------    ----------    ----------
<S>                                                    <C>           <C>           <C>
Cash flows from operating activities:
   Net income                                          $    5,543    $    4,286    $    3,169
   Adjustments to reconcile net income to net
     cash provided by operating activities:
       Provision for loan losses                              360            35           504
       Net decrease(increase) in deferred loan
         origination costs                                    173           (14)           85
       Depreciation and amortization                          404           600           567
       Gain on sale of loans, net                            (294)         (809)         (445)
       Stock-based compensation expense                       229
       Tax benefit from exercise of options                  (736)          (79)          (39)
       Increase in Company owned life insurance,
         net                                                 (208)         (165)         (188)
       Increase in accrued interest
         receivable and other assets                         (392)       (1,094)         (198)
       Increase (decrease) in accrued interest
         payable and other liabilities                        418         1,394           (12)
       Benefit (provision) for deferred income taxes           12          (131)         (230)
                                                       ----------    ----------    ----------
           Net cash provided by operating
              Activities                                    5,509         4,023         3,213
                                                       ----------    ----------    ----------
Cash flows from investing activities:
   Net decrease (increase) in interest-bearing
     deposits in banks                                                    6,100        (2,100)
   Purchases of available-for-sale investment
     securities                                           (11,257)      (13,992)      (14,352)
   Proceeds from matured and called available-
     for-sale investment securities                        16,364         1,800         7,374
   Proceeds from principal repayments from
     available-for-sale government-guaranteed
     mortgage-backed securities                               696           979           984
   Proceeds from matured and called held-to-maturity
     investment securities                                     26
   Proceeds from principal repayments from
     held-to-maturity government-guarantee
     mortgage-backed securities                                23            21            36
   Purchase of FRB and FHLB stock                            (180)         (405)
   Net increase in loans                                  (45,786)      (41,233)      (44,194)
   Purchases of premises and equipment                     (3,128)         (396)       (1,521)
   Purchase of Company owned life insurance                (1,460)
                                                       ----------    ----------    ----------
           Net cash used in investing activities          (44,702)      (46,721)      (54,178)
                                                       ----------    ----------    ----------
</TABLE>

                                   (Continued)

30
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                   (Continued)
              For the Years Ended December 31, 2006, 2005 and 2004
                                 (In thousands)

<TABLE>
<CAPTION>
                                                          2006          2005          2004
                                                       ----------    ----------    ----------
<S>                                                    <C>           <C>           <C>
Cash flows from financing activities:
   Net (decrease) increase in demand,
     interest-bearing and savings deposits             $  (13,262)   $   26,861    $   54,438
   Net increase (decrease) in time deposits                81,184        22,452        (6,969)
   Proceeds from exercise of stock options                    880           330           183
   Tax benefit from exercise of stock options                 736            79            39
   Share repurchase and retirement                                          (12)
   Proceeds from the issuance of mandatorily
     redeemable trust preferred securities                                              3,609
   Proceeds from stock issuance                               250
   Net increase (decrease) in short-term borrowings           900                      (1,000)
                                                       ----------    ----------    ----------
           Net cash provided by financing
              Activities                                   70,688        49,710        50,300
                                                       ----------    ----------    ----------
           Increase (decrease) in cash and cash
              equivalents                                  31,495         7,012          (665)

Cash and cash equivalents at beginning of year             19,120        12,108        12,773
                                                       ----------    ----------    ----------
Cash and cash equivalents at end of year               $   50,615    $   19,120    $   12,108
                                                       ==========    ==========    ==========

Supplemental disclosure of cash flow information:

   Cash paid during the year for:
     Interest expense                                  $   10,475    $    4,773    $    3,083
     Income taxes                                      $    3,805    $    2,081    $    1,845

Non-cash investing activities:
   Net change in unrealized loss on available-
     for-sale investment securities                            78    $     (232)   $      (26)
</TABLE>

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

31
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.      NATURE OF OPERATIONS

        On June 24, 2002, Pacific State Bancorp ("Bancorp") commenced operations
        as a bank holding company by acquiring all of the outstanding  shares of
        Pacific   State   Bank   ("Bank")   in  a  one  bank   holding   company
        reorganization.  This  corporate  structure  gives  Bancorp and the Bank
        greater   flexibility   in   terms   of   operation,    expansion,   and
        diversification.

        Pacific State  Bancorp's  subsidiaries  include the Bank, in addition to
        Pacific State  Statutory  Trust I and Pacific State  Statutory Trust II,
        both of which are  unconsolidated  Delaware  statutory  business  trusts
        formed in June  2002 and March  2004,  respectively,  for the  exclusive
        purpose of issuing and selling trust  preferred  securities  and holding
        subordinated  debentures  issued  by  Bancorp.  The  proceeds  from  the
        issuance of  subordinated  debentures  in 2004 and 2002 were utilized by
        Bancorp  to  provide  capital  to the  Bank  and for  general  corporate
        purposes.

        The   Bank   commenced   operations   in  1987   and  is  a   California
        state-chartered  member bank of the  Federal  Reserve  System.  The Bank
        operates nine branches in California, including two branches in Stockton
        and branches in Modesto, Groveland, Arnold, Angels Camp, Tracy, Lodi and
        one limited  service  branch in Hayward.  The Bank's  primary  source of
        revenue is providing loans to customers who are predominately  small and
        middle-market businesses and individuals.

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        The accounting  and reporting  policies of Pacific State Bancorp and its
        subsidiary   (collectively,   the  "Company")  conform  with  accounting
        principles  generally  accepted  in the  United  States  and  prevailing
        practice  within the banking  industry.  The more  significant  of these
        policies  applied in the  preparation of the  accompanying  consolidated
        financial statements are discussed below.

        Principles of Consolidation

        The accompanying  consolidated financial statements include the accounts
        of the  Company and its  wholly-owned  subsidiary,  Pacific  State Bank.
        Significant intercompany  transactions and balances have been eliminated
        in  consolidation.  For  financial  reporting  purposes,  the  Company's
        investment in Pacific  State  Statutory  Trusts I and II ("Trusts")  are
        accounted  for under the  equity  method  and are  included  in  accrued
        interest receivable and other assets in the consolidated  balance sheet.
        The  subordinated  debentures  issued and  guaranteed by the Company and
        held by the  Trusts  are  included  as  subordinated  debentures  in the
        consolidated balance sheet.

        Segment Information

        Management has determined  that because all of the banking  products and
        services  offered by the  Company  are  available  in each branch of the
        Bank, all branches are located within the same economic  environment and
        management  does not  allocate  resources  based on the  performance  of
        different  lending  or  transaction  activities,  it is  appropriate  to
        aggregate  the Bank  branches  and  report  them as a  single  operating
        segment.  No customer  accounts for more than 10 percent of revenues for
        the Company or the Bank.

        Stock Splits

        On  September  16, 2004,  the  Company's  Board of Directors  approved a
        two-for-one  split of  outstanding  shares at the close of  business  on
        September 30, 2004,  effective on the same date. All shares outstanding,
        stock option and per share data in the consolidated financial statements
        have been retroactively restated to give effect to the stock split.

32
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Use of Estimates

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

        Reclassifications

        Certain  reclassifications  have been made to prior  years'  balances to
        conform to classifications used in 2006.

        Cash and Cash Equivalents

        For the purpose of the statement of cash flows, cash, due from banks and
        Federal  funds sold are  considered to be cash  equivalents.  Generally,
        Federal funds are sold for one-day periods.

        Investment Securities

        Investment securities are classified into the following categories:

                o       Available-for-sale  securities,  reported at fair value,
                        with unrealized  gains and losses excluded from earnings
                        and  reported,   net  of  taxes,  as  accumulated  other
                        comprehensive income (loss) within shareholders' equity.

                o       Held-to-maturity  securities,  which  management has the
                        positive   intent  and  ability  to  hold  to  maturity,
                        reported at amortized  cost,  adjusted for the accretion
                        of discounts and amortization of premiums.

        Management determines the appropriate  classification of its investments
        at the  time of  purchase  and may only  change  the  classification  in
        certain limited circumstances.  The Company did not have any investments
        classified  as trading  at  December  31,  2006 or 2005.  All  transfers
        between  categories  are  accounted  for at fair  value.  There  were no
        transfers between categories in 2006 or 2005.

        Gains or losses on the sale of investment securities are computed on the
        specific identification method. Interest earned on investment securities
        is  reported in  interest  income,  net of  applicable  adjustments  for
        accretion of discounts and amortization of premiums.

        Investment  securities  are  evaluated  for  impairment  on at  least  a
        quarterly basis and more  frequently when economic or market  conditions
        warrant such an evaluation to determine whether a decline in their value
        is  other  than  temporary.  Management  utilizes  criteria  such as the
        magnitude  and duration of the decline and the intent and ability of the
        Company to retain its  investment in the securities for a period of time
        sufficient  to allow  for an  anticipated  recovery  in fair  value,  in
        addition to the reasons underlying the decline, to determine whether the
        loss in value is other than  temporary.  The term "other than temporary"
        is not intended to indicate that the decline is permanent, but indicates
        that the prospects for a near-term  recovery of value is not necessarily
        favorable,  or that there is a lack of evidence to support a  realizable
        value equal to or greater  than the  carrying  value of the  investment.
        Once a decline in value is  determined to be other than  temporary,  the
        value of the security is reduced and a corresponding  charge to earnings
        is recognized.

33
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Investment Securities (Continued)

        As a member of the Federal  Reserve  System,  the Federal Home Loan Bank
        System  and the  Farmer  Mac  Home  Administration  System,  the Bank is
        required to maintain an investment  in restricted  capital stock of each
        system.  These investments are carried at cost and are redeemable at par
        and are included in accrued interest  receivable and other assets in the
        consolidated balance sheet.

        Loans

        Loans are stated at principal balances outstanding.  Interest is accrued
        daily  based upon  outstanding  loan  balances.  However,  when,  in the
        opinion of  management,  loans are  considered  to be  impaired  and the
        future  collectability  of interest and  principal is in serious  doubt,
        loans are placed on nonaccrual status and the accrual of interest income
        is suspended. Any interest accrued but unpaid is charged against income.
        Payments  received  are  applied  to  reduce  principal  to  the  extent
        necessary to ensure collection.  Subsequent  payments on these loans, or
        payments   received  on   nonaccrual   loans  for  which  the   ultimate
        collectability of principal is not in doubt, are applied first to earned
        but unpaid interest and then to principal.

        An  impaired  loan is measured  based on the  present  value of expected
        future cash flows discounted at the loan's  effective  interest rate or,
        as a practical matter, at the loan's observable market price or the fair
        value of  collateral  if the  loan is  collateral  dependent.  A loan is
        considered impaired when, based on current information and events, it is
        probable  that the  Company  will be unable to collect  all  amounts due
        (including   both  principal  and  interest)  in  accordance   with  the
        contractual  terms of the loan  agreement.  Interest  income on impaired
        loans, if appropriate, is recognized on a cash basis.

        Loan origination  fees,  commitment fees,  direct loan origination costs
        and purchase premiums and discounts on loans are deferred and recognized
        as an  adjustment of yield,  and  amortized to interest  income over the
        contractual  term of the loan. The unamortized  balance of deferred fees
        and costs is reported as a component of net loans.

        The  Company  may  purchase  loans or acquire  loans  through a business
        combination for which  differences  exist between the  contractual  cash
        flows and the cash flows expected to be collected due, at least in part,
        to credit quality.  When the Company acquires such loans, the yield that
        may be  accreted  (accretable  yield) is  limited  to the  excess of the
        Company's  estimate of undiscounted  cash flows expected to be collected
        over the  Company's  initial  investment  in the  loan.  The  excess  of
        contractual  cash flows over cash flows expected to be collected may not
        be recognized as an adjustment to yield, loss, or a valuation allowance.
        Subsequent  increases in cash flows  expected to be collected  generally
        should be  recognized  prospectively  through  adjustment  of the loan's
        yield over its remaining  life.  Decreases in cash flows  expected to be
        collected  should be  recognized as an  impairment.  The Company may not
        "carry over" or create a valuation  allowance in the initial  accounting
        for loans  acquired  under these  circumstances.  At December  31, 2006,
        there were no such loans being accounted for under this policy.

        Loan Sales and Servicing

        The Company  accounts for the transfer and servicing of financial assets
        based on the financial and servicing  assets it controls and liabilities
        it has  incurred,  derecognizes  financial  assets when control has been
        surrendered and derecognizes liabilities when extinguished.

34
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Loan Sales and Servicing (Continued)

        Government Guaranteed Loans

        Included in the loan portfolio are loans which are 75% to 90% guaranteed
        by the Small Business Administration (SBA), Farmer Mac and USDA Business
        and  Industry.  The  guaranteed  portion of these loans may be sold to a
        third party,  with the Company retaining the unguaranteed  portion.  The
        Company generally  receives a premium in excess of the adjusted carrying
        value of the loan at the time of sale.  The  Company  may be required to
        refund a portion  of the  sales  premium  if the  borrower  defaults  or
        prepays within ninety days of the settlement date. At December 31, 2006,
        there were no premiums subject to these recourse provisions.

        The Company's  investment in the loan is allocated  between the retained
        portion  of the  loan,  the  servicing  asset  (liability)  and the sold
        portion of the loan based on their  relative fair values on the date the
        loan is sold.  The gain on the sold portion of the loan is recognized as
        income at the time of sale. The carrying  value of the retained  portion
        of the loan is discounted  based on the estimated  value of a comparable
        non-guaranteed  loan. The servicing asset  (liability) is recognized and
        amortized  over the  estimated  life of the  related  loan.  Significant
        future  prepayments  of these  loans will result in the  recognition  of
        additional amortization of related servicing assets (liabilities).

        The Company  serviced  government-guaranteed  loans for others  totaling
        $47,285,000   and   $48,030,000   as  of  December  31,  2006  and  2005
        respectively.

        Servicing Rights

        Servicing rights acquired through 1) a purchase or 2) the origination of
        loans which are sold with  servicing  rights  retained are recognized as
        separate  assets or  liabilities.  Servicing  assets or liabilities  are
        recorded at the difference  between the  contractual  servicing fees and
        adequate compensation for performing the servicing, and are subsequently
        amortized  in  proportion  to and over the  period  of the  related  net
        servicing income or expense. Servicing assets are periodically evaluated
        for  impairment.  Servicing  rights were not significant at December 31,
        2006 and 2005.

        Allowance for Loan Losses

        The  allowance  for loan  losses is  maintained  to  provide  for losses
        related to impaired loans and other losses that can be expected to occur
        in the normal course of business.  The determination of the allowance is
        based on estimates made by management,  to include  consideration of the
        character of the loan portfolio,  specifically identified problem loans,
        potential  losses  inherent in the portfolio taken as whole and economic
        conditions in the Company's service area.

        Classified  loans and loans  determined to be impaired are  individually
        evaluated by management for specific risk of loss. In addition,  reserve
        factors are assigned to currently performing loans based on management's
        assessment of the following for each  identified loan type: (1) inherent
        credit risk,  (2)  historical  losses and, (3) where the Company has not
        experienced  losses,  the loss experience of peer banks. These estimates
        are particularly  susceptible to changes in the economic environment and
        market conditions.

        The Bank's Loan Committee reviews the adequacy of the allowance for loan
        losses at least  quarterly,  to include  consideration  of the  relative
        risks  in the  portfolio  and  current  economic  conditions  and  other
        factors.  The  allowance  is  adjusted  based on that  review if, in the
        judgment of the Loan Committee and management, changes are warranted.

35
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Allowance for Loan Losses (Continued)

        This allowance is established  through a provision for loan losses which
        is charged to  expense.  Additions  to the  allowance  are  expected  to
        maintain the adequacy of the total  allowance  after net charge-offs and
        loan  growth.  The  allowance  for loan losses at December  31, 2006 and
        2005, respectively, reflects management's estimate of probable losses in
        the portfolio.

        Other Real Estate

        Other real  estate  includes  real  estate  acquired  in full or partial
        settlement of loan obligations. When property is acquired, any excess of
        the  Company's  recorded  investment  in the loan  balance  and  accrued
        interest  income over the  estimated  fair market value of the property,
        net of estimated  selling  costs,  is charged  against the allowance for
        loan losses.  A valuation  allowance  for losses on other real estate is
        maintained to provide for temporary  declines in value. The allowance is
        established through a provision for losses on other real estate which is
        included  in other  expenses.  Subsequent  gains or  losses  on sales or
        writedowns  resulting from permanent  impairments  are recorded in other
        income or  expenses as  incurred.  At  December  31, 2006 and 2005,  the
        Company did not have any other real estate owned.

        Premises and Equipment

        Premises and equipment are carried at cost.  Depreciation  is determined
        using the  straight-line  method over the estimated  useful lives of the
        related assets.  The useful lives of premises are estimated to be twenty
        to  twenty-seven  years.  The useful  lives of  furniture,  fixtures and
        equipment are estimated to be two to seven years. Leasehold improvements
        are  amortized  over  the life of the  asset or the life of the  related
        lease,  whichever is shorter. When assets are sold or otherwise disposed
        of, the cost and related  accumulated  depreciation and amortization are
        removed from the accounts,  and any resulting gain or loss is recognized
        in income for the period. The cost of maintenance and repairs is charged
        to expense as incurred.

        The Company evaluates premises and equipment for financial impairment as
        events or changes in circumstances  indicate that the carrying amount of
        such assets may not be fully recoverable.

        Goodwill and Intangible Assets

        As a result of the Company's 2002  acquisition of the Stockton branch of
        California  Bank  &  Trust,  the  Company   recognized  a  core  deposit
        intangible asset of $448,000 and goodwill of $718,000.  The valuation of
        the core deposit  intangible  was based on the  estimated  fair value of
        deposits  acquired  and is  amortized  on a  straight-line  basis over a
        period of ten years. The current balance of the core deposit  intangible
        of $155,000 is included in accrued interest  receivable and other assets
        in the  consolidated  balance sheet.  Goodwill is not amortized,  but is
        measured  along with the core  deposit  intangible  for  impairment.  At
        December 31, 2006 and 2005, no impairment of the core deposit intangible
        or goodwill has been recognized in the Company's  consolidated financial
        statements.

        Income Taxes

        The  Company  files its income  taxes on a  consolidated  basis with its
        subsidiary.  The allocation of income tax expense  (benefit)  represents
        each  entity's  proportionate  share of the  consolidated  provision for
        income taxes.

36
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Income Taxes (Continued)

        Deferred  tax  assets  and   liabilities  are  recognized  for  the  tax
        consequences of temporary  differences  between the reported  amounts of
        assets  and  liabilities  and their tax basis.  Deferred  tax assets and
        liabilities  are  adjusted  for the  effects  of changes in tax laws and
        rates on the date of enactment.  On the consolidated  balance sheet, net
        deferred  tax assets are  included in accrued  interest  receivable  and
        other assets.

        Earnings Per Share

        Basic earnings per share (EPS), which excludes dilution,  is computed by
        dividing income available to common shareholders by the weighted-average
        number of common shares outstanding for the period. Diluted EPS reflects
        the potential dilution that could occur if securities or other contracts
        to issue common stock, such as stock options,  result in the issuance of
        common stock which shares in the earnings of the Company.  All data with
        respect to  computing  earnings per share is  retroactively  adjusted to
        reflect  stock splits and  dividends  and the  treasury  stock method is
        applied to determine  the dilutive  effect of stock options in computing
        diluted EPS.

        Share-Based Compensation and Adoption of SFAS 123(R)

        At  December  31,  2006,  the  Company  had  one  shareholder   approved
        stock-based  compensation  plan which is described more fully in Note 11
        Prior to January 1, 2006,  the Company  accounted  for those plans under
        the  recognition  and  measurement  provisions of Accounting  Principals
        Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees,
        and  related  interpretations,  as  permitted  by  Financial  Accounting
        Standards Board Statement No. 123 (SFAS 123), Accounting for Stock-Based
        Compensation  and FASB  Statement No. 148,  Accounting  for  Stock-Based
        Compensation - Transition and  Disclosure.  For the years ended December
        31,  2005  and  2004,  no  share-based  employee  compensation  cost was
        recognized in the  consolidated  statement of income for options granted
        as all options  granted under those plans had an exercise price equal to
        the market value of the underlying common stock on the date of grant.

        Effective   January  1,  2006,  the  Company   adopted  the  fair  value
        recognition provisions of FASB Statement No. 123(R), Share-Based Payment
        (SFAS 123(R)),  using the modified prospective  transition method. Under
        that transition method, compensation cost recognized in fiscal year 2006
        includes:  (a)  compensation  cost for all share-based  payments vesting
        during 2006 that were 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 (b) compensation  cost for all
        share-based payments vesting during 2006 that were granted subsequent to
        January  1,  2006,  based on the  grant-date  fair  value  estimated  in
        accordance  with the  provisions  of SFAS 123(R).  There were no options
        granted in 2006,  2005 or 2004.  The  Company  applied  the  alternative
        transition  method  in  calculating  its  pool of  excess  tax  benefits
        available  to absorb  future tax  deficiencies  as  provided  by FSP FAS
        123(R)-3,  Transition Election Related to Accounting for the Tax Effects
        of Share-Based  Payment Awards.  Compensation  cost is recognized net of
        estimated forfeitures. Results for prior periods have not been restated.

        As a result of adopting  SFAS 123(R) on January 1, 2006,  the  Company's
        income  before  provision  for income  taxes and net income for the year
        ended December 31, 2006 was $229,000 and $133,000  lower,  respectively,
        than if it had continued to account for share-based  compensation  under
        APB 25. Basic and diluted earnings per share for the year ended December
        31, 2006 after adopting SFAS 123(R) were $0.03 lower than if the Company
        had continued to account for share-based compensation under APB 25.

37
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        SFAS 123(R)  requires  the cash flows  resulting  from the  realized tax
        benefit  related  to  the  excess  of the  deductible  amount  over  the
        compensation  cost recognized for stock-based  compensation  (excess tax
        benefits)  to be  classified  as a  cash  flow  from  financing  in  the
        consolidated  statement of cash flows.  Excess tax benefits for the year
        ended December 31, 2006 were $736,000.

        Determining Fair Value

        The Company  bases the fair value of the options  previously  granted on
        the date of grant using a  Black-Scholes  option pricing model that uses
        assumptions  based on expected  option life, the level of expected stock
        volatility and the risk-free interest rate. Stock volatility is based on
        the historical  volatility of the Company's stock. The risk-free rate is
        based on the U.S.  Treasury  yield  curve and the  expected  term of the
        options. The expected term of the options represents the period that the
        Company's share-based awards are expected to be outstanding based on the
        terms of the  optionee's  employment  agreement and position  within the
        Company,  previous option activity, the number of shares currently owned
        and the expected  time of when those  options  would be  exercised.  The
        Company  has  not  paid  cash  dividends.   The  Company  estimates  the
        forfeiture   rate  in  calculating  the   compensation   expense  to  be
        insignificant. There were no options granted in 2006, 2005, or 2004.

        Pro Forma

        The following  table  illustrates  the effect on net income and earnings
        per share  for the  years  ended  December  31,  2005 and 2004 as if the
        Company had applied the fair value recognition provisions of SFAS 123 to
        options  granted  under the  Company's  stock option  plans  (dollars in
        thousands, except per share data):

                                                           2005         2004
                                                        ----------   ----------
                                                         (In thousands, except
                                                           per share amounts)

        Net income, as reported                         $    4,286   $    3,169
        Deduct:  Total stock-based employee
          compensation expense determined under
          the fair value based method for all awards,
          net of related tax effects                           264          264
                                                        ----------   ----------
        Pro forma net income                            $    4,022   $    2,905
                                                        ==========   ==========
        Basic earnings per share - as reported          $     1.23   $     0.92
        Basic earnings per share - pro forma            $     1.16   $     0.85

        Diluted earnings per share - as reported        $     1.10   $     0.84
        Diluted earnings per share - pro forma          $     1.03   $     0.77

38
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        NEW FINANCIAL ACCOUNTING STANDARDS

        Accounting for Servicing of Financial Assets

        In March 2006, the Financial  Accounting  Standards  Board (FASB) issued
        Statement  No. 156 (SFAS 156),  Accounting  for  Servicing  of Financial
        Assets - An Amendment of FASB  Statement No. 140. SFAS 156 requires that
        all separately  recognized servicing assets and servicing liabilities be
        initially measured at fair value, if practicable,  and permits, but does
        not  require,  the  subsequent   measurement  of  servicing  assets  and
        servicing liabilities at fair value. Under SFAS 156, an entity can elect
        subsequent fair value  measurement of its servicing assets and servicing
        liabilities  by class.  An entity  should  apply  the  requirements  for
        recognition  and initial  measurement of servicing  assets and servicing
        liabilities  prospectively to all transactions after the effective date.
        SFAS 156  permits  an entity to  reclassify  certain  available-for-sale
        securities to trading  securities  provided that they are  identified in
        some manner as offsetting the entity's exposure to changes in fair value
        of servicing assets or servicing  liabilities  subsequently  measured at
        fair value. The provisions of SFAS 156 are effective for an entity as of
        the  beginning of its first fiscal year that begins after  September 15,
        2006.  Management  does not  expect the  adoption  of SFAS 156 to have a
        material  impact on the  Company's  financial  position  or  results  of
        operations.

        Accounting for Uncertainty in Income Taxes

        In  July  2006,   the  FASB  issued   Financial   Accounting   Standards
        Interpretation  No. 48 (FIN 48),  Accounting  for  Uncertainty in Income
        Taxes - An  Interpretation  of FASB  statement No. 109. FIN 48 clarifies
        the  accounting  for  uncertainty  in  income  taxes  recognized  in  an
        enterprise's  financial statements in accordance with FASB Statement No.
        109,  Accounting for Income Taxes.  FIN 48 also prescribes a recognition
        threshold  and   measurement   standard  for  the  financial   statement
        recognition  and measurement of an income tax position taken or expected
        to  be  taken  in a  tax  return.  FIN  48  also  provides  guidance  on
        derecognition,  classification,  interest and  penalties,  accounting in
        interim periods,  disclosures and  transitions.  FIN 48 is effective for
        fiscal years beginning after December 15, 2006.

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

        The  provisions  of FIN 48 were  effective for the Company on January 1,
        2007 and are to be applied to all tax positions upon initial application
        of this standard. Only tax positions that meet the  more-likely-than-not
        recognition  threshold  at  the  effective  date  may be  recognized  or
        continue to be recognized upon adoption.

        The cumulative effect of applying the provisions of FIN 48, if any, will
        be reported as an adjustment to the opening balance of retained earnings
        for the fiscal year of adoption. Management does not expect the adoption
        of FIN 48 to have a material impact on the Company's  financial position
        or results of operations.

39
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Fair Value Measurements

        In September  2006, the FASB issued  Statement No. 157 (SFAS 157),  Fair
        Value Measurements. SFAS 157 defines fair value, establishes a framework
        for  measuring  fair  value and  expands  disclosures  about  fair value
        measurements.  SFAS 157 applies  whenever  other  standards  require (or
        permit)  assets or liabilities to be measured at fair value but does not
        expand the use of fair value in any new circumstances. In this standard,
        the FASB  clarifies the principle that fair value should be based on the
        assumptions  market  participants  would use when  pricing  the asset or
        liability.  In support of this  principle,  SFAS 157  establishes a fair
        value hierarchy that  prioritizes the information  used to develop those
        assumptions.  The  provisions  of SFAS 157 are  effective  for financial
        statements issued for fiscal years beginning after November 15, 2007 and
        interim  periods  within those fiscal years.  The  provisions  should be
        applied  prospectively,   except  for  certain  specifically  identified
        financial  instruments.  Management does not expect the adoption of SFAS
        157 to have a material  impact on the  Company's  financial  position or
        result of operations.

        Accounting for Purchases of Life Insurance

        In September  2006,  the FASB  ratified the  consensuses  reached by the
        Emerging  Issues  Task  Force (the Task  Force) on Issue No.  06-5 (EITF
        06-5)  Accounting for the Purchases of Life Insurance - Determining  the
        Amount that Could be Realized in Accordance with FASB Technical Bulletin
        No.85-4  (FTB  85-4).  FTB 85-4  indicates  that the amount of the asset
        included in the balance sheet for life  insurance  contracts  within its
        scope should be "the amount that could be realized  under the  insurance
        contract  as of  the  date  of the  statement  of  financial  position."
        Questions  arose in applying  the  guidance in FTB 85-4 to whether  "the
        amount that could be realized" should consider 1) any additional amounts
        included in the contractual terms of the insurance policy other than the
        cash surrender value and 2) the contractual  ability to surrender all of
        the individual-life  policies (or certificates in a group policy) at the
        same time. EITF 06-5 determined that "the amount that could be realized"
        should 1) consider any additional  amounts  included in the  contractual
        terms of the policy and 2) assume the surrender of an individual-life by
        individual-life  policy  (or  certificate  by  certificate  in  a  group
        policy).  Any amount that is  ultimately  realized by the policy  holder
        upon the assumed  surrender of the final policy (or final certificate in
        a  group  policy)  shall  be  included  in the  "amount  that  could  be
        realized."  An entity  should apply the  provisions of EITF 06-5 through
        either a change in  accounting  principle  through  a  cumulative-effect
        adjustment  to  retained  earnings  as of the  beginning  of the year of
        adoption  or a change  in  accounting  principle  through  retrospective
        application  to all  prior  periods.  The  provisions  of EITF  06-5 are
        effective for fiscal years beginning after December 15, 2006. Management
        does not believe the  adoption of EITF 06-5 will have a material  impact
        on the Company's financial position or results of operations.

40
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

        In September 2006, the FASB ratified the consensuses reached by the Task
        Force on Issue No. 06-4 (EITF 06-4) Accounting for Deferred Compensation
        and  Postretirement  Benefit  Aspects of Endorsement  Split-Dollar  Life
        Insurance Arrangements. A question arose when an employer enters into an
        endorsement  split-dollar life insurance  arrangement related to whether
        the employer  should  recognize a liability  for the future  benefits or
        premiums to be provided to the  employee.  EITF 06-4  indicates  that an
        employer  should  recognize a liability  for future  benefits and that a
        liability for the benefit  obligation  has not been settled  through the
        purchase of an  endorsement  type  policy.  An entity  should  apply the
        provisions of EITF 06-4 either through a change in accounting  principle
        through a  cumulative-effect  adjustment to retained  earnings as of the
        beginning  of the year of adoption or a change in  accounting  principle
        through  retrospective  application to all prior periods. The provisions
        of EITF 06-4 are effective for fiscal years beginning after December 15,
        2007. Management has not yet completed its evaluation of the impact that
        EITF 06-4 will have.

        Consideration of the Effects of Prior Year Misstatements

        In September,  2006, the Securities  and Exchange  Commission  published
        Staff Accounting  Bulleting No. 108 (SAB 108) Considering the Effects of
        Prior Year Misstatements when Quantifying  Misstatements in Current Year
        Financial  Statements.  The  interpretations  in SAB 108 were  issued to
        address  diversity  in  practice  in  quantifying   financial  statement
        misstatements  and the  potential  under  current  practice  to build up
        improper  amounts on the balance sheet.  This guidance will apply to the
        first fiscal year ending after  November 15, 2006,  or December 31, 2006
        for the Company.  The adoption of SAB 108 did not have a material impact
        on the  Company's  financial  position or results of  operations  and no
        cumulative adjustment was required.

3.      INVESTMENT SECURITIES

        The amortized cost and estimated fair value of investment  securities at
        December 31, 2006 and 2005 consisted of the following:

        Available-for-Sale

<TABLE>
<CAPTION>
                                                                                      2006
                                                               ---------------------------------------------------
                                                                              Gross         Gross       Estimated
                                                               Amortized    Unrealized    Unrealized       Fair
                                                                  Cost         Gains        Losses         Value
                                                               ----------   ----------    ----------    ----------
                                                                                (In thousands)
        <S>                                                    <C>          <C>           <C>           <C>
        Debt securities:
          U.S. Treasury securities                             $   10,902                        (26)       10,876
          Obligations of states and
             political sub-divisions                                2,646          181           (67)        2,760
          Mortgage-backed securities                                7,047                       (155)        6,892
          Corporate bonds                                           2,518                        (12)        2,506
                                                               ----------   ----------    ----------    ----------
                                                               $   23,113   $      181    $     (260)   $   23,034
                                                               ==========   ==========    ==========    ==========
</TABLE>

41
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

3.      INVESTMENT SECURITIES (Continued)

        Net  unrealized  losses  on  available-for-sale   investment  securities
        totaling  $79,000  were  recorded,  net of  $32,000 in tax  benefit,  as
        accumulated  other  comprehensive  loss within  shareholders'  equity at
        December 31, 2006.  There were no proceeds or gross  realized gains from
        the sale or call of  available-for-sale  investment  securities  for the
        year ended December 31, 2006.

<TABLE>
<CAPTION>
                                                                                      2005
                                                               ---------------------------------------------------
                                                                              Gross         Gross        Estimated
                                                                Amortized   Unrealized    Unrealized       Fair
                                                                  Cost         Gains        Losses         Value
                                                               ----------   ----------    ----------    ----------
                                                                                (In thousands)
        <S>                                                    <C>          <C>           <C>           <C>
        Debt securities:
          U.S. Treasury securities                             $   14,897                 $      (45)   $   14,852
          Obligations of states and
             political sub-divisions                                2,783   $       86            (4)        2,865
          Mortgage-backed securities                                7,568            1          (195)        7,374
          Corporate bonds                                           3,325            2            (2)        3,325
                                                               ----------   ----------    ----------    ----------
                                                               $   28,573   $       89    $     (246)   $   28,416
                                                               ==========   ==========    ==========    ==========
</TABLE>

        Net  unrealized  losses  on  available-for-sale   investment  securities
        totaling  $157,000  were  recorded,  net of $62,000 in tax  benefit,  as
        accumulated  other  comprehensive  loss within  shareholders'  equity at
        December 31, 2005.  There were no proceeds or gross  realized gains from
        the sale or call of  available-for-sale  investment  securities  for the
        year ended December 31, 2005. Net unrealized gains on available-for-sale
        investment securities totaling $75,000 were recorded,  net of $30,000 in
        tax  expense,   as  accumulated   other   comprehensive   income  within
        shareholders'  equity at December  31,  2004.  There were no proceeds or
        gross  realized  gains  from  the  sale or  call  of  available-for-sale
        investment securities for the year ended December 31, 2004.

        Held-to-Maturity

<TABLE>
<CAPTION>
                                                                                      2006
                                                               ---------------------------------------------------
                                                                              Gross         Gross        Estimated
                                                                Amortized   Unrealized    Unrealized       Fair
                                                                  Cost         Gains        Losses         Value
                                                               ----------   ----------    ----------    ----------
                                                                                (In thousands)
        <S>                                                    <C>          <C>           <C>           <C>
        Debt securities:
           Mortgage-backed securities                          $       73   $             $       (1)   $       72
                                                               ==========   ==========    ==========    ==========
</TABLE>

<TABLE>
<CAPTION>
                                                                                      2005
                                                               ---------------------------------------------------
                                                                              Gross         Gross        Estimated
                                                                Amortized   Unrealized    Unrealized       Fair
                                                                  Cost         Gains        Losses         Value
                                                               ----------   ----------    ----------    ----------
                                                                                (In thousands)
        <S>                                                    <C>          <C>           <C>           <C>
        Debt securities:
            Mortgage-backed securities                         $      123   $        1    $       (1)   $      123
                                                               ==========   ==========    ==========    ==========
</TABLE>

        There  were  no  sales  or  transfers  of  held-to-maturity   investment
        securities during the years ended December 31, 2006, 2005 and 2004.

42
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

3.      INVESTMENT SECURITIES (Continued)

        Investment  securities with  unrealized  losses at December 31, 2006 and
        2005 are summarized and classified according to the duration of the loss
        period as follows:

<TABLE>
<CAPTION>
                                                                        2006
                                  --------------------------------------------------------------------------------
                                    Less than 12 Months           12 Months or More                Total
                                  ------------------------    ------------------------    ------------------------
                                     Fair       Unrealized       Fair       Unrealized       Fair       Unrealized
                                    Value         Losses        Value         Losses        Value         Losses
                                  ----------    ----------    ----------    ----------    ----------    ----------
                                                                    (In thousands)
        <S>                       <C>           <C>           <C>           <C>           <C>           <C>
        Debt securities:
          U.S. Treasury
             Securities           $    7,895    $      (11)   $    2,981    $      (15)   $   10,876    $      (26)
          Obligations of states
             and political sub-
             divisions                 1,357           (64)          203            (3)        1,560           (67)
          Mortgage-backed
             securities                   51            (1)        6,882          (155)        6,933          (156)
          Corporate obligations        1,506           (12)                                    1,506           (12)
                                  ----------    ----------    ----------    ----------    ----------    ----------
                                  $   10,809    $      (88)   $   10,066    $     (173)   $   20,875    $     (261)
                                  ==========    ==========    ==========    ==========    ==========    ==========
</TABLE>

<TABLE>
<CAPTION>
                                                                        2005
                                  --------------------------------------------------------------------------------
                                    Less than 12 Months           12 Months or More                Total
                                  ------------------------    ------------------------    ------------------------
                                     Fair       Unrealized       Fair       Unrealized       Fair       Unrealized
                                    Value         Losses        Value         Losses        Value         Losses
                                  ----------    ----------    ----------    ----------    ----------    ----------
                                                                    (In thousands)
        <S>                       <C>           <C>           <C>           <C>           <C>           <C>

        Debt securities:
           U.S. Treasury
              Securities          $   10,883    $      (18)   $    1,970    $      (27)   $   12,853    $      (45)
           Obligations of states
              and political sub-
              divisions                  361            (4)                                      361            (4)
           Mortgage-backed
              securities               6,489          (143)        1,224           (53)        7,713          (196)
           Corporate obligations         999            (2)                                      999            (2)
                                  ----------    ----------    ----------    ----------    ----------    ----------
                                  $   18,732    $     (167)   $    3,194    $      (80)   $   21,926    $     (247)
                                  ==========    ==========    ==========    ==========    ==========    ==========
</TABLE>

        U.S. TREASURY SECURITIES

        At December 31, 2006, the Company's held 7 U.S.  Treasury  Securities of
        which 5 were in a loss  position for less than twelve  months and 2 were
        in a loss  position and had been in a loss position for twelve months or
        more. Management believes the unrealized losses on these securities were
        caused by interest rate increases and is not  attributable to changes in
        credit  quality.  Additionally,  the  contractual  cash  flows  of these
        investments are guaranteed by the U.S.  Government.  Because the decline
        in market  value is  attributable  to changes in interest  rates and not
        credit  quality,  and  because the Company has the ability and intent to
        hold the  investment  until  recovery  of fair  value,  which  may be at
        maturity,   the  Company  does  not  consider  the   investment   to  be
        other-than-temporarily impaired at December 31, 2006.

43
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

3.      INVESTMENT SECURITIES (Continued)

        OBLIGATIONS OF STATES AND POLITICAL SUBDIVISION

        At December  31,  2006,  the Company  held 7  obligations  of states and
        political  subdivisions of which 6 were in a loss position for less than
        twelve  months  and 1 was in a loss  position  and  had  been  in a loss
        position for twelve months or more.  Management  believes the unrealized
        losses  on the  Company's  investments  in  obligations  of  states  and
        political subdivisions were caused by interest rate increases and is not
        attributable to changes in credit quality. Because the decline in market
        value is  attributable  to  changes  in  interest  rates and not  credit
        quality,  and  because  the  Company  has the ability and intent to hold
        these investments until a recovery of fair value, which may be maturity,
        the   Company   does   not   consider    these    investments    to   be
        other-than-temporarily impaired at December 31, 2006.

        MORTGAGE-BACKED SECURITIES

        At December 31, 2006,  the Company  held 11  mortgage-backed  investment
        securities  of  which 3 were in a loss  position  for less  than  twelve
        months and 8 were in a loss position and had been in a loss position for
        twelve months or more. Management believes that the unrealized losses on
        the Company's investments in mortgage-backed  investment securities were
        caused by interest rate increases and is not  attributable to changes in
        credit  quality.  The  contractual  cash flows of those  investments are
        guaranteed by an agency of the U.S.  government.  Because the decline in
        market value is attributable to changes in interest rates and not credit
        quality,  and  because  the  Company  has the ability and intent to hold
        those investments until a recovery of fair value, which may be maturity,
        the   Company   does   not   consider    those    investments    to   be
        other-than-temporarily impaired at December 31, 2006.

        CORPORATE OBLIGATIONS

        At December 31, 2006,  the Company held 3 corporate  debt  securities of
        which 2 were in a loss position for less than twelve months.  Management
        believes the unrealized losses on the Company's investments in corporate
        debt  securities  were  caused by  interest  rate  increases  and is not
        attributable to changes in credit quality. Because the decline in market
        value is  attributable  to  changes  in  interest  rates and not  credit
        quality,  and  because  the  Company  has the ability and intent to hold
        these investments until a recovery of fair value, which may be maturity,
        the   Company   does   not   consider    these    investments    to   be
        other-than-temporarily impaired at December 31, 2006.

44
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

3.      INVESTMENT SECURITIES (Continued)

        The amortized cost and estimated fair value of investment  securities at
        December 31, 2006 by  contractual  maturity  are shown  below.  Expected
        maturities will differ from contractual  maturities  because the issuers
        of the securities may have the right to call or prepay  obligations with
        or without call or prepayment penalties.

<TABLE>
<CAPTION>
                                              Available-for-Sale        Held-to-Maturity
                                           -----------------------   -----------------------
                                                         Estimated                 Estimated
                                           Amortized       Fair      Amortized       Fair
                                              Cost        Value         Cost        Value
                                           ----------   ----------   ----------   ----------
                                                            (In thousands)
        <S>                                <C>          <C>                  <C>          <C>
        Within one year                    $   11,917       12,022
        After one year through five
          years                                 2,505        2,509
        After five years through ten
          years

        After ten years                         1,644        1,611
                                           ----------   ----------
                                               16,066       16,142

        Investment securities not due at
          a single maturity date:

          Mortgage-backed securities            7,047        6,892           73           72
                                           ----------   ----------   ----------   ----------
                                           $   23,113   $   23,034           73           72
                                           ==========   ==========   ==========   ==========
</TABLE>

        Investment  securities  with  amortized  costs  totaling  $3,782,000 and
        $5,372,000  and  estimated   market  values   totaling   $3,716,000  and
        $5,382,000  were pledged to secure  treasury  tax and loan  accounts and
        public  deposits at December  31, 2006 and 2005,  respectively.  Certain
        other  investment  securities are pledged to secure  borrowings with the
        Federal Reserve Bank and the Federal Home Loan Bank (see Note 7).

4.      LOANS AND ALLOWANCE FOR LOAN LOSSES

        Outstanding loans are summarized below:

                                                     December 31,
                                               -----------------------
                                                  2006         2005
                                               ----------   ----------
                                                   (In thousands)
        Commercial                             $   57,942   $   43,063
        Agricultural                               16,873       17,582
        Real estate - commercial mortgage         127,545      126,166
        Real estate - construction                 75,654       43,352
        Installment                                11,742       13,536
                                               ----------   ----------
                                                  289,756      243,699
        Deferred loan origination costs, net           40          213
        Allowance for loan losses                  (2,478)      (2,356)
                                               ----------   ----------
                                               $  287,318   $  241,556
                                               ==========   ==========

45
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

4.      LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

        Changes in the allowance for loan losses were as follows:

<TABLE>
<CAPTION>
                                                  Year Ended December 31,
                                          --------------------------------------
                                             2006          2005          2004
                                          ----------    ----------    ----------
                                                      (In thousands)
        <S>                               <C>           <C>           <C>
        Balance, beginning of year        $    2,356    $    2,214    $    1,653
        Provision charged to operations          360            35           504
        Losses charged to allowance              (24)          (17)           (9)
        Recoveries                                 1           124            66
        Reclassification of reserve for
           unfunded commitments                 (215)
                                          ----------    ----------    ----------
               Balance, end of year       $    2,478    $    2,356    $    2,214
                                          ==========    ==========    ==========
</TABLE>

        There were no loans  considered  impaired at December 31, 2006 and 2005.
        There was no average recorded investment in impaired loans for the years
        ended  December 31, 2006,  2005 and 2004.  The Company did not recognize
        any interest income on impaired loans during 2006, 2005 and 2004.

        There were no  nonaccrual  loans and no interest  foregone on nonaccrual
        loans at December 31, 2006, 2005 and 2004.

        Salaries and employee benefits totaling $227,000,  $263,000 and $208,000
        have  been  deferred  as loan  origination  costs  for the  years  ended
        December 31, 2006, 2005 and 2004, respectively.

5.      PREMISES AND EQUIPMENT

        Premises and equipment consisted of the following:

                                                  December 31,
                                            -----------------------
                                               2006         2005
                                            ----------   ----------
                                                (In thousands)
        Land                                $    3,047   $    3,047
        Buildings and improvements               6,969        5,066
        Furniture, fixtures and equipment        4,264        4,774
        Leasehold improvements                   1,802        1,186
        Construction in progress                    64           12
                                            ----------   ----------
                                                16,146       14,085
           Less accumulated depreciation
            and amortization                    (4,189)      (4,574)
                                            ----------   ----------
                                            $   11,957   $    9,511
                                            ==========   ==========

        Depreciation  and  amortization  included in  occupancy,  furniture  and
        equipment expense totaled $682,000,  $632,000 and $529,000 for the years
        ended December 31, 2006, 2005 and 2004, respectively.

46
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

6.      INTEREST-BEARING DEPOSITS

        Interest-bearing deposits consisted of the following:

                                                December 31,
                                           -----------------------
                                              2006         2005
                                           ----------   ----------
                                               (In thousands)
        Savings                            $    5,705   $    6,307
        Money market                           68,850       89,095
        NOW accounts                           18,873       15,827
        Time, $100,000 or more                114,768       61,180
        Other time                             59,603       32,008
                                           ----------   ----------
                                           $  267,799   $  204,417
                                           ==========   ==========

        Aggregate  annual  maturities  of  time  deposits  are  as  follows  (in
        thousands):

                 Year Ending
                December 31,
        --------------------------------
                    2007                   $  142,080
                    2008                       27,221
                    2009                        2,478
                    2010                          337
                    2011                        2,255
                                           ----------
                                           $  174,371
                                           ==========

        Interest expense  recognized on  interest-bearing  deposits consisted of
        the following:

                                       Year Ended December 31,
                                 ------------------------------------
                                    2006         2005         2004
                                 ----------   ----------   ----------
                                            (In thousands)
        Savings                  $       56   $       36   $       20
        Money market                  2,122        2,147          805
        NOW accounts                    315          237          139
        Time, $100,000 or more        3,906        1,248          899
        Other time                    1,703          942          701
                                 ----------   ----------   ----------
                                 $    8,102   $    4,610   $    2,564
                                 ==========   ==========   ==========

7.      OTHER BORROWINGS

        The Company has unsecured  short-term  borrowing  arrangements  totaling
        $16,000,000  with  four  of  its  correspondent  banks.  There  were  no
        borrowings outstanding under these arrangements at December 31, 2006 and
        2005.

        Additionally,  the Company has a borrowing  arrangement with the Federal
        Reserve Bank  secured by  investment  securities  with  amortized  costs
        totaling  $9,967,000 and  $8,548,000 and estimated fair values  totaling
        $9,924,000 and  $8,510,000 at December 31, 2006 and 2005,  respectively.
        At December 31, 2006 and 2005, the Company had no outstanding borrowings
        under this arrangement.

47
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

7.      OTHER BORROWINGS (Continued)

        The Company has a borrowing  arrangement with the Federal Home Loan Bank
        of San  Francisco  (FHLB)  which allow the Company to borrow on either a
        short-term  or long-term  basis up to  approximately  $11,349,000  as of
        December  31,  2006  based on  specific  percentages  of the  collateral
        pledged.  For the  years  ended  December  31,  2006 and  2005,  various
        residential  mortgage  loans  totaling   approximately   $8,018,000  and
        $8,488,000 and investment securities totaling  approximately  $5,911,000
        and $6,659,000,  respectively,  secured this borrowing arrangement.  The
        following table  represents the Company's total other borrowings for the
        periods indicated:

                                                             December 31,
                                                        -----------------------
                                                           2006         2005
                                                        ----------   ----------
                                                             (In thousands)
        FHLB, interest at 5.26%, matures May 16, 2007   $    4,900   $    4,000
                                                        ==========   ==========

8.      SUBORDINATED DEBENTURES

        The following is a summary of the subordinated debentures payable to the
        Company's  subsidiary  grantor  trusts  at  December  31,  2006 and 2005
        (dollars in thousands):

<TABLE>
<CAPTION>
                                                                                       December 31,
                                                                                  -----------------------
                                                                                     2006         2005
                                                                                  ----------   ----------
        <S>                                                                       <C>          <C>
        Subordinated debentures due to Pacific State Statutory Trust I with
            interest payable semi-annually based on 6-month LIBOR plus 3.45% to
            a maximum of 11.95% prior to June 26, 2007 (8.82% at December 31,
            2006), and redeemable under certain conditions with a premium prior
            to June 26, 2007 and with no premium beginning June 26, 2007 and
            due June 26, 2031.                                                    $    5,155   $    5,155

        Subordinated debentures due to Pacific State Statutory Trust II with
            interest payable quarterly based on 3-month LIBOR plus 2.79% (8.15%
            at December 31, 2006), and redeemable with no premium beginning
            March 17, 2009 and due March 17, 2034.                                     3,609        3,609
                                                                                  ----------   ----------
                                                                                  $    8,764   $    8,764
                                                                                  ==========   ==========
</TABLE>

        Under  applicable  regulatory  guidance,  the amount of trust  preferred
        securities  that is eligible as Tier 1 capital is limited to twenty-five
        percent  of the  Company's  Tier 1  capital  on a pro  forma  basis.  At
        December  31,  2006,   $7,265,000  of  the  trust  preferred  securities
        qualified as Tier 1 capital and $1,235,000 qualified as Tier 2 capital.

48
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

8.      SUBORDINATED DEBENTURES (Continued)

        The Company has guaranteed,  on a subordinated basis,  distributions and
        other  payments  due on the  trust  preferred  securities  issued by the
        subsidiary  grantor trusts.  Interest expense  recognized by the Company
        for the years ended  December  31,  2006,  2005 and 2004  related to the
        subordinated   debentures   was   $710,000,   $527,000   and   $366,000,
        respectively.  The amount of deferred costs was $144,000 at December 31,
        2006.

9.      INCOME TAXES

        The  provision  for income taxes for the years ended  December 31, 2006,
        2005 and 2004 consisted of the following:

<TABLE>
<CAPTION>
                                                Federal       State          Total
                                              ----------    ----------    ----------
                                                         (In thousands)
        <S>                                   <C>           <C>           <C>
        2006

        Current                               $    2,671    $      944    $    3,615
        Deferred                                      54           (42)           12
                                              ----------    ----------    ----------
                 Provision for income taxes   $    2,725    $      902    $    3,627
                                              ==========    ==========    ==========

        2005

        Current                               $    2,040    $      687    $    2,727
        Deferred                                    (108)          (23)         (131)
                                              ----------    ----------    ----------
                 Provision for income taxes   $    1,932    $      664    $    2,596
                                              ==========    ==========    ==========

        2004

        Current                               $    1,534    $      570    $    2,104
        Deferred                                    (157)          (73)         (230)
                                              ----------    ----------    ----------
                 Provision for income taxes   $    1,377    $      497    $    1,874
                                              ==========    ==========    ==========
</TABLE>

        Deferred tax assets (liabilities) consisted of the following:

<TABLE>
<CAPTION>
                                                            December 31,
                                                      -----------------------
                                                         2006        2005
                                                      ----------   ----------
                                                          (In thousands)
        <S>                                           <C>          <C>
        Deferred tax assets:
            Allowance for loan losses                 $      953   $      841
            Future benefit of state tax deduction            145          234
            Organization costs                                 3           19
            Deposit purchase premium                         103           46
            Mark-to-market adjustment                                      10
            Deferred compensation                            385          237
            Litigation reserve                                             82
            Off Balance Sheet Reserve                         96
            Unrealized losses on available-for-sale
               investment securities                          32           62
                                                      ----------   ----------
                  Total deferred tax assets                1,717        1,531
                                                      ----------   ----------
</TABLE>

49
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

9.      INCOME TAXES (Continued)

                                                        December 31,
                                                   ------------------------
                                                      2006          2005
                                                   ----------    ----------
                                                        (In thousands)
        Deferred tax liabilities:
            Bank premises and equipment            $      (84)   $      (86)
            Goodwill                                      (98)          (33)
            FHLB Dividends                                (48)
            Prepaid expense                              (161)          (44)
                                                   ----------    ----------
                  Total deferred tax liabilities         (391)         (163)
                                                   ----------    ----------
                  Net deferred tax assets          $    1,326    $    1,368
                                                   ==========    ==========

        The  Company  believes  that it is more  likely  than  not  that it will
        realize the above deferred tax assets in future periods;  therefore,  no
        valuation allowance has been provided against its deferred tax assets.

        The provision for income taxes differs from amounts computed by applying
        the statutory Federal income tax rates to operating income before income
        taxes. The significant  items comprising these differences for the years
        ended December 31, 2006, 2005 and 2004 consisted of the following:

<TABLE>
<CAPTION>
                                                            2006          2005           2004
                                                         ----------    ----------     ----------
        <S>                                                    <C>           <C>            <C>
        Federal income tax, at statutory rate                  34.0%         34.0%          34.0%
        State franchise tax, net of Federal tax effect          6.5%          6.3%           7.2%
        Tax exempt investment security income, net             (0.7)%        (0.8)%         (1.1)%
        Company owned life insurance, net                      (0.8)%        (0.9)%         (1.5)%
        Other                                                   0.6%         (0.8)%         (1.4)%
                                                         ----------    ----------     ----------
                 Effective tax rate                            39.6%         37.8%          37.2%
                                                         ==========    ==========     ==========
</TABLE>

10.     COMMITMENTS AND CONTINGENCIES

        Leases

        The  Company   leases  branch  offices  and  certain   equipment   under
        non-cancelable  operating  leases.  The leases  expire on various  dates
        through 2021 and have various  renewal  options ranging from five to ten
        years.

50
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

10.     COMMITMENTS AND CONTINGENCIES (Continued)

        Leases (Continued)

        Future minimum lease payments are as follows (in thousands):

               Year Ending
              December 31,
        -----------------------------
                  2007                  $    457
                  2008                       465
                  2009                       275
                  2010                       200
                  2011                       206
               Thereafter                  1,005
                                        --------
                                        $  2,608
                                        ========

        Rental expense  included in occupancy,  furniture and equipment  expense
        totaled $319,000, $276,000 and $236,000 for the years ended December 31,
        2006, 2005 and 2004, respectively.

        Federal Reserve Requirements

        Banks are  required  to  maintain a  combination  of  reserves  with the
        Federal  Reserve  Bank and vault  cash  equal to a  percentage  of their
        reservable deposits.  The reserve balances held with the Federal Reserve
        Bank or in the form of vault cash totaled  $4,552,000  and $2,619,000 as
        of December 31, 2006 and 2005, respectively.

        Correspondent Banking Agreements

        The Company  maintains  funds on deposit  with other  federally  insured
        financial institutions under correspondent banking agreements. Uninsured
        deposits totaled $3,822,000 at December 31, 2006.

        Financial Instruments With Off-Balance-Sheet Risk

        The Company is a party to financial  instruments with  off-balance-sheet
        risk in the normal  course of  business  in order to meet the  financing
        needs of its customers and to reduce its own exposure to fluctuations in
        interest rates.  These financial  instruments  consist of commitments to
        extend credit and standby letters of credit.  These instruments involve,
        to varying degrees,  elements of credit and interest rate risk in excess
        of the amount recognized on the balance sheet.

        The Company's  exposure to credit loss in the event of nonperformance by
        the other party for  commitments to extend credit and standby letters of
        credit is represented by the  contractual  amount of those  instruments.
        The Company  uses the same credit  policies  in making  commitments  and
        standby  letters of credit as it does for loans  included on the balance
        sheet.

        The following financial instruments represent  off-balance-sheet  credit
        risk:

                                             December 31,
                                       -----------------------
                                          2006         2005
                                       ----------   ----------
                                           (In thousands)
        Commitments to extend credit   $  110,937   $  112,066
        Standby letters of credit      $    2,971   $    2,318

51
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

10.     COMMITMENTS AND CONTINGENCIES (Continued)

        Financial Instruments With Off-Balance-Sheet Risk (Continued)

        Commitments  to extend  credit are  agreements  to lend to a customer as
        long as  there  is no  violation  of any  condition  established  in the
        contract.  Commitments  generally have fixed  expiration  dates or other
        termination  clauses and may require payment of a fee. Since some of the
        commitments  are expected to expire  without being drawn upon, the total
        commitment   amounts   do  not   necessarily   represent   future   cash
        requirements.  The Company evaluates each customer's creditworthiness on
        a  case-by-case  basis.  The amount of  collateral  obtained,  if deemed
        necessary  by  the  Company  upon  extension  of  credit,  is  based  on
        management's credit evaluation of the borrower.  Collateral held varies,
        but   may   include   accounts   receivable,    inventory,    equipment,
        income-producing commercial properties and residential real estate.

        Standby  letters of credit  are  conditional  commitments  issued by the
        Company to  guarantee  the  performance  or  financial  obligation  of a
        customer to a third party.  The credit risk involved in issuing  letters
        of credit is essentially the same as that involved in extending loans to
        customers.  The fair value of the  liability  related  to these  standby
        letters of credit,  which  represents  the fees received for issuing the
        guarantees,  was not  significant  at December  31,  2006 and 2005.  The
        Company recognizes these fees as revenue over the term of the commitment
        or when the commitment is used.

        At  December   31,   2006,   commercial   loan   commitments   represent
        approximately  43% of total  commitments  and are  generally  secured by
        various assets of the borrower.  Real estate loan commitments  represent
        approximately  46% of total  commitments  and are  generally  secured by
        property with a loan-to-value  ratio not to exceed 75% to 80%.  Consumer
        loan  commitments  represent the remaining 11% of total  commitments and
        are  generally  unsecured.  In addition,  the majority of the  Company's
        commitments have variable interest rates.

        Concentrations of Credit Risk

        The  Company's   customers   are  primarily   located  in  San  Joaquin,
        Stanislaus,  Calaveras  and  Tuolumne  Counties.  At December  31, 2006,
        approximately  20% of the  Company's  loans are for  general  commercial
        uses, including professional,  retail and small business, and 6% are for
        agricultural uses. Additionally,  26% of the Company's loans are for the
        construction of residential and commercial real estate and 44% are loans
        which are collateralized by mortgages on residential and commercial real
        estate.  Generally, real estate loans are secured by real property while
        commercial  and other loans are secured by funds on deposit and business
        or personal assets. The remaining 4% of the Company's loans are consumer
        installment loans.  Repayment is generally expected from the proceeds of
        property  sales and  permanent  financing  for real estate  construction
        loans and borrower cash flows for other loans.

        Contingencies

        The Company is subject to legal  proceedings  and claims  which arise in
        the  ordinary  course of  business.  In the opinion of  management,  the
        amount of  ultimate  liability  with  respect to such  actions  will not
        materially  affect the consolidated  financial  position or consolidated
        results of operations of the Company.

52
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

11.     SHAREHOLDERS' EQUITY

        Dividends

        The  Company's  ability to pay cash  dividends is dependent on dividends
        paid to it by the Bank and limited by California  corporation law. Under
        California  law, the holders of common stock of the Company are entitled
        to receive dividends when and as declared by the Board of Directors, out
        of  funds  legally  available,  subject  to  certain  restrictions.  The
        California  general  corporation  law  prohibits the Company from paying
        dividends  on its  common  stock  unless:  (i)  its  retained  earnings,
        immediately prior to the dividend payment,  equals or exceeds the amount
        of the dividend or (ii) immediately after giving effect to the dividend,
        the sum of the  Company's  assets  (exclusive  of goodwill  and deferred
        charges)  would  be at  least  equal  to  125% of its  liabilities  (not
        including   deferred   taxes,   deferred   income  and  other   deferred
        liabilities)  and the current  assets of the  Company  would be at least
        equal to its current  liabilities,  or, if the  average of its  earnings
        before taxes on income and before interest expense for the two preceding
        fiscal years was less than the average of its  interest  expense for the
        two  preceding  fiscal  years,  at least  equal  to 125% of its  current
        liabilities.  In addition,  the  Company's  ability to pay  dividends is
        subject to certain covenants  contained in the indentures related to the
        trust preferred securities issued by the Trusts.

        Upon  declaration  by  the  Board  of  Directors  of  the  Company,  all
        shareholders  of  record  will  be  entitled  to  receive  dividends.  A
        significant  source of cash for the Company is dividends  from the Bank.
        The California  Financial  Code restricts the total dividend  payment of
        any bank in any calendar  year to the lesser of (1) the bank's  retained
        earnings or (2) the bank's net income for its last three  fiscal  years,
        less  distributions  made to  shareholders  during  the same  three-year
        period.  As a member of the  Federal  Reserve  System,  the Bank is also
        subject to similar  restrictions imposed by Federal law. At December 31,
        2006,  Bank  retained   earnings  of  $12,147,000   were  free  of  such
        restrictions and available for dividend payments to Bancorp.

        Earnings Per Share

        A  reconciliation  of the numerators and  denominators  of the basic and
        diluted earnings per share computations is as follows:

<TABLE>
<CAPTION>
                                                         Year Ended December 31,
                                                ---------------------------------------
                                                    2006          2005         2004
                                                -----------   -----------   -----------
                                                    (In thousands, except share and
                                                            per share amounts)
        <S>                                     <C>           <C>           <C>
        Basic Earnings Per Share

        Numerator:
          Net income                            $     5,543   $     4,286   $     3,169

        Denominator:
          Weighted average shares outstanding     3,537,314     3,473,511     3,432,023
                                                -----------   -----------   -----------
        Basic earnings per share                $      1.57   $      1.23   $      0.92
                                                ===========   ===========   ===========
</TABLE>

53
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

11.     SHAREHOLDERS' EQUITY (Continued)

        Earnings Per Share (Continued)

<TABLE>
<CAPTION>
                                                         Year Ended December 31,
                                                ---------------------------------------
                                                   2006          2005          2004
                                                -----------   -----------   -----------
                                                    (In thousands, except share and
                                                            per share amounts)
        <S>                                     <C>           <C>           <C>
        Diluted Earnings Per Share

        Numerator:
          Net income                            $     5,543   $     4,286   $     3,169

        Denominator:
          Weighted average shares outstanding     3,537,314     3,473,511     3,432,023
          Effect of dilutive stock options          386,183       433,493       341,150
                                                -----------   -----------   -----------
        Weighted average shares of common
          stock and common stock equivalents      3,923,497     3,907,004     3,773,173
                                                -----------   -----------   -----------
        Diluted earnings per share              $      1.41   $      1.10   $      0.84
                                                ===========   ===========   ===========
</TABLE>

        All of the stock options outstanding were included in the computation of
        diluted  earnings per share for the years ended December 31, 2006,  2005
        and 2004 as none of the stock options were antidilutive.

        Stock Option Plan

        The Company  currently has one  shareholder  approved stock option plan,
        the Pacific  State Bancorp 1997 Stock Option Plan. At December 31, 2006,
        the plans have  668,499  shares  remaining  as reserved for issuance for
        options  already  granted.  Under the 1997 Plan 65,204  shares of common
        stock remain  reserved for future  issuance to employees  and  directors
        through incentive and nonstatutory agreements The plan requires that the
        price may not be less than the fair market value of the Company's common
        stock at the date of grant  and that the  stock  must be paid in full at
        the time the  option is  exercised.  The Plans do not  provided  for the
        settlement of awards in cash and new shares are issued upon the exercise
        of the options. There were no options granted in 2006, 2005 or 2004. The
        options  under the  plans  expire  on dates  determined  by the Board of
        Directors,  but not  later  than ten years  from the date of grant.  The
        vesting period is generally over five years.

        Stock Option Compensation Expense

        The  compensation  cost that has been charged  against  income for stock
        options was  $229,000 for the year ended  December  31, 2006.  The total
        income tax benefit  recognized in shareholders  equity for stock options
        exercised was $736,000 for the year ended December 31, 2006.

54
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

11.     SHAREHOLDERS' EQUITY (Continued)

        Stock Options (Continued)

        At December 31, 2006, the total  compensation  cost related to nonvested
        stock option  awards  granted to  employees  under the  Company's  stock
        option  plans  but  not  yet  recognized  was  $356,000.   Stock  option
        compensation  expense is  recognized on a  straight-line  basis over the
        vesting  period of the option.  This cost is  expected to be  recognized
        over a  weighted  average  remaining  period  of 1.5  years  and will be
        adjusted for subsequent changes in estimated forfeitures. The total fair
        value of options  vested  during the year ended  December  31,  2006 was
        $229,000.

        A summary of the  activity  within the plans  adjusted to give effect to
        the stock split in 2004 follows:

<TABLE>
<CAPTION>
                                                   2006                      2005                       2004
                                         -----------------------   ------------------------   ------------------------
                                                       Weighted                   Weighted                   Weighted
                                                       Average                    Average                    Average
                                                       Exercise                   Exercise                   Exercise
                                           Shares       Price        Shares        Price        Shares        Price
                                         ----------   ----------   ----------    ----------   ----------    ----------
        <S>                                 <C>       <C>             <C>        <C>             <C>        <C>
        Incentive Agreements

        Options outstanding,
          beginning of year                 461,050   $     6.52      528,810    $     6.23      587,696    $     5.90

          Options granted
          Options exercised                 (76,337)  $     5.74      (44,760)   $     3.93      (58,886)   $     2.96
          Options canceled                   (6,900)  $     7.28      (23,000)   $     5.19            -
                                         ----------                ----------                 ----------
        Options outstanding,
          end of year                       377,813   $     6.69      461,050    $     6.52      528,810    $     6.23
                                         ==========                ==========                 ==========
        Options exercisable,
          end of year                       248,040   $     6.32      223,330    $     5.84      174,648    $     4.78
                                         ==========                ==========                 ==========
        Nonstatutory Agreements

        Options outstanding,
          beginning of year                 379,800   $     7.50      400,000    $     7.50      411,500    $     7.31

          Options granted
          Options exercised                 (59,114)  $     7.50      (20,200)         7.50      (11,500)   $     1.00
          Options cancelled                 (30,000)  $     7.50
                                         ----------                ----------    ----------   ----------
        Options outstanding,
          end of year                       290,686   $     7.50      379,800    $     7.50      400,000    $     7.50
                                         ==========                ==========                 ==========
        Options exercisable,
          end of year                       174,412         7.50      151,920    $     7.50       80,000    $     7.50
                                         ==========                ==========                 ==========
</TABLE>

55
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

11.     SHAREHOLDERS' EQUITY (Continued)

        Stock Options (Continued)

        The aggregate  intrinsic  value is calculated as the difference  between
        the exercise price of the underlying  awards and the quoted price of the
        Company's  common stock for options that were  in-the-money  at December
        31, 2006. The intrinsic value of options  outstanding and exercisable as
        of December  31,  2006  relating  to the above  stock  option  plans was
        $6,308,000. The intrinsic value of options vested or expected to vest as
        of December  31,  2006  relating  to the above  stock  option  plans was
        $9,519,000.  The weighted average remaining contractual term for options
        outstanding  and  exercisable  was 6.8  years.  During  the years  ended
        December  31,  2006,  205 and 2004,  the  aggregate  intrinsic  value of
        options exercised was $1,011,000, $1,166,000 and $821,000, respectively.

        The cash  received from options  exercised for the years ended  December
        31,   2006,   2005  and  2004  was  $880,000   $330,000  and   $183,000,
        respectively.  The actual tax benefit  realized  for the tax  deductions
        from options  exercised was $736,000,  $79,000 and $39,000 for the years
        ended December 31, 2006, 2005 and 2004, respectively.

        Regulatory Capital

        The  Company  and the Bank are  subject  to certain  regulatory  capital
        requirements  administered  by the  Board of  Governors  of the  Federal
        Reserve System and the Federal  Deposit  Insurance  Corporation  (FDIC).
        Failure to meet these minimum 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  consolidated  financial  statements.  Under capital  adequacy
        guidelines and the regulatory  framework for prompt  corrective  action,
        the Bank must meet specific capital guidelines that involve quantitative
        measures of its assets,  liabilities and certain off-balance-sheet items
        as calculated under regulatory accounting  practices.  The Company's and
        the  Bank's  capital  amounts  and  classification  are also  subject to
        qualitative   judgments  by  the  regulators  about   components,   risk
        weightings and other factors.

        Quantitative  measures  established  by  regulation  to  ensure  capital
        adequacy  require the Company and the Bank to maintain  minimum  amounts
        and  ratios of total and Tier 1 capital to  risk-weighted  assets and of
        Tier 1 capital to average  assets as set forth on the  following  table.
        Each of these  components  is  defined  in the  regulations.  Management
        believes  that the Company and the Bank met all their  capital  adequacy
        requirements as of December 31, 2006 and 2005.

        In addition,  the most recent notification from the FDIC categorized the
        Bank as well  capitalized  under the  regulatory  framework  for  prompt
        correction  action.  To be considered  well  capitalized,  the Bank must
        maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage
        ratios  as set forth  below.  There are no  conditions  or events  since
        December  31,  2006 that  management  believes  have  changed the Bank's
        category.

56
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

11.     SHAREHOLDERS' EQUITY (Continued)

        Regulatory Capital (Continued)

<TABLE>
<CAPTION>
                                                                                                          To Be Well
                                                                                                       Capitalized Under
                                                                               For Capital             Prompt Corrective
                                                       Actual               Adequacy Purposes          Action Provisions
                                              -----------------------    -----------------------    -----------------------
                                                                          Minimum      Minimum        Minimum     Minimum
                                                Amount       Ratio         Amount       Ratio         Amount       Ratio
                                              ----------   ----------    ----------   ----------    ----------   ----------
                                                                         (Dollars in thousands)
        <S>                                   <C>               <C>      <C>                 <C>    <C>                <C>
        December 31, 2006

        Company:
          Total capital (to risk-
             weighted assets)                 $   39,427        11.83%   $   26,654          8.0%          N/A          N/A
          Tier 1 capital (to risk-
             weighted assets)                 $   35,499        10.65%   $   13,327          4.0%          N/A          N/A
          Tier 1 capital (to average
             assets)                          $   35,499        10.17%   $   13,961          4.0%          N/A          N/A

        Bank:
          Total capital (to risk-
             weighted assets)                 $   37,141         11.2%   $   27,922          8.0%   $   33,317         10.0%
          Tier 1 capital (to risk-
             weighted assets)                 $   34,141         10.3%   $   13,327          4.0%   $   19,990          6.0%
          Tier 1 capital (to average
             assets)                          $   34,141          9.7%   $   13,961          4.0%   $   17,451          5.0%

        December 31, 2005

        Company:
          Total capital (to risk-
             weighted assets)                 $   31,650         11.9%   $   21,268          8.0%          N/A          N/A
          Tier 1 capital (to risk-
             weighted assets)                 $   27,654         10.4%   $   10,634          4.0%          N/A          N/A
          Tier 1 capital (to average
             assets)                          $   27,654          9.2%   $   12,067          4.0%          N/A          N/A

        Bank:
          Total capital (to risk-
             weighted assets)                 $   29,933         11.5%   $   20,865          8.0%   $   26,082         10.0%
          Tier 1 capital (to risk-
             weighted assets)                 $   27,577         10.6%   $   10,433          4.0%   $   15,649          6.0%
          Tier 1 capital (to average
             assets)                          $   27,577          9.1%   $   12,067          4.0%   $   15,083          5.0%
</TABLE>

12.     OTHER EXPENSES

        Other expenses consisted of the following:

                                                  Year Ended December 31,
                                           ------------------------------------
                                              2006         2005         2004
                                           ----------   ----------   ----------
                                                       (In thousands)
        Professional fees                  $      349   $      397   $      316
        Appraisal fees                            337          255          253
        Directors fees                            274          259          190
        Postage, stationery and supplies          184          196          159
        Telephone                                 210          190          152
        Data processing                           286          243          102
        Advertising and promotion                 365          127           74
        Other operating expenses                1,224        1,245        1,151
                                           ----------   ----------   ----------
                                           $    3,229   $    2,912   $    2,397
                                           ==========   ==========   ==========

57
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

13.     LOANS TO RELATED PARTIES

        During the normal course of business, the Company enters into loans with
        related parties, including executive officers and directors. These loans
        are  made  with  substantially  the  same  terms,  including  rates  and
        collateral, as loans to unrelated parties. The following is a summary of
        the aggregate activity involving related party borrowers (in thousands):

        Balance, January 1, 2006                            $  1,889,000

            Disbursements                                      6,170,000
            Addition of outstanding loans to new director      1,698,000
            Amounts repaid                                    (2,830,000)
                                                            ------------
        Balance, December 31, 2006                          $  6,927,000
                                                            ============
        Undisbursed commitments to related
            parties, December 31, 2006                      $  1,071,000
                                                            ============

14.     EMPLOYEE BENEFIT PLANS

        The 401(k)  Savings Plan  established  by the Bank in 1990 was converted
        into a Company  plan in 2002.  Under  the  provisions  of the plan,  the
        Company matches one-half of the employees' contributions up to a maximum
        of three percent of an employee's  annual salary.  All employees who are
        at least 21 years of age and  have  completed  one year of  service  are
        eligible under the plan. The Company's  contributions  vest at a rate of
        20%  after  one year of  service  and an  additional  20% for each  year
        thereafter.  Contributions  to the plan  totaled  $21,000,  $30,000  and
        $45,000  for  the  years  ended  December  31,  2006,   2005  and  2004,
        respectively.

58
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

14.     EMPLOYEE BENEFIT PLANS (Continued)

        Salary Continuation and Retirement Plans

        The Board of Directors approved salary continuation and retirement plans
        for six key executives in 2003.  Under these plans,  the executives will
        receive  monthly  payments  for twenty  years  after  retirement.  These
        benefits  are   substantially   equivalent  to  those   available  under
        split-dollar  life  insurance  policies  purchased by the Company on the
        lives of the  executives.  In addition,  the estimated  present value of
        these  future  benefits is accrued  over the period  from the  effective
        dates of the plans until the  participants'  expected  retirement  dates
        based on a 7% discount  rate. The expense  recognized  under these plans
        for the years ended  December  31, 2006 and 2005  totaled  $209,000  and
        $242,000,  respectively.  Accrued  compensation  payable under the plans
        totaled   $785,000   and   $576,000  at  December  31,  2006  and  2005,
        respectively.

        In connection  with these plans,  the Company  purchased  single premium
        life insurance  policies with cash surrender values totaling  $6,079,000
        at December 31, 2006. Income earned on these policies,  net of expenses,
        totaled $208,000, $165,000 and $188,000 for the years ended December 31,
        2006,  2005 and 2004,  respectively.  Income earned on these policies is
        not subject to federal or state income tax under certain circumstances.

15.     COMPREHENSIVE INCOME

        Comprehensive income is a more inclusive financial reporting methodology
        that includes disclosure of other comprehensive income that historically
        has not been recognized in the calculation of net income.  The Company's
        only source of other comprehensive income (loss) is unrealized gains and
        losses on the Company's available-for-sale  investment securities. Total
        comprehensive   income  and  the   components   of   accumulated   other
        comprehensive income (loss) are presented in the consolidated  statement
        of changes in shareholders' equity.

        At  December  31,  2006,  2005 and 2004,  the  Company  held  securities
        classified  as  available-for-sale  which had changes in net  unrealized
        gains or losses as follows:

<TABLE>
<CAPTION>
                                                            2006          2005          2004
                                                         ----------    ----------    ----------
                                                                     (In thousands)
        <S>                                              <C>           <C>           <C>
        Other comprehensive (loss) income:
          Unrealized holding gains (losses)              $       78    $     (233)   $      (26)
          Tax (expense) benefit on unrealized
             holding gains                                      (30)           93             6
                                                         ----------    ----------    ----------
               Total other comprehensive (loss) income   $       48    $     (140)   $      (20)
                                                         ==========    ==========    ==========
</TABLE>

59
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

16.     DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

        Disclosures include estimated fair values for financial  instruments for
        which it is practicable to estimate fair value. These estimates are made
        at  a  specific  point  in  time  based  on  relevant  market  data  and
        information  about the  financial  instruments.  These  estimates do not
        reflect any  premium or discount  that could  result from  offering  the
        Company's entire holdings of a particular  financial instrument for sale
        at one time,  nor do they attempt to estimate  the value of  anticipated
        future  business  related  to the  instruments.  In  addition,  the  tax
        ramifications  related to the realization of unrealized gains and losses
        can have a significant  effect on fair value estimates and have not been
        considered in any of these estimates.

        Because no market  exists  for a  significant  portion of the  Company's
        financial  instruments,  fair  value  estimates  are based on  judgments
        regarding current economic  conditions,  risk characteristics of various
        financial instruments and other factors.  These estimates are subjective
        in nature and involve  uncertainties and matters of significant judgment
        and  therefore   cannot  be  determined  with   precision.   Changes  in
        assumptions could significantly affect the fair values presented.

        The  following  methods  and  assumptions  were  used by  management  to
        estimate  the  fair  value of the  Company's  financial  instruments  at
        December 31, 2006 and 2005:

        Cash and cash equivalents:  For cash and cash equivalents,  the carrying
        amount is estimated to be fair value.

        Investment securities: For investment securities,  fair values are based
        on quoted market prices,  where  available.  If quoted market prices are
        not available,  fair values are estimated using quoted market prices for
        similar securities and indications of value provided by brokers.

        Loans:  For  variable-rate   loans  that  reprice   frequently  with  no
        significant  change in credit  risk,  fair  values are based on carrying
        values.  The fair values for the  remaining  loans are  estimated  using
        discounted  cash flow  analyses,  using  interest rates being offered at
        each  reporting  date for  loans  with  similar  terms to  borrowers  of
        comparable  creditworthiness adjusted for the allowance for loan losses.
        The carrying amount of accrued interest receivable approximates its fair
        value.

        Company owned life insurance: The fair values of life insurance policies
        are  based on  current  cash  surrender  values at each  reporting  date
        provided by the insurers.

        Other investments: Other investments include Federal Reserve Bank Stock,
        Federal Home Loan Bank Stock and Farmer Mac Home  Administrative  Stock.
        The carrying value of other  investments  approximate fair value.  These
        investments  are carried at cost and are  redeemable at par with certain
        restrictions.

        Deposits: The fair values for demand deposits are, by definition,  equal
        to the amount  payable on demand at the reporting  date  represented  by
        their  carrying  amount.  Fair  values for  fixed-rate  certificates  of
        deposit  are  estimated  using a  discounted  cash flow  analysis  using
        interest  rates  offered  at  each  reporting  date by the  Company  for
        certificates with similar remaining  maturities.  The carrying amount of
        accrued interest payable approximates its fair value.

        Other  borrowings:  The carrying  amount of  short-term  borrowings  and
        interest  payable  approximates  their  fair  value.  The fair  value of
        long-term debt is estimated  using a discounted cash flow analysis using
        interest  rates  currently  available  to the Company  for similar  debt
        instruments.

60
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

16.     DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

        Subordinated  debentures:  The fair value of subordinated debentures was
        determined  based on the current market value for like-kind  instruments
        of similar rates and terms.

        Commitments to fund loans/standby  letters of credit:  Off-balance-sheet
        commitments to extend credit are primarily for adjustable rate loans and
        letters of credit.  The fair values of commitments  are estimated  using
        the fees currently charged to enter into similar agreements, taking into
        account  the  remaining   terms  of  the   agreements  and  the  present
        creditworthiness  of the  counterparties.  The  differences  between the
        carrying value of commitments to fund loans or standby letters of credit
        and their fair value are not significant and, therefore, not included in
        the following table.

<TABLE>
<CAPTION>
                                           December 31, 2006         December 31, 2005
                                        -----------------------   -----------------------
                                         Carrying      Fair        Carrying      Fair
                                          Amount       Value        Amount       Value
                                        ----------   ----------   ----------   ----------
                                                          (In thousands)
        <S>                             <C>          <C>          <C>          <C>
        Financial assets:
          Cash and due from banks       $   18,985   $   18,985   $   14,453   $   14,453
          Federal funds sold                31,630       31,630        4,667        4,667
          Investment securities             23,107       23,106       28,539       28,539
          Loans, net                       287,318      287,012      241,556      239,629
          Company owned life
             insurance                       6,079        6,079        4,411        4,411
          Accrued interest receivable        6,201        6,201        1,890        1,890
          Other investments                  1,409        1,409        1,229        1,229

        Financial liabilities:
          Deposits                      $  340,996   $  340,756   $  273,074   $  272,362
          Other borrowings                   4,900        4,900        4,000        4,000
          Subordinated debentures            8,764        8,604        8,764        8,630
          Accrued interest payable           3,033        3,033          810          810
</TABLE>

61
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

17.     PARENT ONLY CONDENSED FINANCIAL STATEMENTS

                             CONDENSED BALANCE SHEET

                           December 31, 2006 and 2005
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                  2006          2005
                                                               ----------    ----------
                                ASSETS
        <S>                                                    <C>           <C>
        Cash and cash equivalents                              $      614    $        2
        Investment in bank subsidiary                              35,274        28,420
        Investment in Pacific State Statutory Trust I and II          264           264
        Investment in other securities                                              204
        Other assets                                                1,671         1,267
                                                               ----------    ----------
               Total assets                                    $   37,823    $   30,157
                                                               ==========    ==========
                            LIABILITIES AND
                         SHAREHOLDERS' EQUITY

        Liabilities:
          Subordinated debentures                              $    8,764    $    8,764
          Other liabilities                                             -            20
                                                               ----------    ----------
               Total liabilities                                    8,764         8,784
                                                               ----------    ----------
        Shareholders' equity:
          Common stock                                              9,651         7,556
          Retained earnings                                        19,455        13,912
          Accumulated other comprehensive (loss) income,
             net of taxes                                             (47)          (95)
                                                               ----------    ----------
               Total shareholders' equity                          29,059        21,373
                                                               ----------    ----------
               Total liabilities and shareholders' equity      $   37,823    $   30,157
                                                               ==========    ==========
</TABLE>

62
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

17.     PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)

                          CONDENSED STATEMENT OF INCOME

              For the Years Ended December 31, 2006, 2005 and 2004
                                 (In thousands)

<TABLE>
<CAPTION>
                                                          2006          2005          2004
                                                       ----------    ----------    ----------
        <S>                                            <C>           <C>           <C>
        Income:
          Dividends declared by bank subsidiary        $      250    $      550    $      395
          Interest                                             12            12             5
                                                       ----------    ----------    ----------
               Total income                                   262           562           400
                                                       ----------    ----------    ----------
        Expenses:
          Interest on subordinated debentures                 710           527           366
          Salaries and employee benefits                       92            70            70
          Professional                                         78            76            60
          Other expenses                                       67            99            92
                                                       ----------    ----------    ----------
               Total expenses                                 947           772           588
                                                       ----------    ----------    ----------
               Loss before equity in undistributed
                 income of subsidiary                        (685)         (210)         (188)

        Equity in undistributed income of subsidiary        5,843         4,190         3,135
                                                       ----------    ----------    ----------
               Income before income tax benefit             5,158         3,980         2,947

        Income tax benefit                                   (385)         (306)         (222)
                                                       ----------    ----------    ----------
               Net income                              $    5,543    $    4,286    $    3,169
                                                       ==========    ==========    ==========
</TABLE>

63
<PAGE>

                      PACIFIC STATE BANCORP AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

18.     PARENT ONLY CONDENSED FINANCIAL STATEMENTS (Continued)


                        CONDENSED STATEMENT OF CASH FLOWS

              For the Years Ended December 31, 2006, 2005 and 2004
                                 (In thousands)

<TABLE>
<CAPTION>
                                                              2006          2005          2004
                                                           ----------    ----------    ----------
        <S>                                                <C>           <C>           <C>
        Cash flows from operating activities:
          Net income                                       $    5,543    $    4,286    $    3,169
          Adjustments to reconcile net income to net
             cash used in operating activities:
               Undistributed net income of subsidiary          (5,843)       (4,190)       (3,135)
               Increase in other assets                        (1,138)         (498)         (263)
               (Decrease) increase in other liabilities           (20)                         (1)
                                                           ----------    ----------    ----------
                 Net cash used in operating activities         (1,458)         (402)         (230)
                                                           ----------    ----------    ----------
        Cash flows from investing activities:
          Proceeds from matured and called available-
             for-sale investment securities                       204
          Investment in bank subsidiary                                                    (3,500)
          Investment in Pacific State Statutory
             Trust II                                                                        (109)
                                                           ----------    ----------    ----------
                 Net cash provided by (used in)
                    investing activities                          204                      (3,609)
                                                           ----------    ----------    ----------
        Cash flows from financing activities:
          Proceeds from issuance of junior
             subordinated debentures                                                        3,609
          Stock options exercised and related
             tax benefit                                        1,616           409           222
          Proceeds from the issuance of Common Stock              250
          Repurchase of common stock                                            (12)
                                                           ----------    ----------    ----------
                 Net cash provided by financing
                   activities                                   1,866           397         3,831
                                                           ----------    ----------    ----------
        Increase (decrease) in cash and cash equivalents
                                                                  612            (5)           (8)
        Cash and cash equivalents at beginning
          of year                                                   2             7            15
                                                           ----------    ----------    ----------
        Cash and cash equivalents at end of year           $      614    $        2    $        7
                                                           ==========    ==========    ==========
        Non-cash investing activities:
          Net change in unrealized loss on
             available-for-sale investment securities      $       78    $     (232)   $      (26)
</TABLE>

                            FORWARD LOOKING STATMENTS

        Certain statements discussed or incorporated by reference in this Annual
Report including, but not limited to, information concerning possible or assumed
future  results  of  operations  of the  Company  set forth in the  Management's
Discussion  and Analysis of Financial  Condition and Results of  Operation,  are
forward-looking  statements within the meaning of the Securities Exchange Act of
1934 (the "Exchange  Act").  Forward-looking  statements  include  statements in
which  words  such  as  "expect,"  "anticipate,"  "intend,"  "plan,"  "believe,"
"estimate,"  "consider"  or  variants  or  similar  expressions  are  used.  The
Company's  actual future results and  shareholder  values may differ  materially
from those anticipated and expressed in these forward-looking statements,  which
are based on management's  beliefs and assumptions and on information  currently
available to management,  and are subject to risks and uncertainties  that could
cause actual results to differ  materially from those projected.  Such risks and
uncertainties  include,  among others, (1) competitive  pressures in the banking
industry;  (2) changes in the interest rate  environment;  (3) general  economic
conditions,  either  nationally  or  regionally;  (4) changes in the  regulatory
environment;  (5) changes in business conditions and inflation;  and (6) changes
in securities markets. Many of these factors are beyond the Company's ability to
control or predict.  Investors are  cautioned  not to put undue  reliance on any
forward-looking statements. In addition, the Company does not have any intention
or  obligation  to update  forward-looking  statements  contained in this Annual
Report, even if new information,  future events or other circumstances have made
them incorrect or misleading. Except as specifically noted herein all references
to the "Company" refer to Pacific State Bancorp, a California corporation.

64
<PAGE>

                         GENERAL DESCRIPTION OF BUSINESS

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

        The Bank conducts a general  commercial  banking business,  primarily in
the  five  county  region  that  comprises  Alameda,   Calaveras,  San  Joaquin,
Stanislaus and Tuolumne  counties,  and offers  commercial  banking  services to
residents  and employers of  businesses  in the Bank's  service area,  including
professional firms and small to medium sized retail and wholesale businesses and
manufacturers.  The Company as of March 15, 2007 had 84 employees,  including 36
officers.  The Bank  does not  engage in any  non-bank  lines of  business.  The
business of the Bank is not to any significant  degree  seasonal in nature.  The
Bank has no operations outside California and has no material amount of loans or
deposits  concentrated among any one or few persons,  groups or industries.  The
Bank operates nine branches with its  Administrative  Office  located at 1899 W.
March Lane, in Stockton, California; additional branches are located in downtown
Stockton and in the communities of Angels Camp, Arnold, Groveland, Lodi, Modesto
and Tracy and a limited service branch in Hayward, California.

        Pacific  State  Bancorp  common stock trades on the NASDAQ Global Market
under the symbol of "PSBC".

        Business Plan

        The  focus  of the  Company's  business  plan  is to  attract  "Business
Relationship" small, medium and large accounts,  but not to the exclusion of any
other business which the Company can reasonably and profitably attract. In order
to provide a level of  service  to  attract  such  customers,  the  Company  has
structured  its  specific  services  and  charges  on a basis  which  management
believes  to be  profitable,  taking  into  consideration  other  aspects of the
account relationship. The Company offers a full range of banking services to its
customers  intended  to  attract  the  following  specific  types  of  accounts:
relatively large consumer accounts; professional group and association accounts,
including the accounts of groups or firms of physicians, dentists, attorneys and
accountants; and accounts of small to medium-sized businesses engaged in retail,
wholesale, light industrial, manufacturing, agricultural and service activities.

        Trust Subsidiaries

        The Company  during 2002 and 2004  established  two  subsidiary  grantor
trusts.  Pacific State Statutory  Trusts I and II (the  "Trusts"),  for the sole
purpose  of  issuing  capital  securities  ("Capital  Securities")  pursuant  to
declarations  of trust (the  "Declarations").  The proceeds from the sale of the
Capital Securities were loaned to the Company as subordinated debentures

65
<PAGE>

(the   "Debentures")   issued  to  the  Trusts   pursuant  to  indentures   (the
"Indentures").  Interest payments on the Debentures will flow through the Trusts
to the Pooling  Vehicles,  which are the holders of the Capital  Securities  and
similar  securities  issued  by  other  financial   institutions.   Payments  of
distributions  by the  Trusts  to the  Pooling  Vehicle  are  guaranteed  by the
Company. See Note 8 to the Company's  consolidated financial statements included
with this report.

        Proceeds from the issuance of the 2002 subordinated debentures were used
to  provide  the Bank with an  additional  $4.5  million  in capital in order to
support the continued  growth of the Bank. The remaining  $500,000 was placed in
the Company for general  corporate  purposes.  Proceeds from the issuance of the
2004  subordinated  debentures  were used to provide the Bank with an additional
$3.5 million in capital in order to support the continued growth of the Bank.

        Product Lines and Services

        The Bank currently offers the following  general banking services at all
of its branches:  commercial,  construction,  agricultural and real estate loans
and personal  credit lines,  interest on checking,  U.S.  Savings bond services,
domestic and foreign drafts, banking by appointment, automatic transfer of funds
between savings and checking accounts,  business courier services,  checking and
savings accounts for personal and business purposes, domestic letters of credit,
a depository for MasterCard and Visa drafts,  federal depository services,  cash
management  assistance,  wire and  telephone  transfers,  Individual  Retirement
Accounts,  time certificates of deposit,  courier service for non-cash deposits,
Visa and MasterCard,  revolving lines of credit to consumers secured by deeds of
trust  on  private  residences,  unsecured  overdraft  protection  credit  lines
attached to checking  accounts,  ATM cards and  MasterMoney  debit cards via the
Star, Cirrus, Plus, MasterCard and Visa networks.

        The Bank is not authorized to offer trust services.  The Federal Reserve
Bank of San Francisco is the Company's primary correspondent  relationship.  The
Bank currently also has correspondent  relationships  with City National Bank in
Beverly Hills, California,  First Tennessee Bank in Memphis,  Tennessee, Bank of
the West in Walnut Creek, California, U. S. Bank, Minneapolis,  Minnesota, Wells
Fargo Bank,  San  Francisco,  California  and Pacific Coast  Bankers  Bank,  San
Francisco, California.

        The Bank recognizes that, in order to be competitive,  it must attract a
certain number of consumer accounts.  Individual  Retirement Accounts,  Visa and
MasterCard,  revolving lines of credit to consumers secured by deeds of trust on
private residences,  and unsecured overdraft protection credit lines attached to
checking  accounts  currently  offered  by  the  Bank  are  designed  to  appeal
particularly to consumers.  Moreover,  participation in large-scale ATM networks
assists the Company in competing for consumer accounts.

        The Bank is an approved  Small Business  Administration  and 504 lender,
FSA, USDA Business and Industry,  USDA  Part-time  Farmer Program and FHA and VA
lender. The Bank is a national leader in the underwriting of U.S.  Department of
Agriculture  business and industry loans, as well as a Preferred Lender for this
program.

66
<PAGE>

         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                              RESULTS OF OPERATION

CRITICAL ACCOUNTING POLICIES

General

        Pacific State Bancorp's  consolidated  financial statements are prepared
in accordance with accounting principles generally accepted in the United States
of America (GAAP). The financial  information  contained within our consolidated
financial statements is, to a significant extent,  financial information that is
based on measures of the financial  effects of transactions and events that have
already  occurred.  A variety of factors could affect the ultimate value that is
obtained either when earning income, recognizing an expense, recovering an asset
or  relieving  a  liability.  We use  historical  loss  factors as one factor in
determining the inherent loss that may be present in our loan portfolio.  Actual
losses  could  differ  significantly  from the  historical  factors that we use.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 123(R),  "Share Based Payment";  see information under the
header "Share Based Payments" in Note 2 to the consolidated financial statements
included  with this  report.  Other  estimates  that we use are  related  to the
expected useful lives of our depreciable  assets and the  determination  whether
any  impairment  exists  related to our  investments  and  intangible  and other
long-lived  assets.  In  addition,  GAAP itself may change  from one  previously
acceptable method to another method.  Although the economics of our transactions
would be the same, the timing of events that would impact our transactions could
change.

        A critical  accounting  estimate is one that  requires a company to make
assumptions  about matters that are highly  uncertain at the time the accounting
estimate is made. If different  estimates that the company reasonably could have
used for the accounting  estimate in the current period were made, or if changes
in the accounting  estimate that are  reasonably  likely to occur from period to
period  occurred,  they could have a material impact on the  presentation of the
company's  financial  condition,  changes in  financial  condition or results of
operations.

Allowance for Loan Losses

        The  allowance  for loan losses is an estimate of the losses that may be
sustained in our loan portfolio.  The allowance is based on two basic principles
of accounting.  (1) Statement of Financial  Accountings  Standards  (SFAS) No. 5
"Accounting for Contingencies",  which requires that losses be accrued when they
are probable of occurring  and estimable  and (2) SFAS No. 114,  "Accounting  by
Creditors  for  Impairment  of a Loan",  which  requires that losses on impaired
loans be accrued  and  measured  based on the  differences  between the value of
collateral,  present value of future cash flows or values that are observable in
the secondary market and the loan balance.

Stock Based Compensation

        Effective  January 1, 2006, the Company  adopted  Statement of Financial
Accounting  Standards No. 123 (R),  Share-Based  Payment ("SFAS 123 (R)"). Under
SFAS 123(R), compensation cost recognized for all awards that vest subsequent to
the date of  adoption  based  are on the  grant-date  fair  value  estimated  in
accordance with SFAS No. 123,  Accounting for Stock-Based  Compensation and SFAS
123(R).   The  grant-date  fair  value  is  estimated  using  the  Black-Scholes
option-pricing formula, which involves making estimates of the assumptions used,
including the expected term of the option,  expected  volatility over the option
term,  expected dividend yield over the option term and risk-free interest rate.
In addition,  when  determining  the  compensation  expense to amortize over the
vesting period, management makes estimates about the expected forfeiture rate of
options.

67
<PAGE>

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005

        Net  income  for the  year  ended  December  31,  2006,  was  $5,543,000
representing  an increase of  $1,257,000 or 29.33% over net income of $4,286,000
for the year ended  December 31, 2005.  The primary  contributing  factor to the
increase in net income was an increase in net interest income of $3,771,000 as a
result of an increase in both the volume of average earning assets and the rates
earned on those  assets,  offset by the  increase  in average  interest  bearing
liabilities  and the rates paid on those  liabilities.  Overall the net interest
margin  increased  35 basis  points in 2006  from  2005.  This was  offset by an
increase  in  non-interest  expense  of  $1,260,000  and  mitigated  by a slight
increase in  non-interest  income of  $102,000.  The  increase  in  non-interest
expenses was primarily  due to an increase in salaries and employee  benefits of
$737,000 and in other expenses of $317,000.

        Return on average  assets  (ROA)  improved  to 1.67% while the return on
average  equity (ROE)  decreased  slightly to 22.91% in 2006 compared with 1.53%
and 22.98%, respectively,  in 2005. Diluted earnings per share for 2006 and 2005
were $1.41 and $1.10,  respectively,  an  increase  of 28.18%.  The  increase in
earnings per share was primarily due to the increase in net income of 29.33%.

        The Company's  average total assets  increased to $331.2 million in 2006
or 18.16% over $280.3 million in 2005. In 2006 average earning assets  increased
to $300.4  million  or 18.16%  over  $250.1  million in 2005.  Average  interest
bearing liabilities increased to $241.0 million or 19.53% over $204.6 million in
2005.

        The Company's  total assets  increased to $386.8  million as of December
31,  2006 or 24.92%  over  $309.6  million at  December  31,  2005.  Total loans
increased in 2006 to $289.8  million from $243.7 million in 2005, an increase of
$46.1  million or 18.90%.  Total  Deposits  grew to $341.0  million,  or 24.86%,
compared to $273.1  million in 2005.  The  increases  in the balance  sheet and,
particularly in loans and deposits, were attributable to the continued growth of
the bank.

YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004

        Net  income  for the  year  ended  December  31,  2005,  was  $4,286,000
representing  an increase of  $1,117,000 or 35.24% over net income of $3,169,000
for the year ended  December 31, 2004.  The primary  contributing  factor to the
increase in net income was an increase in net interest income of $3,085,000 as a
result of an increase  in the volume of average  earning  assets,  offset by the
increase in average  interest  bearing  liabilities,  and an increase in the net
interest  margin.  This was offset by an  increase  in  non-interest  expense of
$1,671,000 and a slight decrease in non-interest income of $44,000. The increase
in  non-interest  expenses  was  primarily  due to an increase  in salaries  and
employee benefits of $928,000 and in other expenses of $515,000.

        Return on average  assets (ROA)  improved to 1.53% and return on average
common  equity (ROE)  improved to 22.98% in 2005 compared with 1.37% and 21.64%,
respectively,  in 2004.  Diluted earnings per share for 2005 and 2004 were $1.10
and $0.84,  respectively,  an increase of 30.95%.  The  increase in earnings per
share was primarily due to the increase in net income of 35.24%.

68
<PAGE>

        The Company's  average total assets  increased to $280.3 million in 2005
or 21.45% over $230.8 million in 2004. In 2005 average earning assets  increased
to $250.1  million  or 22.90%  over  $203.5  million in 2004.  Average  interest
bearing liabilities increased to $201.6 million or 20.79% over $166.9 million in
2004.

        The Company's  total assets  increased to $309.6  million as of December
31,  2005 or 21.70%  over  $254.4  million at  December  31,  2004.  Total loans
increased to $243.9  million from $201.7  million in 2004,  an increase of $42.2
million or 20.92%. Total Deposits grew to $273.0 million, or 21.98%, compared to
$223.8 million in 2004. The increases on the balance sheet were  attributable to
the growth of the bank.

NET INTEREST INCOME

        The  primary  source of  income  for the  Company  is  derived  from net
interest income.  Net interest income represents the excess of interest and fees
earned on  interest-earning  assets  (loans,  securities and federal funds sold)
over the interest paid on deposits and borrowed  funds.  Net interest  margin is
net interest income expressed as a percentage of average earning assets.

        Net interest income increased $3.8 million or 28.15% to $17.3 million in
2006 from $13.5  million  in 2005 and $3.1  million or 29.81% in 2005 from $10.4
million in 2004. The average  balance of total earning assets for 2006 increased
$50.3  million or 20.13% to $300.4  million  from $250.1  million.  Average loan
balances  outstanding  during  2006  increased  $53.5  million or 24.77%,  while
average  balances  of  investments,  federal  funds  sold and  interest  bearing
deposits in banks  decreased  by $3.1  million or 9.20%.  The average  yields on
loans in 2006 increased by 110 basis points.  The average yield on  investments,
federal funds sold and interest bearing  deposits  increased 158 basis points in
2006  compared  to 2005.  The  increase in yields is  directly  attributable  to
increases in the prime rate during 2006.  During 2006,  the prime rate increased
four times from 7.25% to 8.25%. As a result of both the change in mix of earning
assets and the increase in rates,  the overall yield on average  earning  assets
during 2006 increased 131 basis points to 8.82% from 7.51% for 2005.

        Total interest expense  increased $4.0 million or 76.92% to $9.2 million
in 2006,  from $5.2 million for 2005 which increased $2.2 million or 71.55% over
$3.1  million  for  2004.  In  2006  the  average  balance  of  interest-bearing
liabilities  increased  $39.4  million or 19.53% to $241.0  million  from $201.6
million for the year ended  December  31, 2005.  Additionally,  the average rate
paid on  interest-bearing  liabilities  increased 121 basis points to 3.81% from
2.60% in 2006. In 2005 compared to 2004 interest expense increased primarily due
to (1) the increase in average balances of interest-bearing liabilities of $34.7
million  or 20.81% to $201.6  million  from  $166.9  million  for the year ended
December 31, 2004 and (2) the increase in rates paid of 77 basis points.

        Average  interest-bearing  demand  deposits  decreased  $12.6 million or
12.05% to $92.3  million in 2006 from $104.9  million in 2005.  The average rate
paid  on  these  deposits  during  2006  increased  37  basis  points.   Average
certificates  of deposit  increased $48.4 million or 62.43% to $126.0 million in
2006 from $77.6  million  in 2005.  The  average  rate paid on  certificates  of
deposit during 2006 increased 163 basis points.  As a result of the increases in
interest   rates   described   above  and   overall   changes   in  the  mix  of
interest-bearing  deposits,  the  average  rate  paid  on all  interest  bearing
deposits and borrowings  increased 121 basis points for 2006 to 3.81% from 2.60%
for 2005.

        The  Company's  net  interest  margin (net  interest  income  divided by
average  earning  assets  was 5.76% in 2006,  up from 5.41% in 2005 and 5.14% in
2004. The increases in both the volume of and yields on earning assets,  coupled
with  the  change  in mix of and  rates  paid  on  interest-bearing  liabilities
resulted in an increase of $3.8 million or 28.15% in net interest income for the
year ended  December 31, 2006 compared to 2005.  For the year ended December 31,
2005  compared to 2004,  the  combined  effect of the  increase in volume of and
yield on earning assets,  coupled with the change in mix and rates paid resulted
in an increase of $3.1 million 29.81% in net interest income over 2004.

69
<PAGE>

The following table sets forth the Company's daily average balance sheet,
related interest income or expense and yield or rate paid for the periods
indicated. The yield on tax-exempt securities has not been adjusted to a
tax-equivalent yield basis. Average balances are based on daily averages.

AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND YIELDS/RATES PAID
(Dollars in thousands)

<TABLE>
<CAPTION>
                                                             YEARS ENDED DECEMBER 31,
                    ----------------------------------------------------------------------------------------------------------
                                   2006                                2005                                2004
                    ----------------------------------  ----------------------------------  ----------------------------------
                                 Interest                            Interest                            Interest
                      Average    Income /    Average      Average    Income /    Average      Average    Income /    Average
                      Balance    Expense    Yield/Rate    Balance    Expense    Yield/Rate    Balance    Expense    Yield/Rate
                    ----------  ----------  ----------  ----------  ----------  ----------  ----------  ----------  ----------
<S>                 <C>         <C>               <C>   <C>         <C>               <C>   <C>         <C>            <C>
ASSETS
 Loans[1]           $  269,395  $   24,901        9.24% $  215,907  $   17,565        8.14% $  180,559  $   12,846        7.11%
Investment
 Securities             25,418       1,321        5.20%     19,694         707        3.59%     15,068         535        3.55%
Federal Funds Sold       5,602         273        4.87%     11,169         354        3.17%      6,775          93        1.37%
Interest-bearing
 Deposits in Banks           -           -        0.00%      3,299         156        4.73%      1,066          35        3.28%
                    ----------  ----------              ----------  ----------              ----------  ----------
Total Average
Earning Assets      $  300,415  $   26,495        8.82% $  250,069  $   18,782        7.51% $  203,766  $   13,509        6.64%
                    ----------  ----------  ----------  ----------  ----------  ----------  ----------  ----------  ----------
Cash & Due From
 Banks              $   13,655                          $   14,474                          $   11,579
Bank Premises and
 Equipment              10,609                               9,581                               9,599
Other Assets             9,058                               8,511                               8,066
Less: Allowance
 for loan  loss         (2,536)                             (2,346)                             (1,961)
                    ----------                          ----------                          ----------
Total Average
Assets              $  331,201                          $  280,289                          $  230,751
                    ==========                          ==========                          ==========
LIABILITIES AND
 SHAREHOLDERS
 EQUITY
Interest Bearing
Liabilities:
Interest-bearing
 Demand             $   92,280  $    2,438        2.64% $  104,922  $    2,384        2.27% $   61,801  $      944        1.53%
Savings                  6,359          56        0.88%      6,307          36        0.57%      6,606          20        0.30%
Time  Deposits         125,994       5,608        4.45%     77,567       2,190        2.82%     85,548       1,600        1.87%
Other Borrowings        16,379       1,086        6.63%     12,845         636        4.95%     12,958         494        3.81%
                    ----------  ----------              ----------  ----------              ----------  ----------
Total Average
 Interest Bearing
 Liabilities        $  241,012  $    9,188        3.81% $  201,641  $    5,246        2.60% $  166,913  $    3,058        1.83%
                    ----------  ----------  ----------  ----------  ----------  ----------  ----------  ----------  ----------
Non-interest
 Bearing Demand         64,593                              59,009                              47,969
Other Liabilities        1,405                                 986                               1,233
Shareholder Equity      24,191                              18,653                              14,636
                    ----------                          ----------                          ----------
Total Average
 Liabilities and
 Shareholders
 Equity             $  331,201                          $  280,289                          $  230,751
                    ==========                          ==========                          ==========
Net Interest
 Income and Net
 Interest Margin                $   17,307        5.76%             $   13,536        5.41%             $   10,451        5.14%
                                ==========                          ==========                          ==========
</TABLE>

    1.  Interest  income and yields on loans  include fee income of  $1,868,000,
        $1,680,000 and  $1,112,000  for the years ended December 31, 2006,  2005
        and 2004,  respectively.  The Company did not have any nonaccrual  loans
        for the years ended December 31, 2006, 2005 and 2004.

70
<PAGE>

        The Company's  average total assets  increased to $331.2 million in 2006
from $280.3 million in 2005 and $230.8 million in 2004,  representing  an 18.16%
increase  in 2006 over 2005 and a 21.45%  increase  in 2005 over  2004.  Average
loans increased to $269.4 million in 2006 from $215.9 million in 2005 and $180.6
million in 2004  representing  a 24.77% and 19.58%  increase  respectively.  The
Company's average total interest bearing liabilities increased to $241.0 million
in 2006 from $201.6 million in 2005 and $166.9  million in 2004,  representing a
19.53% and 20.80%  increase  respectively.  The Company's  average  non-interest
bearing demand deposits increased to $64.6 million in 2006 from $59.0 million in
2005 and  $48.0  million  in  2004,  representing  a 9.46%  and  23.0%  increase
respectively.  The growth came from the expansion of the Bank's  current  market
share.

        The following  table sets forth  changes in interest  income and expense
for each major category of earning assets and interest-bearing  liabilities, and
the amount of change attributable to volume, rates and the combination of volume
and rates (mix) for the periods  indicated.  The yield on tax-exempt  securities
has not been adjusted to a tax-equivalent yield basis.

         Analysis of Changes in Net Interest Income and Expense

<TABLE>
<CAPTION>
                                                                    YEARS ENDED DECEMBER 31,
                                  --------------------------------------------------------------------------------------------
                                                  2006 OVER 2005                                 2005 OVER 2004
                                  ---------------------------------------------   --------------------------------------------
                                   Average     Average                             Average     Average
                                   Volume       Rate                               Volume       Rate
    (Dollars in thousands)          (1)          (2)       Mix (3)      Total        (1)         (2)      Mix (3)     Total
-------------------------------   ---------   ---------   ---------   ---------   ---------   ---------  ---------   ---------
<S>                               <C>         <C>         <C>         <C>         <C>         <C>        <C>         <C>
Increase (Decrease)
In Interest Income:
Loans                             $   4,351   $   2,392   $     593   $   7,336   $   2,515   $   1,843  $     361   $   4,719
Investment securities                   205         317          92         614         164           6          2         172
Federal Funds sold                     (176)        190         (95)        (81)         60         122         79         261
Interest-bearing Deposits
 in Banks                              (156)       (156)        156        (156)         73          15         32         121
                                  ---------   ---------   ---------   ---------   ---------   ---------  ---------   ---------
Total Increase                    $   4,225   $   2,743   $     746   $   7,713   $   2,813   $   1,986  $     474   $   5,273
                                  ---------   ---------   ---------   ---------   ---------   ---------  ---------   ---------
Increase (Decrease)
In Interest Expense:
Interest-bearing Demand           $    (287)  $     388   $     (47)  $      54   $     659   $     459  $     322   $   1,440
Savings                                   -          20           -          20          (1)         18         (1)         16

Time Deposits                         1,367       1,263         788       3,418        (149)        815        (76)        590

Other Borrowings                        175         216          59         450          (4)        148         (2)        142
                                  ---------   ---------   ---------   ---------   ---------   ---------  ---------   ---------
Total Increase                    $   1,255   $   1,886   $     801   $   3,942   $     505   $   1,440  $     243   $   2,188
                                  ---------   ---------   ---------   ---------   ---------   ---------  ---------   ---------
Net Increase (Decrease)           $   2,969   $     857   $     (55)  $   3,771   $   2,308   $     547  $     231   $   3,085
                                  =========   =========   =========   =========   =========   =========  =========   =========
</TABLE>

    1.  The  volume  change in net  interest  income  represents  the  change in
        average balance divided by the previous year's rate.
    2.  The rate change in net  interest  income  represents  the change in rate
        divided by the previous year's average balance.
    3.  The mix change in net interest  income  represents the change in average
        balance multiplied by the change in rate.

71
<PAGE>

        Non-interest Income

        The Company's  non-interest income consists primarily of service charges
on deposit  accounts,  gain on sale of loans and ATM and other service fees. For
the year ended December 31, 2006,  non-interest  income represented 8.88% of the
Company's revenues versus 11.67% in 2005, and 15.75% in 2004.

        Total  non-interest  income increased  slightly to $2.58 million in 2006
from $2.48 million in 2005 which decreased  slightly from $2.53 million in 2004,
representing an increase of 4.11% and a decrease of 1.74% respectively.  Service
charge income  increased  $106 thousand in 2006 or 13.98% to $864  thousand,  up
from $758 thousand for the  comparable  period in 2005.  The increase in service
charge  income is the result of the increase in deposit  accounts as a result of
the growth of the Company.  The decrease in service  charge  income in 2005 over
2004 was the result of (1) the higher  earning  rate used to offset fees paid on
accounts  charged through  account  analysis and (2) a decrease in the volume of
account  overdrafts.  The  increase  in service  charges in 2006 was offset by a
decrease in gain on sales of loans of $515  thousand or 63.66%.  The decrease in
the gain on sale of loans in 2006 and the  increase  in 2005  over  2004 of $364
thousand  are due to both the timing of the sale of the loans and the changes in
the number and dollar amount of loans sold. Other income increased $511 thousand
or 56.53% in 2006 from $914 thousand in 2005. The increase in 2006 over 2005 was
primarily  the result of an increase in fee income  derived from the referral of
commercial  mortgage  loans to third  parties.  Decrease in other  income of $92
thousand in 2005 from 2004 was  primarily the result of a decrease in the income
derived from the referral of commercial  mortgage  loans to third  parties.  The
income derived for the referral of commercial mortgage loans to third parties is
dependant on the size and volume of the loans generated.

        The following table sets forth a summary of non-interest  income for the
periods indicated.

                                        YEARS ENDED DECEMBER 31,
                                     -------------------------------
(Dollars in thousands)                 2006       2005       2004
-----------------------------------  ---------  ---------  ---------
Non-interest Income:
Service charges                      $     864  $     758  $   1,075
Gain on sale of loans                      294        809        445
Other income                             1,425        914      1,005
                                     ---------  ---------  ---------
Total Non-interest Income            $   2,583  $   2,481  $   2,525
                                     =========  =========  =========

        Non-interest Expense

        Non-interest expense consists of salaries and related employee benefits,
occupancy and equipment expenses,  professional fees, appraisal fees, directors'
fees,  postage,  stationery  and supplies  expenses,  telephone  expenses,  data
processing  expenses,  advertising  and  promotion  expense and other  operating
expenses.  Non-interest  expense  for 2006 was $10.4  million  compared  to $9.1
million  for 2005 and $7.4  million in 2004,  representing  an  increase of $1.3
million or 13.84% for 2006,  and $1.7  million or 22.48% for 2005.  Increases in
salaries and benefits are  indicative of the  continuing  additions to staff the
expanded  branch  operations  in line

72
<PAGE>

with their growth over the past two years,  and the  recognition  of stock based
compensation  expenses  of $229,000  of which  $124,000  was related to director
stock based compensation,  as a result of adopting SFAS No. 123(R). The increase
in occupancy  and  equipment  expense in 2006 over 2005 is  attributable  to the
addition  of the new  branches  in Lodi  and  Hayward  Data  Processing  expense
increased $141 thousand in 2005 due to increased cost of overall system upgrades
to support the growth of the company.  Other expenses decreased slightly in 2006
over 2005 as a result of  decreased  miscellaneous  operating  losses  offset by
slightly higher  correspondent  banking charges  associated with volume of items
processed.  Other expense increased in 2005 over 2004 primarily due to increased
insurance costs  associated with the growth of the Company.  The following table
sets forth a summary of non-interest expense for the periods indicated.

                                        YEARS ENDED DECEMBER 31,
                                     -------------------------------
(Dollars in thousands)                 2006       2005       2004
-----------------------------------  ---------  ---------  ---------
Non-interest Expense:
Salaries & benefits                  $   5,479  $   4,742  $   3,814
Occupancy & equipment                    1,652      1,446      1,218
Professional fees                          349        397        316
Appraisal fees                             337        255        253
Directors' fees                            274        259        190
Postage, stationery and supplies           184        196        159
Telephone                                  210        190        152
Data processing                            286        243        102
Advertising and promotion                  365        127         74
Other operating expenses                 1,224      1,245      1,151
                                     ---------  ---------  ---------
Total Non-Interest Expenses          $  10,360  $   9,100  $   7,429
                                     =========  =========  =========

        Share-Based Compensation

        In 2006, the Company adopted Statement of Financial Accounting Standards
No. 123(R),  Share-Based Payment (SFAS 123(R)),  using the modified  prospective
application  transition method.  Prior to January 1, 2006, the Company accounted
for share-based compensation under the recognition and measurement principles of
APB  Opinion  No. 25,  Accounting  for Stock  Issued to  Employees,  and related
Interpretations  (APB 25). No share-based  compensation cost is reflected in net
income  prior to January 1, 2006,  as all options  granted by the company had an
exercise price equal to the market value of the  underlying  common stock on the
date of the grant.  As a result of adopting SFAS 123(R),  the  Company's  income
before provision for income taxes and net income for the year ended December 31,
2006 was $229  thousand and $133  thousand,  respectively,  lower than if it had
continued to account for share-based compensation under APB 25.

        The Company  bases the fair value of the options  previously  granted on
the  date  of  grant  using a  Black-Scholes  option  pricing  model  that  uses
assumptions  based  on  expected  option  life,  the  level  of  expected  stock
volatility  and the risk-free  interest rate.  Stock  volatility is based on the
historical volatility of the Company's stock. The risk-free rate is based on the
U.S.  Treasury  yield curve and the expected  term of the options.  The expected
term of the options represents the period that the Company's  share-based awards
are expected to be outstanding  based on the terms of the optionee's  employment
agreement and position within the Company,  previous option activity, the number
of shares  currently  owned and the expected time of when those options would be
exercised.  The Company has not paid cash dividends.  The Company  estimates the
forfeiture rate in calculating the compensation expense to be insignificant.

73
<PAGE>

There were no options granted in 2006,  2005, or 2004. There were no significant
changes in the valuation methods or types of awards or terms made by the Company
subsequent  to  the  adoption  of  SFAS  No.  123(R)  and no  cumulative  effect
adjustments were made to the financial statements.

As of  December  31,  2006,  there  was  $356  thousand  of  total  unrecognized
compensation cost related to non-vested share-based  compensation  arrangements.
The related  compensation  expense is  expected  to be realized  over a weighted
average  period of 1.5  years.  See Notes 2 and 11 to the  audited  Consolidated
Financial Statements.

        Provision for Income Taxes

        The Company's  provision for income taxes  includes both federal  income
and state  franchise  taxes and  reflects the  application  of federal and state
statutory  rates  to the  Company's  net  income  before  taxes.  The  principal
difference  between statutory tax rates and the Company's  effective tax rate is
the benefit  derived from  investing in tax-exempt  securities and Company owned
life  insurance.  Increases and  decreases in the provision for taxes  primarily
reflect changes in the Company's net income before tax.

The  following  table  reflects  the  Company's  tax  provision  and the related
effective tax rate for the periods indicated.

                                         YEARS ENDED DECEMBER 31,
                                     -------------------------------
(Dollars in thousands)                 2006       2005       2004
-----------------------------------  ---------  ---------  ---------
Tax Provision                        $   3,627  $   2,596  $   1,874
Effective Tax Rate                       39.56%     37.72%     37.16%

74
<PAGE>

FINANCIAL CONDITION

INVESTMENT SECURITIES

        The Company classifies its investment  securities as  "held-to-maturity"
or  "available-for-sale"  at the time of  investment  purchase.  Generally,  all
securities  are purchased with the intent and ability to hold them for long-term
investment,   and  the   Company  has  both  the  ability  and  intent  to  hold
"held-to-maturity"  investments  to  maturity.  The  Company  does not engage in
trading activities.

        Investment securities  held-to-maturity are carried at cost adjusted for
the   accretion  of  discounts   and   amortization   of  premiums.   Securities
available-for-sale  may be  sold  to  implement  the  Company's  asset/liability
management  strategies and in response to changes in interest rates,  prepayment
rates and similar factors.  Securities  available-for-sale  are recorded at fair
value and  unrealized  gains or losses,  net of income  taxes,  are  reported as
accumulated  other  comprehensive  income or loss,  in a separate  component  of
shareholder's  equity. Gain or loss on sale of investment securities is based on
the specific identification method.

        Investment  securities  held-to-maturity at December 31, 2006, consisted
of mortgage-backed securities totaling $73 thousand with a remaining contractual
maturity of 11 to 18 years and a weighted-average yield to maturity of 6.21%.

        The  following  table  summarizes  the  contractual  maturities  of  the
Company's   investment   securities   at  their   carrying   value   and   their
weighted-average yields at December 31, 2006. The yield on tax-exempt securities
has not been adjusted to a tax-equivalent yield basis.

<TABLE>
<CAPTION>
                                    WITHIN ONE         ONE TO FIVE        FIVE TO TEN
                                       YEAR               YEARS              YEARS           OVER TEN YEARS          TOTAL
                                 ----------------    ----------------   ----------------    ----------------    ----------------
   (Dollars in thousands)         Amount    Yield     Amount    Yield    Amount    Yield     Amount    Yield     Amount    Yield
----------------------------     --------   -----    --------   -----   --------   -----    --------   -----    --------   -----
<S>                              <C>         <C>        <C>      <C>    <C>         <C>     <C>         <C>     <C>         <C>
AVAILABLE-FOR-SALE
 SECURITIES:
US Government Agencies and
 Treasuries                      $ 10,876    4.54%                             -       -                        $ 10,876    4.54%

Municipal Obligations                 148    5.21%        462    3.62%         -       -    $  2,150    4.81%      2,760    4.14%
Corporate and Other Bonds                                   -       -          -       -       2,506    6.31%      2,506    6.31%
Mortgage- backed
 securities                           998    3.59%      2,047    3.58%                         3,847    4.40%      6,892    4.01%
                                 --------            --------                               --------            --------
TOTAL AVAILABLE-FOR-SALE
 SECURITIES                        12,022    4.48%      2,509    4.31%                         8,503    5.02%     23,034    5.06%
                                 ========   =====    ========   =====                       ========   =====    ========   =====
HELD-TO-MATURITY SECURITIES
Mortgage-backed securities                                              $     17    5.47%   $     56    6.41%   $     73    6.21%
                                                                        ========   =====    ========   =====    ========   =====
</TABLE>

75
<PAGE>

The following table summarizes the carrying value of the Company's investment
securities held on the dates indicated.

                                            AS OF DECEMBER 31,
                                     -------------------------------
(Dollars in thousands)                 2006       2005       2004
-----------------------------------  ---------  ---------  ---------
AVAILABLE-FOR-SALE SECURITIES
 - AT FAIR VALUE:

U.S. Government & Agencies           $  10,876  $  14,852  $   5,956
Municipal Obligations                    2,760      2,865      3,153
Corporate and Other Bonds                2,506      3,325        306
Mortgage- backed securities              6,892      7,374      7,922
                                     ---------  ---------  ---------
Total available-for-sale                23,034  $  28,416  $  17,337
                                     =========  =========  =========
HELD-TO-MATURITY SECURITIES - AT
 AMORTIZED COST:
Mortgage-backed Securities                  73  $     123  $     145
                                     ---------  ---------  ---------

        As of December  31,  2006,  the  aggregate  book value of the  Company's
investment  in securities of a single issuer did not exceed 10% of the company's
shareholders' equity.

76
<PAGE>

        Loans and Asset Quality

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

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

        The  following  table sets forth the  amounts  of loans  outstanding  by
category as of the dates indicated:

<TABLE>
<CAPTION>
                                                                     AS OF DECEMBER 31,
                                                 ---------------------------------------------------------
(Dollars in thousands)                              2006       2005        2004        2003        2002
-----------------------------------------------  ---------   ---------   ---------   ---------   ---------
<S>                                              <C>         <C>         <C>         <C>         <C>
Commercial and Agricultural                      $  74,815   $  60,645   $  55,569   $  57,638   $  40,226
Real estate-construction                            75,654      43,352      22,965      28,219      33,887
Real estate-commercial mortgage                    127,545     126,166     109,895      60,174      53,160
Installment                                         11,742      13,536      13,121      10,823       7,734
Deferred Loan Fees and Costs                            40         213         199         284         265
Allowance for Loan Losses                           (2,478)     (2,356)     (2,214)     (1,653)     (1,306)
                                                 ---------   ---------   ---------   ---------   ---------
Total Net Loans                                  $ 287,318   $ 241,556   $ 199,535   $ 155,485   $ 133,966
                                                 =========   =========   =========   =========   =========
</TABLE>

        Net loans have increased  $45.8 million or 18.94%,  to $287.3 million at
December 31, 2006 from $241.5  million at December 31, 2005.  Comparing  2006 to
2005 commercial and  agricultural  loans have increased $14.2 million or 23.37%,
real estate  construction  loans have  increased  $32.3 million or 74.51%,  real
estate  commercial loans have increased by $1.4 million or 1.09% and installment
loans have  decreased by $1.8 million or 13.25% over 2005. The portfolio mix has
changed in 2006 as compared  with the mix of the previous  year with  commercial
and  agricultural  loans increasing to 26.0% compared to 25.1% in 2005, of total
loans,  real estate  construction  loans increased to 26.3% compared to 17.9% in
2005, real estate - commercial  mortgage loans decreasing to 44.4%,  compared to
52.2% and  Installment  loans  decreased to 4.1%  compared to 5.6% in 2005.  The
shift in the mix  reflects  the changes in lending  needs  within the  Company's
service  area.  The  overall  change  in the mix of the loan  portfolio  did not
significantly impact the overall risk profile in the loan portfolio.

        The  following  table  sets  forth  the  maturity  distribution  of  the
Company's  commercial and agricultural  loans and construction loans outstanding
as of December  31, 2006,  which,  based on remaining  scheduled  repayments  of
principal, were due within the periods indicated.

<TABLE>
<CAPTION>
                                    Within One   After One through
(Dollars in thousands)                    Year          Five Years    After Five Years      Total
--------------------------------  ------------  ------------------  ------------------  ---------
<S>                               <C>           <C>                 <C>                 <C>
Commercial and agricultural
 loans                            $     41,139  $           21,245  $           12,431  $  74,815
Construction Loans                      73,378               1,594                 682     75,654
                                  ------------  ------------------  ------------------  ---------
Total                             $    114,517  $           22,839  $           13,113  $ 150,469
                                  ============  ==================  ==================  =========
Loans due after one year with:
Fixed Rates                                     $           12,116  $            1,700  $  13,186
Variable Rates                                  $           10,723  $           11,413  $  22,136
</TABLE>

77
<PAGE>

        The Company's  practice is to place a loan on nonaccrual status when one
of the following  events  occurs:(i) Any installment of principal or interest is
90  days  or  more  past  due  (unless  in  management's  opinion  the  loan  is
well-secured and in the process of collection),  (ii) management  determines the
ultimate  collection  of principal or interest to be unlikely or (iii) the terms
of the loan have been  renegotiated due to a serious weakening of the borrower's
financial condition.  Nonperforming loans are loans that are on nonaccrual,  are
90 days past due and still accruing or have been restructured.

        The following table sets forth a summary of the Company's  nonperforming
loans and other assets as of the dates indicated:

<TABLE>
<CAPTION>
                                                                     AS OF DECEMBER 31,
                                                  ---------------------------------------------------------
 (Dollars in Thousands)                             2006        2005        2004        2003        2002
-----------------------------------------------   ---------   ---------   ---------   ---------   ---------
<S>                                               <C>         <C>         <C>         <C>         <C>
Nonaccrual loans                                  $      --   $      --   $      --   $      --   $     199
90 days past due and  still  accruing
 interest                                                --          --          --          --          --
Other Real Estate Owned                                  --          --          --          --          49
</TABLE>

        The Company did not have any  nonaccrual  loans at December  31, 2006 or
2005. At December 31, 2006, the Company has not identified any potential problem
loans that would result in these loans being included as nonperforming  loans at
a future date.

ALLOWANCE FOR LOAN LOSSES (ALL)

        In  determining  the amount of the  Company's  Allowance for Loan Losses
("ALL"), management assesses probable loss characteristics of the loan portfolio
including the concentrations,  nature and diversification of the portfolio. Each
credit is assigned a credit risk rating factor,  and this factor,  multiplied by
the dollars  associated  with the credit risk rating,  is used to calculate  one
component of the ALL. In addition,  management  estimates  the probable  loss on
individual  credits that are  receiving  increased  management  attention due to
identified  increases in credit risk.  Management reviews the credit risk report
with the  Director  Loan  Committee  on a weekly  basis as well as with the full
Board monthly.

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

        The  Company  makes  provisions  to the ALL on a regular  basis  through
charges to operations  that are reflected in the Company's  statements of income
as a  provision  for loan  losses.  When a loan is deemed  uncollectible,  it is
charged against the allowance.  Any recoveries of previously  charged-off  loans
are credited  back to the  allowance.  There is no precise  method of predicting
specific  losses or amounts that  ultimately  may be  charged-off  on particular
categories  of the loan  portfolio.  Similarly,  the adequacy of the ALL and the
level of the related  provision  for  probable  loan losses is  determined  on a
judgment  basis by  management  based on  consideration  of a number of  factors
including (i) economic conditions,  (ii) borrowers'  financial condition,  (iii)
loan  impairment,  (iv)  evaluation of industry  trends,  (v) industry and other
concentrations,  (vi) loans which are contractually  current as to payment terms
but  demonstrate  a higher degree of risk as  identified  by  management,  (vii)
continuing  evaluation of the performing loan  portfolio,

78
<PAGE>

(viii)  monthly  review and  evaluation of problem loans  identified as having a
loss  potential,  (ix)  monthly  review  by the  Board  of  Directors,  and  (x)
assessments by regulators and other third parties. Certain members of Management
and the Board of Directors  evaluate the  allowance  and  determine  its desired
level considering  objective and subjective  measures,  such as knowledge of the
borrowers'  businesses,  valuation of collateral,  the determination of impaired
loans and exposure to potential losses.


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

        The  Company's  principal  lines  of  lending  are  (i)  commercial  and
agricultural, (ii) real estate construction and (iii) commercial and residential
real estate. The primary sources of repayment of the Company's  commercial loans
are the  borrowers'  conversion of short-term  assets to cash and operating cash
flow.  The net assets of the borrower or guarantor  are usually  identified as a
secondary  source of repayment.  The principal  factors  affecting the Company's
risk of loss from commercial  lending include each borrower's  ability to manage
its business affairs and cash flows,  local and general economic  conditions and
real estate  values in the  Company's  service  area.  The  Company  manages its
commercial loan portfolio by monitoring its borrowers'  payment  performance and
their  respective  financial  condition  and  makes  periodic  adjustments,   if
necessary,  to the  risk  grade  assigned  to each  loan in the  portfolio.  The
Company's evaluations of its borrowers are facilitated by management's knowledge
of local market conditions and periodic reviews by a consultant of the Company's
credit administration policies.

        The  principal   source  of  repayment  of  the  Company's  real  estate
construction loans is the sale of the underlying  collateral or the availability
of permanent  financing from the Company or other lending source.  The principal
risks  associated  with real estate  construction  lending  include project cost
overruns and deterioration of real estate values as a result of various factors,
including competitive pressures and economic downturns.  The Company manages its
credit risk  associated  with real estate  construction  lending by establishing
loan-to-value  ratios and  loan-to-cost  ratios on projects  on an  as-completed
basis,  inspecting  project  status in advance of controlled  disbursements  and
matching  maturities  with expected  completion  dates.  Generally,  the Company
requires a loan-to-value ratio of not more than 80% on single family residential
construction loans.

        The principal  source of repayment of the Company's real estate mortgage
loans is the borrowers'  operating cash flow.  Similar to commercial  loans, the
principal  factors  affecting the Company's risk of loss in real estate mortgage
lending include each borrower's  ability to manage its business affairs and cash
flows,  local and general  economic  conditions  and real  estate  values in the
Company's service area. The Company manages its credit risk associated with real
estate mortgage lending primarily by establishing  maximum  loan-to-value ratios
and using strategies to match the borrower's cash flow to loan repayment terms.

        The Company's  specific  underwriting  standards and methods for each of
its principal lines of lending include  industry-accepted  analysis and modeling
and certain  proprietary  techniques.  The Company's  underwriting  criteria are
designed to comply with applicable  regulatory  guidelines,  including  required
loan-to-value  ratios.  The Company's  credit  administration  policies  contain
mandatory lien position and debt service coverage requirements,  and the Company
generally  requires  a  guarantee  from  20% or  more  owners  of its  corporate
borrowers.

79
<PAGE>

        The ALL should not be interpreted as an indication  that  charge-offs in
future periods will occur in the stated amounts or proportions.

The following  table  summarizes the Company's  loan loss  experience as well as
provisions  and charges to the allowance for loan losses and certain  ratios for
the periods indicated.

<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                  ---------------------------------------------------------
(Dollars in thousands)                              2006        2005         2004        2003       2002
-----------------------------------------------   ---------   ---------   ---------   ---------   ---------
<S>                                               <C>         <C>         <C>         <C>         <C>
Beginning Balance:                                $   2,356   $   2,214   $   1,653   $   1,307   $   1,172

Provision for loan losses                               360          35         504         536         286
Charge-offs:
  Commercial                                            (10)          -          (9)        (90)       (171)
  Real Estate                                             -           -           -           -           -
  Other                                                 (14)        (17)         (-)       (105)        (28)
                                                  ---------   ---------   ---------   ---------   ---------
Total Charge-offs                                       (24)        (17)         (9)       (195)       (199)
                                                  ---------   ---------   ---------   ---------   ---------
Recoveries:
  Commercial                                              -         124          66           1           -
  Other                                                   1           -           -           4          48
                                                  ---------   ---------   ---------   ---------   ---------
Total Recoveries                                          1         124          66           5          48
                                                  ---------   ---------   ---------   ---------   ---------
Reclassification of the reserve
 for unfunded commitments                              (215)
                                                  =========
Ending Balance                                        2,478       2,356       2,214   $   1,653   $   1,307
                                                  =========   =========   =========   =========   =========
ALL to total loans                                     0.86%       0.98%       1.10%       1.05%        .97%
Net charge-offs (recoveries) to
 average loans                                         0.01%       (.01)%      (.03)%       .12%        .13%
</TABLE>

        The  provision for loan losses was $360,000 for 2006 compared to $35,000
for 2005 and $504,000 in 2004.  The  increase in the amount of the  provision in
2006  compared to 2005 is a direct result of growth in the portfolio in addition
to the analysis of the loan  portfolio and the loan loss history of the Company.
In 2005,  the Company  received a large  recovery on one loan of $120,000 in the
fourth quarter.  As a result of management's  assessment of the overall required
level of allowance and the impact of this recovery on the allowance, the Company
reduced the provision in the fourth quarter of 2005 by $175,000 resulting in the
total provision for 2005 of $35,000.  Net charge-offs  (recoveries) were $23,000
or .01% of average  loans for 2006  compared  to  $(107,000)  or .05% of average
loans for 2005 and $(57,000) or .03% of average loans for 2004.  Management does
not believe that there were any trends  indicated by the detail of the aggregate
charge-offs for any of the periods discussed.

        The following table  summarizes the allocation of the allowance for loan
losses  (ALL) by loan type and the loans as a percent  of loans  outstanding  in
each loan category at the dates indicated

<TABLE>
<CAPTION>

(Dollars in thousands)             2006                2005                2004                2003               2002
------------------------------   --------   ------   --------   ------   --------   ------   --------   ------   --------   ------
<S>                              <C>        <C>      <C>        <C>      <C>        <C>      <C>        <C>      <C>        <C>
Commercial and
 Agricultural                    $  1,086    25.82%  $    994    24.89%  $    880    27.57%  $    736    36.75%  $    400    29.80%
Real estate -
 construction                         269    26.11%       196    17.79%       115    11.39%       141    17.94%  $    160    25.10%
Real estate -
 commercial                           642    44.01%       501    51.77%       422    54.52%       229    38.36%  $    462    39.38%
Installment                           279     4.06%       300     5.55%       308     6.52%       248     6.95%  $    285     5.72%
Unallocated                           202                 365                 489                 305
                                 --------   ------   --------   ------   --------   ------   --------   ------   --------   ------
Total                            $  2,478   100.00%  $  2,356   100.00% $   2,214   100.00%  $  1,653   100.00%  $  1,307   100.00%
                                 ========   ======   ========   ======   ========   ======   ========   ======   ========   ======
</TABLE>

80
<PAGE>

        Deposits

        The  Company  primarily  obtains  deposits  from  local  businesses  and
professionals as well as through  certificates of deposit,  savings and checking
accounts.

The following  table sets forth the  remaining  maturities  of  certificates  of
deposit at December 31, 2006

                                          DEPOSIT MATURITY SCHEDULE
                                      ---------------------------------
(Dollars in thousands)                 Under $100,000    Over $100,000
-----------------------------------   ---------------   ---------------
Three Months or less                  $        24,552   $         9,028
Over three through six months                  19,569            30,405
Over six through twelve months                 11,062            47,464
Over twelve months                              4,421            27,870
                                      ---------------   ---------------
Total                                 $        59,604   $       114,767
                                      ===============   ===============

        Liquidity and Market Risk

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

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

        Because  estimates of the  liquidity  needs of the Company may vary from
actual needs,  the Company  maintains a  substantial  amount of liquid assets to
absorb short-term  increases in loans or reductions in deposits.  As loan demand
decreases or loans are paid off, investment assets can absorb these excess funds
or deposit rates can be decreased to run off excess liquidity.  Therefore, there
is some correlation  between financing  activities  associated with deposits and
investing activities  associated with lending. The Company's liquid assets (cash
and due from banks,  federal funds sold,  interest bearing deposits in banks and
available-for-sale  investment  securities)  totaled  $73.7  million or 19.0% of
total  assets at December 31,  2006,  $47.5  million or 15.4% of total assets at
December  31, 2005 and $35.6  million or 14.0% of total  assets at December  31,
2004. The Company  expects that its primary source of liquidity will be earnings
of  the  Company,   acquisition  of  core  deposits,   and  wholesale  borrowing
arrangements.

81
<PAGE>

        Market Risk

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

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

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

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

        Net Interest Income Simulation

        In order to measure interest rate risk at December 31, 2006, the Company
used a simulation  model to project  changes in net interest  income that result
from  forecasted  changes in interest rates.  This analysis,  which is performed
quarterly by management,  calculates the difference  between net interest income
forecasted  using a rising and falling  interest  rate scenario and net interest
income  forecasted  using a base market derived from the current interest rates.
The  income  simulation  model  includes  various   assumptions   regarding  the
re-pricing  relationships  for  each  of the  Company's  products.  Many  of the
Company's  assets  are  floating  rate  loans,  which  are  assumed  to  reprice
immediately  and to the same extent as the change in market  rates  according to
their  contracted  index.  The Company's  non-term deposit products reprice more
slowly,  usually  changing  less  than the  change  in  market  rates and at the
discretion of the Company.

        The analysis  indicates the impact of changes in net interest income for
the given set of rate changes and assumptions. It assumes that the balance sheet
grows  modestly,  but that its structure will remain similar to the structure at
year-end.  It does not  account  for all  factors  that  impact  this  analysis,
including  the potential  impact of loan  prepayments,  deposit  drifts or other
balance sheet movements  including  changes by management to mitigate the impact
of interest  rate changes or secondary  impacts such as changes to the Company's
credit risk profile as interest  rates change.  Changes that vary  significantly
from the assumptions may have significant  effects on the Company's net interest
income.

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<PAGE>

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

                                     December 31, 2006
                            ---------------------------------
                              Adjusted Net
                                Interest
                                 Income       Percent change
Change in Rates              (in thousands)       from base
-------------------------   ---------------   ---------------
Up 200 basis points         $        21,185             10.33%
Up 150 basis points                  20,692              7.76%
Up 100 basis points                  20,197              5.18%

Base Scenario                        19,202              0.00%
Down 100 basis points               (18,474)            -3.79%
Down 150 basis points               (18,113)            -5.67%
Down 200 basis points               (17,748)            -7.57%

Contractual Obligations

        The  following  table  summarizes  the  contractual  obligations  of the
Company as of December 31, 2006:

<TABLE>
<CAPTION>
                                                        Less                             More
                                                        than        1-3        3-5       than
                                            Total     one year     years      years    5 years
                                           --------   --------   --------   --------   --------
<S>                                        <C>        <C>        <C>        <C>        <C>
Subordinated Debentures, floating rate
 of 8.82% payable June 26, 2031            $  5,155                                    $  5,155
Subordinated Debentures, floating rate
 of 8.15% payable March 17, 2034              3,609                                       3,609
FHLB Loan fixed rate of 5.26%, payable
 on May 16, 2007                              4,900   $  4,900

Operating lease obligations                     570        243   $    327
Salary continuation plan (1)                    785                                         785
                                           --------   --------   --------   --------   --------
Total                                      $ 15,019   $  5,143   $    327   $    -0-   $  9,549
                                           ========   ========   ========   ========   ========
</TABLE>

    (1) Salary  continuation  plan obligations  represents  amount accrued as of
        December31, 2006 under the terms of the plan.

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<PAGE>

        In addition to those  obligations  listed above, in the normal course of
business,  the Company will make cash  distributions for, among other items, the
payment of interest on interest bearing deposit  accounts and debt  obligations,
payments for  quarterly  tax estimates  and  contributions  to certain  employee
benefit plans.

        Capital Resources

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

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

        This standard  characterizes an institution's  capital as being "Tier 1"
capital (defined as principally  comprising  shareholders' equity and qualifying
subordinated debentures) and "Tier 2" capital (defined as principally comprising
the qualifying  portion of subordinated  debt and the qualifying  portion of the
ALL), the total amount not to exceed 100% of Tier 1 capital.

        The minimum ratio of total risk-based  capital to risk-adjusted  assets,
including certain off-balance sheet items, is 8%.

        At  December  31,  2006,  2005 and 2004 the  company's  capital  met all
minimum regulatory requirements.

        As of December 31,  2006,  the most recent  notification  by the Federal
Depository Insurance Corporation (FDIC) categorized the Bank as well capitalized
under the regulatory  framework for prompt corrective  action. To be categorized
as well  capitalized  the Bank must meet the minimum  ratios as set forth below.
There are no  conditions  or events  since  that  notification  that  management
believes have changed the institution's category.

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

                                      December 31,    December 31,
Pacific State Bancorp                     2006            2005
-----------------------------------   ------------    ------------
Total Risk-Based Capital                      11.8%           11.9%
Tier 1 Capital to Risk-Based Assets           10.7%           10.4%
Tier 1 Capital to Average Assets
 (Leverage ratio)                             10.2%            9.2%

<TABLE>
<CAPTION>
                                                                       To Be Well
                                                                      Capitalized
                                                                         Under
                                                                         Prompt
                                      December 31,    December 31,     Corrective
Pacific State Bank                       2006             2005           Action
-----------------------------------   ------------    ------------    ------------
<S>                                           <C>             <C>     <C>
Total Risk-Based Capital                      11.2%           11.5%   >      10.00%
Tier 1 Capital to Risk-Based Assets           10.3%           10.6%   >       6.00%
Tier 1 Capital to Average Assets
 (Leverage ratio)                              9.7%            9.1%   >       5.00%
</TABLE>

84

<PAGE>

IMPACT OF INFLATION

        Inflation  affects  the  Company's  financial  position  as  well as its
operating results.  It is management's  opinion that the effects of inflation on
the financial statements have not been material.

                   QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The following table presents the summary  unaudited results for the stated eight
quarters:

  (Dollars in thousands, except per share)

<TABLE>
<CAPTION>
                                                    2006                                        2005
                                  -----------------------------------------   -----------------------------------------
                                     4th        3rd        2nd        1st        4th        3rd        2nd        1st
Net Income Per Common Share:       Quarter    Quarter    Quarter    Quarter    Quarter    Quarter    Quarter    Quarter
-------------------------------   --------   --------   --------   --------   --------   --------   --------   --------
<S>                               <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
       Diluted                    $   0.39   $   0.39   $   0.33   $   0.31   $   0.28   $   0.31   $   0.27   $   0.24
       Basic                      $   0.43   $   0.44   $   0.37   $   0.35   $   0.31   $   0.35   $   0.31   $   0.27

Interest income                   $  7,440   $  6,942   $  6,321   $  5,792   $  5,208   $  5,117   $  4,529   $  3,928
Net interest income                  4,573      4,463      4,199      4,072      3,605      3,752      3,326      2,853

Provision for loan losses               90         90         90         90       (175)        90         60         60
Total non-interest income              766        718        500        599        538        577        597        769
Total non-interest expense           2,719      2,602      2,452      2,587      2,521      2,361      2,186      2,032
Income before taxes                  2,530      2,489      2,157      1,994      1,797      1,878      1,677      1,530
Net Income                           1,517      1,512      1,307      1,207      1,083      1,198      1,057        948
</TABLE>

85

<PAGE>

       MARKET PRICE FOR REGISTRANT'S COMMON EQUITY, DIVIDENDS AND RELATED
                               STOCKHOLDER MATTERS

        The  Company's  common stock is listed for trading on the NASDAQ  Global
Market  under the  symbol  PSBC.  Prior to July 12,  2005,  trading  information
regarding  the  common  stock was  available  via the OTC  Bulletin  Board.  The
following table, which summarizes trading activity during the Company's last two
fiscal years, is based on information  provided by Yahoo.com  Historical Quotes.
The  quotations  reflect the price that would be received by the seller  without
retail  mark-up,  mark-down or commissions and may not have  represented  actual
transactions.

                                   Sales Price
                         ------------------------------
Quarter Ended:             High       Low       Volume
----------------------   --------   --------   --------
December 31, 2006        $  23.90   $  18.50    154,129
September 30, 2006       $  19.25   $  17.65    379,539
June 30, 2006            $  18.99   $  17.75    281,245
March 31, 2006           $  18.50   $  16.26    100,211

December 31, 2005        $  20.10   $  17.05    211,271
September 30, 2005       $  20.75   $  14.00    125,902
June 30, 2005            $  15.50   $  14.00    224,430
March 31, 2005           $  20.50   $  15.50    195,429

        As of March 15, 2007, there were  approximately 290 holders of record of
the common stock of the Company.

Dividends

        The Company's  primary  source of cash is dividends  from the Bank.  The
Bank's ability to pay dividends is subject to certain  regulatory  requirements.
The California  Financial Code restricts the total dividend  payment of any bank
in any calendar  year to the lesser of (1) the bank's  retained  earnings or (2)
the bank's net income for its last three fiscal years, less  distributions  made
to shareholders' during the same three-year period. As of December 31, 2006, the
Bank had  $12.15  million  in  retained  earnings  available  for  dividends  to
shareholders.  In addition, the Company's ability to pay dividends is subject to
certain  covenants  contained in the indentures  related to the trust  preferred
securities issued by the Trusts.

        The power of the board of directors of an insured depository institution
to declare a cash  dividend  or other  distribution  with  respect to capital is
subject  to  statutory  and  regulatory  restrictions  which  limit  the  amount
available for such distribution depending upon the earnings, financial condition
and cash needs of the institution, as well as general business conditions.

86