##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-QSB
 Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended September 30, 2005
 COMMISSION FILE No.: 333-122090
 DISCOVERY BANCORP
      þ o
 o þ
   o þ




---



TABLE OF CONTENTS  PART I  FINANCIAL INFORMATIONITEM 1. FINANCIAL STATEMENTSITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONITEM 3. CONTROLS AND PROCEDURESPART II  OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGSITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDSITEM 3. DEFAULTS UPON SENIOR SECURITIESITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 5. OTHER INFORMATIONITEM 6. EXHIBITSSIGNATURESExhibit 10.1Exhibit 10.2Exhibit 10.3Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2    Table of Contents  
 PART I  FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 DISCOVERY BANCORP
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, 2005 AND DECEMBER 31, 2004
 2005
    
    
    2004ASSETSCash & due from banks
    
    $
    5,795,032
    
    
    $
    1,638,876Fed Funds sold
    
    
    11,360,000
    
    
    
    4,945,000Cash and cash equivalents
    
    
    17,155,032
    
    
    
    6,583,876Interest-bearing deposits at banks
    
    
    2,999,532
    
    
    
    2,691,623Investment securities
    
    
    3,499,138
    
    
    
    2,705,734Common stock, substantially restricted
    
    
    628,600
    
    
    
    483,000Loans, net
    
    
    126,684,348
    
    
    
    80,036,566Goodwill
    
    
    1,731,000
    
    
    
    Accrued interest receivable and other assets
    
    
    760,743
    
    
    
    479,987Deferred income tax asset
    
    
    153,048
    
    
    
    291,600Premises and equipment, net
    
    
    6,100,686
    
    
    
    5,933,602TOTAL ASSETS
    
    $
    159,712,127
    
    
    $
    99,205,988LIABILITIESDepositsNon-interest-bearing demand
    
    $
    22,503,523
    
    
    $
    14,761,372Interest-bearing demand
    
    
    26,517,756
    
    
    
    27,487,866Savings
    
    
    1,740,353
    
    
    
    1,449,503Time, under $100,000
    
    
    28,050,626
    
    
    
    18,035,413Time, $100,000 and over
    
    
    30,404,091
    
    
    
    17,937,972Total deposits
    
    
    109,216,349
    
    
    
    79,672,126Borrowings under line of credit
    
    
    14,976,988
    
    
    
    Overnight borrowings  FHLB
    
    
    12,000,000
    
    
    
    9,000,000Accrued interest payable and other liabilities
    
    
    1,047,645
    
    
    
    234,370TOTAL LIABILITIES
    
    
    137,240,982
    
    
    
    88,906,496STOCKHOLDERS EQUITYCommon stock, no par value; authorized 10,000,000 shares, issued and
outstanding 1,671,426 and 1,037,498 shares at September 30, 2005 and
December 31, 2004, respectively
    
    
    19,727,183
    
    
    
    10,756,630Paid stock subscriptions
    
    
    2,999,979
    
    
    
    Accumulated deficit
    
    
    (224,467
    )
    
    
    (447,104
    )Accumulated other comprehensive (loss)
    
    
    (31,550
    )
    
    
    (10,034
    )22,471,145
    
    
    
    10,299,492TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    159,712,127
    
    
    $
    99,205,988
 The accompanying notes are an integral part of these financial statements.
 2




---



##### Table of Contents



DISCOVERY BANCORP
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
SEPTEMBER 30, 2005 AND 2004
 THREE MONTHS ENDED
    
    
    NINE MONTHS ENDEDSEPTEMBER 30,
    
    
    SEPTEMBER 30,2005
    
    
    2004
    
    
    2005
    
    
    2004INTEREST INCOMEInterest and fees on loans
    
    $
    2,530,843
    
    
    $
    1,270,886
    
    
    $
    6,018,936
    
    
    $
    3,415,522Interest on federal funds sold
    
    
    88,481
    
    
    
    18,166
    
    
    
    186,639
    
    
    
    30,592Interest on securities
    
    
    38,803
    
    
    
    23,692
    
    
    
    109,069
    
    
    
    61,226Other
    
    
    26,011
    
    
    
    15,587
    
    
    
    61,436
    
    
    
    42,286TOTAL INTEREST INCOME
    
    
    2,684,138
    
    
    
    1,328,331
    
    
    
    6,376,080
    
    
    
    3,549,626INTEREST EXPENSEDeposits
    
    
    685,535
    
    
    
    305,202
    
    
    
    1,747,277
    
    
    
    773,682Other
    
    
    182,705
    
    
    
    21,868
    
    
    
    312,717
    
    
    
    38,758TOTAL INTEREST EXPENSE
    
    
    868,240
    
    
    
    327,070
    
    
    
    2,059,994
    
    
    
    812,440NET INTEREST INCOME
    
    
    1,815,898
    
    
    
    1,001,261
    
    
    
    4,316,086
    
    
    
    2,737,186PROVISION FOR LOAN LOSSES
    
    
    350,395
    
    
    
    57,497
    
    
    
    632,822
    
    
    
    208,698NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
    
    
    1,465,503
    
    
    
    943,764
    
    
    
    3,683,264
    
    
    
    2,528,488NON  INTEREST INCOMECustomer service fees & charges
    
    
    53,339
    
    
    
    22,560
    
    
    
    93,765
    
    
    
    43,961Gain on sale of SBA loans
    
    
    
    
    
    
    
    
    
    
    123,423
    
    
    
    Other income
    
    
    167,355
    
    
    
    12,039
    
    
    
    485,144
    
    
    
    62,435TOTAL NON  INTEREST INCOME
    
    
    220,694
    
    
    
    34,599
    
    
    
    702,332
    
    
    
    106,396NON  INTEREST EXPENSESalaries and employee benefits
    
    
    817,148
    
    
    
    494,748
    
    
    
    1,939,806
    
    
    
    1,378,201Net occupancy
    
    
    174,846
    
    
    
    18,684
    
    
    
    394,008
    
    
    
    123,979Furniture and equipment
    
    
    80,261
    
    
    
    40,392
    
    
    
    219,587
    
    
    
    129,434Data processing
    
    
    138,793
    
    
    
    83,509
    
    
    
    238,603
    
    
    
    167,836Advertising
    
    
    29,984
    
    
    
    24,343
    
    
    
    82,331
    
    
    
    69,666Professional
    
    
    342,538
    
    
    
    84,953
    
    
    
    719,221
    
    
    
    189,307Office supplies
    
    
    18,302
    
    
    
    13,111
    
    
    
    53,300
    
    
    
    39,664Other operating
    
    
    48,967
    
    
    
    64,966
    
    
    
    354,154
    
    
    
    267,671TOTAL NON  INTEREST EXPENSE
    
    
    1,650,839
    
    
    
    824,706
    
    
    
    4,001,010
    
    
    
    2,365,758INCOME BEFORE INCOME TAXES
    
    
    35,358
    
    
    
    153,657
    
    
    
    384,586
    
    
    
    269,126INCOME TAX PROVISION
    
    
    22,134
    
    
    
    (231,319
    )
    
    
    161,949
    
    
    
    (210,825
    )NET INCOME
    
    $
    13,224
    
    
    $
    384,976
    
    
    $
    222,637
    
    
    $
    479,951Earnings per share
    
    $
    0.01
    
    
    $
    0.37
    
    
    $
    0.20
    
    
    $
    0.46Diluted earnings per share
    
    $
    0.01
    
    
    $
    0.35
    
    
    $
    0.19
    
    
    $
    0.44
 The accompanying notes are an integral part of these financial statements.
 3




---



##### Table of Contents



DISCOVERY BANCORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
 Common Stock no par value;
    
    
    
    
    
    
    
    
    
    
    Accumulated10,000,000 shares authorized
    
    
    Paid Stock
    
    
    
    
    
    
    Other
    
    
    TotalShares
    
    
    
    
    
    
    Subscriptions
    
    
    Accumulated
    
    
    Comprehensive
    
    
    StockholdersOutstanding
    
    
    Amount
    
    
    Amount
    
    
    Deficit
    
    
    Income(Loss)
    
    
    EquityBalance,January 1, 2004
    
    
    1,037,298
    
    
    $
    10,754,630
    
    
    
    
    
    
    $
    (1,065,744
    )
    
    $
    7,356
    
    
    $
    9,696,242Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    479,951
    
    
    
    
    
    
    
    479,951Unrealized losses on investment securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,959
    )
    
    
    (10,959
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    468,992Balance,September 30, 2004
    
    
    1,037,298
    
    
    $
    10,754,630
    
    
    
    
    
    
    $
    (585,793
    )
    
    $
    (3,603
    )
    
    $
    10,165,234Balance,January 1, 2005
    
    
    1,037,498
    
    
    $
    10,756,630
    
    
    
    
    
    
    $
    (447,104
    )
    
    $
    (10,034
    )
    
    $
    10,299,492Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    222,637
    
    
    
    
    
    
    
    222,637Unrealized losses on investment securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,516
    )
    
    
    (21,516
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    201,121Stock issued as part of Celtic asset
purchase
    
    
    53,613
    
    
    
    831,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    831,000Stock issued as part of offering
    
    
    580,265
    
    
    
    8,137,803
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,137,803Paid Stock Subscriptions-Shares not issued
    
    
    
    
    
    
    
    
    
    $
    2,999,979
    
    
    
    
    
    
    
    
    
    
    
    2,999,979Warrants exercised
    
    
    250
    
    
    
    3,750
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,750Repurchase of Organizational Shares Issued
    
    
    (200
    )
    
    
    (2,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,000
    )Balance,September 30, 2005
    
    
    1,671,426
    
    
    $
    19,727,183
    
    
    $
    2,999,979
    
    
    $
    (224,467
    )
    
    $
    (31,550
    )
    
    $
    22,471,145
 The accompanying notes are an integral part of these financial statements.
 4




---



##### Table of Contents



DISCOVERY BANCORP
STATEMENTS OF CASH FLOWS (UNAUDITED)
 FOR THE NINE MONTHS ENDED SEPTEMBER 30,
    
    2005
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net Income
    
    $
    222,637
    
    
    $
    479,951Adjustments to reconcile net income to net cash provided by operating activities:Provision for loan losses
    
    
    632,822
    
    
    
    208,698Depreciation and amortization
    
    
    305,948
    
    
    
    88,131Amortization of deferred loan fees
    
    
    (168,478
    )
    
    
    (166,938
    )Gain on sale of SBA loans
    
    
    (123,423
    )
    
    
    Change in:Deferred tax assets
    
    
    138,552
    
    
    
    (232,095
    )Accrued interest receivable and other assets
    
    
    (300,699
    )
    
    
    (17,533
    )Accrued interest payable and other liabilities
    
    
    760,696
    
    
    
    159,906Net cash provided by operating activities
    
    
    1,468,055
    
    
    
    520,120CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of premises and equipment
    
    
    (388,585
    )
    
    
    (5,193,735
    )Proceeds from sales of premises and equipment
    
    
    
    
    
    
    19,986Net change in interest bearing deposits at banks
    
    
    (307,909
    )
    
    
    Purchase of common stock substantially restricted
    
    
    (145,600
    )
    
    
    (143,400
    )Sales, maturities and paydowns of securities available-for-sale
    
    
    936,300
    
    
    
    2,044,905Purchases of securities available-for-sale
    
    
    (1,751,219
    )
    
    
    (2,836,411
    )Proceeds from sale of SBA loans
    
    
    1,776,104Net change in loans
    
    
    (32,765,443
    )
    
    
    (18,162130
    )Net cash used for purchase of Celtic Capital Corporation
    
    
    (3,697,551
    )
    
    
    Net cash used for investing activities
    
    
    (36,343,903
    )
    
    
    (24,270,785
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from borrowings under line of credit
    
    
    1,763,250
    
    
    
    Proceeds from overnight borrowings FHLB, net of repayments
    
    
    3,000,000
    
    
    
    3,295,000Proceeds from warrants exercised
    
    
    3,750
    
    
    
    Repurchase of organizational shares issued
    
    
    (2,000
    )
    
    
    Proceeds from issuance of common stock, net of capital raising costs
    
    
    11,137,782
    
    
    
    Net change in deposits
    
    
    29,544,222
    
    
    
    25,974,094Net cash provided by financing activities
    
    
    45,447,004
    
    
    
    29,269,094Increase in cash and cash equivalents
    
    
    10,571,156
    
    
    
    5,518,429CASH AND CASH EQUIVALENTS BALANCEBeginning of period
    
    
    6,583,876
    
    
    
    2,110,388End of period
    
    $
    17,155,032
    
    
    $
    7,628,817Supplemental Disclosures of Cash Flow InformationCash paid during the year for:Income taxes
    
    $
    20,000
    
    
    $
    28,500Interest
    
    $
    1,955,134
    
    
    $
    785,765
 The accompanying notes are an integral part of these financial statements.
 5




---



##### Table of Contents



NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
Note 1  The Business
     Note 2  Summary of Significant Accounting Policies
  Note 3  Basis of presentation
   Note 4  Stock Option Plan
 Accounting for Stock Issued
to Employees, Accounting for Stock Based Compensation
 6




---



##### Table of Contents



Accounting for Stock Based Compensation,
 For the three months ended
    
    
    For the nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income
    
    $
    13,224
    
    
    $
    384,976
    
    
    $
    222,637
    
    
    $
    479,951Additional compensation for fair value of stock options
    
    
    (30,498
    )
    
    
    (26,820
    )
    
    
    (91,495
    )
    
    
    (80,461
    )Pro forma net income (loss)
    
    $
    (17,274
    )
    
    $
    358,156
    
    
    $
    131,142
    
    
    $
    399,490Basic EPS:As reported
    
    $
    0.01
    
    
    $
    0.37
    
    
    $
    0.20
    
    
    $
    0.46Pro Forma
    
    $
    (0.01
    )
    
    $
    0.35
    
    
    $
    0.12
    
    
    $
    0.39Diluted EPS:As reported
    
    $
    0.01
    
    
    $
    0.35
    
    
    $
    0.19
    
    
    $
    0.44Pro Forma
    
    $
    (0.01
    )
    
    $
    0.33
    
    
    $
    0.11
    
    
    $
    0.36
 Note 5  Earnings Per Share
  Earnings per share calculationFor the three months ended September 30,2005
    
    
    2004Weighted
    
    
    
    
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    
    
    
    
    Average
    
    
    PerNet
    
    
    Shares
    
    
    Per Share
    
    
    Net
    
    
    Shares
    
    
    ShareIncome
    
    
    Outstanding
    
    
    Amount
    
    
    Income
    
    
    Outstanding
    
    
    AmountBasic EPS:Income available to common
shareholders
    
    $
    13,224
    
    
    
    1,303,694
    
    
    $
    0.01
    
    
    $
    384,976
    
    
    
    1,037,298
    
    
    $
    0.37Effect of dilutive securities:Stock options
    
    
    
    
    
    
    58,628
    
    
    
    
    
    
    
    
    
    
    
    64,297
    
    
    $
    (0.02
    )Diluted EPS:Income available to common
shareholders
    
    $
    13,224
    
    
    
    1,362,322
    
    
    $
    0.01
    
    
    $
    384,976
    
    
    
    1,101,595
    
    
    $
    0.35
 7




---



##### Table of Contents



Earnings per share calculationFor the nine months ended September 30,2005
    
    
    2004Weighted
    
    
    
    
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    
    
    
    
    AverageNet
    
    
    Shares
    
    
    Per Share
    
    
    Net
    
    
    Shares
    
    
    Per ShareIncome
    
    
    Outstanding
    
    
    Amount
    
    
    Income
    
    
    Outstanding
    
    
    AmountBasic EPS:Income available to common
shareholders
    
    $
    222,637
    
    
    
    1,120,571
    
    
    $
    0.20
    
    
    $
    479,951
    
    
    
    1,037,298
    
    
    $
    0.46Effect of dilutive securities:Stock options
    
    
    
    
    
    
    59,985
    
    
    $
    (0.01
    )
    
    
    
    
    
    
    58,088
    
    
    $
    (0.02
    )Diluted EPS:Income available to common
shareholders
    
    $
    222,637
    
    
    
    1,180,556
    
    
    $
    0.19
    
    
    $
    479,951
    
    
    
    1,095,386
    
    
    $
    0.44
 Note 6Purchase of Assets and Liabilities
   (dollars in thousands)Assets acquired:Cash
    
    $
    1,529Loans
    
    
    15,966Goodwill
    
    
    1,731Other assets
    
    
    98Total assets acquired
    
    $
    19,324Liabilities assumed:Liabilities for borrowed money
    
    $
    13,214Other liabilities
    
    
    53Total liabilities assumed
    
    $
    13,267
  Note 7Borrowings
  8




---



##### Table of Contents



Note 8 Recently Issued Accounting Pronouncements
        9




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 Introduction .
      
    
    competition within the banking industry;
    
    changes in the interest rate environment;
    
    general economic conditions, nationally, regionally and in our market areas, including declines in
real estate values;
 10




---



##### Table of Contents




    
    the effects of terrorism and the conduct of the war on terrorism by the United States and its allies;
    
    the regulatory environment;
    
    business conditions and inflation;
    
    the securities markets;
    
    technology;
    
    regulatory compliance issues;
    
    planned asset growth;
    
    unanticipated loan losses;
    
    unanticipated increases in operating expenses; and
    
    the ability to generate fee and other non-interest income.
  Critical Accounting Policies .
   Allowance for Loan Losses
  Securities Available-for-Sale .
 11




---



##### Table of Contents



Goodwill
 Income Taxes
 General
       Distribution of Assets, Liabilities and Shareholders Equity
  12




---



##### Table of Contents



Three Months Ended September 30,2005
    
    
    2004Interest
    
    
    Rates
    
    
    
    
    
    
    Interest
    
    
    RatesAverage
    
    
    Income/
    
    
    Earned/
    
    
    Average
    
    
    Income/
    
    
    Earned/Balance
    
    
    Expense
    
    
    Paid1
    
    
    Balance
    
    
    Expense
    
    
    Paid1(dollars in thousands)AssetsInvestment securities
    
    $
    3,594
    
    
    $
    39
    
    
    
    4.31
    %
    
    $
    2,209
    
    
    $
    24
    
    
    
    4.31
    %Interest-bearing deposits
    
    
    3,241
    
    
    
    26
    
    
    
    3.24
    %
    
    
    2,771
    
    
    
    16
    
    
    
    2.15
    %Federal funds sold
    
    
    9,952
    
    
    
    88
    
    
    
    3.49
    %
    
    
    5,078
    
    
    
    18
    
    
    
    1.48
    %Loans, net2
    
    
    113,298
    
    
    
    2,531
    
    
    
    8.86
    %
    
    
    76,006
    
    
    
    1,270
    
    
    
    6.63
    %Total Interest-Earning Assets
    
    
    130,085
    
    
    
    2,684
    
    
    
    8.19
    %
    
    
    86,064
    
    
    
    1,328
    
    
    
    6.12
    %Noninterest-earning assets
    
    
    12,402
    
    
    
    
    
    
    
    
    
    
    
    7,258Total Assets
    
    $
    142,487
    
    
    
    
    
    
    
    
    
    
    $
    93,322LiabilitiesTransaction and NOW accounts
    
    $
    7,467
    
    
    
    19
    
    
    
    1.01
    %
    
    $
    7,976
    
    
    
    33
    
    
    
    1.64
    %Savings and money market
    
    
    21,375
    
    
    
    124
    
    
    
    2.30
    %
    
    
    17,828
    
    
    
    61
    
    
    
    1.36
    %Time deposits
    
    
    60,594
    
    
    
    542
    
    
    
    3.55
    %
    
    
    37,541
    
    
    
    211
    
    
    
    2.23
    %Borrowings
    
    
    16,273
    
    
    
    183
    
    
    
    4.45
    %
    
    
    5,763
    
    
    
    22
    
    
    
    1.51
    %Total Interest-Bearing Liabilities
    
    
    105,709
    
    
    
    868
    
    
    
    3.26
    %
    
    
    69,108
    
    
    
    327
    
    
    
    1.88
    %Demand deposits
    
    
    19,945
    
    
    
    
    
    
    
    
    
    
    
    14,067Other liabilities
    
    
    933
    
    
    
    
    
    
    
    
    
    
    
    279Total Liabilities
    
    
    126,587
    
    
    
    
    
    
    
    
    
    
    
    83,455Shareholders Equity
    
    
    15,900
    
    
    
    
    
    
    
    
    
    
    
    9,867Total Liabilities and Shareholders Equity
    
    $
    142,487
    
    
    
    
    
    
    
    
    
    
    $
    93,322Net interest income &
margin3
    
    
    
    
    
    $
    1,816
    
    
    
    5.54
    %
    
    
    
    
    
    $
    1,001
    
    
    
    4.61
    %Net interest spread4
    
    
    
    
    
    
    
    
    
    
    4.93
    %
    
    
    
    
    
    
    
    
    
    
    4.24
    %Return on Average Assets
    
    
    
    
    
    
    
    
    
    
    0.04
    %
    
    
    
    
    
    
    
    
    
    
    1.65
    %Return on Average Equity
    
    
    
    
    
    
    
    
    
    
    0.33
    %
    
    
    
    
    
    
    
    
    
    
    15.61
    %Average Equity to Average Assets Ratio
    
    
    
    
    
    
    
    
    
    
    11.2
    %
    
    
    
    
    
    
    
    
    
    
    10.6
    %
 Three Months Ended September 30, 2005 and 2004 .
 13




---



##### Table of Contents



1
    
    The ratios have been annualized.2
    
    Average loans are net of unearned loan fees and allowances for loan
losses. Unearned loan fees were $347,000 ($100,000 relates to Celtic)
and $183,000 at September 30, 2005 and 2004, respectively. Allowances
for loan losses were $1,387,000 and $969,000 at September 30, 2005 and
2004, respectively. Interest income from loans includes loan fees of
$46,000 ($16, 000 relates to Celtic) and $52,000 for the three months
ended September 30, 2005 and 2004, respectively.3
    
    Net interest income as a percentage of average interest-earning assets.4
    
    Net interest spread is the absolute difference between the rate earned
on interest-earning assets and the rate paid on interest-bearing
liabilities. 14




---



##### Table of Contents



Nine Months Ended September 30,2005
    
    
    2004Interest
    
    
    Rates
    
    
    
    
    
    
    Interest
    
    
    RatesAverage
    
    
    Income/
    
    
    Earned/
    
    
    Average
    
    
    Income/
    
    
    Earned/Balance
    
    
    Expense
    
    
    Paid1
    
    
    Balance
    
    
    Expense
    
    
    Paid1(dollars in thousands)AssetsInvestment securities
    
    $
    3,372
    
    
    $
    109
    
    
    
    4.33
    %
    
    $
    2,139
    
    
    $
    61
    
    
    
    3.80
    %Interest-bearing deposits
    
    
    2,995
    
    
    
    61
    
    
    
    2.74
    %
    
    
    2,605
    
    
    
    42
    
    
    
    2.15
    %Federal funds sold
    
    
    7,891
    
    
    
    187
    
    
    
    3.16
    %
    
    
    3,293
    
    
    
    31
    
    
    
    1.25
    %Loans, net2
    
    
    100,222
    
    
    
    6,019
    
    
    
    8.03
    %
    
    
    69,066
    
    
    
    3,415
    
    
    
    6.59
    %Total Interest-Earning Assets
    
    
    114,480
    
    
    
    6,376
    
    
    
    7.45
    %
    
    
    77,103
    
    
    
    3,549
    
    
    
    6.13
    %Noninterest-earning assets
    
    
    11,246
    
    
    
    
    
    
    
    
    
    
    
    4,628Total Assets
    
    $
    125,726
    
    
    
    
    
    
    
    
    
    
    $
    81,731LiabilitiesTransaction and NOW accounts
    
    $
    6,991
    
    
    
    52
    
    
    
    1.00
    %
    
    $
    6,631
    
    
    
    66
    
    
    
    1.33
    %Savings and money market
    
    
    20,768
    
    
    
    335
    
    
    
    2.16
    %
    
    
    13,662
    
    
    
    146
    
    
    
    1.42
    %Time deposits
    
    
    55,385
    
    
    
    1,360
    
    
    
    3.28
    %
    
    
    35,023
    
    
    
    561
    
    
    
    2.13
    %Borrowings
    
    
    11,617
    
    
    
    313
    
    
    
    3.60
    %
    
    
    3,966
    
    
    
    39
    
    
    
    1.31
    %Total Interest-Bearing Liabilities
    
    
    94,761
    
    
    
    2,060
    
    
    
    2.91
    %
    
    
    59,282
    
    
    
    812
    
    
    
    1.82
    %Demand deposits
    
    
    18,042
    
    
    
    
    
    
    
    
    
    
    
    12,298Other liabilities
    
    
    703
    
    
    
    
    
    
    
    
    
    
    
    208Total Liabilities
    
    
    113,506
    
    
    
    
    
    
    
    
    
    
    
    71,788Shareholders Equity
    
    
    12,220
    
    
    
    
    
    
    
    
    
    
    
    9,943Total Liabilities and Shareholders Equity
    
    $
    125,726
    
    
    
    
    
    
    
    
    
    
    $
    81,731Net interest income &
margin3
    
    
    
    
    
    $
    4,316
    
    
    
    5.04
    %
    
    
    
    
    
    $
    2,737
    
    
    
    4.73
    %Net interest spread4
    
    
    
    
    
    
    
    
    
    
    4.54
    %
    
    
    
    
    
    
    
    
    
    
    4.31
    %Return on Average Assets
    
    
    
    
    
    
    
    
    
    
    0.24
    %
    
    
    
    
    
    
    
    
    
    
    0.78
    %Return on Average Equity
    
    
    
    
    
    
    
    
    
    
    2.43
    %
    
    
    
    
    
    
    
    
    
    
    6.44
    %Average Equity to Average Assets Ratio
    
    
    
    
    
    
    
    
    
    
    9.7
    %
    
    
    
    
    
    
    
    
    
    
    12.2
    %
 Nine Months Ended September 30, 2005 and 2004.
 15




---



##### Table of Contents



1
    
    The ratios have been annualized.2
    
    Average loans are net of unearned loan fees and allowances for loan
losses. Unearned loan fees were $347,000 ($100,000 relates to Celtic)
and $183,000 at September 30, 2005 and 2004, respectively. Allowances
for loan losses were $1,631,000 and $969,000 at September 30, 2005 and
2004, respectively. Interest income from loans includes loan fees of
$184,000 ($16, 000 relates to Celtic) and $191,000 for the nine months
ended September 30, 2005 and 2004, respectively3
    
    Net interest income as a percentage of average interest-earning assets.4
    
    Net interest spread is the absolute difference between the rate earned
on interest-earning assets and the rate paid on interest-bearing
liabilities. 16




---



##### Table of Contents



Net Interest Income and Net Yield
   For the Three Months Ended September 30,
    
    
    For the Nine Months Ended September 30,2005 Compared to the Three Months
    
    
    2005 Compared to the Nine MonthsEnded September 30, 2004
    
    
    Ended September 30, 2004Increase (Decrease) Due To Change In
    
    
    Increase (Decrease) Due To Change InTotal
    
    
    
    
    
    
    
    
    
    
    TotalVolume
    
    
    Rate
    
    
    Change
    
    
    Volume
    
    
    Rate
    
    
    Change(dollars in thousands)Interest-Earning AssetsInvestment
securities
    
    $
    15
    
    
    $
    0
    
    
    $
    15
    
    
    $
    35
    
    
    $
    13
    
    
    $
    48Interest-earning
deposits
    
    
    3
    
    
    
    8
    
    
    
    11
    
    
    
    7
    
    
    
    12
    
    
    
    19Federal funds sold
    
    
    19
    
    
    
    51
    
    
    
    70
    
    
    
    43
    
    
    
    113
    
    
    
    156Loans
    
    
    622
    
    
    
    638
    
    
    
    1,260
    
    
    
    1,534
    
    
    
    1,069
    
    
    
    2,603Total Interest
Income
    
    
    659
    
    
    
    697
    
    
    
    1,356
    
    
    
    1,619
    
    
    
    1,207
    
    
    
    2,826Interest-Bearing
LiabilitiesTransaction and Now
Accounts
    
    
    (2
    )
    
    
    (12
    )
    
    
    (14
    )
    
    
    3
    
    
    
    (17
    )
    
    
    (14
    )Savings and Money
Market
    
    
    12
    
    
    
    51
    
    
    
    63
    
    
    
    76
    
    
    
    113
    
    
    
    189Time Deposits
    
    
    130
    
    
    
    201
    
    
    
    331
    
    
    
    325
    
    
    
    474
    
    
    
    799Borrowings
    
    
    40
    
    
    
    121
    
    
    
    161
    
    
    
    75
    
    
    
    199
    
    
    
    274Total Interest
Expense
    
    
    180
    
    
    
    361
    
    
    
    541
    
    
    
    479
    
    
    
    769
    
    
    
    1,248Net Interest
Income
    
    $
    479
    
    
    $
    336
    
    
    $
    815
    
    
    $
    1,140
    
    
    $
    439
    
    
    $
    1,579
 Investments
 17




---



##### Table of Contents



Investment Portfolio
 September 30, 2005
    
    
    December 31, 2004Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Fair
    
    
    Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    Value
    
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Value(dollars in thousands)Available-for-Sale:Obligations of US
Govt. Agency Book
    
    $
    3,531
    
    
    
    
    
    
    
    ($32
    )
    
    $
    3,499
    
    
    $
    2,716
    
    
    
    
    
    
    
    ($10
    )
    
    $
    2,706Total
    
    $
    3,531
    
    
    
    
    
    
    
    ($32
    )
    
    $
    3,499
    
    
    $
    2,716
    
    
    
    
    
    
    
    ($10
    )
    
    $
    2,706
  Loans
 Loan Categories.
 September 30,
    
    
    December 31,2005
    
    
    2004Percent of
    
    
    
    
    
    
    Percent ofAmount
    
    
    Total
    
    
    Amount
    
    
    Total(dollars in thousands)Loan CategoryReal estate loans:Construction loans
    
    $
    26,976
    
    
    
    21
    %
    
    $
    10,420
    
    
    
    13
    %Real estate 1st trust deeds
    
    
    39,531
    
    
    
    31
    
    
    
    36,716
    
    
    
    45Other real estate mortgage
    
    
    2,838
    
    
    
    2
    
    
    
    2,528
    
    
    
    3Total real estate
    
    
    69,345
    
    
    
    54
    
    
    
    49,664
    
    
    
    61Business secured loans
    
    
    51,873
    
    
    
    40
    
    
    
    24,855
    
    
    
    31Business unsecured loans
    
    
    1,702
    
    
    
    1
    
    
    
    1,147
    
    
    
    1Consumer and other
    
    
    5,745
    
    
    
    5
    
    
    
    5,546
    
    
    
    7
 18




---



##### Table of Contents



September 30,
    
    
    December 31,2005
    
    
    2004Percent of
    
    
    
    
    
    
    Percent ofAmount
    
    
    Total
    
    
    Amount
    
    
    Total(dollars in thousands)Total Loans
    
    
    128,665
    
    
    
    100
    %
    
    
    81,212
    
    
    
    100
    %Less deferred loan income
    
    
    (350
    )
    
    
    
    
    
    
    (177
    )Less allowance for loan losses
    
    
    (1,631
    )
    
    
    
    
    
    
    (998
    )Net Loans
    
    $
    126,684
    
    
    
    
    
    
    $
    80,037
    Loan Origination and Underwriting.
   Loan Commitments. 3
 Non-Performing Assets.
 19




---



##### Table of Contents



Allowance and Provision for Loan Losses
     September 30,
    
    
    
    
    
    
    September 30,(unaudited)
    
    
    December 31,
    
    
    (unaudited)2005
    
    
    2004
    
    
    2004(dollars in thousands)Outstanding loans:End of the period
    
    $
    128,665
    
    
    $
    81,212
    
    
    $
    79,208Average for the period
    
    $
    100,222
    
    
    $
    71,861
    
    
    $
    69,066Allowance for loan losses:Balance at beginning of period
    
    $
    998
    
    
    $
    760
    
    
    $
    760Loans charged off
    
    
    
    
    
    
    
    
    
    
    Recoveries
    
    
    
    
    
    
    
    
    
    
    Provisions charged to operating expense
    
    
    633
    
    
    
    238
    
    
    
    209Balance at end of period
    
    $
    1,631
    
    
    $
    998
    
    
    $
    969Ratios:Net charge-offs (recoveries) to average loans
    
    
    
    
    
    
    
    
    
    
    Allowance to loans at period end
    
    
    1.27
    %
    
    
    1.23
    %
    
    
    1.22
    %
 20




---



##### Table of Contents



At September 30, 2005(unaudited)
    
    
    At December 31,2004(dollars in thousands)Percent of
    
    
    
    
    
    
    Percent ofLoans in
    
    
    Allowance
    
    
    Loans inAllowance for
    
    
    Category to
    
    
    for Loan
    
    
    Category toLoan Losses
    
    
    Total Loans
    
    
    Losses
    
    
    Total LoansReal Estate:Construction
    
    $
    309
    
    
    
    21
    %
    
    $
    141
    
    
    
    13
    %1st Trust Deed R.E.
    
    
    557
    
    
    
    31
    %
    
    
    373
    
    
    
    45
    %Other Real Estate
    
    
    35
    
    
    
    2
    %
    
    
    91
    
    
    
    3
    %Total Real Estate
    
    
    901
    
    
    
    54
    %
    
    
    605
    
    
    
    61
    %Business Secured Loans
    
    
    636
    
    
    
    40
    %
    
    
    322
    
    
    
    31
    %Business Unsecured
    
    
    22
    
    
    
    1
    %
    
    
    14
    
    
    
    1
    %Consumer & other
    
    
    72
    
    
    
    5
    %
    
    
    57
    
    
    
    7
    %Unallocated allowance
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    1,631
    
    
    
    100
    %
    
    $
    998
    
    
    
    100
    %
 Non-Interest Income .
   Non-Interest Expense .
  21




---



##### Table of Contents



Three Months Ended September 30,Percentage2005
    
    
    2004
    
    
    Change(dollars in thousands)Salaries and benefits
    
    $
    817
    
    
    $
    495
    
    
    
    65.1
    %Occupancy expense
    
    
    175
    
    
    
    19
    
    
    
    821.1
    %Furniture & Equipment
    
    
    80
    
    
    
    40
    
    
    
    100.0
    %Data Processing
    
    
    139
    
    
    
    84
    
    
    
    65.5
    %Advertising
    
    
    30
    
    
    
    24
    
    
    
    25.0
    %Professional fees
    
    
    343
    
    
    
    85
    
    
    
    303.5
    %Office supplies
    
    
    18
    
    
    
    13
    
    
    
    38.5
    %Other expenses
    
    
    49
    
    
    
    65
    
    
    
    -24.6
    %Total
    
    $
    1,651
    
    
    $
    825
    
    
    
    100.2
    %
 Nine Months Ended September 30,Percentage2005
    
    
    2004
    
    
    Change(dollars in thousands)Salaries and benefits
    
    $
    1,940
    
    
    $
    1,378
    
    
    
    40.8
    %Occupancy expense
    
    
    394
    
    
    
    124
    
    
    
    217.7
    %Furniture & Equipment
    
    
    220
    
    
    
    129
    
    
    
    70.5
    %Data Processing
    
    
    239
    
    
    
    167
    
    
    
    43.1
    %Advertising
    
    
    82
    
    
    
    70
    
    
    
    17.1
    %Professional fees
    
    
    719
    
    
    
    190
    
    
    
    278.4
    %Office supplies
    
    
    53
    
    
    
    40
    
    
    
    32.5
    %Other expenses
    
    
    354
    
    
    
    268
    
    
    
    32.1
    %Total
    
    $
    4,001
    
    
    $
    2,366
    
    
    
    69.1
    %
   Income Taxes .
  Cash and Cash Equivalents .
  22




---



##### Table of Contents



Deposits .
   September 30, 2005(unaudited)(dollars inthousands)Three months or less
    
    $
    2,368Over three to six months
    
    
    27,932Over six to twelve months
    
    
    Over twelve months
    
    
    104Total
    
    $
    30,404
 Borrowings
   Capital Resources .
  23




---



##### Table of Contents



Risk-based capital ratios
 Well
    
    
    MinimumCapitalized
    
    
    CapitalAt 9/30/05
    
    
    At 12/31/04
    
    
    Requirement
    
    
    RequirementDiscovery Bancorp:Total Risk-Based capital ratio
    
    
    15.50
    %
    
    
    n/a
    
    
    
    10.00
    %
    
    
    8.00
    %Tier 1 Risk-Based capital ratio
    
    
    14.35
    %
    
    
    n/a
    
    
    
    6.00
    %
    
    
    4.00
    %Tier 1 Leverage Ratio
    
    
    14.76
    %
    
    
    n/a
    
    
    
    5.00
    %
    
    
    4.00
    %Discovery Bank:Total Risk-Based capital ratio
    
    
    10.00
    %
    
    
    12.41
    %
    
    
    10.00
    %
    
    
    8.00
    %Tier 1 Risk-Based capital ratio
    
    
    8.86
    %
    
    
    11.30
    %
    
    
    6.00
    %
    
    
    4.00
    %Tier 1 Leverage Ratio
    
    
    8.14
    %
    
    
    10.57
    %
    
    
    5.00
    %
    
    
    4.00
    %
 Liquidity and Liquidity Management .
     24




---



##### Table of Contents



Recent Accounting Pronouncements.
        Quantitative And Qualitative Disclosures About Market Risk
 25




---



##### Table of Contents



Credit Risk .
 Interest Rate Risk .
      26




---



##### Table of Contents



Adjusted Net
    
    
    ChangeInterest Rate Scenario
    
    Interest Income
    
    
    From BaseUp 300 basis points
    
    $
    7,820
    
    
    
    24.09
    %Up 200 basis points
    
    $
    7,354
    
    
    
    16.69
    %Up 100 basis points
    
    $
    6,851
    
    
    
    8.70
    %Base
    
    $
    6,302
    
    
    
    Down 100 basis points
    
    $
    5,990
    
    
    
    (4.96
    )%Down 200 basis points
    
    $
    5,683
    
    
    
    (9.82
    )%Down 300 basis points
    
    $
    5,430
    
    
    
    (13.83
    )%
 Inflation .
   
 ITEM 3. CONTROLS AND PROCEDURES
     27




---



##### Table of Contents



PART II  OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  
 ITEM 6. EXHIBITS
 Exhibit No.
    
    Description of Exhibit
    
    Page10.1
    
    Employment Agreement  Mark Hafner
    
    
    2910.2
    
    Employment Agreement  Alex Falo
    
    
    3910.3
    
    Consulting Agreement  Bron Hafner
    
    
    4831.1
    
    Certification of James P. Kelly, II
    
    
    5631.2
    
    Certification of Martin McNabb
    
    
    5732.1
    
    Section 1350 Certification of James P. Kelly, II
    
    
    5832.2
    
    Section 1350 Certification of Martin McNabb
    
    
    59
 
 SIGNATURES
  Discovery BancorpDated: November 16, 2005
    By:
    /s/ James P. Kelley, IIJames P. Kelley, II,President and Chief Executive Officer By:
    /s/ Martin McNabbMartin McNabb,Executive Vice President and Chief
Financial Officer 28