**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      DC 20549**


**_____________________**




**FORM
      10-QSB**


**_____________________**





**QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d)**




**OF
      THE SECURITIES EXCHANGE ACT OF 1934**




Commission
      File Number: 333-122090




**_____________________**




**DISCOVERY
      BANCORP**




(Name
      of
      Small Business Issuer as Specified in its Charter)




**_____________________**




**California**
              (State
                or other jurisdiction
              of
                incorporation or organization)
            
            **20-1814766**
              (I.R.S.
                Employee
              Identification
                No.)





**338
                Via Vera Cruz, San Marcos, California 92078**(Address
                of Principal Executive Offices) (Zip Code)**(760)
                736-8900**(Issuer’s
                Telephone Number including Area Code)





**_____________________**







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





Yes
                x
            No
                o





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





Yes
                o
            No
                x





As
      of
      August 1, 2006, 1,871,883 shares of the issuer’s common stock were
      outstanding.




Transitional
      Small Business Disclosure Format (Check one):





Yes
                o
            No
                x














**ITEM
      1. FINANCIAL STATEMENTS**




**DISCOVERY
      BANCORP AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


**JUNE
      30, 2006 AND DECEMBER 31, 2005**





(dollars
                in thousands)**June
                30,2006**
            ****
            ****
            **December
                31, 2005****ASSETS**
            
            
            (unaudited)Cash
                & due from banks
            
            $
            6,393
            
            $
            6,709Fed
                Funds sold
            
            
            11,840
            
            
            8,145Cash
                and cash equivalents
            
            
            18,233
            
            
            14,854Interest-bearing
                deposits at banks
            
            
            6,086
            
            
            2,606Investment
                securities available-for-sale
            
            
            3,276
            
            
            3,402Common
                stock, substantially restricted
            
            
            669
            
            
            648Loans,
                net of allowance for loan losses of$2,007
                in 2006 and $1,784 in 2005
            
            
            148,992
            
            
            134,326Goodwill
            
            
            1,731
            
            
            1,731Accrued
                interest receivable and other assets
            
            
            1,281
            
            
            1,127Premises
                and equipment, net
            
            
            5,825
            
            
            6,012**TOTAL
                ASSETS**
            
            $
            186,093
            
            $
            164,706**LIABILITIES**DepositsNon-interest-bearing
                demand
            
            $
            19,721
            
            $
            21,569Interest-bearing
                demand
            
            
            30,728
            
            
            28,560Savings
            
            
            1,812
            
            
            1,987Time,
                under $100,000
            
            
            43,923
            
            
            28,032Time,
                $100,000 and over
            
            
            36,807
            
            
            32,437Total
                deposits
            
            
            132,991
            
            
            112,585Borrowings
                under line of credit
            
            
            15,115
            
            
            16,086Overnight
                borrowings - FHLB
            
            
            12,784
            
            
            12,000Accrued
                interest payable and other liabilities
            
            
            1,324
            
            
            1,192**TOTAL
                LIABILITIES**
            
            $
            162,214
            
            $
            141,863**STOCKHOLDERS’
                EQUITY**Common
                stock, no par value; authorized 10,000,000 shares,
              issued
                and outstanding 1,871,883 shares at
              June
                30, 2006 and December 31, 2005
            
            $
            22,854
            
            $
            22,776Retained
                earnings
            
            
            1,079
            
            
            106Accumulated
                other comprehensive loss
            
            
            (54
            )
            
            (39
            )23,879
            
            
            22,843**TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY**
            
            $
            186,093
            
            $
            164,706




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


2




**DISCOVERY
      BANCORP AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF INCOME (UNAUDITED)**


**FOR
      THE PERIODS ENDED JUNE 30, 2006 AND 2005**




**Three
                Months EndedJune 30,**
            
            **Six
                Months Ended June 30,**Dollar
                amounts in thousands, except per share amounts
            
            **2006**
            
            **2005**
            
            **2006**
            
            **2005****INTEREST
                INCOME**Interest
                and fees on loans
            
            $
            4,049
            
            $
            1,924
            
            $
            7,682
            
            $
            3,488Interest
                on federal funds sold
            
            
            100
            
            
            58
            
            
            203
            
            
            98Interest
                on securities
            
            
            43
            
            
            44
            
            
            84
            
            
            70Other
            
            
            65
            
            
            18
            
            
            104
            
            
            36**TOTAL
                INTEREST INCOME**
            
            
            4,257
            
            
            2,044
            
            
            8,073
            
            
            3,692**INTEREST
                EXPENSE**Deposits
            
            
            1,113
            
            
            610
            
            
            1,986
            
            
            1,062Borrowings
                under line of credit
            
            
            296
            
            
            0
            
            
            589
            
            
            0Overnight
                borrowings - FHLB
            
            
            121
            
            
            70
            
            
            240
            
            
            125Other
            
            
            0
            
            
            5
            
            
            0
            
            
            5**TOTAL
                INTEREST EXPENSE**
            
            
            1,530
            
            
            685
            
            
            2,815
            
            
            1,192**NET
                INTEREST INCOME**
            
            
            2,727
            
            
            1,359
            
            
            5,258
            
            
            2,500**PROVISION
                FOR LOAN LOSSES**
            
            
            117
            
            
            124
            
            
            223
            
            
            282**NET
                INEREST INCOME AFTER PROVISION FOR LOAN LOSSES**
            
            
            2,610
            
            
            1,235
            
            
            5,035
            
            
            2,218**NON
                - INTEREST INCOME**Customer
                service fees & charges
            
            
            42
            
            
            29
            
            
            79
            
            
            40Gain
                on sale of SBA loans
            
            
            52
            
            
            123
            
            
            167
            
            
            123Rental
                income, net
            
            
            75
            
            
            55
            
            
            152
            
            
            132Other
                loan fees & charges
            
            
            123
            
            
            85
            
            
            222
            
            
            102**TOTAL
                NON - INTEREST INCOME**
            
            
            292
            
            
            292
            
            
            620
            
            
            397**NON
                - INTEREST EXPENSE**Salaries
                and employee benefits
            
            
            1,244
            
            
            611
            
            
            2,412
            
            
            1,123Net
                occupancy
            
            
            135
            
            
            72
            
            
            262
            
            
            135Furniture
                and equipment
            
            
            85
            
            
            73
            
            
            154
            
            
            139Data
                processing
            
            
            91
            
            
            51
            
            
            192
            
            
            100Advertising
            
            
            53
            
            
            31
            
            
            97
            
            
            52Professional
            
            
            189
            
            
            210
            
            
            369
            
            
            377Office
                supplies
            
            
            22
            
            
            18
            
            
            43
            
            
            35Other
                operating
            
            
            211
            
            
            150
            
            
            423
            
            
            305**TOTAL
                NON - INTEREST EXPENSE**
            
            
            2,030
            
            
            1,216
            
            
            3,952
            
            
            2,266**INCOME
                BEFORE INCOME TAXES**
            
            
            872
            
            
            311
            
            
            1,703
            
            
            349**INCOME
                TAX PROVISION**
            
            
            373
            
            
            103
            
            
            730
            
            
            140**NET
                INCOME**
            
            $
            499
            
            $
            208
            
            $
            973
            
            $
            209Basic
                earnings per share
            
            $
            0.27
            
            $
            0.20
            
            $
            0.52
            
            $
            0.20Diluted
                earnings per share
            
            $
            0.26
            
            $
            0.19
            
            $
            0.50
            
            $
            0.19




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


3




**DISCOVERY
      BANCORP**  **AND
      SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)**


**FOR
      THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005**





(dollars
                in thousands)**Common
                SharesOutstanding**
            
            **Amoun**t
            
            **RetainedEarnings
                (AccumulatedDeficit)**
            
            **Accumulated
                Other Comprehensive Loss**
            
            **Total
                Stockholders’ Equity****Balance,**January 1,
                2005
            
            
            1,037,498
            
            $
            10,756
            
            $
            (447
            )
            $
            (10
            )
            $
            10,299Comprehensive
                income:Net
                income
            
            
            
            
            
            
            
            
            209
            
            
            
            
            
            209Change
                in unrealized loss on investment securities, net of tax
                effect
            
            
            
            
            
            
            
            
            
            
            
            (12
            )
            
            (12
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            197Warrants
                exercised
            
            
            250
            
            
            4
            
            
            
            
            
            
            
            
            4Repurchase
                of organizational shares
            
            
            (200
            )
            
            (2
            )
            
            
            
            
            
            
            
            (2
            )**Balance,**June
                30, 2005
            
            
            1,037,548
            
            $
            10,758
            
            $
            (238
            )
            $
            (22
            )
            $
            10,498**Balance,**January
                1, 2006
            
            
            1,871,883
            
            $
            22,776
            
            $
            106
            
            $
            (39
            )
            $
            22,843Comprehensive
                income:Net
                income
            
            
            
            
            
            
            
            
            973
            
            
            
            
            
            973Change
                in unrealized loss on investment securities, net of tax
                effect
            
            
            
            
            
            
            
            
            
            
            
            (15
            )
            
            (15
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            958Compensation
                expense on incentive stock options
            
            
            
            
            
            78
            
            
            
            
            
            
            
            
            78**Balance,**June
                30, 2006
            
            
            1,871,383
            
            $
            22,854
            
            $
            1,079
            
            $
            (54
            )
            $
            23,879





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


4




**DISCOVERY
      BANCORP** **AND
      SUBSIDARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**FOR
      THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005 (UNAUDITED)**





(dollars
                in thousands)**June
                30,2006**
            
            **June
                30,2005****CASH
                FLOWS FROM OPERATING ACTIVITIES:**Net
                income
            
            $
            973
            
            $
            209Adjustments
                to reconcile net income to net cash provided by operating activities:Provision
                for loan losses
            
            
            223
            
            
            282Depreciation
                and amortization
            
            
            247
            
            
            188Amortization
                of deferred loan fees
            
            
            (76
            )
            
            (139
            )Compensation
                expense on stock options
            
            
            78
            
            
            0Change
                in:Deferred
                tax assets
            
            
            (94
            )
            
            29Accrued
                interest receivable and other assets
            
            
            (60
            )
            
            (341
            )Accrued
                interest payable and other liabilities
            
            
            133
            
            
            499Net
                cash provided by operating activities
            
            
            1,424
            
            
            727**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Purchases
                of premises and equipment
            
            
            (60
            )
            
            (344
            )Net
                change in interest bearing deposits at banks
            
            
            (3,480
            )
            
            100Purchase
                of common stock substantially restricted
            
            
            (21
            )
            
            (29
            )Sales,
                maturities and paydowns of securities available-for-sale
            
            
            —
            
            
            618Purchases
                of securities available-for-sale
            
            
            110
            
            
            (1,751
            )Net
                change in loans
            
            
            (14,813
            )
            
            (22,144
            )Net
                cash used for investing activities
            
            
            (18,264
            )
            
            (23,550
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Net
                change in borrowings under lines of credit, net of repayments
            
            
            (187
            )
            
            898Proceeds
                from warrants exercised
            
            
            0
            
            
            4Repurchase
                of organizational shares issued
            
            
            0
            
            
            (2
            )Net
                change in deposits
            
            
            20,406
            
            
            26,605Net
                cash provided by financing activities
            
            
            20,219
            
            
            27,505Increase
                in cash and cash equivalents
            
            
            3,379
            
            
            4,682**CASH
                AND CASH EQUIVALENTS BALANCE**Beginning
                of period
            
            
            14,854
            
            
            6,584End
                of period
            
            $
            18,233
            
            $
            11,266**Supplemental
                Disclosures of Cash Flow Information**Cash
                paid during the year for:Interest
            
            $
            2,768
            
            $
            1,128Income
                taxes
            
            $
            1,134
            
            $
            0




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




5




**DISCOVERY
      BANCORP AND SUBSIDIARIES**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**NOTE
      1 - OPERATIONS, BASIS OF PRESENTATION AND STOCK BASED
      COMPENSATION**





**Nature
      of Operations** -
      Discovery Bancorp (the “Company”) is the holding company for Discovery Bank (the
“Bank”), headquartered in San Marcos, California, and Celtic Capital Corporation
      (“Celtic”), headquartered in Santa Monica, California. On June 22, 2005,
      the Company acquired ownership of the Bank through a corporate reorganization
      and became a bank holding company registered under the Bank Holding Company
      Act
      of 1956, as amended.




The
      Bank,
      through its wholly owned subsidiary, San Marcos Building, LLC, owns a
      28,000-square-foot, two story commercial building to house the Bank’s corporate
      offices and head branch location. The Bank occupies approximately 13,500 square
      feet with the remaining spaces leased to third parties on a short term basis.
      Net rental income activity for the three months ended June 30, 2006 totaled
      $75
      thousand and for the six months ended June 30, 2006 totaled $152 and is
      reflected as other income within the consolidated financial statements.





On
      August
      31, 2005, the Company, through its wholly-owned subsidiary, Celtic Merger Corp.,
      acquired certain assets and assumed certain liabilities of Celtic Capital
      Corporation, a commercial finance lender. $19.3 million of commercial loans
      and
      other assets, including $1.7 million of goodwill established as part of the
      purchase, were acquired. Funding for the purchase was provided by a borrowing
      line established with an unaffiliated bank and $5.2 million in cash and 53,613
      shares of the Company common stock. Celtic Merger Corp. has been renamed Celtic
      Capital Corporation (“Celtic”) and operates as a commercial finance lender. As
      a
      commercial finance lender, Celtic makes “asset-based” loans to companies that do
      not qualify for bank credit and secures its loans with business assets, such
      as
      accounts receivable, equipment and inventory. The
      Company’s financial statements include the accounts of Celtic since the date of
      acquisition.





Further,
      at September 30, 2005, the Company had largely completed a $12.8 million public
      stock offering, of which 53,613 shares or $831 thousand were issued to
      principals of Celtic as part of the Celtic asset acquisition, and received
      proceeds, net of underwriting costs, of approximately $ 11.1 million. On
      November 8, 2005, the Company closed its public offering registered on Form
      SB-2
      and issued a total of 827,425 shares ($12.8 million) of its common
      stock.





**Basis
      of Presentation** - The
      accompanying unaudited consolidated financial statements have been prepared
      in
      accordance with accounting principles generally accepted in the United States
      of
      America.




On
      June 22, 2005, all of the outstanding shares of the Bank were converted
      into shares of Discovery Bancorp. The consolidated financial statements for
      the
      period ending June 30, 2006 include the Company, the Bank and the Bank’s
      premises subsidiary, and Celtic. All significant inter-company balances and
      transactions have been eliminated in consolidation. The consolidated financial
      statements as of June 30, 2005 are derived from the company’s unaudited
      consolidated financial statements and do not include Celtic, as the acquisition
      of Celtic had not yet occurred. These consolidated financial statements should
      be reviewed in conjunction with the consolidated financial statements and notes
      thereto included in the Company’s Annual Report on Form 10-KSB filed with the
      Securities and Exchange Commission, as amended. In the opinion of management,
      all adjustments, consisting of normal recurring accruals considered necessary
      for a fair presentation of the financial statements, have been
      included.





**Reclassifications** - Certain
      prior year amounts have been reclassified to conform to the current year
      presentation.




**Stockholder’s
      Equity and Stock Based Compensation** - **** The
      Company has a stock option plan (hereinafter the “Plan”) which provides for
      non-qualified stock options for non-employee directors and incentive stock
      options for employees for a maximum of 500,000 shares of authorized common
      stock. Pursuant to the Plan, the Company has awarded options to directors and
      employees. The options granted vest and become exercisable in incremental
      percentages over five years from the grant date and expire ten years after
      grant. As of June 30, 2006, 6,910 options had been exercised since the inception
      of the Plan. The Company had options outstanding to purchase a total of 244,457
      shares of common stock, at exercise prices ranging from $10.00 per share to
      $18.05 per share, leaving 248,633 shares available for future
      grants.




6




Prior
      to
      January 1, 2006, the Company accounted for its stock options under the
      recognition and measurement principles of Accounting Principles Board (APB)
      Opinion No. 25, *Accounting
      for Stock Issued to Employees* (APB
      No.
      25), and related interpretations. Accordingly, no stock based employee
      compensation cost was reflected in net earnings prior to January 1, 2006 as
      all
      options to purchase common stock of the Company had an exercise price equal
      to,
      or greater than, the market value of the underlying common stock on the date
      of
      grant.





Effective
      January 1, 2006, the Company began recording compensation expense associated
      with stock-based awards in accordance with Statement of Financial Accounting
      Standards (SFAS) No. 123 (revised 2004), *Share-Based
      Payment* (SFAS
      No.
      123R) as interpreted by SEC Staff Accounting Bulletin No. 107. SFAS No. 123R
      supercedes APB No. 25, and amends SFAS No. 95 *Statement
      of Cash Flows* .
      Generally, the approach in SFAS No. 123R is similar to the approach described
      in
      SFAS No. 123, *Accounting
      for Stock-Based Compensation* (SFAS
      No.
      123). However, SFAS No. 123R requires all stock-based payments to employees,
      including grants of employee stock options, to be recognized in the income
      statement based on their fair values at the date of grant. The stock-based
      compensation expense amount recorded was $39,000 (pre-tax amount) for the three
      months ended June 2006 and $78,000 (pre-tax amount) for the six months ended
      June 2006.





The
      following table illustrates the effect on net earnings and earnings per share
      if the
      Company had applied the fair value recognition provisions of SFAS No. 123 in
      the
      previous year:


****


**Three
                months ended June 30, 2005**
            
            
            **Six
                Months endedJune 30, 2005**(dollars
                in thousands)Reported
                net earnings
            
            $
            208
            
            $
            209Stock-based
                employee compensation expense, net of related tax effects
            
            
            2
            
            
            16Pro
                forma net earnings
            
            $
            206
            
            $
            193Basic
                net earnings per shareAs
                Reported
            
            $
            0.20
            
            $
            0.20Pro
                Forma
            
            $
            0.20
            
            $
            0.19Diluted
                net earnings per shareAs
                Reported
            
            $
            0.19
            
            $
            0.19Pro
                Forma
            
            $
            0.19
            
            $
            0.18




The
      fair
      value of each option granted is estimated on the date of grant using the
      Black-Scholes option-pricing model. The Company uses the following input
      variables as of the grant date, to arrive at the fair value for each grant:




1)
            Grant
                date;


2)
            Options
                granted;


3)
            Exercise
                price;


4)
            Stock
                price on date of grant;


5)
            Expected
                dividend rate;


6)
            Expected
                volatility;


7)
            Risk
                free interest rate on grant date;


8)
            Expected
                term; and


9)
            Expected
                forfeiture rate.





7




**NOTE
      2 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**




In
      June
      2006, the Financial Accounting Standards Board (the "FASB") issued FASB
      Interpretation No. 48 *Accounting
      for Uncertainty in Income Taxes* (an
      interpretation of FASB Statement No. 109) which is effective for fiscal years
      beginning after December 15, 2006 with earlier adoption encouraged. This
      interpretation was issued to clarify the accounting for uncertainty in income
      taxes recognized in the financial statements by prescribing a recognition
      threshold and measurement attribute for the financial statement recognition
      and
      measurement of a tax position taken or expected to be taken in a tax return.
      Management is currently evaluating the potential impact of this
      interpretation.





In
      March 2006, SFAS No. 156, *Accounting
      for Servicing of Financial Assets—an Amendment of FASB Statement
      No. 140* ,
      was
      issued. SFAS No. 156 requires recognition of a servicing asset or liability
      at fair value each time an obligation is undertaken to service a financial
      asset
      by entering into a servicing contract. SFAS No. 156 also provides guidance
      on subsequent measurement methods for each class of servicing assets and
      liabilities and specifies financial statement presentation and disclosure
      requirements. SFAS No. 156 is effective for fiscal years beginning after
      September 15, 2006. The Company is currently evaluating the impact of
      adopting SFAS No. 156 on its consolidated financial position, results of
      operations and cash flows.





On
      November 2, 2005, the FASB issued FASB Staff Position (“FSP”) Nos, FAS 115-1 and
      FAS 124-1, *The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments* .
      This FSP
      addresses the determination as to when an investment is considered impaired,
      whether that impairment is other than temporary, and the measurement of an
      impairment loss. This FSP also includes accounting considerations, subsequent
      to
      the recognition of an other-than-temporary impairment and requires certain
      disclosures about unrealized losses that have not been recognized as
      other-than-temporary impairments. This FSP nullifies certain requirements of
      EITF Issue 03-1, and supersedes EITF Topic No. D-44, Recognition of
      Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost
      Exceeds Fair Value. The guidance in this FSP amends FASB Statement No. 115,
      Accounting for Certain Investments in Debt and Equity Securities. The FSP is
      effective for reporting periods beginning after December 15, 2005. The Company
      does not anticipate any material impact to its financial condition or results
      of
      operations as a result of the adoption of this guidance.





In
      May 2005 the FASB issued FAS 154, *Accounting
      Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB
      Statement No. 3* which
      changes the requirements for the accounting for and reporting of a change in
      accounting principles. This Statement applies to all voluntary changes in
      accounting principles. It also applies to changes required by an accounting
      pronouncement in the unusual instance that the pronouncement does not include
      specific transition provisions. When a pronouncement includes specific
      transition provisions, those provisions should be followed.





Opinion
      20
      previously required that most voluntary changes in accounting principles be
      recognized by including in net income of the period of the change the cumulative
      effect of changing to the new accounting principle. This Statement requires
      retrospective application to prior periods’ financial statements of changes in
      accounting principle, unless it is impracticable to determine either the
      period-specific effects or the cumulative effect of the change. When it is
      impracticable to determine the period specific effects of an accounting change
      on one or more individual prior periods presented, this Statement requires
      that
      the new accounting principle be applied to the balances of assets and
      liabilities as of the beginning of the earliest period for which retrospective
      application is practicable and that a corresponding adjustment be made to the
      opening balance of retained earnings (or other appropriate components of equity
      or net assets in the statement of financial position) for that period rather
      than being reported in an income statement. When it is impracticable to
      determine the cumulative effect of applying a change in accounting principle
      to
      all prior periods, this Statement requires that the new accounting principle
      be
      applied as if it were adopted prospectively from the earliest date
      practicable.





This
      Statement defines retrospective application as the application of a different
      accounting principle to prior accounting periods as if that principle had always
      been used or as the adjustment of previously issued financial statements to
      reflect a change in the reporting entity. This Statement also redefines
      restatement as the revising of previously issued financial statements to reflect
      the correction of an error.




This
      Statement requires that retrospective application of a change in accounting
      principle be limited to the direct effects of the change. Indirect effects
      of a
      change in accounting principle, such as a change in nondiscretionary
      profit-sharing payments resulting from an accounting change, should be
      recognized in the period of the accounting change.






8




This
      Statement also requires that a change in depreciation, amortization, or
      depletion method for long-lived, nonfinancial assets be accounted for as a
      change in accounting estimate affected by a change in accounting
      principle.





This
      Statement carries forward without change the guidance contained in Opinion
      20
      for reporting the correction of an error in previously issued financial
      statements and a change in accounting estimate. This Statement also carries
      forward the guidance in Opinion 20 requiring justification of a change in
      accounting principle on the basis of preferability.





At
      June
      30, 2006 the Company had no changes in accounting principles.





In
      December 2004, the FASB issued SFAS No. 153, *Exchanges
      of Nonmonetary Assets - An Amendment of APB Opinion No. 29, Accounting for
      Nonmonetary Transactions* (SFAS
      153). SFAS 153 eliminates the exception from fair value measurement for
      nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB
      Opinion No. 29, *Accounting
      for Nonmonetary Transactions* ,
      and
      replaces it with an exception for exchanges that do not have commercial
      substance. SFAS 153 specifies that a nonmonetary exchange has commercial
      substance if the future cash flows of the entity are expected to change
      significantly as a result of the exchange. This standard was effective for
      fiscal periods beginning after June 15, 2005. Management believes that the
      adoption of SFAS 153 will not have an impact on the Company’s financial
      statements.









**NOTE
      3 - EARNINGS PER SHARE (EPS)**







Basic
      earnings per share represents income available to common shareholders divided
      by
      the weighted-average number of common shares outstanding during the period.
      Diluted earnings per share reflects additional common shares that would have
      been outstanding if dilutive potential common shares had been issued, as well
      as
      any adjustment to income that would result from the assumed issuance. Potential
      common shares that may be issued by the Company relate to outstanding stock
      options and warrants, and are determined using the treasury stock
      method.





The
      following is a reconciliation of basic EPS to diluted EPS for the three months
      ended June 30, 2006 and 2005:








**Earnings
                per share calculation**
              **For
                the three months ended June 30,**(Dollar
                amounts in thousands, except per share amounts)**2006**
            
            **2005****Net
                Income**
            
            **WeightedAverageSharesOutstanding**
            
            **Per
                ShareAmount**
            
            **NetIncome**
            
            **Weighted
                Average**
              **SharesOutstanding**
            
            **Per
                ShareAmount**Basic
                EPS:Income
                available to common shareholders
            
            $
            499
            
            $
            1,871,883
            
            $
            0.27
            
            $
            208
            
            $
            1,037,498
            
            $
            0.20Effect
                of dilutive securities:Stock
                options/warrants
            
            
            —
            
            
            66,469
            
            
            (0.01
            )
            
            —
            
            
            55,449
            
            
            (0.01
            )Diluted
                EPS:Income
                available to common shareholders
            
            $
            499
            
            $
            1,938,352
            
            $
            0.26
            
            $
            208
            
            $
            1,092,947
            
            $
            0.19







9




The
      following is a reconciliation of basic EPS to diluted EPS for the six months
      ended June30, 2006 and 2005:








**Earnings
                per share calculation**
              **For
                the six months ended June 30,**(Dollar
                amounts in thousands, except per share amounts)**2006**
            
            **2005****Net
                Income**
            
            **WeightedAverageSharesOutstanding**
            
            **PerShare**
              **Amount**
            
            **NetIncome**
            
            **WeightedAverageSharesOutstanding**
            
            **Per
                ShareAmount**Basic
                EPS:Income
                available to common shareholders
            
            $
            973
            
            $
            1,871,883
            
            $
            0.52
            
            $
            209
            
            $
            1,037,398
            
            $
            0.20Effect
                of dilutive securities:Stock
                options/warrants
            
            
            —
            
            
            61,766
            
            
            (0.02
            )
            
            —
            
            
            60,391
            
            
            (0.01
            )Diluted
                EPS:Income
                available to common shareholders
            
            $
            973
            
            $
            1,933,649
            
            $
            0.50
            
            $
            209
            
            $
            1,097,789
            
            $
            0.19




**NOTE
      4** **-** **BORROWINGS**





The
      Bank
      has a continuous revolving line of credit with the Federal Home Loan Bank (FHLB)
      providing for working capital advances up to $29 million. Borrowings are payable
      on demand and are fully collateralized by certain Bank assets. Interest on
      outstanding borrowings accrues at the rates negotiated at the time of borrowing
      which ranged from 4.9% to 5.41% during the second quarter 2006. The Bank had
      $12.8 million outstanding against the line as of June 30, 2006 at a rate of
      5.41%. The Bank had $12.0 million outstanding against the line as of December
      31, 2005.





The
      Bank
      has an unsecured line of credit with Pacific Coast Bankers Bank (PCBB) providing
      for federal fund purchases up to $2.5 million. Interest on outstanding
      borrowings accrues at the PCBB daily fed fund rate. The Bank had no outstanding
      borrowings against the line as of June 30, 2006 and December 31, 2005.





Celtic
      has
      a $25 million revolving line-of-credit with a bank. The line-of-credit matures
      in August 2008. The agreement provides for the bank to advance funds up to
      the maximum line of credit, provided the total amount of outstanding advances
      at
      any time does not exceed the “Borrowers’ Borrowing Base” (BBB). The BBB is based
      on a percentage of the Celtic’s good quality accounts receivable, equipment and
      inventory, pledged to it by its debtors. The line of credit is subject to
      covenants requiring Celtic to meet certain leverage and net worth ratios and
      contains restrictions as to the incurrence of additional debt, capital
      expenditures and payment of dividends. Celtic was in compliance with all
      covenants as of June 30, 2006. Principal is payable on demand, and interest
      is
      payable monthly at prime minus 0.25%. The outstanding balance under this
      revolving line of credit was $15.1 million at June 30, 2006 and $16.1 million
      at
      December 31, 2005. The underlying loans serve as collateral for the
      borrowings.








**NOTE
      5 - PURCHASE OF ASSETS AND LIABILITIES**





On
      August
      31, 2005, the
      Company, through its wholly-owned subsidiary (Celtic Merger Corp.), acquired
      the
      assets and certain liabilities of Celtic Capital Corporation for a purchase
      price of $5.2 million in cash and the issuance of 53,613 shares of the Company
      common stock. The value of the stock was determined to be $15.50 per share
      at
      the time of the acquisition. The source of funds for the acquisition was
      available cash, primarily from the partially completed August, 2005 $12.8
      million common stock offering. Celtic Merger Corp. assumed the premises leases
      of Celtic Capital Corporation’s two offices. Celtic Merger Corp., as part of the
      asset purchase, also entered into certain employment and consulting agreements
      with principals of Celtic Capital Corporation. Celtic Merger Corp. was renamed
      Celtic Capital Corporation ("Celtic").




10




The
      acquisition was accounted for using the purchase method of accounting and,
      accordingly, Celtic’s results of operations have been included in the
      consolidated financial statements since the date of acquisition. The following
      table summarizes the estimated fair value of the assets acquired and liabilities
      assumed at the date of acquisition:







Assets
                acquired:
            
            (dollars in thousands)Cash
            
            $
            1,529Loans
            
            
            15,966Goodwill
            
            
            1,731Other
                assets
            
            
            98Total
                assets acquired
            
            $
            19,324Liabilities
                assumed:Borrowing
                under line of credit
            
            $
            13,214Other
                liabilities
            
            
            53Total
                liabilities assumed
            
            $
            13,267







Goodwill
      of $1.7 million represents the excess of purchase price paid over the estimated
      fair values of the assets acquired, net of the liabilities assumed. Goodwill
      is
      not amortized, but is evaluated for possible impairment at least annually and
      more frequently if events and circumstances indicate that the asset might be
      impaired. No impairment losses were recognized in connection with goodwill
      during the period ending June 30, 2006.








**NOTE
      6 — 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 to meet the financing needs of its customers and
      to
      reduce its own exposure to fluctuations in interest rates. These financial
      instruments include commitments to extend credit, standby letters of credit
      and
      financial guarantees. Those instruments involve, to varying degrees, elements
      of
      credit and interest rate risk in excess of the amount recognized in the balance
      sheet. The contract or notional amounts of those instruments reflect the extent
      of the Company’s involvement in particular classes of financial
      instruments.





The
      Company’s exposure to credit loss in the event of nonperformance by the other
      party to the financial instrument for commitments to extend credit, standby
      letters of credit, and financial guarantees written is represented by the
      contractual notional amount of those instruments. The Company uses the same
      credit policies in making commitments and conditional obligations as it does
      for
      on-balance sheet instruments.





At
      June
      30, 2006 and December 31, 2005, the following financial instruments were
      outstanding whose contract amounts represent credit risk:








(dollars
                in thousands)June
                30, 2006
            
            December
                31, 2005Unfunded
                commitments under lines of credit
            
            $
            46,628
            
            $
            38,626Commercial
                and standby letters of credit
            
            $
            765
            
            $
            566








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 many of the
      commitments are expected to expire without being drawn upon, the total
      commitment amounts do not necessarily represent future cash
      requirements.





Standby
      letters of credit are conditional commitments issued by the Company to guarantee
      the performance of a customer to a third party. Those letters of credit are
      primarily issued to support public and private borrowing arrangements. All
      standby letters of credit issued by the Company expire within one year of
      issuance. The credit risk involved in issuing letters of credit is essentially
      the same as that involved in extending loan facilities to customers. The Company
      generally holds collateral supporting those commitments, if deemed
      necessary.






11





Lines
      of
      credit and commercial and standby letters of credit are variable rate loans
      generally tied to the prime rate or other variable indexes.




**ITEM
      2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATION**





**Introduction** **.**





Discovery
      Bancorp (the “Company”) is the holding company for Discovery Bank (the “Bank”),
      headquartered in San Marcos, California, and Celtic Capital Corporation,
      headquartered in Santa Monica, California. On June 22, 2005, the Company
      acquired ownership of the Bank through a corporate reorganization and became
      a
      bank holding company registered under the Bank Holding Company Act of 1956,
      as
      amended.





On
      August
      31, 2005, the Company, through its wholly-owned subsidiary, Celtic Merger Corp.,
      acquired certain assets and assumed certain liabilities of Celtic Capital
      Corporation, a commercial finance lender. $19.3 million of commercial loans
      and
      other assets, including $1.7 million of goodwill established as part of the
      purchase, were acquired. Funding for the purchase was provided by a borrowing
      line established with an unaffiliated bank and $5.2 million in cash and 53,613
      shares of the Company common stock. Celtic Merger Corp. assumed the premises
      leases of Celtic’s two offices. Celtic Merger Corp. has been renamed Celtic
      Capital Corporation (“Celtic”) and continues to operate as a commercial finance
      lender. As a commercial finance lender, Celtic makes “asset-based” loans to
      companies that do not qualify for bank credit and secures its loans with
      business assets, such as accounts receivable and inventory. Because the business
      conducted by Celtic is the same as that previously conducted by Celtic Capital
      Corporation, the Company has caused Celtic to enter into employment agreements
      and/or consulting agreements with the Celtic Capital Corporation principals,
      Mark Hafner, who serves as President and Chief Executive Officer of Celtic,
      Alex
      Falo, who serves as the Vice President and Loan Manager of Celtic, and Bron
      Hafner, who serves as a Consultant. Each of the employment and consulting
      agreements provides for a term of three (3) years and contains certain
      restrictions that prevent or limit the contracting party from competing against
      Celtic. See Notes 1 and 5 to the financial statements for additional information
      regarding the Celtic asset purchase.





Further,
      at September 30, 2005, the Company had largely completed a $12.8 million stock
      offering, of which 53,613 shares or $831 thousand were issued as part of the
      Celtic asset acquisition, and received proceeds, net of underwriting costs,
      of
      approximately $11.1 million. On November 8, 2005, the Company closed its public
      offering registered on Form SB-2 and has issued 827,425 ($12.8 million) shares
      stock. Please refer to the Company’s Registration Statements on Form S-4 and
      SB-2, as amended, for more information regarding the holding company
      reorganization, the Celtic acquisition and the stock offering.





The
      following discussion is designed to provide a better understanding of
      significant trends related to the the Company’s financial condition, results of
      operations, liquidity, capital resources and interest rate sensitivity of the
      Company, the Bank, and Celtic (collectively the “Company”). This discussion
      focuses primarily on the results of operations of the Company on a consolidated
      basis for the three and six months ended June 30, 2006 and 2005, and the
      financial condition of the Company as of June 30, 2006 and December 31, 2005.
      Comparison of the three and six months ended June 30, 2006 to June 30, 2005
      is
      primarily impacted by the Company’s growth and the above-mentioned acquisition
      and stock offering. For a more complete understanding of the Company and its
      operations, reference should be made to the financial statements included in
      this report and to the Bank’s audited financial statements for the years ended
      December 31, 2004 and 2003 and the Company’s Form 10-KSB for the year ended
      December 31, 2005.





Our
      continued growth since commencement of operations in September 2001 has been
      a
      primary factor impacting profitability over the periods reflected in this
      discussion. Profitability for the three and six months ended June 30, 2006
      was
      impacted by the Celtic acquisition as well as loan growth. However, although
      the
      Company anticipates that continued growth will further enhance the results
      of
      operations, the Company’s future results of operations could materially differ
      from those suggested by the forward-looking statements contained in this report
      or the annualized results of our operations for the three and six months ended
      June 30, 2006, depending upon changes to things such as: 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; 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.





This
      Quarterly Report on Form 10-QSB contains certain forward-looking information
      about the Company and its subsidiaries, which statements are intended to be
      covered by the safe harbor for “forward-looking statements” provided by the
      Private Securities Litigation Reform Act of 1995. All statements other than
      statements of historical fact are forward-looking statements. Such statements
      involve inherent risks and uncertainties, many of which are difficult to predict
      and are generally beyond the control of the Company. We caution readers that
      a
      number of important factors could cause actual results to differ materially
      from
      those expressed in, implied or projected by, such forward-looking
      statements.




12


**Critical
      Accounting Policies**





***Use
      of Estimates.*** The
      Company’s financial statements and the notes thereto, have been prepared in
      accordance with accounting principles generally accepted in the United States
      of
      America. The preparation of our financial statements requires us to make a
      number of estimates and assumptions that affect the reported amounts and
      disclosures in the financial statements. On an ongoing basis, the Company
      evaluates estimates and assumptions based upon historical experience and various
      other factors and circumstances. The Company believes that these estimates
      and
      assumptions are reasonable; however, actual results may differ significantly
      from these estimates and assumptions which could have a material impact on
      the
      carrying value of assets and liabilities at the balance sheet dates and on
      our
      results of operations for the reporting periods.





The
      accounting policies that involve significant estimates and assumptions, which
      have a material impact on the carrying value of certain assets and liabilities,
      are considered critical accounting policies. The Company has identified the
      policies for the allowance for loan and lease losses, securities available
      for
      sale, accounting for goodwill, and income taxes as critical accounting policies.
      These policies are summarized below.





***Allowance
      for Loan and Lease Losses*** .
      The
      Company maintains an allowance for loan and lease losses at an amount which
      the
      Company believes is sufficient to provide adequate protection against losses
      in
      the loan portfolio. Our periodic evaluation of the adequacy of the allowance
      is
      based on such factors as our past loan loss experience, known and inherent
      risks
      in the portfolio, adverse situations that have occurred but are not yet known
      that may affect the borrowers’ ability to repay, the estimated value of
      underlying collateral, results of the Company’s collateral monitoring process,
      and economic conditions. As the Company utilizes information currently available
      to evaluate the allowance for loan and lease losses, the allowance for loan
      and
      lease losses is subjective and may be adjusted in the future depending on
      changes in economic conditions or other factors.





During
      the
      time the Company holds collateral, it is subject to credit risks, including
      risks of borrower defaults, bankruptcies and special hazard losses that are
      not
      covered by standard hazard insurance (such as those occurring from earthquakes
      or floods). Although the Company has established an allowance for loan and
      lease
      losses that the Company considers adequate, there can be no assurance that
      the
      established allowance for loan and lease losses will be sufficient to offset
      losses on loans in the future. Detailed information concerning the Bank’s loan
      loss methodology is contained in this Item 2 below under “—Allowance and
      Provision for Loan and Lease Losses.”





***Securities
      Available-for-Sale*** **.** Securities
      available-for-sale are recorded at fair value, based on quoted market prices.
      Unrealized holding gains and losses, net of income taxes, in securities
      available-for-sale, based on quoted market prices, are reported as other
      comprehensive income (loss) in the period incurred. Premiums and discounts
      on
      purchased securities are recognized as an adjustment to yield over the term
      of
      the security. Declines in the fair value of securities available-for-sale below
      the original purchase price that are deemed to be other than temporary are
      reflected in earnings as realized losses. Gains and losses on the sale of
      securities available-for-sale are recorded on the trade date and are determined
      using the specific identification method.





***Goodwill*** .
      Goodwill
      is not amortized, but is evaluated for possible impairment at least annually
      and
      more frequently if events and circumstances indicate that the asset might be
      impaired. Impairment is the condition that exists when the carrying amount
      of
      the asset exceeds its implied fair value. The goodwill impairment test involves
      comparing the fair value of Celtic’s assets and liabilities with its carrying
      amount, including goodwill.





***Income
      Taxes*** .
      The
      Company records provision for income taxes under the asset liability method.
      Deferred tax assets and liabilities are reflected at currently enacted income
      tax rates applicable to the period in which the deferred tax assets or
      liabilities are expected to be realized or settled. As changes in tax laws
      or
      rates are enacted, deferred tax assets and liabilities are adjusted through
      the
      provision for income taxes. Deferred taxes result from temporary differences
      in
      the recognition of certain income and expense amounts between our financial
      statements and our tax returns. The principal items giving rise to these
      differences include the allowance for loan and lease losses, depreciation,
      and
      organization and start-up costs. We have recognized deferred income tax assets
      as of June 30, 2006 and December 31, 2005, of $416,000 and $322,000,
      respectively. The Company evaluates the realizability of deferred tax assets
      and
      liabilities based upon anticipated taxable income from forecast
      models.





**General**





The
      Company earned $499,000 for the three months ended June 30, 2006, or $0.26
      per
      diluted share, and $973,000, or $0.50 per diluted share, for the six months
      ended June 30, 2006. This compares to earnings of $208,000 or $0.19 per diluted
      share and $209,000 or $0.19 per diluted share for the same periods in 2005.
      Increase in net interest income from continued loan growth and the Celtic
      acquisition more than offset increases in operating expenses in the second
      quarter.




13





Total
      assets increased $21.4 million or 13%, to $186.1 million at June 30, 2006,
      from
      $164.7 million at December 31, 2005. Loans, net of unearned income, increased
      10.9% to $151.0 million at June 30, 2006, from $136.1 million at December 31,
      2005. The increases in total assets and loans were primarily funded by a $20.4
      million increase in deposits to $133 million at June 30, 2006, from $112.6
      million at December 31, 2005 partially offset by reductions in borrowings of
      $187,000.





Stockholders’
      equity was $23.9 million at June 30, 2006, compared to $22.8 million at December
      31, 2005. The increase reflects continued profitability during the
      period.





The
      following sections present various tables reflecting the Company’s results of
      operations and financial condition for the dates indicated below. The Bank’s
      averages and rates have been calculated using daily averages. Celtic’s
      interest-earning assets and interest-bearing liabilities averages and rates
      have
      been calculated using daily averages. Monthly averages were used for the balance
      of Celtic’s assets and liabilities, for the Company’s separate assets and
      liabilities, and for San Marcos Building, LLC; however, these balances do not
      impact interest-earning assets or interest-bearing liabilities. Further,
      management believes the impact of using monthly versus daily average balances
      for these items is not material. No assurance can be given that the annualized
      rates and results of operations for the three and six months ended June 30,
      2006
      is indicative of the rates and results of operations that may be expected for
      the year ending December 31, 2006.





14


**RESULTS
      OF OPERATION**





**Distribution
      of Assets, Liabilities and Shareholders’ Equity**





The
      Company’s earnings depend largely upon the difference between the income we
      receive from interest-earning assets, which are principally our loan portfolio
      and investment securities; and the interest paid on our interest-bearing
      liabilities, which consist of deposits and borrowings. This difference is net
      interest income. Net interest margin is net interest income expressed as a
      percentage of average total interest-earning assets.





The
      following table provides information, for the periods indicated, on the average
      amounts outstanding for the major categories of interest-earning assets and
      interest-bearing liabilities, the amount of interest earned or paid, the yields
      and rates on major categories of interest-earning assets and interest-bearing
      liabilities and the net interest margin.





**Average
                Balances and Rates/Yields**
              **For
                the Three Months Ended June 30,**(dollars
                in thousands)**2006**
            
            **2005****Average
                Balance**
            
            **Interest
                Income/Expense**
            
            **Average
                Rate/Yield (1)**
            
            **Average
                Balance**
            
            **Interest**
              **Income/Expense**
            
            **Average
                Rate/Yield (1)****Assets**Investment
                Securities
            
            $
            3,309
            
            $
            43
            
            
            5.21
            %
            $
            3,606
            
            $
            44
            
            
            4.89
            %Interest-earning
                deposits
            
            
            5,698
            
            
            65
            
            
            4.58
            %
            
            2,862
            
            
            18
            
            
            2.52
            %Federal
                funds sold
            
            
            7,895
            
            
            100
            
            
            5.08
            %
            
            7,490
            
            
            58
            
            
            3.11
            %Loans
                (2)
            
            
            147,700
            
            
            4,049
            
            
            11.00
            %
            
            98,681
            
            
            1,924
            
            
            7.82
            %Total
                Interest-Earning Assets
            
            
            164,602
            
            $
            4,257
            
            
            10.37
            %
            
            112,639
            
            $
            2,044
            
            
            7.28
            %Non
                Interest-earning Assets
            
            
            14,999
            
            
            
            
            
            
            
            
            12,550**Total
                Assets**
            
            $
            179,601
            
            
            
            
            
            
            
            $
            125,189**Liabilities**Transaction
                & NOW
            
            
            6,913
            
            
            19
            
            
            1.10
            %
            
            6,752
            
            
            15
            
            
            0.95
            %Savings
                & Money Market
            
            
            23,869
            
            
            199
            
            
            3.34
            %
            
            20,069
            
            
            110
            
            
            2.20
            %Time
                deposits
            
            
            77,103
            
            
            896
            
            
            4.66
            %
            
            59,443
            
            
            485
            
            
            3.27
            %Borrowings
            
            
            24,620
            
            
            416
            
            
            6.78
            %
            
            9,940
            
            
            75
            
            
            3.03
            %Total
                Interest-Bearing Liabilities
            
            
            132,505
            
            
            1,530
            
            
            4.63
            %
            
            96,204
            
            
            685
            
            
            2.86
            %Demand
                deposits
            
            
            22,214
            
            
            
            
            
            
            
            
            17,610Other
                liabilities
            
            
            1,275
            
            
            
            
            
            
            
            
            1,271**Total
                Liabilities**
            
            
            155,994
            
            
            
            
            
            
            
            
            115,085Shareholders’
                Equity
            
            
            23,607
            
            
            
            
            
            
            
            
            10,104Total
                Liabilities and Shareholders’ Equity
            
            $
            179,601
            
            
            
            
            
            
            
            $
            125,189Consolidated
                Net Interest Income/Net Interest Margin (3)
            
            
            
            
            $
            2,727
            
            
            6.65
            %
            
            
            
            $
            1,359
            
            
            4.84
            %





1
            The
                ratios have been annualized.




2
            Average
                loans are net of unearned loan fees and allowances for loan and lease
                losses. Unearned loan fees were $353,000 and $206,000 at June 30,
                2006 and
                2005, respectively. Allowances for loan and lease losses were $2,007,000
                and $1,280,000 at June 30, 2006 and 2005, respectively. Interest
                income
                from loans includes loan fees of $244,000 and $76,000 for the three
                months
                ended June 30, 2006 and 2005,
                respectively.





3
            Net
                interest margin is calculated by dividing net interest income by
                average
                interest-earning assets.




15






***Three
      Months Ended
      June 30, 2006 and 2005.*** Average
      interest-earning assets increased to $164.6 million during the three months
      ended June 30, 2006, from $112.6 million during the same period in 2005, but
      remained relatively constant as a percentage of average earning assets. The
      average yield on these assets increased to 10.37% from 7.28%. Average
      interest-bearing liabilities, consisting primarily of interest-bearing deposits,
      increased to $132.5 million during the three months ended June 30, 2006, from
      $96.2 million during the same period in 2005. The average rate paid on
      interest-bearing liabilities increased to 4.63% for the three months ended
      June
      30, 2006, from 2.86% for the same period in 2005. The increase in the yield
      on
      interest-earning assets was primarily the result of the prime rate increases
      experienced since June 2005 as well as the addition of Celtic loans which earn
      relatively higher yields. The increase in the rate paid on interest-bearing
      liabilities resulted from increases in deposit rates and an increase in
      prime-rate-based borrowings related to Celtic since June 2005. Average
      noninterest-bearing demand deposit accounts, consisting primarily of business
      checking accounts, increased 26.1% for the three months ended June 30, 2006
      to
      $22.2 million from $17.6 million for the same period in 2005.





Net
      interest income for the three months ended June 30, 2006, was $2,727,000 which
      increased $1,368,000 or 100.7% over the same period in the prior year. Our
      net
      interest margin increased 181 basis points to 6.65% for the three months ended
      June 30, 2006, compared to 4.84% for the same period in 2005. The net interest
      margin increase resulted from the repricing lag between interest bearing
      deposits and loans in a rising rate market, and the higher net interest margin
      from the Celtic loan portfolio.




**Average
                Balances and Rates/Yields**
              **For
                the Six Months Ended June 30,**(dollars
                in thousands)**2006**
            
            **2005****Average
                Balance**
            
            **Interest
                Income/Expense**
            
            **Average**
              **Rate/Yield
                (1)**
            
            **AverageBalance**
            
            **Interest**
              **Income/Expense**
            
            **Average**
              **Rate/Yield
                (1)****Assets**Investment
                Securities
            
            $
            3,342
            
            $
            84
            
            
            5.07
            %
            $
            3,258
            
            $
            70
            
            
            4.33
            %Interest-earning
                deposits
            
            
            4,793
            
            
            104
            
            
            4.38
            %
            
            2,871
            
            
            36
            
            
            2.53
            %Federal
                funds sold
            
            
            8,605
            
            
            203
            
            
            4.76
            %
            
            6,844
            
            
            98
            
            
            2.89
            %Loans
                (2)
            
            
            142,859
            
            
            7,682
            
            
            10.84
            %
            
            92,483
            
            
            3,488
            
            
            7.61
            %Total
                Interest-Earning Assets
            
            
            159,599
            
            
            8,073
            
            
            10.20
            %
            
            105,456
            
            
            3,692
            
            
            7.06
            %Non
                Interest-earning Assets
            
            
            15,028
            
            
            
            
            
            
            
            
            11,927**Total
                Assets**
            
            $
            174,627
            
            
            
            
            
            
            
            $
            117,383**Liabilities**Transaction
                & NOW
            
            
            7,083
            
            
            40
            
            
            1.14
            %
            
            6,749
            
            
            33
            
            
            0.99
            %Savings
                & Money Market
            
            
            23,453
            
            
            372
            
            
            3.20
            %
            
            20,460
            
            
            211
            
            
            2.08
            %Time
                deposits
            
            
            71,282
            
            
            1,575
            
            
            4.46
            %
            
            52,737
            
            
            818
            
            
            3.13
            %Borrowings
            
            
            25,515
            
            
            828
            
            
            6.54
            %
            
            9,541
            
            
            130
            
            
            2.75
            %Total
                Interest-Bearing Liabilities
            
            
            127,333
            
            
            2,815
            
            
            4.46
            %
            
            89,487
            
            
            1,192
            
            
            2.69
            %Demand
                deposits
            
            
            22,767
            
            
            
            
            
            
            
            
            17,094Other
                liabilities
            
            
            1,204
            
            
            
            
            
            
            
            
            628**Total
                Liabilities**
            
            
            151,304
            
            
            
            
            
            
            
            
            107,209Shareholders’
                Equity
            
            
            23,323
            
            
            
            
            
            
            
            
            10,174Total
                Liabilities and Shareholders’ Equity
            
            $
            174,627
            
            
            
            
            
            
            
            $
            117,383Consolidated
                Net Interest Income/Net Interest Margin (3)
            
            
            
            
            $
            5,258
            
            
            6.64
            %
            
            
            
            $
            2,500
            
            
            4.78
            %




1
            The
                ratios have been annualized.


2
            Average
                loans are net of unearned loan fees and allowances for loan and lease
                losses. Unearned loan fees were $353,000 and $206,000 at June 30,
                2006 and
                2005, respectively. Allowances for loan and lease losses were $2,007,000
                and $1,280,000 at June 30, 2006 and 2005, respectively. Interest
                income
                from loans includes loan fees of $366,000 and $139,000 for the six
                months
                ended June 30, 2006 and 2005,
                respectively.


3
            Net
                interest margin is calculated by dividing net interest income by
                average
                interest-earning assets.






16




***Six
      Months Ended June 30, 2006 and 2005*** Average
      interest-earning assets increased to $159.6 million during the six months ended
      June 30, 2006, from $105.5 million during the same period in 2005. The average
      yield on these assets increased to 10.2% from 7.06%. Average interest-bearing
      liabilities, consisting primarily of interest-bearing deposits, increased to
      $127.3 million during the six months ended June 30, 2006, from $89.5 million
      during the same period in 2005. The average rate paid on interest-bearing
      liabilities increased to 4.46% for the six months ended June 30, 2006, from
      2.69% for the same period in 2005. The increase in the yield on interest-earning
      assets was primarily the result of the prime rate increases experienced since
      June 2005 as well as the addition of Celtic loans which earn relatively higher
      yields. The increase in the rate paid on interest-bearing liabilities resulted
      from increases in deposit rates and an increase in prime-rate-based borrowings
      related to Celtic since June 2005. Average noninterest-bearing demand deposit
      accounts, consisting primarily of business checking accounts, increased 33.3%
      for the six months ended June 30, 2006 to $22 million from $17.1 million for
      the
      same period in 2005.





Net
      interest income for the six months ended June 30, 2006, was $5,258,000 which
      increased $2,758,000 or 110.3% over the same period in the prior year. Our
      net
      interest margin increased 186 basis points to 6.64% for the six months ended
      June 30, 2006, compared to 4.78% for the same period in 2005. The net interest
      margin increase resulted from the repricing lag between interest bearing
      deposits and loans in a rising rate market and the higher net interest margin
      in
      the Celtic loan portfolio.




**Net
      Interest Income and Rate/Volume Analysis** .





Net
      interest income is affected by changes in the level and the mix of
      interest-earning assets and interest-bearing liabilities. The changes between
      periods in these assets and liabilities are referred to as volume changes.
      The
      impact on net interest income from changes in average volume is measured by
      multiplying the change in volume between the current period and the prior period
      by the prior period rate.





Net
      interest income is also affected by changes in the yields earned on assets
      and
      rates paid on liabilities. These are referred to as rate changes and the impact
      on net interest income from these changes is measured by multiplying the change
      in rate between the current and prior period by the average volume of the prior
      period. Changes in rate-volume between periods, which are measured by the change
      in rate multiplied by the change in volume, are allocated on a pro rata basis
      between the volume and the rate changes. The following table reflects the rate
      and volume changes for the periods indicated:




**Rate/Volume
      Analysis of Net Interest Income**


**For
      the Three Months Ended June 30, 2006**


**Compared
      to the Three Months Ended June 30, 2005**








**Increase
                (Decrease)**
              **Due
                To Change In**(dollars
                in thousands)**Volume**
            
            **Rate**
            
            **Change****Interest-Earning
                Assets**Investment
                Securities
            
            $
            (4
            )
            $
            3
            
            $
            (1
            )Interest-earning
                deposits
            
            
            18
            
            
            29
            
            
            47Federal
                Funds Sold
            
            
            3
            
            
            39
            
            
            42Loans
            
            
            956
            
            
            1,169
            
            
            2,125**Total
                Interest Income**
            
            
            973
            
            
            1,240
            
            
            2,213**Interest-Bearing
                Liabilities**Transaction
                and Now Accounts
            
            
            1
            
            
            3
            
            
            4MMDA
                and Savings
            
            
            21
            
            
            68
            
            
            89Time
                Deposit
            
            
            144
            
            
            267
            
            
            411Borrowings
            
            
            111
            
            
            230
            
            
            341**Total
                Interest Expense**
            
            
            277
            
            
            568
            
            
            845**Net
                Interest Income**
            
            $
            696
            
            $
            672
            
            $
            1,368




17








**Rate/Volume
      Analysis of Net Interest Income**


**For
      the Six Months Ended June 30, 2006**


**Compared
      to the Six Months Ended June 30, 2005**






**Increase
                (Decrease)**
              **Due
                To Change In**(dollars
                in thousands)**Volume**
            
            **Rate**
            
            **Change****Interest-Earning
                Assets**Investment
                Securities
            
            $
            2
            
            $
            12
            
            $
            14Interest-earning
                deposits
            
            
            24
            
            
            44
            
            
            68Federal
                Funds Sold
            
            
            25
            
            
            80
            
            
            105Loans
            
            
            1,900
            
            
            2,294
            
            
            4,194**Total
                Interest Income**
            
            
            1,951
            
            
            2,430
            
            
            4,381**Interest-Bearing
                Liabilities**Transaction
                and Now Accounts
            
            
            2
            
            
            5
            
            
            7MMDA
                and Savings
            
            
            31
            
            
            130
            
            
            161Time
                Deposit
            
            
            288
            
            
            469
            
            
            757Borrowings
            
            
            218
            
            
            480
            
            
            698**Total
                Interest Expense**
            
            
            539
            
            
            1,084
            
            
            1,623**Net
                Interest Income**
            
            $
            1,412
            
            $
            1,346
            
            $
            2,758




**Non-Interest
      Income**





Non-interest
      income includes customer service fees, gains from the sale of SBA loans, rental
      income, and other loan fees and charges.





The
      tables
      below set forth the components of non-interest income as of the periods
      indicated:





**For
                the Three Months Ended June 30**(dollars
                in thousands)**2006**
            
            **2005****Amount**
            
            **Percent
                of Total**
            
            **Amount**
            
            **Percent
                of Total**
            
            **2006/2005**
              **Change**
            
            **PercentageChange**Customer
                service fees & charges
            
            $
            42
            
            
            14.4
            %
            $
            29
            
            
            9.93
            %
            $
            13
            
            
            44.83
            %Gain
                on sale of SBA loans
            
            
            52
            
            
            17.8
            %
            
            123
            
            
            42.12
            %
            
            (71
            )
            
            (57.72)
            %Rental
                income
            
            
            75
            
            
            25.7
            %
            
            55
            
            
            18.84
            %
            
            20
            
            
            36.36
            %Other
                loan fees & charges
            
            
            123
            
            
            42.1
            %
            
            85
            
            
            29.11
            %
            
            38
            
            
            44.71
            %Total
            
            $
            292
            
            
            100.00
            %
            $
            292
            
            
            100.00
            %
            $
            0
            
            
            0
            %As
                a
                percentage of average earning assets
            
            
            
            
            
            0.18
            %
            
            
            
            
            0.26
            %





***Three
      Months Ended June 30, 2006 and 2005.*** Non-interest
      income overall remained flat for the three months ended June 30, 2006 as
      compared to the three months ended June 30, 2005. Non-interest income as a
      percentage of average earning assets declined on higher interest generating
      assets from the acquisition of Celtic loans and year over year loan growth
      in
      the Bank. Other loan fees & charges increased on fees generated by Celtic.
      This increase along with increases in Rental income and Customer service fees
      offset reduced Gain on sale of SBA loans. Reduced Gain on sale of SBA loans
      is
      due to a decline in SBA sales volume.





18




**For
                the Six Months Ended June 30**(dollars
                in thousands)**2006**
            
            **2005****Amount**
            
            **Percent
                of Total**
            
            **Amount**
            
            **Percent
                of Total**
            
            **2006/2005**
              **Change**
            
            **Percentage**
              **Change**Customer
                service fees & charges
            
            $
            79
            
            
            12.74
            %
            $
            40
            
            
            10.08
            %
            $
            39
            
            
            97.50
            %Gain
                on sale of SBA loans
            
            
            167
            
            
            26.94
            %
            
            123
            
            
            30.98
            %
            
            44
            
            
            35.77
            %Rental
                income
            
            
            152
            
            
            24.52
            %
            
            132
            
            
            28.21
            %
            
            20
            
            
            15.15
            %Other
                loan fees & charges
            
            
            222
            
            
            35.81
            %
            
            102
            
            
            30.73
            %
            
            120
            
            
            117.65
            %Total
            
            $
            620
            
            
            100.00
            %
            $
            397
            
            
            100.00
            %
            $
            223
            
            
            56.17
            %As
                a
                percentage of average earning assets
            
            
            
            
            
            0.39
            %
            
            
            
            
            0.38
            %




***Six
      Months Ended June 30,
      2006 and 2005.***Non-interest income increased $223,000 to $620,000
      for the six months ended June 30, 2006 as compared to the six months ended
      June
      30, 2005, but remained relatively constant as a percentage of average earning
      assets. The increase was primarily the result of an increase in other loan
      fees
      totaling $222,000 ($155,000 generated by Celtic for the six months ended June
      30, 2006) and higher gain on the sale of SBA loans totaling
      $167,000.





**Non-Interest
      Expense**





Non-interest
      expenses consist of salaries and related benefits, occupancy and equipment
      expense and other expenses.





The
      tables
      below set forth the components of non-interest expenses as of the periods
      indicated:





**For
                the Three Months Ended June 30,**(dollars
                in thousands)**2006**
            
            **2005****Amount**
            
            **Percent
                of Total**
            
            **Amount**
            
            **Percent
                of Total**
            
            **2006/2005Change**
            
            **PercentageChange**Salaries
                and benefits
            
            $
            1,244
            
            
            61.25
            %
            $
            611
            
            
            50.25
            %
            $
            633
            
            
            103.60
            %Occupancy
                expense
            
            
            135
            
            
            6.65
            %
            
            72
            
            
            5.92
            %
            
            63
            
            
            87.50
            %Furniture
                & Equipment
            
            
            85
            
            
            4.19
            %
            
            73
            
            
            6.00
            %
            
            12
            
            
            16.44
            %Data
                Processing
            
            
            91
            
            
            4.48
            %
            
            51
            
            
            4.19
            %
            
            40
            
            
            78.43
            %Advertising
            
            
            53
            
            
            2.61
            %
            
            31
            
            
            2.55
            %
            
            22
            
            
            70.97
            %Professional
                fees
            
            
            189
            
            
            9.31
            %
            
            210
            
            
            17.27
            %
            
            (21
            )
            
            (10.00
            )%Office
                supplies
            
            
            22
            
            
            1.08
            %
            
            18
            
            
            1.48
            %
            
            4
            
            
            22.22
            %Other
                expenses
            
            
            211
            
            
            10.44
            %
            
            150
            
            
            12.34
            %
            
            61
            
            
            40.67
            %Total
            
            $
            2,030
            
            
            100.00
            %
            $
            1,216
            
            
            100.00
            %
            $
            814
            
            
            66.94
            %




***Three
      Months Ended June 30, 2006 and 2005.*** Our
      non-interest expenses increased by $814,000, or 66.94%, ($232,000, 19.0%
      excluding Celtic) to $2,030,000 for the three months ended June 30, 2006,
      compared to the three months ended June 30, 2005. Salaries and employee benefits
      increased $633,000, or 103.6% for the three months ended June 30, 2006 related
      to staffing increases to support loan growth and deposit activities, setting
      up
      the SBA loan department and increased administrative staff including a
      controller, director of human resources and a director of operations. Occupancy
      expense increased $63,000, or 87.50%, ($8,000 or 11.1% excluding Celtic) to
      $135,000 for the three months ended June 30, 2006. Remaining expenses increased
      in line with business growth and the addition of Celtic.




19




**For
                the Six Months Ended June 30,**(dollars
                in thousands)**2006**
            
            **2005****Amount**
            
            **Percent
                of Total**
            
            **Amount**
            
            **Percent
                of Total**
            
            **2006/2005
                Change**
            
            **Percentage**
              **Change**Salaries
                and benefits
            
            $
            2,412
            
            
            61.03
            %
            $
            1,123
            
            
            49.56
            %
            $
            1,289
            
            
            114.78
            %Occupancy
                expense
            
            
            262
            
            
            6.63
            %
            
            135
            
            
            5.96
            %
            
            127
            
            
            94.07
            %Furniture
                & Equipment
            
            
            154
            
            
            3.90
            %
            
            139
            
            
            6.13
            %
            
            15
            
            
            10.79
            %Data
                Processing
            
            
            192
            
            
            4.86
            %
            
            100
            
            
            4.41
            %
            
            92
            
            
            92.00
            %Advertising
            
            
            97
            
            
            2.45
            %
            
            52
            
            
            2.29
            %
            
            45
            
            
            86.54
            %Professional
                fees
            
            
            369
            
            
            9.34
            %
            
            377
            
            
            16.64
            %
            
            (8
            )
            
            (2.12
            )%Office
                supplies
            
            
            43
            
            
            1.09
            %
            
            35
            
            
            1.54
            %
            
            8
            
            
            22.86
            %Other
                expenses
            
            
            423
            
            
            10.70
            %
            
            305
            
            
            13.46
            %
            
            118
            
            
            38.69
            %Total
            
            $
            3,952
            
            
            100.00
            %
            $
            2,266
            
            
            100.00
            %
            $
            1,686
            
            
            74.41
            %




***Six
      Months Ended June 30, 2006 and 2005.*** Our
      non-interest expenses increased by $1.7 million, or 74.4%, ($502,000, 22.0%
      excluding Celtic) to $4 million for the six months ended June 30, 2006, compared
      to the six months ended June 30, 2005. Salaries and employee benefits increased
      to $2.4 million, or 114.78% for the six months ended June 30, 2006 related
      to
      staffing increases to support loan growth and deposit activities, setting up
      the
      SBA loan department and increased administrative staff including a controller,
      director of human resources and a director of operations. Occupancy expense
      increased $127,000, or 94.07%, ($23,000 or 17.0% excluding Celtic) to $262,000
      for the six months ended June 30, 2006. Remaining expenses increased in line
      with business growth and the addition of Celtic.





**Income
      Taxes**





The
      Company’s effective tax rates were 43.0% for the three and six months ended June
      30, 2006 and 33.1% and 40.0% for the three month and six months ended June
      30,
      2005, respectively. The increase in the effective tax rate for the three months
      and six months ended June 30, 2006 as compared to June 30, 2005 reflects the
      complete utilization of net operating loss carryforwards and tax impact of
      implementing FAS 123(R) -Stock-based compensation.





**Investments**





In
      order
      to maintain a reserve of readily saleable assets to meet our liquidity and
      loan
      requirements, the Company purchases United States Treasury and Agency securities
      and other investments. Sales of Federal Funds and short-term loans to other
      banks are also regularly utilized. Placement of funds in certificates of deposit
      with other financial institutions may be made as alternative investments pending
      utilization of funds for loans or other purposes. None of our securities are
      pledged to meet security requirements imposed as a condition to receipt of
      public fund deposits or for other purposes. Our policy is to stagger the
      maturities of our investments to meet our overall liquidity
      requirements.





At
      June
      30, 2006 and December 31, 2005 our investment portfolio consisted of U.S. Agency
      securities and mortgage backed securities. All of our securities are classified
      as available-for-sale. Available-for-sale securities are bonds, notes,
      debentures, and certain equity securities that are not classified as trading
      securities or as held-to-maturity securities. Unrealized holding gains and
      losses, net of tax, on available-for-sale securities are reported as a net
      amount in a separate component of capital until realized. Gains and losses
      on
      the sale of available-for-sale securities are determined using the specific
      identification method. Premiums and discounts are recognized in interest income
      using the interest method over the period to maturity.




20




The
      following table summarizes the amounts and the distributions of our investment
      securities as of the dates indicated:







**Investment
                Portfolio**(dollars
                in thousands)**As
                of June 30, 2006**
            
            **As
                of December 31, 2005****AmortizedCost**
            
            **Gross
                Unrealized Gains**
            
            **Gross
                Unrealized Losses**
            
            **FairValue**
            
            **Amortized
                Cost**
            
            **Gross
                Unrealized Gains**
            
            **Gross
                Unrealized Losses**
            
            **Fair
                Value**(dollars
                in thousands)Available-for-sale
                securities:U.S.
                Government Agency Securities
            
            $
            2,499
            
            
            —
            
            $
            (53
            )
            $
            2,446
            
            $
            2,496
            
            
            —
            
            $
            (41
            )
            $
            2,455Mortgage-backed
                Securities
            
            
            872
            
            
            —
            
            
            (42
            )
            
            830
            
            
            973
            
            
            1
            
            
            (27
            )
            
            947Total
                securities
            
            $
            3,371
            
            
            —
            
            $
            (95
            )
            $
            3,276
            
            $
            3,469
            
            $
            1
            
            $
            (68
            )
            $
            3,402





As
      of June
      30, 2006 and December 31, 2005, the Bank also owned $60,000 in Pacific Coast
      Bankers’ the Company common stock. In addition, as of June 30, 2006 and December
      31, 2005, the Bank owned $609,000 and $588,000, respectively, in Federal Home
      Loan Bank stock.





**Loans**





**Loan
      Categories.** The
      following table sets forth the components of total net loans outstanding in
      each
      category for the Company at the dates indicated:




**June
                30, 2006**
            
            **December
                31, 2005****Amount**
            
            **Percent
                of Total**
            
            **Amount**
            
            **Percent
                of Total**Real
                Estate Loans
            
            (dollars
                in thousands)Construction
                & Land Development Loans
            
            $
            30,828
            
            
            20
            %
            $
            32,033
            
            
            23
            %Real
                Estate 1st Trust Deed
            
            
            52,153
            
            
            34
            %
            
            41,344
            
            
            30
            %Other
                Real Estate Mortgage
            
            
            2,379
            
            
            2
            %
            
            2,141
            
            
            2
            %Total
                Real Estate
            
            
            85,360
            
            
            56
            %
            
            75,518
            
            
            55
            %Business
                Secured Loans
            
            
            56,530
            
            
            38
            %
            
            52,221
            
            
            38
            %Business
                Unsecured Loans
            
            
            1,575
            
            
            1
            %
            
            1,390
            
            
            1
            %Consumer
                and Other
            
            
            7,887
            
            
            5
            %
            
            7,410
            
            
            6
            %**Total
                Loans**
            
            
            151,352
            
            
            100
            %
            
            136,539
            
            
            100
            %Less
                deferred Loan Income
            
            
            (353
            )
            
            
            
            
            (429
            )Less
                Allowance for Loan and Lease Losses
            
            
            (2,007
            )
            
            
            
            
            (1,784
            )**Net
                Loans**
            
            $
            148,992
            
            
            
            
            $
            134,326





The
      Company provides a variety of credit products to meet the needs of borrowers
      in
      our service area. The Company offers both secured and unsecured loans for
      working capital, equipment acquisition, expansion, purchase or improvement
      of
      real property, as well as seasonal loans and lines of credit. The Company
      maintains a portfolio of interim construction loans. Other real estate loans
      consist primarily of commercial loans secured by real estate collateral and
      “mini-perm” real estate financing. Commercial loans are made available to
      business and professional customers. Consumer loans are offered for a variety
      of
      personal, family household needs, including automobiles, home equity loans
      and
      unsecured revolving lines of credit.





The
      Company’s loan portfolio has consistently increased since the Bank commenced
      operations in September 2001. Furthermore, the Company also had the positive
      addition of Celtic’s $16 million in business secured loans effective September
      1, 2005. The Bank’s loan growth is the result of increased lending in our
      immediate market area and the opening of an additional banking office in Poway
      in 2004, which services the nearby communities of Poway, Carmel Mountain, Rancho
      Bernardo, Rancho Penesquitos, Ramona and Scripps Ranch. In addition, our
      increasing lending limits that result from the growth of our capital allows
      us
      to make larger loans. The size of a loan that a bank can make is limited by
      regulation to a percentage of the institution’s regulatory capital.





The
      Company does not have any concentrations in our loan portfolio by industry
      or
      group of industries, except for the level of loans that are secured by real
      estate as presented in the table above. The Company has not made loans to any
      foreign entities. In addition, the Company has not made any loans to finance
      leveraged buyouts or for highly leveraged transactions.




21




***Loan
      Origination and Underwriting.*** Our
      primary lending emphasis is in construction, commercial real estate and business
      loans, including SBA loans. Major credit risk factors for all categories of
      loans include: changes in national and local economic conditions; the
      experience, ability and depth of our lending staff; changes in the quality
      of
      our internal and external loan review systems; and the impact of certain
      external factors such as competition, legal and regulatory changes. For
      construction and other real estate related loans, additional major risk factors
      include: changes in the valuation of real property; increases in commercial,
      industrial and retail vacancy rates; market absorption levels; excess market
      supply; and rising interest rates. To address these credit risks, all loan
      requests require preparation of a credit memorandum that details the purpose
      of
      the loan, terms, repayment source, collateral, and credit rating of the borrower
      and a general description of the borrower’s background and/or business. The loan
      request is then subjected to various levels of review to assure that larger
      loans are reviewed by more experienced lenders and/or the Bank’s loan committee.
      The Bank’s loan policy establishes criteria for various types of loans, such as
      loan to collateral value ratios or loan to debt ratios. Further, the Bank
      utilizes outside loan reviewers to review and assess the loans made on an
      ongoing basis.





Celtic
      originates business loans that are collateralized primarily by business
      property. The principal factors considered in making lending decisions are
      the
      amount of the loan in comparison to the value of the collateral, the borrower’s
      financial condition and the borrower’s capacity to repay the loan. Celtic
      attempts to minimize lending risk by limiting the total amount loaned to any
      one
      borrower. Additionally, Celtic monitors and restricts its credit exposure in
      specific industries and geographic areas.





Current
      appraisals or evaluations, insurance and perfected liens are generally required
      for any collateral taken on loans.





***Loan
      Commitments.*** In
      the
      normal course of business, the Company maintains outstanding loan commitments
      to
      extend credit. The Company uses the same credit policies in making loan
      commitments as the Company does in extending loans to customers. The Company
      evaluates each customer’s creditworthiness on a case-by-case basis. The amount
      of collateral obtained, if deemed necessary, is based on management’s credit
      evaluation of the customer. The types of collateral held varies, but may include
      accounts receivable, inventory, property, equipment and residential and income
      producing commercial properties. The Company had unfunded loan commitments,
      including standby letters of credit, totaling $47.4 million and $39.2 million
      at
      June 30, 2006 and December 31, 2005, respectively, primarily consisting of
      commercial, construction and equity lines of credit. Based upon the Company’s
      experience, the outstanding loan commitments and standby letters of credit
      are
      expected to grow throughout the year as loan demand continues to increase,
      subject to, economic conditions.





***Non-Performing
      Assets.*** It
      is our
      policy to place loans on non-accrual status when principal or interest payments
      are past due 90 days or more. Certain loans will be placed on non-accrual
      earlier if there is a reasonable doubt as to the collectibility of principal
      and
      interest. Loans which are in the process of renewal in the normal course of
      business or are well secured and in the process of collection will continue
      to
      accrue interest if the Company considers the risk of loss to be
      minimal.





Nonperforming
      assets at June 30, 2006 were unchanged from the December 31, 2005 balance of
      $726,000, representing 0.48% of gross loans at June 30, 2006, compared to 0.53%
      of gross loans at December 31, 2005. Nonperforming assets consists of one
      commercial real estate construction loan, for which management believes there
      is
      no loss exposure. There were no other non-accrual loans, loans past due 90
      days
      or more, restructured loans, or impaired loans or loans that have or had a
      higher than normal risk of loss.





As
      of June
      30, 2006, the Company has identified $3.4 million in loans on our internal
      watch
      list for special attention by our management and board of directors, of which
      $1.1 million is guaranteed by government and other agencies. These loans reflect
      weakened financial conditions or evidence other factors warranting closer
      monitoring, but are performing in accordance with their terms.








**Allowance
      and Provision for Loan and Lease Losses**





The
      Company maintains an allowance for loan and lease losses to provide for probable
      losses in the loan portfolio. Additions to the allowance are made by charges
      to
      operating expenses in the form of a provision for loan and lease losses. All
      loans which are judged to be uncollectible are charged against the allowance
      while any recoveries are credited to the allowance. The Company has instituted
      loan policies, designed primarily for internal use, to adequately evaluate
      and
      assess the analysis of risk factors associated with our loan portfolio and
      to
      enable us to assess such risk factors prior to granting new loans and to assess
      the sufficiency of the allowance. The Company conducts a critical evaluation
      of
      the loan portfolio monthly. This evaluation includes an assessment of the
      following factors: the results of our internal loan review and our collateral
      monitoring process, any external loan review and any regulatory examination,
      loan loss experience, estimated potential loss exposure on each credit,
      concentrations of credit, value of collateral, and any known impairment in
      the
      borrower’s ability to repay and present economic conditions. Until the Company
      has established some historical trend of losses, it relies on industry standards
      to compare allowance adequacy.




22


Each
      month
      the Company also reviews the allowance and makes additional transfers to the
      allowance as needed. For the three months ended June 30, 2006 and June 30,
      2005,
      the provision for loan and lease losses was $117,000 and $124,000, respectively
      and $223,000 and $282,000 for the six months ended June 30, 2006 and June 30,
      2005.





At
      June
      30, 2006, the allowance was 1.33% of the loans then outstanding. At December
      31,
      2005, the allowance for loan and lease losses was 1.31% of loans outstanding.
      Although the Company deemed these levels adequate, no assurance can be given
      that further economic difficulties or other circumstances which would adversely
      affect our borrowers and their ability to repay outstanding loans will not
      occur
      which would be reflected in increased losses in our loan portfolio, which losses
      could possibly exceed the amount then reserved for loan and lease losses.
      Adverse economic conditions, a decline in real estate values, or a significant
      increase in interest rates could negatively affect the construction loan
      business and require an increase in the provision for loan and lease losses,
      which in turn, could adversely affect our future prospects, results of
      operations, and profitability.





The
      following table summarizes our loan loss experience, transactions in the
      allowance for loan and lease losses and certain pertinent ratios for the periods
      indicated:





**Six
                Months**
              **Ended**
              **June
                30,**
              **2006**
            
            **Year**
              **Ended**
              **December
                31, 2005**
            
            **Six
                Months**
              **Ended**
              **June
                30, 2005**(dollars
                in thousands)**Outstanding
                loans:**End
                of the period (1)
            
            $
            150,999
            
            $
            136,110
            
            $
            103,557Average
                for the period
            
            
            142,859
            
            
            107,448
            
            
            92,483**Allowance
                for loan and lease losses:**Balance
                at beginning of period
            
            
            1,784
            
            
            998
            
            
            998Loans
                charged off
            
            
            —
            
            
            —
            
            
            —Recoveries
            
            
            —
            
            
            —
            
            
            —Provisions
                charged to operating expense
            
            
            223
            
            
            786
            
            
            282Balance
                at end of period
            
            $
            2,007
            
            $
            1,784
            
            $
            1,280**Ratios:**Net
                charge-offs (recoveries) to average loans
            
            
            —
            
            
            —
            
            
            —Allowance
                to loans at period end
            
            
            1.33
            %
            
            1.31
            %
            
            1.24
            %Allowance
              to non-performing loans
            
            
            276
            %
            
            246
            %
            
            176
            %


____________


(1)  Loans
      are
      gross, which excludes the allowance for loan and lease losses. Non-accrual
      loans
      are included in the table for computation purposes, but the foregone interest
      of
      such loans is excluded.





23


The
      table
      below sets forth the allocation of the allowance for loan and lease losses
      by
      loan type as of the dates specified. The allocation to individual categories
      of
      loans includes amounts applicable to specifically identified as well as
      unidentified losses inherent in that segment of the loan portfolio and will
      necessarily change whenever management determines that the risk characteristics
      of the loan portfolio have changed. The unallocated allowance includes an
      assessment of general economic and loan concentration factors which management
      believes are significant. Management believes that any breakdown or allocation
      of the allowance for loan and lease losses into loan categories lends an
      appearance of exactness which does not exist, in that the allowance is utilized
      as a single unallocated allowance available for all loans and undisbursed
      commitments. The allocation below should not be interpreted as an indication
      of
      the specific amounts of or loan categories in which future charge-offs may
      occur:








**June
                30, 2006**
            
            **December
                31, 2005**(dollars
                in thousands)**Allowance
                for**
              **Loan
                and Lease**
              **Losses**
            
            **Percent
                of Loans in**
              **Category
                toTotal Loans**
            
            **Allowance
                forLoan and Lease Losses**
            
            **Percent
                of Loans in Category toTotal Loans****Loan
                Loss Allocation****Real
                Estate:****Construction
                & Land Development Loans**
            
            $
            240
            
            
            20
            %
            $
            216
            
            
            23
            %**1st
                Trust Deed R.E.**
            
            
            495
            
            
            34
            %
            
            446
            
            
            30
            %**Other
                Real Estate**
            
            
            8
            
            
            2
            %
            
            11
            
            
            2
            %**Total
                Real Estate**
            
            
            743
            
            
            56
            %
            
            673
            
            
            55
            %**Business
                Secured Loans**
            
            
            642
            
            
            38
            %
            
            583
            
            
            38
            %**Business
                Unsecured Loans**
            
            
            0
            
            
            1
            %
            
            0
            
            
            1
            %**Consumer
                and Other:**
            
            
            68
            
            
            5
            %
            
            62
            
            
            6
            %**Unallocated
                Allowance (including Additional Factors: i.e. —
                Economic/Concentrations)**
            
            
            554
            
            
            —
            
            
            466
            
            
            —**Total**
            
            $
            2,007
            
            
            100
            %
            $
            1,784
            
            
            100
            %




24


**Cash
      and Cash Equivalents** **.**





Cash
      and
      cash equivalents consist of cash on hand and due from correspondent banks,
      Federal funds sold, and balances maintained by Celtic in a non-affiliated bank.
      The Bank maintains balances at correspondent banks adequate to cover daily
      clearings and other charges. Funds in excess of these needs are invested in
      overnight federal funds at correspondent banks. Cash and cash equivalents were
      $18.2 million at June 30, 2006 and $14.9 million at December 31, 2005. The
      increase from December 31, 2005 to June 30, 2006 was to provide additional
      liquidity in line with our asset growth.





**Deposits** **.**





Deposits
      represent our primary source of funds to support our various lending and
      investment activities. Substantially all of our deposits are from individuals
      and businesses within our service area. The Bank has utilized institutional
      deposits. The Bank has also utilized brokered deposits from time to time, but
      they have never exceeded 25% of total deposits. The Bank has no known foreign
      deposits. Celtic does not accept deposits.





The
      following table sets forth the maturity of time certificates of deposit of
      $100,000 or more at June 30, 2006:





**June
                30, 2006(unaudited)**(dollars
                in thousands)Three
                months or less
            
            $
            10,541Over
                three to six months
            
            
            7,263Over
                six to twelve months
            
            
            18,581Over
                twelve months
            
            
            422Total
            
            $
            36,807








**Borrowings** .





Federal
      Home Loan Bank Advances at June 30, 2006 totaled $12.8 million with a month
      end
      rate of 5.41%. Average borrowings for the three months ended June 30, 2006
      was
      $9.7 million with a weighted average rate of 5.04%. Federal Home Bank Loan
      Advances at December 31, 2005 totaled $12 million with a rate of 4.39%. Average
      FHLB borrowings for the year ended December 31, 2005 was $10.0 million with
      a
      weighted average rate of 3.36%. All advances are open-end overnight borrowings
      to supplement liquidity and are repaid during the periods when liquidity needs
      are met with deposits.





Celtic
      has
      a $25 million revolving line-of-credit with a non-affiliated bank. The
      line-of-credit matures in August 2008. The agreement provides for the bank
      to
      advance funds up to the maximum line of credit, provided the total amount of
      outstanding advances at any one time does not exceed the “Borrowers’ Borrowing
      Base” (BBB). The BBB is based on a percentage of the Celtic’s good quality
      accounts receivable, equipment and inventory, pledged to it by its debtors.
      The
      line of credit is subject to covenants requiring Celtic to meet certain leverage
      and net worth ratios and contains restrictions as to the incurrence of
      additional debt, capital expenditures and payment of dividends. Celtic was
      in
      compliance with all covenants as of June 30, 2006. Principal is payable on
      demand, and interest is payable monthly at prime minus 0.25%. The outstanding
      balance under this revolving line of credit was $15.1 million at June 30, 2006.
      The underlying loans serve as collateral for the borrowings.





**Capital
      Resources**





Under
      bank
      regulatory capital adequacy guidelines, capital adequacy is measured as a
      percentage of risk-adjusted assets in which risk percentages are applied to
      assets on as well as off-balance sheet, such as unused loan commitments and
      standby letters of credit. The guidelines require that a portion of total
      capital be core, or Tier 1, capital consisting of common shareholders’ equity
      and perpetual preferred stock, less goodwill and certain other deductions.
      Tier
      2 capital consists of other elements, primarily non-perpetual preferred stock,
      subordinated debt and mandatory convertible debt, plus the allowance for loan
      and lease losses, subject to certain limitations. The guidelines also evaluate
      the leverage ratio, which is Tier I capital divided by average
      assets.





The
      following table provides information regarding the Company’s and the Bank’s
      regulatory capital ratios at June 30, 2006 and December 31, 2005. The decrease
      in the Bank’s ratios reflects increased asset growth. At June 30, 2006 and
      December 31, 2005, the Company and the Bank met or exceeded regulatory capital
      requirements to be considered “well capitalized,” as defined in the regulations
      issued by the FRB and the FDIC, and it is the Company’s and the Bank’s intention
      to remain “well capitalized” in the future.




25


**Risk-based
      capital ratios**





**Discovery
                Bancorp:**
            
            **At
                6/30/2006**
            
            **At
                12/31/2005**
            
            **"WellCapitalized"**
              **Requirement**
            
            **Minimum**
              **Capital**
              **Requirement**Total
                Risk-Based capital ratio
            
            
            13.99
            %
            
            14.73
            %
            
            10.00
            %
            
            8.00
            %Tier
                1 Risk-Based capital ratio
            
            
            12.81
            %
            
            13.57
            %
            
            6.00
            %
            
            4.00
            %Tier
                1 Leverage Ratio
            
            
            12.48
            %
            
            13.45
            %
            
            5.00
            %
            
            4.00
            %**Discovery
                Bank:**Total
                Risk-Based capital ratio
            
            
            10.68
            %
            
            11.33
            %
            
            10.00
            %
            
            8.00
            %Tier
                1 Risk-Based capital ratio
            
            
            9.52
            %
            
            10.17
            %
            
            6.00
            %
            
            4.00
            %Tier
                1 Leverage Ratio
            
            
            9.22
            %
            
            9.92
            %
            
            5.00
            %
            
            4.00
            %




**Liquidity
      and Liquidity Management**





Liquidity
      management for banks requires that funds always be available to pay deposit
      withdrawals and maturing financial obligations in accordance with their terms
      and to meet customer requests for loans. The acquisition of deposits has been
      our primary source of funds used to invest in earning assets. The Bank expects
      that deposits will continue to be the primary source of funds in future periods.
      The Bank emphasizes seeking demand deposits from business customers in our
      market area. When necessary, the Bank also pursues higher cost time deposits,
      including “brokered deposits” (defined to include not only deposits received
      through deposit brokers, but also deposits bearing interest in excess of 75
      basis points over market rates), typically attracting large certificates of
      deposit at high interest rates. Other sources of funds have been the cash
      provided from operations, the proceeds of common stock sales and from
      borrowings.





At
      June
      30, 2006 and December 31, 2005, the Bank had “brokered deposits” of $23.6
      million and $25 million, respectively. We utilized “brokered deposits” and
      deposits from other financial institutions to fund our loan growth.





To
      meet
      liquidity needs, the Bank maintains a portion of our funds in cash deposits
      in
      other banks, Federal Funds sold, and investment securities. As of June 30,
      2006
      and December 31, 2005, our liquidity ratio was 17.20% and 14.66%, respectively
      (defined as liquid assets as a percentage of the total of deposits and short
      term borrowings). Liquid assets were composed of Federal Funds sold,
      available-for-sale investment securities less securities that are pledged to
      secure treasury, tax and loan deposits and other purposes as required by law,
      interest-bearing deposits in other financial institutions and cash and due
      from
      banks. The Bank’s liquidity ratio at June 30, 2006 was above our policy target
      of 15% and at December 31, 2005 was slightly below our policy target of 15%.
      The
      Bank monitors our liquidity ratios daily. The Bank attempts to maximize its
      loan
      to deposit ratios and minimize its liquidity ratio, consistent with its
      liquidity needs and policy, to maximize net interest margins.





The
      Bank
      maintains a $2.5 million line of credit with a correspondent bank for the
      purchase of overnight Federal funds. The Bank also has a credit line with the
      Federal Home Loan Bank of San Francisco which would allow us to borrow up to
      15%
      of our assets. As of June 30, 2006, loans and securities pledged as collateral
      for this facility would have allowed us to borrow up to approximately $29.0
      million. These facilities have been used regularly to provide funding for loans
      at a lower cost than brokered deposits. (See “Borrowings” above.)





The
      primary sources of liquidity for the Company, on a stand alone basis, include
      the receipt of dividends from the subsidiaries, borrowings, and our ability
      to
      raise capital. The ability of the Company to obtain funds for payment of
      dividends is dependent upon the subsidiaries’ earnings. The availability of
      dividends from the subsidiaries is also limited by various state and federal
      statues and regulations. Additionally, the Celtic borrowing agreement (see
      “Borrowings” above) requires Celtic to maintain certain financial covenants
      which may restrict the availability of dividends from Celtic. The Company has
      recently completed a public offering and raised $11.2 million. A part of the
      proceeds was used to repay $550,000 of the Company’s borrowings and fund the
      $5.2 million cash portion of the Celtic acquisition. The Company intends to
      use
      the remainder of the proceeds to provide resources to enhance the Company’s
      capital, and provide separate working capital for the Company.





26




**Off-Balance
      Sheet Arrangements**





Information
      concerning our off-balance sheet arrangements can be found in Note 6 to our
      financial statements included in Item 1 of this Report.





**Quantitative
      And Qualitative Disclosures About Market Risk**





Our
      market
      risk arises primarily from credit risk and interest rate risk inherent in our
      lending and deposit taking activities and the risk of inflation. Risk management
      is an important part of our operations and a key element of our overall
      financial results. The FDIC, in recent years, has emphasized appropriate risk
      management, prompting banks to have adequate systems to identify, monitor and
      manage risks. The Bank’s board of directors and committees meet on a regular
      basis to oversee the Bank’s operations. We monitor our business activities and
      apply various strategies to manage the risks to which we are exposed. We have
      adopted various policies and have empowered the committees of its board of
      directors with oversight responsibility concerning different aspects of
      operations. The Bank’s Audit Committee is responsible for overseeing internal
      auditing functions and for interfacing with the independent outside auditors.
      The Loan Committee establishes the Loan Policy, reviews loans made by management
      and approves loans in excess of management’s lending authority. The Loan
      Committee also reviews “watch list” loans and the adequacy of the Bank’s
      allowance for loan and lease losses. The Asset/Liability Risk Committee
      establishes the Investment Policy and the Asset/Liability Policy, reviews
      investments made by management, and monitors the investment portfolio, interest
      rate risk and liquidity planning.





Celtic’s
      Loan Committee also establishes its Loan Policy, reviews loans made by
      management and approves loans in excess of management’s lending authority.
      Celtic’s Loan Committee also reviews “watch list” loans and the adequacy of its
      allowance for loan and lease losses.





***Credit
      Risk*** *.* Credit
      risk generally arises as a result of our lending activities and may be present
      with our investment activities. To manage the credit risk inherent in our
      lending activities, we rely on adherence to underwriting standards and loan
      policies as well as our allowance for loan and lease losses. We employ frequent
      monitoring procedures and take prompt corrective action when
      necessary.





***Interest
      Rate Risk.*** Interest
      rate risk is the exposure of an institution’s financial condition, both earnings
      and the market value of assets and liabilities, to adverse movements in interest
      rates. Interest rate risk results from differences in the maturity or timing
      of
      interest-earning assets and interest-bearing liabilities, changes in the slope
      of the yield curve over time, imperfect correlation in the adjustment of rates
      earned and paid on different instruments with otherwise similar characteristics
      (e.g. three-month Treasury bill versus three-month LIBOR) and from
      interest-rate-related options embedded in financial products (e.g. loan
      prepayments, floors and caps, callable investment securities, early withdrawal
      of time deposits, etc).





The
      potential impact of interest rate risk is significant because of the liquidity
      and capital adequacy consequences that reduced earnings or losses could imply.
      The Bank recognizes and accepts that interest rate risks are a routine part
      of
      its operations and will from time to time impact profits and capital position.
      The objective of interest rate risk management is to control exposure of net
      interest income to risks associated with interest rate movements in the market,
      to achieve consistent growth in net interest income, and to profit from
      favorable market opportunities.





The
      careful planning of asset and liability maturities and the matching of interest
      rates to correspond with this maturity matching is an integral part of the
      active management of an institution’s net yield. To the extent maturities of
      interest-earning assets and interest-bearing liabilities do not match in a
      changing interest rate environment (an interest rate sensitivity “gap”), net
      yields may be affected. Thus, if rate sensitive assets exceed rate sensitive
      liabilities for a given period, the interest rate would be “positively gapped”
and we would benefit from an increase in interest rates. Conversely, if rate
      sensitive liabilities exceed rate sensitive assets for a given period, the
      interest rate would be “negatively gapped” and our earnings would be negatively
      impacted by an increase in interest rates. The Bank is “positively gapped” as of
      June 30, 2006. Even with perfectly matched repricing of interest-earning assets
      and interest-bearing liabilities, risks remain in the form of prepayment of
      assets, timing lags in adjusting certain assets and liabilities that have
      varying sensitivities to market interest rates and basis risk. In our overall
      attempt to match interest-earning assets and interest-bearing liabilities,
      we
      take into account rates and maturities to be offered in connection with our
      certificates of deposit and our variable rate loans.





The
      Bank’s
      policy quantifies acceptable gap ratios. These targets are monitored quarterly
      and reviewed annually by the board of directors to determine acceptable gap
      risks. We monitor and evaluate our gap position, but do not anticipate
      substantial changes in those gap ratios. Celtic loans and borrowings are prime
      based and will be repriced simultaneously when there is a change in the prime
      rate. Therefore its interest rate risk is minimal.





27


We
      do not
      engage in any hedging activities and do not have any derivative securities
      in
      our portfolio.





The
      Bank
      utilizes the results of a dynamic simulation model to quantify the estimated
      exposure of net interest income to sustained interest rate changes. The
      simulation model, a third-party service, estimates the impact of changing
      interest rates on the interest income from all interest-earning assets and
      the
      interest expense paid on all interest-bearing liabilities reflected on our
      balance sheet. A parallel and pro rata shift in rates over a 12-month period
      is
      assumed. This model is reviewed annually and audited on a regular basis to
      determine accuracy of data and forecasts. The following reflects our net
      interest income sensitivity analysis as of June 30, 2006, based on the
      simulation. This table shows the impact of hypothetical interest rate changes
      on
      net interest income.





(dollars
                in thousands)**Interest
                Rate Scenario**
            
            
            **Adjusted
                NetInterest Income**
            
            
            **Change
                From Base**Up
                300 basis points
            
            $
            7,553
            
            
            24.83
            %Up
                200 basis points
            
            $
            7,092
            
            
            17.21
            %Up
                100 basis points
            
            $
            6,594
            
            
            8.98
            %Base
            
            $
            6,051
            
            
            —Down
                100 basis points
            
            $
            5,759
            
            
            (4.81
            )%Down
                200 basis points
            
            $
            5,475
            
            
            (9.51
            )%Down
                300 basis points
            
            $
            5,210
            
            
            (13.89
            )%





The
      above
      analysis shows that the Bank is “positively gapped”, which means that net
      interest income would increase in a rising interest rate environment, and could
      decrease in a declining interest rate environment. However, these results
      illustrate the effect of immediate rate changes, which are unlikely, and do
      not
      consider the effect of loan prepayments or the yield from reinvesting in
      short-term versus long-term instruments.





**ITEM
      3. CONTROLS AND PROCEDURES**





The
      Company's Chief Executive Officer and its Chief Financial Officer, after
      evaluating the effectiveness of the Company's disclosure controls and procedures
      (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of
      the
      period covered by this report (the "Evaluation Date") have concluded that as
      of
      the Evaluation Date, the Company's disclosure controls and procedures were
      adequate and effective to ensure that material information relating to the
      Company and its consolidated subsidiaries would be made known to them by others
      within those entities, particularly during the period in which this quarterly
      report was being prepared.





Disclosure
      controls and procedures are designed to ensure that information required to
      be
      disclosed by us in the reports that we file or submit under the Exchange Act
      is
      recorded, processed, summarized and reported, within the time periods specified
      in the Securities and Exchange Commission's rules and forms. Disclosure controls
      and procedures include, without limitation, controls and procedures designed
      to
      ensure that information required to be disclosed by us in the reports that
      we
      file under the Exchange Act is accumulated and communicated to our management,
      including our Chief Executive Officer and Chief Financial Officer, as
      appropriate to allow timely decisions regarding required
      disclosure.





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




28


**PART
      II — OTHER INFORMATION**





**ITEM
      1. LEGAL PROCEEDINGS**





There
      are
      no material legal proceedings to which the Company is a party or to which any
      of
      its property is subject.





**ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS**





Not
      applicable





**ITEM
      3. DEFAULTS UPON SENIOR SECURITIES**





Not
      applicable





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





The
      annual
      meeting of shareholders was held on May 17, 2006. At the meeting, the following
      individuals were elected to serve as members of the Company’s Board of Directors
      until the 2007 Annual Meeting of Shareholders and until their successors are
      elected and have qualified:




**NAME:**
            
            **AUTHORITY**
              **GIVEN:**
            
            **AUTHORITY**
              **WITHHELD:**Robert
                Cairns
            
            
            1,331,209
            
            
            0Gabriel
                P. Castano
            
            
            1,331,209
            
            
            0Walter
                F. Cobb
            
            
            1,331,209
            
            
            0Bron
                Hafner, Sr.
            
            
            1,330,709
            
            
            500James
                P. Kelley, II
            
            
            1,331,209
            
            
            0Michael
                A. Lenzner
            
            
            1,331,109
            
            
            100Anthony
                J. Pitale
            
            
            1,331,109
            
            
            100John
                R. Plavan
            
            
            1,331,209
            
            
            0Stuart
                Rubin
            
            
            1,331,209
            
            
            0Mark
                W. Santar
            
            
            1,331,209
            
            
            0




There
      were no abstentions or broker non-votes with repect to this matter.




**ITEM
      5. OTHER INFORMATION**





Not
      applicable





**ITEM
      6. EXHIBITS**




******Exhibit
                  No.**
              **Description
                  of Exhibit**
              ******Page**31.1
              Certification
                  of Chief Executive Officer (Section 302 Certification)
              3031.2
              Certification
                  of Chief Financial Officer (Section 302 Certification)
              3132.1
              Certification
                  of Periodic Financial Report (Section 906 Certification)
              32





29


**SIGNATURES**





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.





**Discovery
                  Bancorp**Dated:
                  August 11, 2006
              By:
                  /s/
                  James P. Kelley, IIJames
                  P. Kelley, II,President
                  and Chief Executive OfficerBy:/s/
                  Martin McNabbMartin
                  McNabb,Executive
                  Vice President and ChiefFinancial
                  Officer





30